Management of Working – CA Inter FM Notes is designed strictly as per the latest syllabus and exam pattern.

Management of Working – CA Inter FM Notes

1. Management of Cash:

Step 1: Prepare cash budget for coming period
Step 2: Take action for coming period on the basis of cash budget

Situations	Planning
Budgeted Cash Balance < Desired Cash Balance         (Deficit Cash)	Plan to arrange cash to fulfil deficiency of cash (Like: Sell of marketable securities or arrangement of overdraft etc.)
Budgeted Cash Balance = Desired Cash Balance (Sufficient Cash)	No action
Budgeted Cash Balance > Desired Cash Balance        (Surplus Cash)	Plan to invest surplus cash (Like: Purchase of marketable securities or invest surplus cash elsewhere)

Proforma Cash Budget

2. Cash Cycle = F + D – C

3. Cash Turnover = 12 months (365 days) ÷ Cash Cycle Period

4. William J. BaumoVs Economic Order Quantity Model, (1952): According to this model, optimum cash level is that level of cash where the carrying costs and transactions costs are the minimum.

Optimum Cash Transaction (C) = \(\sqrt{\frac{2 \mathrm{U} \times \mathrm{P}}{\mathrm{S}}}\)
Where,
C = Optimum cash balance
U = Annual (or monthly) cash disbursement
P = Fixed cost per transaction
S = Opportunity cost of one rupee p.a. (or p.m.)

The model is based on the following assumptions:

• Cash needs of the firm are known with certainty.
• The cash is used uniformly over a period of time and it is also known with certainty.
• The holding cost is known and it is constant.
• The transaction cost also remains constant.

5. Miller-Orr Cash Management Model (1966): According to this model the net cash flow is completely stochastic. In this model control limits are set for cash balances. These limits may consist of h as upper limit, z as the return point; and zero as the lower limit.

• When the cash balance reaches the upper limit, the transfer of cash equal to h – z is invested in marketable securities account.
• When it touches the lower limit, a transfer from marketable securities account to cash account is made.
• During the period when cash balance stays between (h, z) and (z, 0) Le. high and low limits no transactions between cash and marketable securities account is made.

6. Management of Receivables: Management of receivables provides an answer to the following questions:

• Whether credit should be allowed or not?
• To whom credit should be allowed?
• How much amount of credit should be allowed?
• How much credit period should be allowed?

7. Evaluation of Credit Policies (Total Approach):

Select the option having higher net benefit.

Note:
If tax is given in the question and:
a. Cost of fund or Required return or Opportunity cost if before tax: It must be deducted before tax.
b. Cost of fund or Required return or Opportunity cost if after tax: It must be deducted after tax.

Cost of fund or Required return or Opportunity cost is calculated on the basis of total of Variable and Fixed cost related to credit sales and Bad debt, cash discount and credit admin cost are ignored.

Cost of fund or Required return or opportunity cost is calculated as given below:
Formula 1 = (Variable cost + Fixed cost) × \(\frac{\mathrm{ACP}}{365 / 52 / 12}\) × Rate
Formula 2 = (Variable cost + Fixed cost) × \(\frac{1}{\text { DTR }}\) × Rate
Formula 3 = Cost of Debtors X Rate

Average collection period is used to calculate Cost of fund when question provides both average collection period and credit period allowed to debtors.

8. Evaluation of Credit Policies (Incremental Approach)

Statement of Evaluation of Credit Policies (Incremental Approach)

Select the option having higher Incremental net benefit

9. Meaning of Cash Discount with line:
‘x’/’y’, net ‘z’ days or 1 /10 net 45 days:

It means: if the bill is paid within 10 days, there is a 1% cash discount, other-wise, the total amount is due within 45 days.

10. Factoring Service:

Factoring Service: Factoring is an agreement between factor and business firm. Factor provides various services to business firm as per the factoring agreement.

11. Types of Factoring Services:

(a) Collection service: Factor collect amount from debtors on behalf of business firm and charge commission on total bill amount.
(b) Advance service: Factor collect amount from debtors on behalf of business firm and charge commission and also give advance to business firm against bill amount and charge interest.
(c) Non-recourse factoring: Factor suffers loss of bad debts under such arrangement.
(d) Recourse factoring: Business firm suffers loss of bad debts under such arrangement.

12. Steps in case of Collection Factoring Service:

Step 1: Calculate savings due to factoring proposal.
Step 2: Calculate cost due to factoring proposal.
Step 3: Calculate net benefit or loss and take decision accordingly.

Proforma Statement of Evaluation of Factoring Proposal

13. Steps in case of Advance Factoring Service:

Step 1: Calculate amount of advance:
Calculation of Amount of Advance

Step 2: Calculate Effective cost of Factoring (Annual):
Statement of Effective Cost of Factoring to the Firm (Annual)

Step 3: Compare Rate of Effective cost with Rate of Bank interest and take decision accordingly.

14. Forfaiting: Forfaiting is same as bill discounting with bank. In forfaiting a financial institution or bank buys the trade bills or trade receivables from ex-porters of goods or services and bank will receive amount due from importer instead of exporter.

Exporter receives immediate payment from financial institution on ‘without recourse’ basis in which risk and rewards related with the amount receivable is transferred to the financial institutions. It is a unique credit facility arrangement where an importer can open a “letter of credit” in favour of the exporter and can import goods and services on deferred payment terms.

15. Functions of Forfaiting:

• Exporter sells goods or services to an overseas buyer.
• The overseas buyers draws a letter of credit through its bank.
• The exporter on receiving the letter of credit approaches to its bank.
• The exporter’s bank buys the letter of credit ‘without recourse basis’ and provides the exporter the payment for the bill.

16. Features or Advantages of Forfaiting:

• Exporter can increase its business as payment is assured.
• Importer imports goods and services on deferred payment terms.
• Reduction in transaction costs and complexities in international trade transactions.
• The exporter can compete in the international market.
• Exporter can maintain sufficient working capital.

17. Working Capital: Working capital refers to funds invested in Stock of Raw Material, WIP, Finished Goods, Debtors, BR, and Prepaid etc. net of current liabilities.

• Gross Working Capital = Current Assets
• Net Working Capital = Current Assets – Current Liabilities

18. Permanent working capital: The minimum level of investment in the current assets that is carried by the entity at all times to carry its day to day activities.

19. Temporary working capital: It is used to finance the short term working capital requirements which arises due to fluctuation in sales volume. It is in additional of permanent working capital.

20. Estimation of Working Capital:
Method 1: Operating or Working Capital Cycle Method
Method 2: Component wise Estimation or Quantitative Estimation Method

21. Operating or Working Capital Cycle Method:
Step 1: Estimate Various Holding Period:

Step 2: Calculate Operating Cycle Period:
Operating Cycle Period = R + W + F + D – C

Step 3: Estimate Working Capital:

22. Component-wise Estimation Method:

Step 1: Prepare Projected Income Statement
Step 2: Prepare Statement of Estimated Working Capital

Proforma Statement of Working Capital Requirement

23. Valuation of Items Under Total and Cash Cost Approach

Items	Total Approach	Cash Cost Approach
Current Assets
Raw Material Stock	Valued on the basis of Raw Material Consumed	Valued on the basis of Raw Material Consumed
WIP Stock:
Materials	Valued on the basis of Raw Material Consumed	Valued on the basis of Raw Material Consumed
Wages	On the basis of Wages Cost	On the basis of Wages Cost
Production OH	On the basis of Production OH (including Depreciation)	On the basis of Production OH (excluding Depreciation)
Finished Goods Stock	Valued on the basis of Cost of Production (including Depreciation)	Valued on the basis of Cost of Production (excluding Depreciation)
Debtors:
Alternative 1	Valued on the basis of cost of credit sales (including Depreciation)	Valued on the basis of cost of credit sales (excluding Depreciation)
Alternative 2	Valued on the basis of credit sales	N. A.
Prepaid Wages	On the basis of Wages Cost	On the basis of Wages Cost
Prepaid Overheads	On the basis of OH (excluding Depreciation)	On the basis of OH (excluding Depreciation)
Cash and Bank	As per given information	As per given information
Creditors	On the basis of credit purchases	On the basis of credit purchases
Outstanding Wages	On the basis of Wages Cost	On the basis of Wages Cost
Outstanding Over­heads	On the basis of OH (excluding Depreciation)	On the basis of OH (excluding Depreciation)

Note:

• Depreciation can never be outstanding or prepaid
• Debtors can be valued on cost of credit sales (preferred) or amount of credit sales under total approach
• Depreciation and profit are fully ignored under cash cost approach
• Assumption in respect of % of completion of WIP:
  • Material cost 100%
  • Labour cost 50%
  • Production overheads 50%
• If nothing is specified, it is preferred to use total approach

24. Working Capital Estimation Charts of Existing and New Business:


Note: In case of new company Purchase of RM = RM consumed + Closing RM stock

25. Methods of MPBF as Per Mr. P. L. Tandon’s Tandon Committee (1974):

Methods	Maximum Permissible Bank Finance (MPBF)
Method I	15% of (Current Assets Less Current Liabilities) ie. 15% of Net Working Capital
Method II	(15% of Current Assets) Less Current Liabilities
Method III	(15% of Soft Core Current Assets) Less Current Liabilities

Note: During the computation of MPBF current liabilities must be excluding existing bank finance.

26. Impact of Double Shift:

Items	Impact
Production and Sales	Double
Variable Cost	Double
Fixed Cost	No change
Raw Material Stock	Double in quantity and value subject to quantity discount
WIP stock	No change in units
Finished Goods Stock	Double in quantity, lower than double in value due to fixed cost
Debtors	Double

Cost of Capital – CA Inter FM Notes is designed strictly as per the latest syllabus and exam pattern.

Cost of Capital – CA Inter FM Notes

1. Cost of Capital: Cost of capital is the return expected by the providers of capital (i.e. shareholders, lenders and the debt-holders) to the business as a compensation for their contribution to the total capital. Cost of capital is also known as ‘cut-off’ rate, ‘hurdle rate’, ‘minimum rate of return’ etc.

2. Components of Cost of Capital:

3. Cost of Debt (K_d):

(a) Cost of Irredeemable Debenture:
K_d = \(\frac{\mathrm{I}(1-\mathrm{t})}{\mathrm{NP}}\) × 100
Where,
I = Amount of Interest
t = Tax rate
NP = Net Proceeds of Debenture or Current Market Price
Note: If Face Value of Debenture equal to Net Proceeds then
K_d = Rate of Interest (1 – t)

(b) Cost of Redeemable Debenture (in Lump sum):
Approximation Method:
K_d = \(\frac{\mathrm{I}(1-\mathrm{t})+\left(\frac{\mathrm{RV}-\mathrm{NP}}{\mathrm{n}}\right)}{\frac{\mathrm{RV}+\mathrm{NP}}{2}}\) × 100 0r \(\frac{\left(I+\frac{R V-N P}{n}\right)(1-t)}{\frac{R V+N P}{2}}\) × 100
Where, I = Amount of Interest.
RV = Redemption value of Debenture
NP = Net Proceeds of Debenture or Current Market Price
n = Remaining Life of Debenture
Present Value Method (PV)/Yield to Maturity Method (YTM):
K_d = IRR = L + \(\frac{\mathrm{NPV}_{\mathrm{L}}}{\mathrm{NPV}_{\mathrm{L}}-\mathrm{NPV}_{\mathrm{H}}}\) × (H – L)

(c) Cost of Redeemable Debenture (in Instalments):
K_d = IRR = L + \(\frac{\mathrm{NPV}_{\mathrm{L}}}{\mathrm{NPV}_{\mathrm{L}}-\mathrm{NPV}_{\mathrm{H}}}\) × (H – L)

(d) Cost of Zero Coupon Bonds (ZCB):
K_d = \(\sqrt[n]{\frac{\mathrm{RV}}{\mathrm{IP}}}\) – 1
Where, I = Amount of Interest.
RV = Redemption value of Debenture
IP – Issue Price of Bond
n = Life of Bond
Note:

• In case of convertible debenture use convertible value in place of redemption value of debenture.
• If nothing is specified, issue price, redemption value etc. assumed to be equal to face value.
• If nothing is specified, floatation cost assumed to be linked with “face value or issue price whichever is higher”.

4. Cost of Preference Share Capital (K_p):

(a) Cost of Irredeemable Preference Share:
K_p = \(\quad \frac{\mathrm{PD}}{\mathrm{NP}}\) × 100
Where,
PD = Amount of Preference Dividend
NP = Net Proceeds of Preference Share or Current Market Price of Preference Share
Note: If Face Value of Preference Share equal to Net Proceeds then
K_p = Rate of Preference Dividend

(b) Cost of Redeemable Preference Share (in Lump sum):
Approximation Method:
K_p = \(\frac{\mathrm{PD}+\left(\frac{\mathrm{RV}-\mathrm{NP}}{\mathrm{n}}\right)}{\frac{\mathrm{RV}+\mathrm{NP}}{2}}\) × 100
Where,
PD = Amount of Preference Dividend
RV = Redemption value of Preference Share
NP = Net Proceeds of Preference Share or Current Market Price of Preference Share
n = Remaining Life of Preference Share
Present Value Method (PV)/Yield to Maturity Method (YTM):
K_p = IRR = L + \(\frac{\mathrm{NPV}_{\mathrm{L}}}{\mathrm{NPV}_{\mathrm{L}}-\mathrm{NPV}_{\mathrm{H}}}\) × (H – L)

(c) Cost of Redeemable Preference Share (in Instalments):
K_d = IRR = L + \(\frac{\mathrm{NPV}_{\mathrm{L}}}{\mathrm{NPV}_{\mathrm{L}}-\mathrm{NPV}_{\mathrm{H}}}\) × (H – L)
Note:

• In case of convertible preference share use convertible value in place of redemption value.
• If nothing is specified, issue price, redemption value etc. assumed to be equal to face value.
• If nothing is specified, floatation cost assumed to be linked with “face value or issue price whichever is higher”.

5. Cost of Equity Share Capital (K_e):

(a) Dividend Price /Yield Approach:
K_e = \(\frac{\mathrm{D}}{\mathrm{P}_0}\) × 100
Where,
D = Expected/Current Dividend
P₀ = Current Market Price of Equity Share
Assumption: Constant Dividend

(b) Earning Price /Yield Approach:
K_e = \(\frac{\mathrm{E}}{\mathrm{P}_0}\) × 100
Where,
E = Expected/Current EPS
P₀ = Current Market Price of Equity Share
Assumption: Constant EPS

(c) Growth Approach or Gordon’s Model:
K_e = \(\frac{\mathrm{D}_1}{\mathrm{P}_0}\) + g or \(\frac{\mathrm{D}_0(1+\mathrm{g})}{\mathrm{P}_0}\) + g
Where,
D₁ = D₀ (1 + g) = Expected DPS
P₀ = Current Market Price of Equity Share
g = Constant Growth Rate of Dividend
Note:

• In case of fresh issue of Equity shares (New Shares), Net Proceeds from equity share {(Issue price – Issue expenses/Floatation cost) or (P – F)} is used in place of current price of share.
• If nothing is specified, floatation cost assumed to be linked with “face value or issue price whichever is higher”.
• Estimation of Growth Rate:
  (a) Average Method: Growth rate = \(\sqrt[n]{\frac{D_0}{D_n}}\) – 1
  D₀ = Current Dividend
  D_n = Dividend in n years ago

(b) Gordon’s Growth Model: g = b × r
r = Rate of return on fund invested
b = Earning retention ratio

(c) Realised Yield Approach:
K_e = Average rate of return realised in past few years
= IRR or Geometric mean

(d) Capital Asset Pricing Model (CAPM);
K_e = R_f + B (R_m – R_f)
R_f = Risk Free Rate of Return
R_m = Rate of Return on Market Portfolio
R_m – R_f = Market Risk Premium
β = Beta coefficient

6. Cost of Retained Earnings (Kr): After tax return to shareholder if he invest elsewhere.
Formulae:
K_r = K_e (of existing investors)
K_r = K_e (1 – t_p) (In case of personal tax)
K_r = K_e (1 – t_p) (1 – f) (f is rate of floatation cost)

7. Weighted Average Cost of Capital (K₀): WACC is also known as the overall cost of capital of having capitals from the different sources as explained above. WACC of a company depends on the capital structure of a company. Weighted average cost of capital is the weighted average after tax costs of the individual components of firm’s capital structure. That is, the after tax cost of each debt and equity is calculated separately and added together to a single overall cost of capital. It can be calculated by using either Book Value weights or Market Value weights.

Proforma Statement of WACC

Capital Structure (a)	Amount (b)	Weight (c)	Specific Cost (d)	Cost of Capital (e) = c × d
Equity Share Capital	XXX	0.XXX	0.XX	0.0XX
Retained Earnings	XXX	0.XXX	0.XX	0.0XX
Preference Share Capital	XXX	0.XXX	0.XX	0.0XX
Debentures	XXX	0.XXX	0.XX	0.0XX
Total	XXX	1.000	WACC	0.0XXX

Note: Market Value of equity has been apportioned in the ratio of Book Value of equity and retained earnings when Market Value weights are used.

8. Marginal Cost of Capital (MCC): The marginal cost of capital may be defined as the cost of raising an additional rupee of capital. Marginal cost of capital is derived, when the average cost of capital is calculated using the marginal weights.

Financial Analysis and Planning-Ratio Analysis – CA Inter FM Notes is designed strictly as per the latest syllabus and exam pattern.

Financial Analysis and Planning-Ratio Analysis – CA Inter FM Notes

1. Financial/Account Ratio:
A ratio is defined as “the indicated quotient of two mathematical expressions and as the relationship between two or more things.” Here ratio means financial ratio or accounting ratio which is a mathematical expression of the relationship between accounting figures.

2. Ratio Analysis:
Ratio analysis is a relationship expressed in mathematical terms between two individual figures or group of figures connected with each other in some logical manner and are selected from financial statements of the concern to draw conclusions about the performance (past, present and future), strengths & weaknesses of a firm and can take decisions in relation to the firm.

3. Types of Ratios:

4. Profitability Ratios:
The profitability ratios measure the profitability or the operational efficiency of the firm. Profitability ratios are broadly classified in four categories:

• Profitability Ratios related to Sales.
• Profitability Ratios related to overall Return on Investment/Assets.
• Profitability Ratios required for Analysis from Owner’s Point of View.
• Profitability Ratios related to Market/Valuation/Investors.

(A) Profitability Ratios Related to Sales:

Note:

• Operating Expenses = Administration Expenses + Selling Expenses
• Sales must be excluding indirect tax (GST if any) and net of sales return.

(B) Profitability Ratios Related to Overall Return on Investment or Assets:
(a) Return on Assets (RUA):

(b) Return on Capital Employed (ROCE):

1. Pre Tax (Before Tax) = \(\frac{\text { EBIT }}{\text { Average Capital Employed }}\) × 100
2. Post Tax (After Tax) = \(\frac{\text { EBIT }(1-t)}{\text { Average Capital Employed }}\) × 100

(c) Return on Equity (ROE) = \(\frac{\text { EAT }- \text { Preference Dividend }}{\text { Equity Shareholders’ Fund }}\) × 100
Note:

• Equity Share Holders Fund or Net Worth: Equity Share Capital + Reserve and Surplus – Fictitious Assets.
• Shareholders Fund or Owners Fund or Proprietors Fund: Equity Share Holders’ Fund + Preference Share Capital.
• Capital Employed:
  Alternative 1: Liability Route: Shareholders Fund + Long Term Debt – Non Trade Investments – Capital WIP.
  Alternative 2: Assets Route: Fixed Assets + Long Term trade Investments + Working Capital.
• Total Assets must be excluding fictitious assets.
• If one figure is opted from P/L and another from Balance Sheet then average of Balance Sheet figure shall be taken if possible.

(C) Profitability Ratios Required For Analysis From Owner’s Point of View:
(a) Earnings Per Share (EPS) = \(\frac{\text { EAT }- \text { Preference Dividend }}{\text { No. of Equity Shares Outstanding }}\)
(b) Dividend Per Share (DPS) = \(\frac{\text { Equity Dividend }}{\text { No. of Equity Shares Outstanding }}\)
(c) Dividend Payout Ratio (DP) = \(\frac{\mathrm{DPS}}{\mathrm{EPS}}\) X 100

(D) Profitability Ratios Related to Market/Valuation/Investors:

5. Return on Equity (ROE) as per DuPont Model:
Return on Equity (ROE) = Net Profit Margin × Asset Turnover × Equity Multiplier

6. Activity/Efficiency/Performance/Turnover Ratios: These ratios are employed to evaluate the efficiency with which the firm manages and utilises its assets.

Note:

• Sales must be excluding indirect tax (GST if any) and net of sales return.
• Total Assets must be excluding fictitious assets.
• If one figure is opted from P/L and another from Balance Sheet then average of Balance Sheet figure shall be taken if possible.
• In case of Stock Turnover Ratio = COGS is preferred
• In case of Receivable turnover ratio:
  1. Credit Sales net of Return including GST is used
  2. Debtors before Bad debt or Provision for Doubtful debt is used

7. Liquidity/Short Term Solvency Ratios: These ratios are used to measure short term solvency of the firm.
(a) Current Ratio = \(\frac{\text { Current Assets }}{\text { Current Liabilities }}\)
(b) Quick / Acid test / Liquid Ratio = \(\frac{\text { Quick / Liquid Assets }}{\text { Current Liabilities }}\)
Quick Assets or Liquid Assets = Current Assets – Stock (All) – Prepaid
(c) Cash Ratio/Absolute Liquidity

(e) Net Working Capital Ratio = Current Assets – Current Liabilities (Excluding short term bank borrowing)

8. Long Term Solvency Ratios/Leverage Ratios: These ratios are used to measure long term solvency (stability) and structure of the firm.
(A) Capital Structure Ratios:

(B) Coverage Ratios:

Note:

• Equity Share Holders Fund or Net Worth: Equity Share Capital + Reserve and Surplus – Fictitious Assets.
• Shareholders’ Equity or Shareholders Fund or Owners Fund or Proprietary Fund: Equity Share Holders’ Fund + Preference Share Capital.
• Total Debt or Total Outside Liabilities includes Short and Long term borrowings.
• Total Assets must be excluding fictitious assets.

CA Inter FM ECO Paper July 2021 – CA Inter FM ECO Study Material is designed strictly as per the latest syllabus and exam pattern.

CA Inter FM ECO Question Paper July 2021 Solution

Question 1.
(a) Current annual sales of SKD Ltd. ₹ 360 Lakhs. It’s directors are of the opinion that company’s current expenditure on receivables management is too high and with a view to reduce the expenditure they are considering following two new alternate credit policies:

Selling price per unit of product is ₹ 150. Total cost per unit is ₹ 120. Current credit terms are 2 months and percentage of default is 3%. Current annual collection expenditure is ₹ 8 Lakhs. Required rate of return on investment of SKD Ltd. is 20%.

Determine which credit policy SKD Ltd. should follow. (5 Marks)

Answer:

Statement of Evaluation of Credit Policies

SKD Ltd. should follow Policy X having lowest cost of credit.

Working Notes:

Calculation of cost of investment in debtors:

Current policy = 3,60,00,000 × 8096 × 2/12 × 20% = 9,60,000
Policy X = 3,60,00,000 × 8096 × 15/12 × 20% = 7,20,000
Policy Y = 3,60,00,000 × 8096 × 1/12 × 20% = 4,80,000
Percentage of cost of sales = 120/150 × 100 = 80%

(b) The details about two companies R Ltd. and S Ltd. having same operating risk are given below:

Particulars	R Ltd.	S Ltd.
Profit before interest and tax	₹ 10 Lakhs	₹ 10 Lakhs
Equity share capital ₹ 10 each	₹ 17 Lakhs	₹ 50 Lakhs
Long term borrowings @ 10%	₹ 33 Lakhs	–
Cost of Equity (K.)	18%	15%

(1) Calculate the value of equity of both the companies on the basis of M.M. Approach without tax.
(2) Calculate the total value of both the companies on the basis of M.M. Approach without tax. (5 Marks)

Answer:

(1) Value of Equity = \(\frac{\text { EBIT }-\mathrm{I}}{\mathrm{Ke}}\)
R Ltd. = \(\frac{\mathrm{EBIT}-\mathrm{I}}{\mathrm{Ke}}\) = \(\frac{10,00,000-10 \% \text { of } 33,00,000}{18 \%}\) = 37,22,222
S. Ltd. = \(\frac{\mathrm{EBIT}-\mathrm{I}}{\mathrm{Ke}}\) = \(\frac{10,00,000-0}{15 \%}\) = 66,66,667

(2) Value of Companies:
Value of S Ltd. (V_UL) = EBIT ÷ K₀ = 10,00,000 ÷ 15% = 66,66,667
Value of R Ltd. (V_L) = Value of S Ltd. (V_UL) = 66,66,667

Note: Alternatively Value of R Ltd. can be calculated as: V = S + D (V = 37,22,222 + 33,00,000 = 70,22,222).

(c) K. P. Ltd. is investing ₹ 50,00,000 in a project. The life of the project is 4 years. Risk free rate of return is 6% and risk premium is 6%, other information is as under:

Sales of 1^st year : ₹ 50,00,000
Sales of 2^nd year : ₹ 60,00,000
Sales of 3^rd year : ₹ 70,00,000
Sales of 4^th year : ₹ 80,00,000
P/V Ratio (same in all the years) : 50%
Fixed Cost (excluding Depreciation) of 1^st year : ₹ 10,00,000
Fixed Cost (excluding Depreciation) of 2^nd year ₹ 12,00,000
Fixed Cost (excluding Depreciation) of 3^rd year : ₹ 14,00,000
Fixed Cost (excluding Depreciation) of 4^th year : ₹ 16,00,000

Ignore interest and taxes, You are required to calculate NPV of given project on the basis of Risk Adjusted Discount Rate.
Discount factor @ 6% and 12% are as under:

Years	1	2	3	4
Discount Factor @ 6%	0.943	0.890	0.840	0.792
Discount Factor @ 12%	0.893	0.797	0.712	0.636

(5 Marks)
Answer:
Net Present Value Using Risk Adjusted Discount Rate

Year	Particulars	₹	DF @ 12%	PV
0	Initial outflows	(50,00,000)	1.000	(50,00,000)
1	Cash Inflows	15,00,000	0.893	13,39,500
2	Cash Inflows	18,00,000	0.797	14,34,600
3	Cash Inflows	21,00,000	0.712	14,95,200
4	Cash Inflows	24,00,000	0.636	15,26,400
NPV				7,95,700

Yes, accept the proposal having positive NPV.
Working Notes: Statement Showing Cash Inflows

(d) The following information relates to LMN Ltd.

Earnings of the Company	₹ 30,00,000
Dividend Payout ratio	60%
No. of shares outstanding	5,00,000
Rate of return on investment	15%
Equity capitalized rate	13%

Required:

1. Determine what would be the market value per share as per Walter’s model?
2. Compute optimum dividend payout ratio according to Walter’s model and the market value of company’s share at that payout ratio? (5 Marks)

Answer:

1. Calculation of market value per share as per, Walter’s model:
P = \(\frac{\mathrm{D}+(\mathrm{E}-\mathrm{D}) \times \frac{\mathrm{r}}{\mathrm{K}_{\mathrm{e}}}}{\mathrm{K}_{\mathrm{e}}}\) = \(\frac{3.60+(6-3.60) \times \frac{0.15}{0.13}}{0.13}\) = ₹ 6
DPS = EPS × Dividend payout ratio = ₹ 6 × 60% = 13.60

2. According to Walter’s model when the return on investment is more than the cost of equity capital, the price per share increases as the dividend payout ratio decreases. Hence, the optimum dividend payout ratio in this case is nil.

P(at 0 Payout) = \(\frac{\mathrm{D}+(\mathrm{E}-\mathrm{D}) \times \frac{\mathrm{r}}{\mathrm{K}_e}}{\mathrm{~K}_{\mathrm{e}}}\) = \(\frac{0+(6-0) \times \frac{0.15}{0.13}}{0.13}\) = ₹ 53.25

Question 2.
Following are the information of TT Ltd.:

Particulars
Earnings per share	₹ 10
Dividend per share	₹ 6
Expected growth rate in dividend	6%
Current market price per share	₹ 120
Tax rate	30%
Requirement of additional finance	₹ 30,00,000
Debt Equity ratio (for additional finance)	2 : 1
Cost of Debt: 0 – 5,00,000	10%
5,00,001 – 10,00,000	9%
Above 10,00,000	8%

Assuming that there is no Reserve and Surplus available in TT Ltd.

You are required to:

(a) Find the pattern of finance for additional requirement.
(b) Calculate post tax average cost of additional debt.
(c) Calculate cost of equity.
(d) Calculate overall weighted average after tax cost of additional finance. (10 Marks)

Answer:

(a) Pattern for additional requirement:
Total requirement of additional fund is ₹ 30,00,000. With a Debt Equity ratio of 2 : 1. It means ₹ 20,00,000 is to be raised through debt and ₹ 10,00,000 through equity. Out of ₹ 20,00,000 debt, first 5,00,000 @10%, next 5,00,000 @10% and remaining 10,00,000 @8%. Entire equity finance of ₹ 10,00,000 through issuing equity shares.

(b) Post tax average cost of additional debt:
K_d1 = I (1 – t) – 10% (1 – 0.30) = 7%
K_d2 = I (1 – t) = 9% (1 – 0.30) = 6.30%
K_d3 = I (1 – t) = 8% (1 – 0.30) = 5.60%
Average K_d = K_d1W_d1 + K_d2W_d2 + K_d3W_d3
= 7% × 5/20 + 6.3096 × 5/20 + 5.6096 × 10/20
= 6.125%

(c) Cost of Equity:
K_e = \(\frac{D_1}{P_0}\) + g = \(\frac{6(1+0.06)}{120}\) + 0.06 = 11.30%

(d) Overall WACC after tax of additional finance:
K₀ = K_eW_e + K_dW_d
= 11.30% × \(\frac{10}{30}\) + 6.12596 × \(\frac{20}{30}\) = 7.85%
Assumption: DPS is treated at D_o.

Question 3.
Masco Limited has furnished the following ratios and information relating to the year ended 31^st March, 2021.

Sales : ₹ 75,00,000
Return on Net Worth : 25%
Rate of Income Tax : 50%
Share Capital to Reserve : 6 : 4
Current Ratio : 2.5
Net Profit to Sales (after tax) : 6.50%
Inventory Turnover (Based on cost of goods sold) : 12
Cost of Goods Sold : ₹ 22,50,000
Interest on Debenture : ₹ 75,000
Receivables (includes Debtors ₹ 1,25,000) : ₹ 2,00,000
Payables : ₹ 2,50,000
Bank Overdraft : ₹ 1,50,000

You are required to:

(a) Calculate the operating expenses for the year ended 31^st March, 2021.
(b) Prepare Balance Sheet as on 31st March in the following format:

(10 Marks)
Answer:
(a) Operating Expenses = Gross Profit (Sales – COGS) – EBIT
= ₹ 52,50,000 (75,00,000 – 22,50,000) – ₹ 10,50,000
= ₹ 42,00,000

(b) Balance Sheet

Working notes:

1. Calculation of EBIT

2. Return on Net Worth \(=\frac{\text { PAT }}{\text { Net Worth }}\) × 100 = 25%
Net Worth = 4,87,500 ÷ 25% = 19,50,000
Net Worth = Share Capital + Reserve = 19,50,000
Share capital to Reserve = 6 : 4
Share capital = 19,50,000 × 6/10 = 11,70,000
Reserve = 19,50,000 × 4/10 = 7,80,000

3. Debentures \(=\frac{\text { Interest }}{\text { Rate of Interest }}\)
= 75,000 ÷ 15% = 5,00,000

4. Inventory \(=\frac{\text { COGS }}{\text { Closing Stock }}\)
Closing stock \(=\frac{\text { COGS }}{\text { Inventory Turnover }}\)
= \(\frac{22,50,000}{12}\) = 1,87,500

5. Current Ratio = \(=\frac{C A}{C L}\)
2.5 times \(=\frac{\text { Receivables }+ \text { Closing Stock }+ \text { Cash }}{\text { Payables }}\)
Cash = 2,50,000 × 2.5 – 2,00,000 – 1,87,500
= 2,37,500

Notes: Payables include bank overdraft and there is no Bank term loan.

Question 4.
An existing company has a machine in operation for two years, its estimated life is 4 years with no residual value in the end. Its current market value is ₹ 3 lakhs. The management is considering a proposal to purchase an improved model of a machine which gives increase output. The details are as under:

Assuming that cost of capital is 10% and the company uses written down value of depreciation @ 20% and it has several machines In 20% block.
Advice the management on the replacement of machine as per NPV method.
The discounting factor table given below:

Dicount Factors	Year 1	Year 2	Year 3	Year 4
10%	0.909	0.826	0.751	0.683

(10 Marks)
Answer:
Statement of NPV

Advise: The company should go ahead with replacement of machine, since it has positive NPV.

Working Notes:

1. Calculation of initial outflow:
Cost of new machine ₹ 10,00,000
Less: Sales value of old machine (₹ 3,00,000)
Add: Increase in Working Capital ₹ 1,00,000
Initial outflow ₹ 8,00,000

2. Total operating hours = 300 days × 6 hours = 1,800 hours

3. Increase in output = 1,800 hours × (40 – 20) = 36,000 units

4. Incremental Depreciation:
Year 1 = {10,00,000 – (6,00,000 × 8096 × 8096)} × 2096 = 1,23,200
Year 2 = 1,23,200 × 8096 = 98,560
Year 3 = 98,560 × 8096 = 78,840
Year 4 = 78,840 × 8096 = 63,078

5. Calculation of incremental CFAT:

Notes: Since company has several machines in 20% block of assets, there is no tax benefit on loss on sale of machine.

Question 5.
A Company had the following Balance Sheet as on 31^st March 31, 2021:

The additional information given is as under:

Fixed costs per annum (excluding interest) : ₹ 6 Crores
Variable operating costs ratio : 60% of sales
Total assets turnover ratio : 2.5 times
Income tax rate : 40%

Calculate the following and comment:

(a) Earnings per share
(b) Operating Leverage
(c) Financial Leverage
(d) Combined Leverage (10 Marks)

Answer:

(a) Statement of EPS

(b) Operating Leverage = \(\frac{\text { Contribution }}{\text { EBIT }}\) = \(\frac{30 \text { Crores }}{24 \text { Crores }}\) = 1.25 times

It indicates fixed cost in cost structure. It indicates sensitivity of earnings before interest and tax (EBIT) to change in sales at a particular level.

(c) Financial Leverage = \(\frac{\mathrm{EBIT}}{\mathrm{EBT}}\) = \(\frac{24 \text { Crores }}{21.75 \text { Crores }}\) = 1.10 times
The financial leverage is very comfortable since the debt service obligation is small vis-a-vis EBIT.

(d) Combined Leverage = OL × FL = 1.25 × 1.10 = 1.38 times

The combined leverage studies the choice of fixed cost in cost structure and choice of debt in capital structure. It studies how sensitive the change in EPS is vis-a-vis change in sales.
The leverages – operating, financial and combined are measures of risk.

Question 6.
(a) Explain in brief the forms of Post Shipment Finance. (4 Marks)
Answer:
Followings are the forms of Post Shipment Finance:

(a) Purchase /discounting of documentary export bills: Finance is provided to exporters by purchasing export bills drawn payable at sight or by discounting usance export bills covering confirmed sales and backed by documents including documents of the title of goods such as bill of lading, post parcel receipts, or air consignment notes.

(b) E.C.G.C. Guarantee: Post-shipment finance, given to an exporter by a bank through purchase, negotiation or discount of an export bill against an order, qualifies for post-shipment export credit guarantee. It is necessary, however, that exporters should obtain a shipment or contracts risk policy of E.C.G.C.

Banks insist on the exporters to take a contracts shipments (comprehensive risks) policy covering both political and commercial risks. The Corporation, on acceptance of the policy, will fix credit limits for individual exporters and the Corporation’s liability will be limited to the extent of the limit so fixed for the exporter concerned irrespective of the amount of the policy.

(c) Advance against export bills sent for collection: Finance is provided by banks to exporters by way of advance against export bills forwarded through them for collection, taking into account the creditworthiness of the party, nature of goods exported, usance, standing of drawee, etc.

(d) Advance against duty draw backs, cash subsidy, etc.: To finance export losses sustained by exporters, bank advance against duty draw-back, cash subsidy, etc., receivable by them against export performance. Such advances are of clean nature; hence necessary precaution should be exercised.

Question 6.
(b) Describe the salient features of FORFEITING. (4 Marks)
Answer:
‘Forfait’ is a French term which means “relinquish a right”. Forfaiting is an arrangement of bill discounting in which a financial institution or bank buys the trade bills (invoices) or trade receivables from exporters of goods or services, where the exporter relinquish his right to receive payment from importer. Financial Institutions or banks provides immediate finance to export er ‘without recourse’ basis in which risk and rewards related with the bills/ receivables transferred to the financial institutions/banks. It is a unique credit facility arrangement where an overseas buyer (importer) can open a “letter of credit” (or other negotiable instruments) in favour of the exporter and can import goods and services on deferred payment terms.

Features of Forfaiting

(a) It motivates exporters to explore new geographies as payment is assured.
(b) An overseas buyer (importer) can import goods and services on deferred payment terms.
(c) The exporter enjoys reduced transaction costs and complexities of international trade transactions.
(d) The exporter gets to compete in the international market and can continue to put his working capital to good use to scale up operations.
(e) While importers avail of forfaiting facility from international financial institutions in order to finance their imports at competitive rates.

Question 6.
(c) List out the steps to be followed by the manager to measure and max-imize the Shareholder’s wealth. (2 Marks)
Or
Explain the limitations of Average Rate of Return. (2 Marks)
Answer:
We will first like to define what is Wealth/Value Maximization Model. Shareholders wealth are the result of cost benefit analysis adjusted with their timing and risk i.e. time value of money.
So,
Wealth = Present value of benefits – Present Value of Costs

It is important that benefits measured by the finance manager are in terms of cash flow. Finance manager should emphasison Cash flow for investment or financing decisions not on accounting profit. The shareholder value maximization model holds that the primary goal of the firm is to maximize its market value and implies that business decisions should seek to increase the net present value of the economic profits of the firm. So for measuring and maximising shareholders wealth finance manager should follow:

• Cash Flow approach not Accounting Profit
• Cost benefit analysis
• Application of time value of money.

Or

Answer:

Following are the limitations of ARR:

(a) The accounting rate of return technique, like the payback period technique, ignores the time value of money and considers the value of all cash flows to be equal.

(b) The technique uses accounting numbers that are dependent on the or-ganization’s choice of accounting procedures, and different accounting procedures, e.g., depreciation methods, can lead to substantially different amounts for an investment’s net income and book values.

(c) The method uses net income rather than cash flows; while net income is a useful measure of profitability, the net cash flow is a better measure of an investment’s performance.

(d) Furthermore, inclusion of only the book value of the invested asset ignores the fact that a project can require commitments of working capital and other outlays that are not included in the book value of the project.

Question 7.
(a) Explain the measurement of Net Domestic Product at market price. (2 Marks)
Answer:
Net domestic product at market prices (NDP_MP) is a measure of the market value of all final economic goods and services, produced within the domestic territory of a country by its normal residents and non-residents during an accounting year less depreciation. The portion of the capital stock used up in the process of production or depreciation must be subtracted from final sales because depreciation represents capital consumption and therefore a cost of production.
NDP_MP = GDP_MP – Depreciation
NDP_MP = NNP_MP – Net Factor Income from Abroad
The basis of distinction between ‘gross’ and ‘net’ is depreciation or consumption of fixed capital.
Gross = Net + Depreciation or Net = Gross – Depreciation

(b) In the context of India, measure money supply (In crores of) (M3) as per guidelines published by Reserve Bank of India.

1. Currency notes and coins with the public : 24,637.20
2. Demand deposits of Banks : 2,01,589.60
3. Net time deposits with post office saving accounts : 28,116.40
4. Other deposits with Reserve Bank : 420.10
5. Saving deposits with post office saving banks : 415.25 (3 Marks)

Answer:

M1 = Currency with public + Demand Deposits with Banking System + Other Deposits with the RBI
= 24,637.20 + 2,01,589.60 + 420.10 = 2,26,646.90 Crores
M3 = Ml + net time deposits with the banking system
= 2,26,646.90 + Nil
= 2,26,646.90 Crores

(c) Justify the role of public debt as an instrument of Fiscal Policy. (2 Marks)
Answer:
A rational policy of public borrowing and debt repayment is a potent weapon to fight inflation and deflation. Public debt may be internal or external; when the government borrows from its own people in the country, it is called internal debt. On the other hand, when the government borrows from outside sources, the debt is called external debt. Public debt takes two forms namely, market loans and small savings.

In the case of market loans, the government issues treasury bills and government securities of varying denominations and duration which are traded in debt markets. For financing capital projects, long-term capital bonds are floated and for meeting short-term government expenditure, treasury bills are issued.

The small savings represent public borrowings, which are not negotiable and are not bought and sold in the market. In India, various types of schemes are introduced for mobilising small savings e.g., National Savings Certificates, National Development Certificates, etc.

Borrowing from the public through the sale of bonds and securities curtails the aggregate demand in the economy. Repayments of debt by governments increase the availability of money in the economy and increase aggregate demand.

(d) Compare and contrast between devaluation and depreciation in the context of exchange rate. (2 Marks)
Answer:
Devaluation is a deliberate downward adjustment in the value of a country’s currency relative to another currency, group of currencies or standard. It is a monetary policy tool used by countries that have a fixed exchange rate or nearly fixed exchange rate regime and involves a discrete official reduction in the otherwise fixed par value of a currency.

The monetary authority formally sets a new fixed rate with respect to a foreign reference currency or currency basket. In contrast, depreciation is a decrease in a currency’s value (relative to other major currency benchmarks) due to market forces under a floating exchange rate and not due to any government or centred bank policy actions.

Question 8.
(a) Calculate the national income using income and expenditure method from the data given below:


(3 + 2 = 5 Marks)
Answer:
Income Method:
GDP_MP = Compensation of employees + profits + rent + interest + mixed income of self employed + depreciation+net indirect taxes (Indirect taxes – subsidies)
GDP_MP = 24,000 + 10,000 + 28,000 + 4,000 + 7,200 (9,000 – 1,800)
GNP_MP = GDP_MP + NFIA = 73,200 + (-) 300
NNP_MP = GNP_MP – Depreciation = 72,900 – 4,000 = 68,900
NNP_FC (NI) = NNP_MP – Net indirect taxes
= 68,900 – 7,200 = 61,700

Expenditure Method:
GDP_MP(Y) = C + I + G + (X – M)
= 51,000 + 16,000 (13,000 + 3,000) + 7,000 + (4,800 – 5,600)
= 73,200
GNP_MP = GDP_MP + NFIA = 73,200 + (-) 300 = 72,900
NNP_MP = GNP_MP – Depreciation = 72,900 – 4,000 = 68,900
NNP_FC (NI) = NNP_MP – Net indirect taxes = 68,900 – 7,200 = 61,700

(b)

(i) Describe various types of externalities which cause market failure. (3 Marks)
Answer:
Sometimes, the actions of either consumers or producers result in costs or benefits that do not reflect as part of the market price. Such costs or benefits which are not accounted for by the market price are called externalities be cause they are “external” to the market. In other words, there is an externality when a consumption or production activity has an indirect effect on other’s consumption or production activities and such effects are not reflected directly in market prices.
The four possible types of externalities are:

1. Negative Production Externalities:
“A negative externality initiated in production which imposes an external cost on others may be received by another in consumption or in production.”

As an example, a negative production externality occurs when a factory which produces aluminium discharges untreated waste water into a nearby river and pollutes the water causing health hazards for people who use the water for drinking and bathing. Pollution of river also affects fish output as there will be less catch for fishermen due to loss of fish resources.

The former is a case where a negative production externality is received in consumption and the latter presents a case of a negative production externality received in production. The firm, however, has no incentive to account for the external costs that it imposes on consumers of river water or fishermen when making its production decision. Additionally, there is no market in which these external costs can be reflected in the price of aluminium.

2. Positive production externalities:
“A positive production externality initiated in production that confers external benefits on others may be received in production or in consumption.”

Compared to negative production externalities, positive production externalities are less common. As an example of positive production externality received in production, we can cite the case of a firm which offers training to its employees for increasing their skills. The firm generates positive benefits on other firms when they hire such workers as they change their jobs.

A positive production externality is received in consumption when an individual raises an attractive, garden and the persons walking by enjoy the garden. These external effects were not in fact taken into account when the production decisions were made.

3. Negative consumption externalities:
“Negative consumption externalities are extensively experienced by us in our day to day life. Such negative consumption externalities initiated in consumption which produce external costs on others may be received in consumption or in production.”

Examples to cite where they affect consumption of others are smoking cigarettes in public place causing passive smoking by others, creating litter and diminishing the aesthetic value of the room and playing the radio loudly obstructing one from enjoying a concert.

The act of undisciplined students talking and creating disturbance in a class preventing teachers from making effective instruction and the case of excessive consumption of alcohol causing impairment in efficiency for work and production are instances of negative consumption externalities affecting production.

4. Positive consumption externalities:
“A positive consumption externality initiated in consumption that confers external benefits on others may be received in consumption or in production.”

For example, if people get immunized against contagious diseases, they would confer a social benefit to others as well by preventing others from getting infected. Consumption of the services of a health club by the employees of a firm would result in an external benefit to the firm in the form of increased efficiency and productivity.

(b)

(ii) Mention any four sectors in which foreign direct investment is prohibited. (2 Marks)
Answer:
In India, foreign investment is prohibited in the following sectors:

1. Lottery business including Government /private lottery, online lotteries, etc.
2. Gambling and betting including casinos etc.
3. