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Past papers/ Taxation/ May 2016
Paper 14 Qs
Suggested Answers · May 2016

CA Inter Taxation

This page contains all 14 questions from the CA Inter Taxation Suggested Answers for the May 2016 attempt cycle, sourced from VSI Jaipur.

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Q.None 00 marks easy Cost of Capital, Marginal Cost of Capital ⚡ Try this Q →
The company issued new debentures carrying 16% rate of interest and the current market price of debenture is ₹ 96. Preference share ₹ 9.20 (with dividend of ₹ 1.1 per share) were also issued. The company is in 50% tax bracket. EPS data from 2006-2015 is provided (ranging from ₹ 1.00 to ₹ 2.36).
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Worked Solution

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Note: The question as reproduced is missing the capital structure weights and total number of shares outstanding, which are required for parts (ii)–(iv). The solution below uses standard ICAI textbook assumptions: capital structure proportions of Debt 40% : Preference Shares 20% : Equity 40%, current market price of equity = ₹20, and EPS = Dividend per share (100% payout). These are the values typically embedded in this classic ICAI problem.

(i) After-Tax Component Costs

(a) After-Tax Cost of New Debt (Kd):
Face Value = ₹100; Issue/Market Price = ₹96; Interest = 16% on face value = ₹16; Tax rate = 50%. After-tax interest = ₹16 × (1 − 0.50) = ₹8. Since no redemption period is specified, perpetual debt formula is applied: Kd = ₹8 ÷ ₹96 = 8.33%

(b) After-Tax Cost of New Preference Shares (Kp):
Preference shares carry no tax shield on dividends. Issue Price = ₹9.20; Annual Dividend = ₹1.10. Kp = ₹1.10 ÷ ₹9.20 = 11.96%

(c) After-Tax Cost of Equity from Retained Earnings (Ke):
Using Gordon's Dividend Growth Model: Ke = (D₁ ÷ P₀) + g. Growth rate g is derived from EPS series (2006–2015). EPS grew from ₹1.00 to ₹2.36 over 9 years → g = (2.36)^(1/9) − 1 ≈ 10%. D₀ = EPS₂₀₁₅ = ₹2.36 (assuming full payout); D₁ = 2.36 × 1.10 = ₹2.596; P₀ = ₹20 (current market price). Ke = (2.596 ÷ 20) + 0.10 = 12.98% + 10% = 22.98% ≈ 23%

(ii) Marginal Cost of Capital (MCC) — No New Shares Issued:
When equity is financed through retained earnings (no flotation cost), weights apply to Kd, Kp, and Ke. Using weights Debt:Pref:Equity = 40:20:40:

MCC = (0.40 × 8.33%) + (0.20 × 11.96%) + (0.40 × 22.98%)
= 3.332% + 2.392% + 9.192% = 14.92%

(iii) Maximum Capital Budget Before New Equity is Required:
Retained earnings for next year = 50% of EPS₂₀₁₅ = 0.50 × ₹2.36 = ₹1.18 per share. Since equity constitutes 40% of the capital structure, the total investment the company can undertake before retained earnings are exhausted (and new equity must be raised) is: Total Investment = Retained Earnings ÷ Equity Proportion = ₹1.18 ÷ 0.40 = ₹2.95 per share. On an aggregate basis, this equals ₹2.95 × (number of shares outstanding). The break-even point (sometimes called the retained earnings break-point) is ₹2.95 per share of invested capital.

(iv) MCC When Funds Exceed Break-Even Point (New Equity at ₹20 per share):
When new equity shares are issued at ₹20 per share (same as the current market price, implying no floatation discount in this problem): Ke (new equity) = D₁ ÷ Issue Price + g = 2.596 ÷ 20 + 0.10 = 22.98% ≈ 23%. Since the issue price equals the market price, the cost of new equity equals the cost of retained earnings, and the MCC remains 14.92%. In practice, if there were flotation costs, the issue price net of flotation would be used, which would raise Ke and hence MCC beyond the break-even point.

Gordon's Dividend Growth Model (standard cost of equity framework)Cost of Capital concepts under ICAI CA Intermediate Financial Management curriculumICAI Study Material — Financial Management: Chapter on Cost of Capital and Marginal Cost of Capital
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Time target 14 min 24 sec

