Question 1

What will be the total manufacturing cost and total cost of sales on cash cost basis?

Accepted Answer

**Answer: (A) ₹20,70,000; ₹23,40,000**

Since the proposal is on **cash cost basis**, depreciation is excluded from all computations.

**Total Manufacturing Cost (Cash Basis):**

- **Raw Material Consumed** = 25% of Sales = 25% × ₹30,00,000 = ₹7,50,000
- **Wages** = 20% of Sales = 20% × ₹30,00,000 = ₹6,00,000
- **Cash Manufacturing Overhead**: The outstanding balance at year-end is ₹60,000, paid in one month arrear. This means the **monthly** cash manufacturing overhead = ₹60,000, so **annual** = ₹60,000 × 12 = ₹7,20,000

**Total Manufacturing Cost (Cash) = ₹7,50,000 + ₹6,00,000 + ₹7,20,000 = ₹20,70,000**

**Total Cost of Sales (Cash Basis):**

To arrive at cost of sales, selling and administrative expenses are added to manufacturing cost:
- **Administrative Cost** = ₹1,80,000 (given)
- **Sales Promotion Expenses** = ₹90,000 (given)

**Total Cost of Sales (Cash) = ₹20,70,000 + ₹1,80,000 + ₹90,000 = ₹23,40,000**

Note: Depreciation, though part of cost of production as stated, is a **non-cash item** and is therefore excluded entirely from cash cost basis computations.

Question 2

The following information is available for S Ltd. for the year ended 31st March, 2023: Raw Material consumed 20% of COGS, Raw Material Inventory turnover ratio 4.00, Finished Goods Inventory holding period 0.75 month, Gross profit (based on COGS) 12.50%, Debtor collection period (all sales are credit sales) 3 months, Proprietary ratio 0.3125, Fixed Asset turnover ratio (based on sales) 3.00, Fixed Assets to Total Assets 40%. You are required to prepare a Balance Sheet as on 31st March, 2023 in the given format.

Accepted Answer

**Balance Sheet of S Ltd. as on 31st March, 2023**

Since no absolute figure is given, all ratios are used to derive consistent values. Assuming **COGS = ₹1,280** (in consistent units), the following balance sheet is prepared:

| **Liabilities** | **₹** | **Assets** | **₹** |
|---|---|---|---|
| Shareholders' Funds | 375 | Fixed Assets | 480 |
| External Liabilities | 825 | Raw Material Inventory | 64 |
| | | Finished Goods Inventory | 80 |
| | | Trade Debtors | 360 |
| | | Cash & Bank Balance | 216 |
| **Total** | **1,200** | **Total** | **1,200** |

**Key derivations:** Sales = 1,440 | Fixed Assets = 480 | Total Assets = 1,200 | Shareholders' Funds = 375 | External Liabilities (balancing figure) = 825.

Question 3

What will be the total estimated current assets on cash cost basis?

Accepted Answer

**Unable to solve without case scenario data.** This question asks for total estimated current assets on cash cost basis, but requires context from the case scenario that has not been provided. To calculate current assets on cash cost basis, I would need: (a) opening inventory, receivables, and other current asset values; (b) the adjustments required to convert accrual-based figures to cash cost basis (such as excluding accrued expenses, adding back depreciation on depreciable current assets if any, adjusting for credit purchases and sales); (c) any specific instructions on which items to include/exclude. Without this data, none of the four options can be verified as correct.

Question 4

The following information is available for S Ltd. for the year ended 31st March, 2025: Raw Material consumed: 20% of COGS; Raw Material Inventory turnover ratio: 4.00; Finished Goods Inventory holding period: 0.75 month; Gross profit (based on COGS): 12.50%; Debtor collection period (all sales are credit sales): 3 months; Proprietary ratio: 0.3125; Fixed Assets turnover ratio (based on sales): 3.00; Fixed Assets to Total Assets: 40%. You are required to prepare a Balance Sheet as on 31st March, 2025 with given balances: Long-term Debt ₹ 15,00,000; Fixed Assets ₹ 12,00,000.

Accepted Answer

**Balance Sheet of S Ltd. as on 31st March, 2025**

**Step 1 – Establish Total Assets:**
Fixed Assets to Total Assets = 40%. Given Fixed Assets = ₹12,00,000.
Total Assets = 12,00,000 ÷ 0.40 = **₹30,00,000**.

**Step 2 – Sales:**
Fixed Assets Turnover Ratio = Sales ÷ Fixed Assets → 3.00 = Sales ÷ 12,00,000.
Sales = **₹36,00,000**.

**Step 3 – COGS:**
Gross Profit = 12.5% of COGS → Sales = COGS × 1.125.
COGS = 36,00,000 ÷ 1.125 = **₹32,00,000**.

**Step 4 – Raw Material Inventory:**
Raw Material Consumed = 20% × 32,00,000 = ₹6,40,000.
RM Turnover = RM Consumed ÷ RM Inventory → RM Inventory = 6,40,000 ÷ 4 = **₹1,60,000**.

**Step 5 – Finished Goods Inventory:**
Holding Period = (FG Inventory ÷ COGS) × 12 → 0.75 = (FG ÷ 32,00,000) × 12.
FG Inventory = **₹2,00,000**.

**Step 6 – Debtors:**
Collection Period = (Debtors ÷ Sales) × 12 → 3 = (Debtors ÷ 36,00,000) × 12.
Debtors = **₹9,00,000**.

**Step 7 – Cash & Bank (Balancing Figure):**
Current Assets = Total Assets − Fixed Assets = 30,00,000 − 12,00,000 = ₹18,00,000.
Cash = 18,00,000 − 1,60,000 − 2,00,000 − 9,00,000 = **₹5,40,000**.

**Step 8 – Shareholders' Funds:**
Proprietary Ratio = Shareholders' Funds ÷ Total Assets → 0.3125 = SF ÷ 30,00,000.
Shareholders' Funds = **₹9,37,500**.

**Step 9 – Current Liabilities (Balancing Figure):**
CL = Total Assets − Shareholders' Funds − Long-term Debt = 30,00,000 − 9,37,500 − 15,00,000 = **₹5,62,500**.

**Balance Sheet of S Ltd. as on 31st March, 2025**

| **Liabilities** | **₹** | **Assets…

Question 5

Y Ltd. produces energy drinks in different flavours. Due to high demand, the rate of return on its earnings is 25%. Currently, the company retains 60% of its earnings and distributes the rest. The current P/E ratio is 8 and earnings per share is ₹ 10. According to Gordon's Model: (i) What will be retention ratio of the company wants to maintain its P/E ratio at 12 in current year, given that the expected rate of return for an investor is 20%? (ii) What will be the expected price per share after one year if Y Ltd. follows given-mentioned targeted P/E ratio? (iii) Will there be any change in retention ratio of the company wants to maintain its P/E ratio to 10 in current year, given that the expected rate of return for an investor is 17.50%?

Accepted Answer

**Gordon's Growth Model** states: P = E(1 – b) / (Ke – br), where E = EPS, b = retention ratio, Ke = required rate of return, r = internal rate of return, and br = g (growth rate). The **P/E form** is: P/E = (1 – b) / (Ke – br).

**Given data:** EPS (E) = ₹10, r = 25%, current b = 60%, current P/E = 8.

**(i) Retention ratio to maintain P/E at 12 (Ke = 20%)**

Using Gordon's P/E formula: 12 = (1 – b) / (0.20 – 0.25b)

Solving: 12(0.20 – 0.25b) = 1 – b → 2.4 – 3b = 1 – b → 1.4 = 2b → **b = 0.70 = 70%**

To achieve a target P/E of 12, Y Ltd. must increase its **retention ratio to 70%** (from the current 60%), thereby retaining a larger proportion of earnings to fuel higher growth, which investors capitalise at a premium.

**(ii) Expected price per share after one year (at targeted P/E of 12, b = 70%)**

Current market price: P₀ = P/E × EPS = 12 × ₹10 = **₹120**

Growth rate: g = b × r = 0.70 × 25% = **17.5%**

Expected EPS after one year: E₁ = ₹10 × (1 + 0.175) = **₹11.75**

Expected price after one year: P₁ = P/E × E₁ = 12 × ₹11.75 = **₹141**

Alternatively: P₁ = P₀ × (1 + g) = ₹120 × 1.175 = ₹141.

The **expected price per share after one year is ₹141**.

**(iii) Change in retention ratio to maintain P/E at 10 (Ke = 17.5%)**

Using Gordon's P/E formula: 10 = (1 – b) / (0.175 – 0.25b)

Solving: 10(0.175 – 0.25b) = 1 – b → 1.75 – 2.5b = 1 – b → 0.75 = 1.5b → **b = 0.50 = 50%**

**Yes, there is a change.** The retention ratio decreases from the current 60% to **50%**. To target …

Question 6

Y Ltd. produces energy drinks in different flavours. Due to high demand of its product, the rate of return on its earnings is 25%. Currently, the company retains 60% of its earnings and distributes the rest. The current P/E ratio is 8 and earnings per share is ₹ 10. According to Gordon's Model, answer the following:

Accepted Answer

**Gordon's Model Formula:** P = E(1 − b) / (Ke − br)

Where: P = Market Price, E = EPS, b = Retention Ratio, Ke = Expected Rate of Return (investor), r = Rate of Return on Investment, br = Growth Rate (g)

**Given Data:** r = 25%, Current b = 60%, Current P/E = 8, EPS = ₹10

Current Market Price = 8 × ₹10 = **₹80**

---

**(i) Retention Ratio for P/E = 12, Ke = 12%**

Using Gordon's Model in P/E form:
P/E = (1 − b) / (Ke − br)

12 = (1 − b) / (0.12 − 0.25b)

12(0.12 − 0.25b) = (1 − b)

1.44 − 3b = 1 − b → 0.44 = 2b → **b = 22%**

To achieve a P/E of 12, the company must **reduce its retention ratio from 60% to 22%**, i.e., distribute 78% as dividend.

---

**(ii) Expected Price Per Share After One Year**

With P/E = 12 and EPS = ₹10:
Current Price (P₀) = 12 × ₹10 = ₹120

Growth rate (g) = b × r = 22% × 25% = **5.5%**

EPS after one year = ₹10 × 1.055 = ₹10.55

Expected Price after one year = 12 × ₹10.55 = **₹126.60**

---

**(iii) Change in Retention Ratio for P/E = 10, Ke = 17.5%**

10 = (1 − b) / (0.175 − 0.25b)

10(0.175 − 0.25b) = (1 − b)

1.75 − 2.5b = 1 − b → 0.75 = 1.5b → **b = 50%**

**Yes, there will be a change.** The retention ratio will **decrease from 60% to 50%** (dividend payout increases from 40% to 50%) to maintain P/E at 10 when Ke = 17.5%.

Question 7

Following information relates to A Ltd. for the year ended 31st March, 2025: Profit volume ratio: 24%, Operating leverage: 2.00, Financial leverage: 1.50, Interest Expenses: ₹ 12,000, Tax rate: 30%, Number of Equity Shares: 1,000. You are required to: (i) Prepare Income Statement for the year ended 31st March, 2025. (ii) Calculate EPS. (iii) Calculate percentage change in earnings per share, if sales increase by 5%.

Accepted Answer

**Solution:**

**(i) Income Statement for the year ended 31st March, 2025**

Using the given leverages and interest to work backwards:

**Financial Leverage (FL)** = EBIT / (EBIT − Interest)
1.50 = EBIT / (EBIT − 12,000)
∴ EBIT = **₹36,000**

**EBT** = EBIT − Interest = 36,000 − 12,000 = **₹24,000**

**Operating Leverage (OL)** = Contribution / EBIT
2.00 = Contribution / 36,000
∴ Contribution = **₹72,000**

**P/V Ratio** = Contribution / Sales
0.24 = 72,000 / Sales
∴ Sales = **₹3,00,000**

**Variable Cost** = Sales − Contribution = 3,00,000 − 72,000 = ₹2,28,000

**Fixed Cost** = Contribution − EBIT = 72,000 − 36,000 = ₹36,000

**Income Statement of A Ltd. for the year ended 31st March, 2025**

| Particulars | ₹ |
|---|---|
| Sales | 3,00,000 |
| Less: Variable Costs | (2,28,000) |
| **Contribution** | **72,000** |
| Less: Fixed Costs | (36,000) |
| **EBIT (Earnings Before Interest & Tax)** | **36,000** |
| Less: Interest Expenses | (12,000) |
| **EBT (Earnings Before Tax)** | **24,000** |
| Less: Tax @ 30% | (7,200) |
| **EAT (Earnings After Tax)** | **16,800** |

**(ii) Earnings Per Share (EPS)**

**EPS** = EAT / Number of Equity Shares = 16,800 / 1,000 = **₹16.80 per share**

**(iii) % Change in EPS if Sales increase by 5%**

**Combined Leverage** = Operating Leverage × Financial Leverage = 2.00 × 1.50 = **3.00**

The Combined Leverage measures the sensitivity of EPS to a change in Sales.

**% Change in EPS** = Combined Leverage × % Change in Sales = 3.00 × 5% = **15%**

If…

Question 8

Following information relates to A Ltd. for the year ended 31st March, 2025: Profit volume ratio: 24%; Operating leverage: 2.00; Financial leverage: 1.50; Interest Expenses: ₹ 12,000; Tax rate: 30%; Number of Equity Shares: 1,000. [Question prompts not visible]

Accepted Answer

**Solution: Leverage Analysis for A Ltd. for the year ended 31st March, 2025**

**Step 1 – Calculate EBIT using Financial Leverage**

**Financial Leverage (FL)** = EBIT / (EBIT – Interest)
1.50 = EBIT / (EBIT – ₹12,000)
⟹ 1.50 EBIT – ₹18,000 = EBIT
⟹ 0.50 EBIT = ₹18,000
⟹ **EBIT = ₹36,000**

**Step 2 – Calculate Contribution using Operating Leverage**

**Operating Leverage (OL)** = Contribution / EBIT
2.00 = Contribution / ₹36,000
⟹ **Contribution = ₹72,000**

**Step 3 – Calculate Sales using P/V Ratio**

**P/V Ratio** = Contribution / Sales
0.24 = ₹72,000 / Sales
⟹ **Sales = ₹3,00,000**

**Step 4 – Calculate Fixed Costs**
Fixed Costs = Contribution – EBIT = ₹72,000 – ₹36,000 = **₹36,000**

**Step 5 – Prepare Income Statement and Calculate EPS**

| Particulars | ₹ |
|---|---|
| Sales | 3,00,000 |
| Less: Variable Costs (₹3,00,000 – ₹72,000) | 2,28,000 |
| **Contribution** | **72,000** |
| Less: Fixed Costs | 36,000 |
| **EBIT** | **36,000** |
| Less: Interest | 12,000 |
| **EBT** | **24,000** |
| Less: Tax @ 30% | 7,200 |
| **EAT (Earnings After Tax)** | **16,800** |

**EPS** = EAT / Number of Equity Shares = ₹16,800 / 1,000 = **₹16.80 per share**

**Step 6 – Combined Leverage**

**Combined Leverage** = Operating Leverage × Financial Leverage = 2.00 × 1.50 = **3.00**

This means a 1% change in Sales will lead to a 3% change in EPS.

Question 9

What will be the total estimated finished goods inventory and total debtors on cash cost basis?

Accepted Answer

**Answer: (C) ₹1,72,500; ₹3,31,500**

**Finished Goods Inventory (Cash Cost Basis):**
Since the proposal is on **cash cost basis**, depreciation is excluded. The cash components of manufacturing cost are: Raw Material (25% of ₹30,00,000 = ₹7,50,000), Wages (20% of ₹30,00,000 = ₹6,00,000), and Cash Manufacturing Overhead (₹60,000 outstanding = 1 month's OH, so annual = ₹7,20,000). Total cash manufacturing cost = ₹20,70,000. Finished goods are held for **1 month**, so inventory = ₹20,70,000 ÷ 12 = **₹1,72,500**.

**Total Debtors (Cash Cost Basis):**
Total cash cost of sales = Cash manufacturing cost + Admin cost + Sales promotion = ₹20,70,000 + ₹1,80,000 + ₹90,000 = **₹23,40,000** (p.a.).

Monthly cash cost = ₹23,40,000 ÷ 12 = ₹1,95,000.

Domestic sales = 80% × ₹30,00,000 = ₹24,00,000 (credit period 2 months). Domestic debtors = (₹24,00,000 ÷ ₹30,00,000) × ₹1,95,000 × 2 = 0.8 × ₹3,90,000 = **₹3,12,000**.

Foreign sales = 20% × ₹30,00,000 = ₹6,00,000 (credit period ½ month). Foreign debtors = (₹6,00,000 ÷ ₹30,00,000) × ₹1,95,000 × 0.5 = 0.2 × ₹97,500 = **₹19,500**.

Total Debtors = ₹3,12,000 + ₹19,500 = **₹3,31,500**.

Question 10

What will be the total estimated current liabilities?

Accepted Answer

Unable to provide a solution. This MCQ references a case scenario or data set (indicated by 'Paper: p6') that has not been provided. To calculate total estimated current liabilities, I need the balance sheet items, accounts, and their values from the case scenario. Please provide the complete case scenario including all asset, liability, and equity accounts with their amounts.

Question 11

Capital structure of B Ltd. for the year ended 31st March, 2025:

Equity share capital @ ₹ 10 each: ₹ 14,00,000
10% Preference share capital @ ₹ 1,000 each: ₹ 10,00,000
Debenture @ ₹ 100 each: ₹ 9,60,000
Bank Loan: ₹ 6,40,000

Additional Information:
- Risk-free rate of return is 14%, Market rate of return is 19% and beta of company is 1.20
- 10% Preference shares are redeemable at ₹ 1,065.40 after 3 years
- Interest on bank loan is 1.30 times of interest on debentures
- Debentures are redeemable at par after 5 years. Floatation cost is ₹ 4 per debenture
- Tax rate is 30%
- Cost of capital is 14%

Also, following details are related to H Ltd.:
EPS: ₹ 3.00
Return on investment: 20%
Cost of equity: 15%

PV factors @ 10% and 14%:
Year 1: PVIF₁₀ = 0.909, PVIF₁₄ = 0.877
Year 2: PVIF₁₀ = 0.826, …

Accepted Answer

**Part (a): Cost of Capital Components**

**(i) Cost of Equity (Ke) using CAPM:**

Ke = Rf + β(Rm − Rf) = 14% + 1.20 × (19% − 14%) = 14% + 6% = **20%**

**(ii) Cost of Preference Share (Kp) using YTM Method (Interpolation):**

Net Proceeds (NP) = ₹1,000 (assumed issued at par); Annual Dividend = 10% × ₹1,000 = ₹100; Redemption Value (RV) = ₹1,065.40; n = 3 years.

PV at 10% = 100(0.909 + 0.826 + 0.751) + 1,065.40 × 0.751 = 248.60 + 800.11 = **₹1,048.71**
PV at 14% = 100(0.877 + 0.769 + 0.675) + 1,065.40 × 0.675 = 232.10 + 719.15 = **₹951.25**

By interpolation: Kp = 10% + [(1,048.71 − 1,000)/(1,048.71 − 951.25)] × 4% = 10% + [48.71/97.46] × 4% = 10% + 2% = **12%**

**(iii) Post-tax Cost of Debenture using Approximation Method:**

Assuming debentures carry a **10% coupon** (derived from WACC constraint); Face Value = ₹100; Net Proceeds = ₹100 − ₹4 = ₹96; RV = ₹100 (at par); n = 5 years; Tax = 30%.

Kd = [I(1−t) + (RV − NP)/n] / [(RV + NP)/2]
Kd = [10(0.70) + (100 − 96)/5] / [(100 + 96)/2]
Kd = [7.00 + 0.80] / 98 = 7.80/98 = **7.96%**

**(iv) Interest Rate of Bank Loan:**

Using WACC = 14% and all known component costs to back-calculate the debenture coupon as 10%, total debenture interest = ₹9,60,000 × 10% = ₹96,000. Since bank loan interest = 1.30 × debenture interest: Bank Loan interest = 1.30 × ₹96,000 = ₹1,24,800. Interest rate on Bank Loan = ₹1,24,800 / ₹6,40,000 × 100 = **19.50%**

---

**Part (b): Walter's Model — Maximum and Minimum Price of Share of H Ltd.**

Given: E…

Question 12

Capital structure of B Ltd. for the year ended 31st March, 2025: Equity share capital @ ₹ 10 each: ₹ 14,00,000; 10% Preference share capital @ ₹ 1,000 each: ₹ 10,00,000; Debenture @ ₹ 100 each: ₹ 9,60,000; Bank Loan: ₹ 6,40,000. Risk-free rate of return is 14%. Market rate of return is 19% and beta of company is 1.20. 10% Preference shares are redeemable at ₹ 1,065.40 after 3 years. Interest on bank loan is 1.30 times the interest on debentures. Debentures are redeemable at par after 5 years. Flotation cost is ₹ 4 per debenture. Tax rate is 30%. Cost of capital is 14%.

Accepted Answer

**Step 1 – Cost of Equity (Ke) using CAPM**

Ke = Rf + β(Rm – Rf)
Ke = 14% + 1.20 × (19% – 14%) = 14% + 6% = **20%**

**Step 2 – Cost of 10% Redeemable Preference Shares (Kp)**

Face value (NP) = ₹1,000; Annual dividend = ₹100; Redemption value (RV) = ₹1,065.40; n = 3 years (issued at par, no flotation cost stated).

Using approximation formula:
Kp = [D + (RV – NP)/n] ÷ [(RV + NP)/2]
= [100 + (1,065.40 – 1,000)/3] ÷ [(1,065.40 + 1,000)/2]
= [100 + 21.80] ÷ 1,032.70
= 121.80 ÷ 1,032.70 = **11.80%**

**Step 3 – Cost of Debentures (Kd) after tax**

Coupon rate = 14% (given as cost of capital); Face value = ₹100; Flotation cost = ₹4; NP = 100 – 4 = ₹96; RV = ₹100 (at par); n = 5 years; Tax rate = 30%.

After-tax interest = 14 × (1 – 0.30) = ₹9.80

Kd = [9.80 + (100 – 96)/5] ÷ [(100 + 96)/2]
= [9.80 + 0.80] ÷ 98
= 10.60 ÷ 98 = **10.82%**

**Step 4 – Cost of Bank Loan (Kb) after tax**

Interest rate on bank loan = 1.30 × debenture rate = 1.30 × 14% = 18.20%
After-tax Kb = 18.20% × (1 – 0.30) = **12.74%**

**Step 5 – WACC (Weighted Average Cost of Capital)**

Total capital = ₹14,00,000 + ₹10,00,000 + ₹9,60,000 + ₹6,40,000 = ₹40,00,000

| Source | Book Value (₹) | Weight | Cost (%) | Weighted Cost (%) |
|---|---|---|---|---|
| Equity | 14,00,000 | 0.35 | 20.00 | 7.000 |
| Preference | 10,00,000 | 0.25 | 11.80 | 2.950 |
| Debentures | 9,60,000 | 0.24 | 10.82 | 2.597 |
| Bank Loan | 6,40,000 | 0.16 | 12.74 | 2.038 |
| **Total** | **40,00,000** | **1.00** | | **14.585** |

**WACC of B L…

Question 13

What will be the total estimated current assets on cash cost basis?

Accepted Answer

**Answer: (D) ₹7,10,250**

The total estimated current assets on cash cost basis is computed by identifying each current asset component and valuing it at cash cost (excluding depreciation).

**Cost Structure:**
Annual sales = ₹30,00,000. Since GP margin is 25% on COGS, Sales = 1.25 × COGS, so COGS = ₹24,00,000. Raw material = 25% × ₹30,00,000 = ₹7,50,000. Wages = 20% × ₹30,00,000 = ₹6,00,000. Cash manufacturing overhead: outstanding at year-end is ₹60,000 paid in 1 month arrear → monthly overhead = ₹60,000 → annual = ₹7,20,000. Cash manufacturing cost = ₹7,50,000 + ₹6,00,000 + ₹7,20,000 = **₹20,70,000** (depreciation excluded as per cash cost basis). Total cash cost of sales = ₹20,70,000 + ₹1,80,000 (admin) + ₹90,000 (sales promotion) = **₹23,40,000**. Cash cost ratio = 23,40,000 ÷ 30,00,000 = **78%**.

**Current Assets:**

**Stock of Raw Material** — held for 1.5 months: (₹7,50,000 ÷ 12) × 1.5 = ₹93,750.

**Stock of Finished Goods** — held for 1 month, valued at cash manufacturing cost: (₹20,70,000 ÷ 12) × 1 = ₹1,72,500.

**Debtors (Domestic)** — 80% of sales = ₹24,00,000, credit period 2 months, on cash cost basis: ₹24,00,000 × 78% × 2/12 = ₹3,12,000.

**Debtors (Foreign)** — 20% of sales = ₹6,00,000, delay 0.5 months, on cash cost basis: ₹6,00,000 × 78% × 0.5/12 = ₹19,500.

**Advance for Sales Promotion** — ₹90,000 p.a. paid quarterly in advance; one quarter's advance = ₹90,000 ÷ 4 = ₹22,500 (current asset).

**Cash Balance** — as given = ₹90,000.

**Total Current Assets …

Question 14

Z Ltd is an unleveraged company. It wants to repurchase its equity shares of ₹300 lakhs by issue of 12% debentures of same amount. Current market value of Z Ltd is ₹1,400 lakhs. Its cost of capital is 18%. The company will maintain same level of EBIT in future years. Dividend payout ratio is 100%. Company pays tax at a rate of 30%.

As per Modigliani and Miller approach, due to such change in capital structure, what will be impact on the following?

Accepted Answer

**Modigliani-Miller (MM) Approach with Corporate Tax — Impact of Change in Capital Structure**

**Given Data:** Unlevered firm value (V_U) = ₹1,400 lakhs; Debt issued (D) = ₹300 lakhs at 12%; Unlevered cost of equity / cost of capital (ρ) = 18%; Tax rate (T) = 30%; Dividend payout = 100%.

**Step 1 — Calculate EBIT:** Since V_U = EBIT(1–T) / ρ → EBIT(1–T) = 1,400 × 18% = ₹252 lakhs → EBIT = 252 / 0.70 = **₹360 lakhs**

**(i) Market Value of Levered Firm (V_L):**
Under MM with taxes: V_L = V_U + T × D
V_L = 1,400 + (0.30 × 300) = 1,400 + 90 = **₹1,490 lakhs**
The market value **increases by ₹90 lakhs** (the present value of the tax shield on debt). This is the key MM proposition — leverage adds value to the firm through interest tax shield.

**(ii) Overall Cost of Capital (WACC / Ko):**
Ko = EBIT(1–T) / V_L = 252 / 1,490 = **16.91%**
The overall cost of capital **decreases from 18% to 16.91%** because the tax benefit of debt reduces the effective cost of financing.

**(iii) Cost of Equity (Ke_L):**
Value of equity in levered firm: E_L = V_L – D = 1,490 – 300 = ₹1,190 lakhs
Interest = 12% × 300 = ₹36 lakhs
EAT (= Dividends, since payout = 100%) = (360 – 36) × (1 – 0.30) = 324 × 0.70 = ₹226.8 lakhs
Ke_L = Dividends / E_L = 226.8 / 1,190 = **19.06%**
The cost of equity **increases from 18% to 19.06%** because equity holders now bear higher financial risk due to the presence of debt.

**Summary of Impact:**
- Market Value: ₹1,400 lakhs → ₹1,490 lakhs (↑ ₹90 lakhs)
- WACC (Ko): 18%…

Question 15

What will be the estimated working capital to be submitted by you in the proposal?

Accepted Answer

**Answer: Cannot be determined without case context**

This question appears to be part of a case scenario problem where the working capital needs to be calculated from prior context (such as gross profit, working capital cycle components, inventory turnover, receivables collection period, payables payment period, etc.). Without the complete case scenario data, financial figures, and working assumptions provided in earlier parts of the question, it is impossible to determine which of the four options is correct.

To solve this, you would need to:
1. Identify the gross profit or net profit from operations
2. Calculate the working capital cycle (in days)
3. Determine the average daily expenditure
4. Multiply daily expenditure by working capital cycle days

The options suggest this involves precise calculations based on specific business parameters outlined in the case scenario.

Question 16

Following data are given for a capital project:

Annual interim cash inflows for first two years: ₹ 1,00,000
Annual interim cash inflows for next two years: ₹ 80,000
Useful life: 4 Years
Salvage value at end of project: ₹ 50,000
Internal rate of return: 12%
Cost of capital: 10%

You are required to calculate the following:
(i) Initial investment
(ii) Net present value
(iii) Profitability Index
(iv) Discounted payback period
(v) MIRR

Accepted Answer

**Given Data:**
Annual cash inflows: Years 1–2 = ₹1,00,000 p.a.; Years 3–4 = ₹80,000 p.a.; Salvage value (Year 4) = ₹50,000; Life = 4 years; IRR = 12%; Cost of Capital (k) = 10%.

**(i) Initial Investment**

Since **IRR = 12%**, at this rate NPV = 0, meaning **PV of all cash inflows = Initial Investment**.

Using PV factors at 12%: Year 1 = 0.893, Year 2 = 0.797, Year 3 = 0.712, Year 4 = 0.636.

PV of inflows at 12%:
- Year 1: ₹1,00,000 × 0.893 = ₹89,300
- Year 2: ₹1,00,000 × 0.797 = ₹79,700
- Year 3: ₹80,000 × 0.712 = ₹56,960
- Year 4 (operating): ₹80,000 × 0.636 = ₹50,880
- Year 4 (salvage): ₹50,000 × 0.636 = ₹31,800

**Initial Investment = ₹3,08,640**

**(ii) Net Present Value (NPV)**

Using PV factors at 10% (cost of capital): Year 1 = 0.909, Year 2 = 0.826, Year 3 = 0.751, Year 4 = 0.683.

PV of inflows at 10%:
- Year 1: ₹1,00,000 × 0.909 = ₹90,900
- Year 2: ₹1,00,000 × 0.826 = ₹82,600
- Year 3: ₹80,000 × 0.751 = ₹60,080
- Year 4 (operating): ₹80,000 × 0.683 = ₹54,640
- Year 4 (salvage): ₹50,000 × 0.683 = ₹34,150

Total PV of inflows = ₹3,22,370

**NPV = ₹3,22,370 − ₹3,08,640 = ₹13,730** (Positive → Project is acceptable)

**(iii) Profitability Index (PI)**

**PI = PV of Future Cash Inflows / Initial Investment = ₹3,22,370 / ₹3,08,640 = 1.04**

Since PI > 1, the project is **financially viable**.

**(iv) Discounted Payback Period (DPP)**

Cumulative discounted cash inflows at 10%:
- End of Year 1: ₹90,900
- End of Year 2: ₹90,900 + ₹82,600 = ₹1,73,500
- End of Year 3: ₹1…

Question 17

Z Ltd. is an unlevered company. It wants to repurchase its equity shares of ₹ 300 lakhs by issue of 12% debentures of same amount. Current market value of Z Ltd. is ₹ 1,400 lakhs. Its cost of capital is 18%. The company will maintain same level of EBIT in future years. Dividend payout ratio is 100%. Company pays tax at a rate of 30%.

As per Modigliani and Miller approach, due to such change in capital structure, what will be the impact on the following?
(i) Market Value of Z Ltd.
(ii) Overall cost of capital
(iii) Cost of equity

Accepted Answer

As per the **Modigliani and Miller (MM) approach with corporate taxes**, the value of a levered firm exceeds the value of an unlevered firm by the present value of the tax shield on debt.

**(i) Market Value of Z Ltd. (Levered):**

Under MM with taxes: **VL = VU + T × D**

VL = ₹1,400 + (0.30 × ₹300) = ₹1,400 + ₹90 = **₹1,490 lakhs**

The market value increases by ₹90 lakhs (the tax shield benefit), as the interest on debentures is tax-deductible, reducing the firm's tax outflow permanently.

**(ii) Overall Cost of Capital (WACC):**

First, EBIT is derived from the unlevered firm: VU = EBIT(1−T)/Ku → EBIT = 1,400 × 0.18/0.70 = **₹360 lakhs**

WACC = EBIT(1−T) / VL = 252 / 1,490 = **16.91%**

Alternatively: WACC = Ku × [1 − (T × D/VL)] = 18% × [1 − (90/1,490)] = 18% × 0.9396 = **16.91%**

The overall cost of capital **falls from 18% to 16.91%** due to the tax advantage of debt financing.

**(iii) Cost of Equity (Ke):**

Value of Equity (E) = VL − D = 1,490 − 300 = ₹1,190 lakhs

Using MM with taxes formula: **Ke = Ku + (Ku − Kd)(1−T)(D/E)**

Ke = 18% + (18% − 12%) × 0.70 × (300/1,190)
= 18% + 6% × 0.70 × 0.2521
= 18% + **1.06%** = **19.06%**

The cost of equity **rises from 18% to 19.06%** because equity holders face higher financial risk due to the introduction of debt, even though the firm value increases. The rise in Ke is moderated (compared to MM without taxes) because the tax shield partially offsets the increase in financial risk.

Question 18

What will be the total estimated current liabilities?

Accepted Answer

**Answer: (D) ₹2,25,000**

The total estimated current liabilities are computed by identifying all amounts payable/outstanding at year-end. Since the proposal is on **cash cost basis**, only cash outflows are considered.

**1. Creditors for Raw Material:** Raw material = 25% of ₹30,00,000 = ₹7,50,000 p.a. Credit period = 2 months. Creditors = ₹7,50,000 × 2/12 = **₹1,25,000**

**2. Outstanding Wages:** Wages = 20% of ₹30,00,000 = ₹6,00,000 p.a. Lag = ½ month. Outstanding = ₹6,00,000 × 0.5/12 = **₹25,000**

**3. Outstanding Cash Manufacturing Overhead:** Directly given as outstanding at year-end = **₹60,000**

**4. Outstanding Administrative Expenses:** Total = ₹1,80,000 p.a. Paid after 1 month. Outstanding = ₹1,80,000 × 1/12 = **₹15,000**

**5. Sales Promotion Expenses:** ₹90,000 p.a., paid quarterly **in advance** — this is a prepaid expense (current asset), not a current liability. Hence, **excluded** from current liabilities.

**Total Current Liabilities = ₹1,25,000 + ₹25,000 + ₹60,000 + ₹15,000 = ₹2,25,000**

Question 19

What is agency cost and what are its types? How can a company minimize agency cost and align the interest of manager and shareholder?

Accepted Answer

**Agency Cost** refers to the economic loss or expense arising from the conflict of interest between managers (agents) who control and operate the company and shareholders (principals) who own it. It represents the cost of the **separation of ownership and control**, where managers may pursue their own interests at the expense of shareholders.

**Types of Agency Cost:**

**1. Monitoring Costs** – Expenditures incurred by shareholders to supervise and monitor managerial decisions and actions. Examples include costs of audits, board meetings, financial statement reviews, and establishing internal audit departments.

**2. Bonding Costs** – Costs incurred by managers to demonstrate their commitment to acting in shareholders' interests. These include costs of hiring external auditors, establishing internal control systems, and obtaining fidelity insurance.

**3. Residual Loss** – The economic loss remaining even after monitoring and bonding expenditures have been made. It arises from the fundamental inability to completely eliminate the divergence between management decisions and optimal shareholder decisions.

**Methods to Minimize Agency Cost and Align Interests:**

**Performance-Based Compensation** – Linking managerial remuneration directly to company performance through stock options, ESOPs (Employee Stock Ownership Plans), performance bonuses, and equity grants ensures managers benefit when shareholder value increases.

**Optimal Debt Financing** – Strategic use of debt intr…

Question 20

What are key features of bridge financing?

Accepted Answer

**Bridge financing** is a short-term loan facility arranged to bridge the gap between when funds are urgently needed and when permanent financing sources become available. The key features are:

**1. Short-term Nature**: Bridge loans are temporary financing arrangements with tenures typically ranging from 3 months to 2 years. They are designed to provide interim funding until the borrower can arrange long-term financing.

**2. Quick Disbursement**: One of the primary advantages is rapid fund availability. Bridge financing is arranged quickly to meet immediate working capital needs or operational gaps, with minimal documentation compared to conventional term loans.

**3. High Rate of Interest**: Due to the short-term nature, higher risk profile, and quick availability, bridge loans carry significantly higher interest rates than conventional financing options. The lender charges a premium for the quick turnaround and liquidity provided.

**4. Defined Exit Route**: A critical feature is that the borrower must have a clear exit strategy or repayment source identified. This could be IPO proceeds, merger/acquisition funds, asset sales, supplier credit, or long-term institutional financing. This reduces lender risk and is essential for approval.

**5. Flexible Terms and Conditions**: Bridge loans offer greater flexibility in repayment schedules, security requirements, and covenants compared to structured term loans. Repayment can be bullet repayment or in installments as per agreeme…

Question 21

What is hierarchy of financing under 'Pecking Order' theory, and why does it exist?

Accepted Answer

The **Pecking Order Theory**, developed by Myers and Majluf, proposes that firms follow a specific hierarchy when selecting financing sources:

**Hierarchy of Financing (in order of preference):**

1. **Internal Financing (Retained Earnings)** - First preference; no external involvement
2. **Debt Financing** - Second preference; external but manageable
3. **Equity Financing** - Last preference; most costly and dilutive

**Why This Hierarchy Exists:**

The hierarchy stems primarily from **information asymmetry** between managers and external investors. Managers possess superior information about the firm's true value and future prospects compared to external parties. This asymmetry creates three critical reasons:

**1. Signaling Effects:** When a firm issues new equity, external investors interpret it as a negative signal—management likely believes the stock is overvalued or the firm faces financial distress and urgently needs cash. Conversely, debt issuance signals management's confidence in future cash flows. Retained earnings send no adverse signal, making them most preferred.

**2. Floatation Costs:** Internal financing incurs zero floatation costs. Debt carries minimal floatation costs, while equity issuance involves substantial floatation expenses (underwriting, legal fees) plus shareholder dilution, making it most expensive.

**3. Agency Costs:** Retaining earnings avoids agency costs of external financing. External equity increases agency conflicts between managers and…

Question 22

The total risk of any business is the combination of degree of operating and financial risk. In the light of the above statement, you are required to consider the first two columns of the given table and give your comments in the 3rd column. Your comments should depict the total risk profile by using the most appropriate amongst the following three words only: Lower, Higher and Moderate. Also select the best combination of DOL and DFL from the given table.

Accepted Answer

**Total Risk = Operating Risk × Financial Risk**, measured by **Degree of Total Leverage (DTL) = DOL × DFL**.

**Operating Risk** arises from the cost structure of the firm (fixed vs. variable costs) and is captured by **DOL (Degree of Operating Leverage)**. **Financial Risk** arises from the use of fixed-cost financing (debt) and is captured by **DFL (Degree of Financial Leverage)**. Since total risk is the product of both, a high value in either dimension amplifies overall risk.

**Comments on Total Risk Profile:**

**(a) High DOL + High DFL → Total Risk: Higher**
Both operating and financial leverage are high. Any change in sales causes a magnified impact on EBIT (due to high DOL), which is further magnified at the EPS level (due to high DFL). Combined effect is the **highest** total risk.

**(b) High DOL + Low DFL → Total Risk: Moderate**
High operating leverage is partially offset by low financial leverage. The magnification at the EBIT level is high, but the impact on EPS is cushioned. Overall risk is **moderate**.

**(c) Low DOL + High DFL → Total Risk: Moderate**
Low operating leverage keeps EBIT relatively stable despite sales fluctuations, but high financial leverage then amplifies the effect on EPS. Net effect is again **moderate**.

**(d) Low DOL + Low DFL → Total Risk: Lower**
Both leverages are low. Sales fluctuations cause minimal impact on EBIT and further minimal impact on EPS. This combination results in the **lowest** total risk.

**Best Combination:** **Lo…

Question 23

What will be the total manufacturing cost and total cost of sales on cash cost basis?

Accepted Answer

**Answer: Cannot determine without complete data**

This question asks for manufacturing cost and cost of sales on a cash cost basis, but the problem statement containing the necessary financial data is missing. To solve such questions, we require:

• Opening and closing stock (raw materials, work-in-progress, finished goods)
• Details of manufacturing expenses (materials, labor, overhead)
• Information about accruals, prepayments, and provisions
• Depreciation and other non-cash items
• Cash payments made during the period

A complete answer requires converting accrual-based costs to cash basis by:

**Manufacturing Cost (Cash Basis)** = Accrual-based manufacturing cost − Non-cash expenses (depreciation, amortization) ± Changes in prepayments and accruals

**Cost of Sales (Cash Basis)** = Manufacturing cost (cash basis) + Opening finished goods inventory − Closing finished goods inventory, adjusted for cash basis

Without the underlying problem data, none of the given options can be verified as correct.

Question 24

You are required to:
(i) Prepare balance Sheet for the year ended 31st March, 2025.
(ii) Calculate EPS.
(iii) Calculate percentage change in earnings per share, if sales increase by 5%.

Accepted Answer

**Note: The question appears to be incomplete — no financial data (trial balance, given figures, or supporting schedules) has been provided.** The following solution framework and illustrative working assumes a typical CA Inter scenario. Please provide the actual data for a precise answer.

**Part (i): Balance Sheet as at 31st March, 2025**

A Balance Sheet under **Schedule III of the Companies Act, 2013** is prepared in vertical format with two sides: **Equity & Liabilities** and **Assets**.

*Equity & Liabilities side* includes: (a) Shareholders' Funds — Share Capital and Reserves & Surplus; (b) Non-Current Liabilities — Long-term borrowings, Deferred tax liabilities; (c) Current Liabilities — Trade payables, Short-term borrowings, Other current liabilities, Short-term provisions.

*Assets side* includes: (a) Non-Current Assets — Fixed Assets (Tangible + Intangible), Long-term investments, Deferred tax assets; (b) Current Assets — Inventories, Trade receivables, Cash & Cash equivalents, Short-term loans and advances.

All items must be classified and presented as per **Schedule III, Part I of the Companies Act, 2013**.

**Part (ii): Earnings Per Share (EPS)**

As per **AS 20 — Earnings Per Share**, Basic EPS is computed as:

**Basic EPS = (Net Profit after Tax − Preference Dividend) ÷ Weighted Average Number of Equity Shares**

If there are dilutive instruments (convertible debentures, ESOPs, warrants), **Diluted EPS** is also computed by adjusting both numerator (adding ba…

Question 25

What is agency cost and what are its types? How can a company minimize agency cost and align the interest of manager and shareholder?

Accepted Answer

**Agency Cost** is the cost incurred due to conflicts of interest between principals (shareholders) and agents (managers) arising from the separation of ownership and management in corporations. It represents the economic loss that occurs when those who manage a company do not have the same objectives as the shareholders. This concept is central to understanding corporate finance and governance.

**Types of Agency Cost:**

**1. Monitoring Costs** are expenses incurred by shareholders to supervise and monitor management's actions and ensure they work in shareholders' interests. These include costs of audits, compliance reviews, and oversight mechanisms.

**2. Bonding Costs** are expenditures made by managers to assure shareholders that they will act in the shareholders' interest. These include costs of certifications, performance audits, and voluntary disclosure of information.

**3. Residual Loss** is the economic loss that remains even after monitoring and bonding efforts. It arises from sub-optimal decisions made by managers when their interests diverge from shareholders', which cannot be completely eliminated.

**Methods to Minimize Agency Cost and Align Interests:**

**1. Performance-Based Compensation** ensures that managerial remuneration is tied to company performance and shareholder returns, creating alignment between manager and shareholder objectives.

**2. Stock Options and ESOP** allow managers to own equity in the company, making them shareholders themselves and …

Question 26

What are key features of bridge financing?

Accepted Answer

**Bridge financing** is a short-term financing arrangement designed to bridge the gap between immediate financial requirements and the availability of long-term or permanent financing. Key features include:

**Short-term Nature**: Bridge loans are temporary funding sources, typically ranging from a few weeks to one year, providing funds until long-term financing is arranged or a definite repayment source materializes.

**Higher Cost**: These loans carry significantly higher interest rates compared to conventional long-term financing due to their short tenure, flexibility, risk profile, and expedited processing nature.

**Flexible Terms and Conditions**: The terms are more flexible than traditional loans, allowing customized repayment schedules and quick approval processes to meet urgent funding needs of borrowers without lengthy documentation.

**Quick Disbursement**: Bridge financing is characterized by expedited approval and rapid fund disbursement, enabling organizations to access liquidity immediately without the lengthy processes associated with long-term financing.

**Identified Repayment Source**: Repayment is expected from a specific identified source such as proceeds from long-term loans, project cash flows, asset sales, expected working capital generation, or refinancing.

**Minimal Security Requirements**: Bridge loans may be unsecured or lightly secured depending on the borrower's creditworthiness and the lender's confidence in the designated repayment source.

**…

Question 27

What is hierarchy of financing under 'Pecking Order' theory, and why does it exist?

Accepted Answer

**Pecking Order Theory** establishes a hierarchy of financing preferences that companies follow when raising capital for their investments:

**Hierarchy of Financing (in order of preference):**

1. **Internal Financing (Retained Earnings)** – Most preferred source. Companies first utilize profits earned and retained within the business.
2. **Debt Financing** – Second preference. Companies issue debt instruments (bonds, bank loans) if internal funds are insufficient.
3. **External Equity Financing** – Least preferred. Companies issue new shares only as a last resort when debt capacity is exhausted.

**Why This Hierarchy Exists:**

**Information Asymmetry:** Managers possess superior information about the company's true value compared to external investors. This creates uncertainty in the minds of potential equity investors about whether shares are fairly priced.

**Signaling Effect:** Issuance of new equity sends a negative signal to the market that managers believe the stock is overvalued. Consequently, equity issuance often leads to stock price decline and is perceived unfavorably by existing shareholders.

**Cost Considerations:** Retained earnings have no flotation costs, whereas equity issuance involves significant transaction costs (underwriting fees, registration expenses). Debt is also cheaper than equity due to lower information asymmetry and tax deductibility of interest.

**Agency Costs and Discipline:** Debt creates fixed obligations that impose financial disciplin…

Question 28

"The total risk of any business is the combination of degree of operating and financial risk". In the light of the above statement, consider the first two columns of the given table and give your comments in the 3rd column. Your comments should depict the total risk profile by using the most appropriate amongst the following three words only: Lower, Higher and Moderate. Also select the best combination of DOL and DFL from the given table.

Accepted Answer

The **Degree of Combined Leverage (DCL)** represents the total business risk and is the product of **Degree of Operating Leverage (DOL)** and **Degree of Financial Leverage (DFL)**. The total risk profile for each combination is assessed as follows:

| DOL | DFL | Total Risk (Comment) |
|-----|-----|----------------------|
| High | High | **Higher** |
| High | Low | **Moderate** |
| Low | High | **Moderate** |
| Low | Low | **Lower** |

**Rationale:** When both DOL and DFL are high, every unit change in sales magnifies EBIT greatly (operating risk), and that magnified EBIT change is further amplified at the EPS level (financial risk), resulting in **Higher** total risk. When one is high and the other is low, the effects partially offset, producing **Moderate** total risk. When both are low, sensitivity is minimised at both levels, yielding **Lower** total risk.

**Best Combination:** **Low DOL + Low DFL** — this combination results in the **Lower** total risk profile, meaning a firm can absorb fluctuations in sales with minimal adverse impact on EPS. This is the most desirable combination from a risk management perspective.

Question 29

What will be the estimated working capital to be submitted by you in the proposal?

Accepted Answer

**Answer: (A) ₹5,33,775**

The estimated working capital on **cash cost basis** with a 10% margin of safety is computed by identifying all current assets (CA) and current liabilities (CL), finding the net working capital (NWC = CA − CL), and then grossing up by the margin of safety.

**Key Derivations:**
Sales = ₹30,00,000. Since gross profit is 25% on COGS → Sales = 1.25 × COGS → COGS = ₹24,00,000.
Raw material (RM) = 25% of sales = ₹7,50,000. Wages = 20% of sales = ₹6,00,000.
Outstanding cash manufacturing OH at year-end = ₹60,000 (1-month lag) → Annual cash mfg OH = ₹7,20,000.
Depreciation (balancing figure) = 24,00,000 − (7,50,000 + 6,00,000 + 7,20,000) = ₹3,30,000.
Cash manufacturing cost = 24,00,000 − 3,30,000 = **₹20,70,000**.
Total cash cost = 7,50,000 + 6,00,000 + 7,20,000 + 1,80,000 + 90,000 = ₹23,40,000.
Cash cost ratio = 23,40,000 / 30,00,000 = **78%**.

**Current Assets:**
- Cash balance: ₹90,000
- RM stock (1.5 months): ₹93,750
- Finished goods stock (1 month, at cash mfg cost): ₹1,72,500
- Domestic debtors (2 months, 80% of sales at cash cost): ₹3,12,000
- Foreign debtors (½ month, 20% of sales at cash cost): ₹19,500
- Advance for sales promotion (quarterly in advance = 1 quarter): ₹22,500
- **Total CA = ₹7,10,250**

**Current Liabilities:**
- RM creditors (2 months): ₹1,25,000
- Wages payable (½ month): ₹25,000
- Mfg OH payable (1 month): ₹60,000
- Admin expenses payable (1 month): ₹15,000
- **Total CL = ₹2,25,000**

**Net Working Capital = ₹7,10,250 − ₹2,25,0…

Question 30

You are required to calculate the following:

Accepted Answer

**Sub-part (b): Walter's Model — Maximum and Minimum Share Price of H Ltd**

**Walter's Model Formula:**

P = [D + (r / Ke) × (E – D)] / Ke

Where: P = Market price per share, D = Dividend per share, E = EPS, r = Return on investment, Ke = Cost of equity

**Given:** EPS (E) = ₹3.00, r = 20%, Ke = 15%

Since **r > Ke** (20% > 15%), H Ltd is a **Growth Firm**. In a growth firm, the company earns more on retained earnings than the shareholders' required return, so:
- **Maximum price** is achieved when **D = 0** (retain all earnings — zero dividend payout)
- **Minimum price** is achieved when **D = E = ₹3** (distribute all earnings — 100% payout)

**Maximum Price (D = 0):**

P = [0 + (0.20/0.15) × (3 – 0)] / 0.15 = [1.3333 × 3] / 0.15 = 4.00 / 0.15 = **₹26.67**

**Minimum Price (D = E = ₹3):**

P = [3 + (0.20/0.15) × (3 – 3)] / 0.15 = [3 + 0] / 0.15 = **₹20.00**

**Conclusion:** As per Walter's Model, the **maximum price of the share is ₹26.67** (at zero dividend) and the **minimum price is ₹20.00** (at 100% dividend payout).

CA Inter FM + SM

Drill 5 questions from this paper — instant grading

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Write it like this

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Worked Solution

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3Common trap

Liabilities	₹	Assets	₹
Shareholders' Funds	375	Fixed Assets	480
External Liabilities	825	Raw Material Inventory	64
		Finished Goods Inventory	80
		Trade Debtors	360
		Cash & Bank Balance	216
Total	1,200	Total	1,200