Financial Management - II: Question Paper (142) : January 2005
Financial Management - II: Question Paper (142) : January 2005
1. A firm’s credit policy consists of which of the following items? < Answer
>
(a) Credit period, cash discounts, credit standards, receivables monitoring
(b) Credit period, cash discounts, credit standards, collection policy
(c) Credit period, cash discounts, receivables monitoring, collection policy
(d) Cash discounts, credit standards, receivables monitoring, collection policy
(e) Credit period, receivables monitoring, credit standards, collection policy.
(1 mark)
2. Protective covenants are < Answer
>
(a) To protect employees
(b) To protect the interests of the company
(c) To protect shareholders
(d) To protect bondholders
(e) To protect customers.
(1 mark)
3. Which of the following is not an assumption underlying the Modigliani and Miller approach to capital structure? < Answer
>
(a) Information is freely available to investors
(b) The transaction cost is constant irrespective of the value of the transactions in securities
(c) Firms can be divided into classes in such a way that all the firms falling within one class have the same
degree of business risk
(d) There is no corporate or personal income tax
(e) Investors make rational investment decisions.
(1 mark)
4. The basic EOQ model makes a number of assumptions, including < Answer
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(a) Fluctuating demand (b) Uncertain lead times
(c) Zero lead-time (d) Uncertain carrying cost
(d) Variable ordering cost.
(1 mark)
5. All of the following are examples of tax deductible expenses, except < Answer
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(a) Dividends on common shares (b) Interest payments
(c) Amortization charges (d) Sales and administrative expenses
(e) Salaries and wages paid.
(1 mark)
6. Which of the following is true with respect to the term ‘capital structure’? < Answer
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(a) It is the mix of long term finances used by the firm
(b) It is the manner, in which a firm obtains its long term sources of funding
(c) It is the length of time needed to collect the accounts receivable
(d) It is the proportion of funds, the firm should invest in long term and short term assets
(e) It is the way, in which the company uses the capital at its disposal.
(1 mark)
7. "Capacity," which is one of the traditional "five C's" of credit analysis, refers to < Answer
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(a) The ability of the supplier of the company to extend the credit period offered to the company
(b) The willingness of the potential customer to meet his financial obligations
(c) The ability of the company to collect receivables from its customers
(d) The ability of the potential customer to meet his financial obligations
(e) The ability of the company to increase its sales.
(1 mark)
8. The least expensive form of financing for the firm is < Answer
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(a) Existing common stock (b) Preferred stock (c) Debenture
(d) New common stock (e) Retained earnings.
(1 mark)
9. The earnings-price ratio approach is used for estimating the cost of < Answer
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(a) Debenture capital (b) Preference capital
(c) Equity capital (d) Term loan (e) Fixed deposits.
(1 mark)
10. Which of the following means of financing does not need any collateral security? < Answer
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(a) Cash credit from a private sector bank (b) Overdraft from a public sector bank
(c) Cash credit from a co-operative bank (d) Public deposit
(e) Term loan from a financial institution.
(1 mark)
11. Shelf stock refers to < Answer
>
(a) Items that are stored by the firm and sold with little or no modification to customers
(b) Items that are sold with a major modification to customers
(c) Items that are stored by the firm and are not sold at all
(d) Items that lost their value and sold as scraps
(e) Items that are stored and sold by the firm on installment basis.
(1 mark)
12. Which of the following is not the assumption of Walter model on dividend policy? < Answer
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(a) Firm has an infinite life
(b) Internal rate of return (r) and Cost of capital (k) are assumed to be constant and thus additional investment
made by the firm will not change its risk and return profile
(c) Retained earning are the only source of finance available to the firm
(d) The retention ratio remains constant and hence the growth rate also is constant
(e) For a given value of the firm, the dividend per share and the earning per share remain constant.
(1 mark)
13. Agency costs in the context of capital structure of firms represent the < Answer
>
(a) Increase in the cost of production due to the increase in the cost of inputs
(b) Increase in the sales commission payable to the sales agents
(c) Increase in financial costs due to the rise in interest rates
(d) Restrictive conditions imposed by the financial institutions for providing loan to the firm
(e) Regulatory requirements to be met by the firm with regard to its human resources.
(1 mark)
14. Which of the following types of current assets is most likely to be absent in a firm, which undertakes trading < Answer
business only? >
(a) A firm issues common stock and uses the proceeds to repurchase an equal amount of preferred stock
(b) A firm issues preferred stock and uses the proceeds to repurchase an equal amount of bonds
(c) A firm with positive additions to retained earnings uses the cash it generates to retire the existing debt
(d) A firm uses excess cash to repurchase common stock in an amount equal to additions to retained earnings for
the year
(e) A firm issues bonds and uses the proceeds to purchase short-term assets.
(1 mark)
23. Which of the following are subsystems of the inventory management system? < Answer
>
I. EOQ subsystem.
II. Stock-level subsystem.
III. Reorder point subsystem.
IV. Safety-stock subsystem.
(a) Only (I) above (b) Only (IV) above
(c) Both (I) and (IV) above (d) (I), (II) and (III) above
(e) All (I), (II), (III) and (IV) above.