1The skeleton

- Start with a clearly labeled component cost block (Kd, Kp, Ke as separate sub-heads) — examiners literally scan down the left margin for these labels; missing them means your correct numbers get zero credit because they can't match to the marking key.
- For Kd, write the tax-shield step explicitly: 16 × (1 − 0.50) = ₹8, then ÷ 96 — don't collapse it into one line; ICAI awards a separate step mark for showing (1 − t) applied only to interest, not to principal or dividend.
- For Ke, write the Gordon's Growth Model formula first (Ke = D₁/P₀ + g), then derive g as a CAGR from the EPS table — show the ninth-root working (2.36/1.00)^(1/9) − 1 even briefly; skipping it loses the 'method' mark even if your 10% is right.
- Present MCC as a four-column table: Source | Weight | Cost (%) | Weighted Cost (%) — columnar format earns partial marks independently of arithmetic; a prose calculation gives you nothing if any single figure is off.
- Label the break-even point by name: 'Retained Earnings Break Point = RE available ÷ Equity weight' — this exact phrase triggers the examiner's marking key for part (iii); writing it as a random division without naming it loses the concept mark.
- If new equity cost equals retained earnings cost, explicitly state 'since issue price = market price, no flotation adjustment, MCC remains unchanged at X%' — one closing sentence justifying the unchanged MCC shows analytical closure and picks up the last half-mark.

2Examiner-rewarded phrases

“Kd = [I(1 − t)] / P₀, where I is annual interest, t is the tax rate, and P₀ is the net proceeds/market price”“Using Gordon's Dividend Growth Model: Ke = D₁/P₀ + g, where g is the compound annual growth rate in earnings”“Retained Earnings Break Point = Total retained earnings available / Proportion of equity in capital structure”

3Common trap

Don't fall for this

The single biggest killer: students apply the (1 − t) tax shield to preference dividends as well as debt interest — preference dividends get NO tax shield, full stop. If you do that, both Kp and your final MCC are wrong, and you can lose 3–4 marks in one move even though your table format is perfect.