(1 mark)
24. The average collection period measures the < Answer
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(a) Number of days between the day a customer places an order with the firm and the day the firm sends the
goods to the customers
(b) Number of days it takes a typical cheque to "clear" through the banking system
(c) Number of days beyond the end of the credit period and before a typical customer payment is received
(d) Number of days between the day a typical credit sale is made and the day a typical account becomes
delinquent
(e) Number of days between the day when a typical credit sale is made and the day when the firm receives the
payment.
(1 mark)
25. ___________ is used, while evaluating mutually exclusive investments having unequal lives. < Answer
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(a) Equivalent annual annuities method (b) Net present value method
(c) Internal rate of return method (d) Accounting rate of return method
(e) Discounted payback period method.
(1 mark)
26. Lead time refers to < Answer
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(a) Work in process time
(b) The time gap between placing of the order and procuring the material
(c) The period in which a whole lot of inventory is consumed
(d) The time finished goods lie as inventories
(e) The time gap between two orders.
(1 mark)
27. The _______ measures the present value return for each rupee of initial investment. < Answer
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(a) Payback period (b) Internal rate of return
(c) Net present value (d) Profitability index
(e) Accounting rate of return.
(1 mark)
28. Which of the following statements is/are true with respect to cash management? < Answer
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I. A cash management system, which minimizes collection float and maximizes payment float is better than the
one with higher collection float and lower payment float.
II. A cash management system, which maximizes collection float and minimizes payment float is better than the
one with lower collection float and higher payment float.
III. If interest rates are increasing; it should be a cause of concern for a finance manager to review his cash
management system.
(a) Only (I) above (b) Only (II) above
(c) Only (III) above (d) Both (I) and (III) above
(e) Both (II) and (III) above.
(1 mark)
29. VED analysis with respect to inventory management is for < Answer
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(a) Monitoring and control of stores and spare parts
(b) Monitoring and control of finished goods
(c) Monitoring and control of work in process
(d) Monitoring and control of production process
(e) Monitoring and control of raw materials.
(1 mark)
30. Which of the following sources of long-term finance arises out of the operations of a profit making business? < Answer
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(a) Preference capital (b) Equity capital
(c) Debenture capital (d) Term loan
(e) Reserves and surplus.
(1 mark)
31. If the net present value of a project is negative, < Answer
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(a) The internal rate of return is less than the required return
(b) The internal rate of return is more than the required return
(c) The internal rate of return is equal to the required return
(d) The internal rate of return is less than 0
(e) The internal rate of return is 1+ required return.
(1 mark)
32. The discount rate that equates the present value of cash flows with the initial outlay is called < Answer
>
(a) The net present value
(b) The internal rate of return
(c) The sum of the present value of cash flows
(d) The terminal value of the cash flows
(e) The profitability index.
(1 mark)
33. Which of the following is/are true regarding cumulative preference shares? < Answer
>
I. They enjoy a right to participate in surplus profits after equity dividends have been paid.
II. They are eligible to get all the arrears of preference dividends before any equity dividend is declared.
III. In case there are arrears in dividends on these shares for two or more years, the shareholders will be entitled
to voting rights.
(a) Only (II) above (b) Only (III) above
(c) Both (I) and (II) above (d) Both (I) and (III) above
(e) Both (II) and (III) above.
(1 mark)
34. According to Gordon with respect to dividend policy of a firm, the growth rate of a firm is a product of its < Answer
>
(a) Dividend pay out ratio and return on equity
(b) Dividend pay out ratio and return on investment
(c) Retention ratio and return on investment
(d) Retention ratio and return on equity
(e) Retention ratio and cost of debt.
(1 mark)
35. As a general rule, the capital structure that maximizes the market value of a company also < Answer
>
(a) Maximizes its average cost of capital
(b) Maximizes its earnings per share
(c) Maximizes the chance of bankruptcy
(d) Minimizes the cost of capital of the company
(e) Minimizes the cost of debt capital of the company.
(1 mark)
36. The advantages of the payback approach include all of the following except < Answer
>
(a) It is easy to compute
(b) It considers a project's liquidity
(c) It considers cash flows, not net income
(d) It provides an objective measure of profitability
(e) It helps in weeding out risky projects.
(1 mark)
37. All of the following influence capital budgeting cash flows except __________. < Answer
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(a) Choice of depreciation method for tax purposes
(b) Economic length of the project
(c) Projected sales (revenues) for the project
(d) Sunk costs of the project
(e) Opportunity cost of the project.
(1 mark)
38. Which of the following is a feature of secured premium note (SPN)? < Answer
>
(a) It is a kind of non-convertible debenture with an attached warrant
(b) It allows the investors to subscribe to the equity of a third firm at a preferential price via-a-vis the market
price
(c) It is a partly convertible debenture with an attached warrant
(d) It is also known as zero coupon convertible note
(e) It is an example of a perpetual preference share.
(1 mark)
39. Which of the following might be attributed to efficient inventory management? < Answer
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I. High inventory turnover ratio.
II. Low incidence of production schedule disruptions.
III. Low total asset turnover.
(a) Only (I) above (b) Only (III) above
(c) Both (I) and (II) above (d) Both (I) and (III) above
(e) Both (II) and (III) above.
(1 mark)
40. If the current ratio is less than one, it signifies that < Answer
>
I. Net working capital is positive.
II. Current assets are more than current liabilities.
III. There is a possibility of technical insolvency.
(a) Only (I) above (b) Only (II) above
(c) Only (III) above (d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
(1 mark)
41. Kunwar Ajay Sarees, a popular Indian name in the field of sarees, presently has the annual sales of Rs.100 crore < Answer
with the credit terms of 1/10, net 30 days. Average collection period of the company is 25 days. It has been >
observed that fifty percent of the customers in terms of sales revenue avail of the cash discount incentive. The
company is contemplating of liberalizing its existing credit terms to 2/10, net 30 days. As a result, sales are likely
to increase by Rs.15 crore and average collection period to decline to 15 days. Eighty percent of the customers in
terms of sales revenue are expected to avail of the cash discount incentive under liberalization scheme. If the
contribution to sales ratio is 20% and the cost of funds to the company is 12%, the total incremental cost to the
company due to this collection relaxation program is (Assume 360 days in a year)
(a) Rs.106.7 lakh (b) Rs.111.1 lakh (c) Rs.114.2 lakh (d) Rs.129.0 lakh (e) Rs.134.0 lakh.
(3 marks)
42. Tyco’s business is booming and it needs to raise more capital. The company purchases raw materials from a < Answer
single supplier on terms of 1/10, net 20 days, and it currently takes the discount. One way of getting the needed >
funds would be to forgo the discount and Tyco’s owner believes that he could delay payment to 40 days without
adverse effects. What is the annual rate of stretching the accounts payable? (Assume 365 days in a year)
(a) 10.00% (b) 11.11% (c) 11.75% (d ) 12.29% (e) 13.01%.
(1 mark)
43. Solana Ltd. follows a policy of fixed dividend payout of 80%. The earning per share for the year 2003-2004 is < Answer
Rs.4.50 per share and the same is expected to grow by 20% during the year 2004-2005. The firm earns a return of >
18% on its investments. The cost of equity of the company is 15%. The value of the share based on Gorden model
would be (approximately)
(a) Rs.31.58 (b) Rs.33.85 (c) Rs.35.75 (d) Rs.39.55 (e) Rs.40.00.
(1 mark)
44. A company has retained earnings of Rs.72 lakh and paid up equity capital of Rs.38 lakh. If the equity investors < Answer
expect a rate of return of 17% and the cost of issuing fresh equity is 6%, the cost of the retained earnings to the >
company is
(a) 16.4% (b) 17.0% (c) 17.7% (d) 18.1% (e) 19.1%.
(1 mark)
45. Consider the following information: < Answer
>
Rs.
Annual consumption of raw material 20,000
Annual cost of production 25,000
Annual cost of sales 1,00,000
Average stock of raw materials 7,500
Average work-in-process 2,000
The average conversion period is
(a) 7.2 days (b) 16.0 days (c) 28.8 days (d) 32.4 days (e) 34.2 days.
(1 mark)
46. Kapur industries places order each time for a lot of 500 units of a particular item. From the < Answer
>
available data, the following results are obtained:
Inventory carrying cost 40%
Ordering cost per order Rs.625
Cost per unit Rs.50
Annual demand 1000 units
What is the loss to the organization due to its ordering policy?
(a) Rs.1,200 (b) Rs.1,250 (c) Rs.1,400 (d) Rs.1,500 (e) Rs.1,600.
(2 marks)
47. Calculate the inventory turnover ratio from the following data < Answer
>
Particulars Rs.
Sales 15,00,000
Purchases 9,66,750
Opening inventory 2,28,750
Closing inventory 2,95,500
(a) 0.17 times (b) 0.29 times (c) 2.28 times (d) 3.43 times (e) 6.72 times.
(1 mark)
48. LISP Inc. is planning to purchase a new mixer/dubber for Rs.50,000. The new equipment will replace an older mixer < Answer
that has been fully depreciated but has a market value of Rs.5,000. Compute the net investment required for this >
project. Assume a marginal tax rate of 40 percent.
(a) Rs.43,000 (b) Rs.45,000 (c) Rs.46,000 (d) Rs.47,000 (e) Rs.48,000.
(2 marks)
49. The following information is given for a project: < Answer
>
Year 0 1 2 3
Initial Investment (Rs.) 2,10,000
Net Cash Inflows (Rs.) 30,000 45,000 75,000
Assuming that salvage value at the end of the 3rd year is zero, the accounting rate of return for the project is
(a) 59.96% (b) 54.56% (c) 47.62% (d) 43.56% (e) 39.80%.
(1 mark)
50. Vijaya Dairy Products, located in Gurgaon, receives large remittances from its customers in New Delhi and Jaipur. < Answer
If the firm deposits these cheques in its local bank, two business days are required for the cheques to clear and the >
funds to become usable by the firm. However, if it sends an employee to New Delhi or Jaipur and presents the
check for payment at the bank upon which it is drawn, the funds are available immediately to the firm. The firm
can earn 8% per annum on short-term investments and the cost of sending an employee to New Delhi or Jaipur to
present the check for payment is Rs.500. What is the net benefit to the firm of employing this special handling
technique for a Rs.50 lakh cheque received on Tuesday from New Delhi (assume 365 days in a year)?
(a) Rs.226 (b) Rs.596 (c) Rs.1,096 (d) Rs.1,192 (e) Rs.1,692.
(2 marks)
51. Miraj Engineering Co. has planned its sales during Oct-Dec 2004 as follows: < Answer
>
Month October November December
Sales (Rs.) 5,00,000 6,00,000 6,50,000
The products are sold on credit where 50 percent is realized in the month of sale whereas the balance is recovered
by the next month. The purchases (amounting to 50% of the month’s sales) are paid in the following month of
purchase. Wages and administrative expenses per month amount to Rs.1,50,000 and Rs.80,000 respectively and
are paid in the following month in which they are incurred. Depreciation and amortization of preliminary expenses
amount to Rs.80,000 and Rs.50,000 respectively. On October 1, a testing equipment worth of Rs.20,000 has been
procured with a credit period of 45 days, while on December 31, a fixed deposit will mature (maturity value
Rs.1,50,000). If the cash balance at the end of October is Rs.1,00,000, the closing cash balance by the end of the
month of November is
(a) Rs.20,000 (b) Rs.1,50,000 (c) Rs.2,10,000 (d) Rs.2,20,000 (e) Rs.3,00,000.
(3 marks)
52. As per the records of Mittal group of companies the following information is available: < Answer
>
Total assets Rs.1200 crore
Return on assets 15%
Cost of equity capital 12%
The total market value of the equity of Mittal group of companies as per net income approach is
(a) Rs.1,200 crore (b) Rs.1,500 crore
(c) Rs.1,800 crore (d) Rs.2,000 crore (e) Rs.2,700 crore.
(1 mark)
53. Subha Enterprises had sales last year of Rs.7,00,000 and 35 percent of its sales are for cash, with the remainder < Answer
buying on terms of net 30 days. It is following 365 day in a year accounting policy. If the receivables conversion >
period is actually 38 days, Subha’s accounts receivable are
(a) Rs.25,507 (b) Rs.47,370 (c) Rs.55,507 (d) Rs.72,877 (e) Rs.97,370.
(2 marks)
54. The following details are available regarding the long term sources of finance of M/s. VK Ltd.: < Answer
>
Range of new financing from the source
Source of finance Cost %
(Rs. crore)
Equity 0 – 10 14
10 – 20 15
20 & above 16
Preference 0–2 13
2 & above 14
Debt 0 – 12 8
12 – 18 9
18 & above 10
The company is considering expanding its operations and requires Rs.50 crore for the same. It is planning to raise
in the following proportions:
(a) Rs.875 (b) Rs.1,250 (c) Rs.2,625 (d) Rs.3,500 (e) Rs.5,000.
(1 mark)
63. Consider the following data regarding a product: < Answer
>
Total cost of ordering and carrying inventory Rs.4,00,000
Quantity per order 20,000 units
Carrying cost 20% of the purchase price
Fixed cost per order Rs.1,000
Purchase price Rs.100.
The annual usage of the materials in units is
(a) 5 lakh (b) 10 lakh (c) 15 lakh (d) 25 lakh (e) 40 lakh.
(2 marks)
64. Decisions-Decisions Inc. is evaluating three potential projects. Given the information in the < Answer
>
table below, the fact that the firm can invest no more than Rs.30 million and the cost of capital
is 10%, the firm should invest in:
Projects (Rs. in millions)
Year
1 2 3
0 -15 -14 -27
1 24 38 65
2 45 60 90
NPV 44.01 70.13 106.47
(a) Only project 1 (b) Only project 3
(c) Projects 1 and 2 (d) Projects 1 and 3 (e) Projects 2 and 3.
(1 mark)
65. If a project is expected to increase inventory by Rs.15,000, increase accounts payable by Rs.10,000 and decrease < Answer
accounts receivable by Rs.1,000, what effect does working capital have during the life of the project? >
(a) Rs.10,500 (b) Rs.30,000 (c) Rs.35,000 (d) Rs.65,000 (e) Rs.45,000.
(1 mark)
67. All Advantage Ltd. writes cheques averaging Rs.15,000 a day and it takes 5 days for these cheques to clear. The < Answer
firm also receives cheques in the amount of Rs.17,000 per day, but the firm loses three days, while its receipts are >
being deposited and cleared. The firm's net float is
(a) Rs.16,000 (b) Rs.24,000 (c) Rs.32,000 (d) Rs.75,000 (e) Rs.1,26,000.
(1 mark)
68. The following information regarding material ‘VIP’ has been collected from the stores register < Answer
>
of Sunny Products Ltd.
Opening stock 100 units @ Rs.9 per unit
Purchases:
September 3 50 units @ Rs.12 per unit
September 15 150 units @ Rs.15 per unit
If 100 units were issued on September 25, according to the weighted average method of pricing, the value of the
issue was
(a) Rs.900 (b) Rs.1,050 (c) Rs.1,200 (d) Rs.1,250 (e) Rs.1,500.
(2 marks)
69. The market value of debt and equity of a firm are Rs.80 lakh and Rs.120 lakh and the costs of equity and debt are < Answer
16% and 14% respectively. Assuming the firm follows 100% dividend payout ratio and there is no income tax, >
corporate or personal, the net operating income for the firm is
(a) Rs.27.2 lakh (b) Rs.28.4 lakh (c) Rs.30.4 lakh (d) Rs.31.6 lakh (e) Rs.32.4 lakh.
(2 marks)
70. Consider the following data: < Answer
>
Raw-material storage period 50 days
Average stock of raw materials Rs.6,51,000
Average balance of trade creditors Rs.2,65,000
Assume 360 days in a year and all purchases are made on credit
If the closing stock of raw-materials is 10% higher than the opening stock of raw-materials, the average payment
period is
(a) 15 days (b) 18 days (c) 20 days (d) 25 days (e) 30 days.
(2 marks)
71. < Answer
Average Daily Probability Lead Time Probability >
Usage (Units) (No. of days)
600 0.6 4 0.3
800 0.4 6 0.7
Normal consumption during lead time will be
(a) 1,776 units (b) 2,720 units (c) 3,672 units (d) 4,080 units (e) 4,800 units.
(1 mark)
72. The following information relates to the sources of long term finance used by Pioneer Industries Ltd.: < Answer
>
Source Book value Market value
(Rs. in lakh) (Rs. in lakh)
Paid-up equity share capital 200 400
Reserves and surplus 400 –
Preference shares 150 159
Debentures 250 241
Cost of equity share capital = 19.25%
Cost of preference share capital = 12.19%
Post tax cost of debenture capital = 8%
The difference between the weighted average cost using book value weights and market value weights would be
(a) 0.52% (b) 0.77% (c) 0.92% (d) 1.23% (e) 1.50%.
(2 marks)
73. The following figures are collected from annual reports of Hyderabad Textiles: < Answer
>
2003 2004
(in Rs. 000) (in Rs.000)
Raw materials inventory – Closing Balance 180 212
Work in process inventory – Closing Balance 25 45
Purchases of raw materials during the year 1085 1192
Manufacturing expenses during the year 1165 1280
Depreciation 75 100
What should be the average conversion period of Hyderabad Textiles for the year 2004? (Assume 360 days in a
year)
(a) 3 days (b) 5 days (c) 7 days (d) 9 days (e) 11 days.
(2 marks)
74. Two companies ZED Ltd. and Que Ltd. operate in a same industry and belong to the same group of companies. < Answer
Both are identical in every respect, except that Zed Ltd. uses debt, while Que Ltd. does not. The levered company >
has Rs.5,00,000 debentures carrying 10% rate of interest. The cost of capital and the EBIT of both firms are 15%
and Rs.4,00,000 respectively. Both the companies pay tax at 40%. The total value of Zed Ltd. and Que Ltd. as per
MM approach would be
(a) Rs.28,00,000 (b) Rs.34,00,000 (c) Rs.37,00,000 (d) Rs.40,00,000 (e) Rs.58,33,000.
(2 marks)
75. Vega India Ltd. is planning to purchase a punching machine having the following details: < Answer
>
Cost of machine Rs.30,00,000
Annual cost of operations Rs.2,50,000 for the first four years
Rs.3,00,000 for the subsequent years
Useful life 10 years
The annual capital charge of the machine at a cost of capital of 10 percent is
(a) Rs.7,62,082 (b) Rs.7,62,182 (c) Rs.7,62,382 (d) Rs.7,62,582 (e) Rs.7,62,782.
(2 marks)
76. The wealth ratio for the year 2002, 2003, and 2004 are 1.12, 1.26 and 1.4 respectively. The realized yield would be < Answer
>
(a) 21% (b) 23.65% (c) 24.91% (d) 25.48% (e) 26.59%.
(1 mark)
77. Your firm buys on credit terms of 2/10, net 45 days and it always pays on the 45 th day. If you calculate that this < Answer
policy effectively costs your firm Rs.1,59,621 each year, the firm’s average accounts payable balance is (Assume >
365 days in a year)
(a) Rs.12,340 (b) Rs.75,000 (c) Rs.1,57,500 (d) Rs.6,25,000 (e) Rs.7,50,000.
(1 mark)
Reason : A firm’s credit policy consists of credit period, cash discounts, credit standards, collection policy.
2. Answer : (d) < TOP >
Reason : Protective covenants are used to protect the interest of the bond holders. Hence, alternative (d) is
correct.
3. Answer : (b) < TOP >
Reason : Dividends on common shares are not tax deductible expenses. All the other mentioned items are tax-
deductible expenses. Hence, alternative (a) is correct.
6. Answer : (a) < TOP >
Reason : Capital structure refers to the composition of a firm’s long term financing consisting of equity,
preference and long term debt. The other alternatives are not best suited to define capital structure.
Hence, the correct answer is (a).
7. Answer : (d) < TOP >
Reason : ‘Capacity’ in credit analysis refers to the ability of the potential customer to meet his financial
obligations.
8. Answer : (c) < TOP >
Reason : The debt capital is the cheapest source of financing but it should be used within reasonable limits.
9. Answer : (c) < TOP >
Reason : In this case, earnings and price represents the equity earnings and equity prices respectively and hence
earnings-price ratio approach is used to estimate the cost of equity capital, not the other types of capitals
as mentioned in other alternatives.
10. Answer : (d) < TOP >
Reason : Public deposit may be raised by a company by duly following certain norms as per the Companies Act.
1956 without the requirement of any collateral security. While in the other cases, security is to be
provided compulsorily.
11. Answer : (a) < TOP >
Reason : Shelf stock refers to items that are stored by the firm and sold with little or no modification to
customers.
12. Answer : (d) < TOP >
Reason : The retention ratio remains constant and hence the growth rate also is constant, this is the assumption of
Gordon’s dividend capitalization model not Walter model. All other are the assumptions of Walter
model.
13. Answer : (d) < TOP >
Reason : In many business entities, the ownership is separated from the management of the company, thereby
resulting in agency problems. It does not have any influence on the manufacturing, selling and financial
expenses, as well as to meet the several regulatory requirements in order to carry out the business. But
considering the safety and security, the lenders generally put some restrictive covenants like, further
borrowings, payment of dividends, appointment of the key persons, etc. The implications of these
restrictions on the operations are known as agency costs.
14. Answer : (d) < TOP >
Reason : A firm which undertakes trading business only will not have work-in-process (d) because work-in-
process arises in the context of manufacturing firms. However such a firm will have the finished goods
inventory (a), cash (b), receivables (c), if it sells goods on credit and prepaid expenses, if it pays for
some services like insurance in advance.
15. Answer : (e) < TOP >
Reason : The equity investors expect a minimum return on their investment based on the risk they are
undertaking, the company’s past performance and the return they are getting from similar companies
they have invested in. So, the correct answer is (e).
16. Answer : (b) < TOP >
Reason : DSO tells us about the number of days of sales that is outstanding. It conveys no information about the
composition of the accounts receivable. Collection Matrix tells us about the collection pattern of
receivables. Ageing schedule not only conveys information about the magnitude of accounts
receivables, it also tells us about the age of the accounts receivable.
17. Answer : (b) < TOP >
Reason : Through letter of credit (L/C), a bank stands as a guarantee for the buyer to honor the payment
obligation. A bank generally disburses funds in the form of cash credit, overdraft, key credit, etc. to
finance the working capital requirements of any company. If any business entity cannot afford to pay the
purchase price of machinery in lump sum, it may buy the same in installments spread over a period of
time; this type of scheme is known as deferred credit facility (also known as supplier’s line of credit),
offered by the supplier of machinery.
18. Answer : (d) < TOP >
Reason : “Shareholder’s wealth” in a firm is the market price per share of the firm’s common stock not the
intrinsic value. Alternative (a) and (c) are no way related to the shareholders wealth. Alternative (b) is
not also true. Hence, alternative (d) is the correct.
19. Answer : (a) < TOP >
Reason : Retained earning are the cumulative earnings of the company after the payment of dividend. All other
points are not true in respect of retained earnings. Hence, alternative (c) is the correct choice.
21. Answer : (b) < TOP >
Reason : Overtrading means that the firm has disproportionately low level of working capital with respect to the
level of sales. To define it as a state in which the firm has disproportionately high level of working
capital with respect to sales or a disproportionately high level of receivables with respect to total assets
or a disproportionately high level of cash with respect to total assets or low turnover of working capital
is incorrect.
< TOP >
22. Answer : (e)
Reason : If a firm issues bonds and uses the proceeds to purchase short-term assets, the debt equity ratio will
increase, for all the other alternatives the debt equity ratio will decrease or remain same.
< TOP >
23. Answer : (d)
Reason : Subsystems of inventory management system are:
i. EOQ subsystem
ii. Stock-level subsystem
iii. Reorder point subsystem
Hence, alternative (d) is the answer.
24. Answer : (e) < TOP >
Reason : The average collection period measures the number of days between when a typical credit sale is made
and when the firm receives the payment.
25. Answer : (a) < TOP >
Reason : Equivalent annual annuities method is used, while evaluating mutually exclusive investments having
unequal lives.
26. Answer : (b) < TOP >
Reason : The time gap between placing an order and procuring the material is called the lead time.
27. Answer : (d) < TOP >
Reason : The profitability index measures the present value return for each rupee of initial investment.
28. Answer : (d) < TOP >
Reason : Net float = Payments float – Collections float; therefore the larger the payments float and the lower the
collections float the better the cash management system. If interest rates are increasing, it increases the
opportunity cost of idle cash and hence should be a cause of concern for a finance manager. So both the
statements (I) and (III) are correct. Hence, answer is (d).
29. Answer : (a) < TOP >
Reason : VED analysis is for monitoring and control of stores and spare parts.
30. Answer : (e) < TOP >
Reason : Preference capital (a) equity capital (b), debenture capital (c) and term loan (d) are all long-term sources
of funds which are tapped from outside the firm. Reserves and surplus (e) represent retained earnings,
which are generated out of profits of the firm, and they are available to the firm over the long-term.
31. Answer : (a) < TOP >
Reason : If the net present value of a project is negative, the internal rate of return is less than the required return.
32. Answer : (b) < TOP >
Reason : The discount rate that equates the present value of cash flows with the initial outlay is called. The
internal rate of return.
33. Answer : (e) < TOP >
Reason : For cumulative preference shares, the dividends will be paid on a cumulative basis; In case they remain
unpaid in any financial year due to insufficient profits, the company will have to pay all the arrears of
preference dividends before declaring any equity dividends. Hence statement II is correct. According to
Companies Act, 1956, the cumulative preference shareholders will be entitled to voting rights, if there
are arrears in dividends for two or more years. Hence statement III is correct and (e) is the answer. The
holder of cumulative preference shares is entitled to receive dividends and any arrears in dividends but
they do not have any right to participate in the surplus profits. Hence, I is not true.
34. Answer : (c) < TOP >
Reason : The model assumes that retained earnings are the only source of finance available and return on
investment is constant throughout the life of the firm. So the growth rate is the multiple of retained
earnings and return on investment. So, the correct answer would be (c).
< TOP >
35. Answer : (d)
Reason : In general when cost of capital of the company is minimum, market value of the firm is maximum.
36. Answer : (d) < TOP >
Reason : The payback approach does not provide an objective measure of profitability.
37. Answer : (d ) < TOP >
Reason : Choice of depreciation method for tax purposes ,economic length of the project, projected sales
(revenues) for the project and opportunity cost of the project all influence the capital budgeting cash
flows. But the sunk cost doesn’t influences the capital budgeting cash flows.
38. Answer : (a) < TOP >
Reason : Secured premium note is a kind of non-convertible debenture with an attached warrant. The warrant
attached to the SPN gives the holder the right to apply for and get allotment of equity shares. Hence,
option (a) is the correct choice.
39. Answer : (c) < TOP >
Reason : High inventory turnover ratio, low incidence of production schedule disruptions, and high total asset
turnover all can be attributed to efficient inventory management. Hence, alternative (c) is the answer.
40. Answer : (c) < TOP >
Current assets
Current liabilities
Reason : Current ratio =
Net working capital = Current Assets – Current Liabilities
From the above equations, the following can be interpreted:
(i) Net working capital is negative
(ii) Current assets are less than current liabilities
(iii) There is a possibility of technical insolvency.
41. Answer: (a) < TOP >
Reason : Retained earnings are the amount due to equity holder which has not been paid to them. Therefore, the
cost of retained earnings will be equal to expected return of equity holder. And as there is no cost of
issue involved, it will be 17%.
45. Answer : (c) < TOP >
Reason : Inventory turnover = cost of goods sold/ average inventory = 900,000/262,125 = 3.43 times.
Cost of goods sold = opening inventory + purchases – closing inventory
= 228,750+ 966,750- 295,500
= Rs. 900,000
Average inventory = (opening inventory+ closing inventory)/2 = 262,125.
48. Answer : (d) < TOP >
2,10, 000 0
Reason : Average investment = 2 = Rs.1,05,000
30, 000 45000 75000
Average profit = 3 = Rs.50,000
Average profit 50, 000
Reason : If the U is the annual usage, Q * is the EOQ ; Q’ is the order stipulated by the supplier for availing the
discount and F is the cost per order, then the savings in the total ordering costs can be computed as:
U U
F �1,80,000 1,80,000 �� 100 Rs.500
Q * Q � 7,200 9,000 �
= � �
Hence option (d) is correct.
56. Answer : (d) < TOP >
Reason : The average cash outflow during the 4 peak days in the month of June was
68, 000 58, 000 55, 000 48, 000
Rs.57, 250
4
As the magnitude of cash out flows in the month of August is 20% more than that in the month of June,
the expected average cash out flows during the 4 peak days in the month of August would be
Rs.57,250 1.2 = Rs.68,700
So the safety level of cash to be maintained is 4 68,700 or Rs. 2,74,800
57. Answer : (c) < TOP >
Reason : The traditional approach to dividend policy establishes a relationship between the market price and the
dividends in the following manner:
P=m(D+E/3)
where, m is a multiplier, D is the Dividend Per Share (DPS) and E is the Earnings Per Share (EPS).
Hence, 17 = 3.4 (3+E/3)
So EPS = Rs.6.
Hence, option (c) is the correct choice.
60. Answer : (c) < TOP >
Reason :The possible levels of usage and their corresponding probabilities are computed in the
following table:
Daily
Rate Lead Time Possible levels of usage
Usage
Probabilit Number Probabilit Possible Usage Levels = Probability =
Units
y of days y (Column 1 x Column 3) (Column 2 x Column 4)
150 20 0.6 3,000 0.12
0.2
35 0.4 5,250 0.08
360 20 0.6 7,200 0.30
0.5
35 0.4 12,600 0.20
450 20 0.6 9,000 0.18
0.3
35 0.4 15,750 0.12
Normal Usage during lead time = Average Daily Usage rate x Average Lead Time
Average Daily Usage rate = 150 x 0.20 + 360 x 0.50 + 450 x 0.30 = 345 units.
Average Lead Time = 20 x 0.6 + 35 x 0.4 = 26 days
Normal Usage during lead time = 345 x 26 = 8,970 units.
Stock outs will occur, if the usage is above 8,970 units. From the table computed above, we can infer that
stock-outs will occur when the usage levels are 12,600 (with probability 0.20); 9,000 (with probability
0.18) and 15,750 (with probability 0.12). The total probability of stockout is 0.2 + 0.18 + 0.12 = 50%.
Hence, (c) is the answer.
62. Answer : (d) < TOP >
Reason : Loss that the company will incur, when the customer actually defaults = Cost of the unit
= (1 – 0.30) 5000 = Rs.3,500.
63. Answer : (e) < TOP >
Reason: Sum of the net present values of projects 1 and 2 = 44.01+70.13 = Rs.114.14 million.
65. Answer : (a ) < TOP >
Reason : Expected average daily usage = 600 0.6 + 800 0.4 = 680 units
Expected lead time = 4 0.3 + 6 0.7 = 5.4 days
Hence, normal consumption during lead-time = 680 5.4 = 3,672 units.
72. Answer : (c) < TOP >
Reason: Weighted Average Cost of Capital (WACC) using book value weights
Sum of book values of all sources of capital used is
200 + 400 + 150 + 250 = 1000
\ Weight for equity capital (we) = 200/1000 = 0.2
Weight for reserves and surplus (wr) = 400/1000 = 0.4
Weight for preference capital (wp) = 150/1000 = 0.15
Weight for debenture capital (wd) = 250/1000 = 0.25
\ WACC = we ke + wr kr + wp kp + wd kd
= 0.2 19.25 + 0.4 19.25 + 0.15 12.19 + 0.25 8.00
= 15.38% (approx.)
Weighted average cost of capital (WACC) using market value weights
Sum of market values of all sources of capital used = 400 + 159 + 241 = 800
Weight of equity capital = 400/800 = 0.5
Weight of preference capital = 159/800 = 0.19875 » 0.20
Weight of debenture capital = 241/800 = 0.30125 » 0.30
\ WAC = 0.5 19.25 + 0.2 12.19 + 0.3 8.00
= 14.46% (approx.)
The difference between the WACC using book value weights and market value weights =
(15.38-14.46)%=0.92%
73. Answer : (b) < TOP >
Reason : The amount of raw materials consumed = Opening balance + Purchases during the year – Closing
balance
= (180,000 + 1,192,000 – 212,000) = Rs.1,160,000
The average stock of work in process = (25,000 + 45,000)/2 = Rs.35,000
Annual cost of production = Opening work in process + Consumption of raw materials + Manufacturing
expenses + Depreciation – Closing work in process
= 25,000 + 1,160,000 + 1,280,000 + 100,000 – 45,000 = Rs.2,520,000
So, the average daily cost of production = Rs.7,000
Hence, the average conversion period = 35,000/7,000 = 5 days.
74. Answer : (b) < TOP >
Reason : Present value of the costs associated with the machine will be
Rs.30,00,000 + Rs.250,000 PVIFA(10 percent, 4 years) + Rs.300,000 PVIFA(10 percent, 6 years)
PVIF(10 percent, 4 years)
= Rs.30,00,000 + Rs.250,000 3.170 + Rs.300,000 4.355 0.683
= Rs.46,84,839.50
The required annual capital charge will be
Rs.46, 84, 839.50 Rs.46, 84, 839.50
PVIFA (10%,10 years) 6.145
= = = Rs.762,382 (approximately)
76. Answer : (d) < TOP >
1
1/ 3
2 365
Reason : Approximate percentage cost = 98 35 = 0.212828.
159, 621
Accounts payable = 0.212828 = Rs.750,000.
< TOP OF THE DOCUMENT >