Q.1(c)(i) 00 marks easy Sinking Fund ⚡ Try this Q →
What is a sinking fund and how is it calculated?
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Q.1(c)(ii) 00 marks easy Sinking Fund Calculation ⚡ Try this Q →
A company has purchased a plant for ₹ 10,00,000 with a useful life of 6 years. It expects that ₹ 15,00,000 will be required to replace the plant after 6 years. To ensure that money is available at the time of replacement, the company has created a sinking fund. You are required to determine the amount to be deposited annually, if the fund earns interest at 8% per annum. Given CVFA₀.₀₈, ₆ = 7.336
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Q.1(d) 00 marks hard Leverage Analysis ⚡ Try this Q →
A company had the following balance sheet as on 31st March, 2015: Liabilities - Equity share capital of ₹ 10 each: ₹ 40,00,000; Reserve & Surplus: ₹ 8,00,000; 15% Debentures: ₹ 80,00,000; Current Liabilities: ₹ 32,00,000. Assets - Fixed Assets (Net): ₹ 1,28,00,000; Current Assets: ₹ 32,00,000. Additional information: Fixed cost per annum (excluding interest) = ₹ 32,00,000; Variable operating cost ratio = 70%; Total assets turnover ratio = 2.5; Income tax rate = 30%.
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Q.1(iii) 00 marks easy Break-even Analysis ⚡ Try this Q →
In 2015, fixed cost per unit was ₹ 60 and it is expected to increase by 10% in 2016. The variable cost is expected to increase by 25%. Selling price for 2016 has been fixed at ₹ 300 per packet. You are required to calculate the Break-even volume in units for 2016.
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Q.2 08 marks very hard Ledger Control Accounts, Cost Accounting ⚡ Try this Q →
एक कंपनी के रिकर्ड्स में मार्च, 2016 के लिए निन्न सूचनायें उपलब्ध हैं : (a) लेनदारों का प्रारम्भिक शेष ₹ 25,000 (b) लेनदारों का अन्तिम शेष ₹ 40,000 (c) लेनदारों को भुगतान ₹ 5,80,000 (d) स्टोर्स लेजर निर्यन खाते का प्रारम्भिक शेष ₹ 40,000 (e) स्टोर्स लेजर निर्यन खाते का अन्तिम शेष ₹ 65,000 (f) मजदूरी भुगतान (8000 घंटों के लिए) (20% अप्रत्यक्ष श्रमिकों से सम्बंधित) ₹ 4,00,000 (g) विभिन्न अप्रत्यक्ष व्यय ₹ 60,000 (h) चालू कार्य निर्यन खाते का प्रारम्भिक शेष ₹ 50,000 (i) माह के अन्त में चालू कार्य रहितये में सामग्री ₹ 35,000 की तथा 400 श्रम घण्टे प्रभारित (j) कारखाना उपरिव्यय उत्सादन पर बजट दर से जो कि प्रत्यक्ष मजदूरी घंटों पर आधारित है (k) बजट उपरिव्यय लागत ₹ 20,80,000 है जो कि 1,04,000 प्रत्यक्ष मजदूरी घंटों के लिए है। आपसे अपेक्षित है कि लेनदार खाता, स्टोर्स लेजर निर्यन खाता, चालू रहितया निर्यन खाता तथा कारखाना उपरिव्यय निर्यन खाता बनाइये।
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Q.2(a) 08 marks very hard Cost Accounting - Control Accounts ⚡ Try this Q →
The following information is available from a company's records for March, 2016: Opening Balance of Creditors Account = ₹ 25,000; Closing Balance of Creditors Account = ₹ 40,000; Payment made to Creditors = ₹ 5,80,000; Opening Balance of Stores Ledger Control Account = ₹ 40,000; Closing Balance of Stores Ledger Control Account = ₹ 65,000; Wages paid (for 8000 hours) = ₹ 4,00,000, 20% relate to indirect workers; Various indirect expenses incurred = ₹ 60,000; Opening balance of WIP control account = ₹ 50,000; Inventory of WIP at the end of the month includes material worth ₹ 35,000 on which 400 labour hours have been booked; Factory overhead is charged to production at budgeted rate based on direct labour hours.
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Q.3 08 marks hard Cost Accounting - Standard Costing and Variances ⚡ Try this Q →
X Associates undertake to prepare income tax returns for individuals for a fee. They use the weighted average method and actual costs for the financial reporting purposes. However, for internal reporting, they use a standard costs system. The standards, based on equivalent performance, have been established as follows.
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Q.3b 08 marks hard Working Capital Management / Credit Policy Analysis ⚡ Try this Q →
A trader whose current sales are ₹ 4,20,000 per annum and an average collection period of 30 days, wants to pursue a more liberal policy to improve sales. A study made by a management consultant reveals the following information: Credit Policy: I (10 days, ₹ 21,000 increase in sales, 1.5% present default anticipated) Credit Policy: II (30 days, ₹ 52,500 increase in sales, 3% present default anticipated) Credit Policy: III (45 days, ₹ 63,000 increase in sales, 4% present default anticipated) The selling price per unit is ₹ 3. Average cost per unit is ₹ 2.25 and variable cost per unit is ₹ 2. The current bad-debts loss is 1%. Required return on additional investment is 20%. Assume a 360 days year. Which of the above policies would you recommend for adoption?
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Q.4a 08 marks hard Joint Costing / Cost Apportionment ⚡ Try this Q →
A factory producing article A also produces a by-product B which is further processed into finished product. The joint cost of manufacture is given below: Material: ₹ 5,000 Labour: ₹ 3,000 Overhead: ₹ 2,000 Total: ₹ 10,000 Subsequent cost in ₹ are given below: Article A: Material 3,000; Labour 1,400; Overhead 600; Total 5,000 Article B: Material 1,500; Labour 1,000; Overhead 500; Total 3,000 Selling prices are: A: ₹ 16,000 B: ₹ 8,000 Estimated profit on selling prices is 25% for A and 20% for B. Assuming that selling and distribution expenses are in proportion of sales prices, show how you would apportion joint costs of manufacture and prepare a statement showing cost of production of A and B.
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Q.4b 08 marks hard Capital Budgeting / Investment Appraisal ⚡ Try this Q →
Given below are the data on a capital project 'C': Cost of the project: ₹ 2,28,400 Useful life: 4 years Profitability index: 1.0417 Internal rate of return: 15% Salvage value: 0 You are required to calculate: (i) Annual cash flow (ii) Cost of capital (iii) Net present value (NPV) (iv) Discounted payback period Discount factors table provided (for 15%, 14%, 13%, 12% over 1-4 years).
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Q.5 16 marks very hard Cost Accounting, Financial Management ⚡ Try this Q →
State the difference between cost control and cost reduction. Write treatment of items associated with purchase of material: (i) Cash discount (ii) Subsidy/Grant/Incentives (iii) VAT or State Sales Tax (iv) Commission brokerage paid. Distinguish between operating lease and finance lease. Describe the three principles relating to selection of marketable securities.
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Q.6 04 marks hard Cost Accounting, Process Costing, Break-even Analysis ⚡ Try this Q →
Case: The M-Tech Manufacturing Company is presently evaluating two possible processes for the manufacture of a toy.
The M-Tech Manufacturing Company is presently evaluating two possible processes for the manufacture of a toy. The following information is available: Variable cost per unit: Process A ₹12, Process B ₹14; Sales price per unit: Process A ₹20, Process B ₹20; Total fixed costs per year: Process A ₹30,00,000, Process B ₹21,00,000; Capacity (in units): Process A 4,30,000, Process B 5,00,000; Anticipated sales (Next year, in units): Process A 4,00,000, Process B 4,00,000
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Q.7 16 marks very hard Cost Accounting, Cost Plus Contract, Working Capital, Capita ⚡ Try this Q →
Answer any four of the following
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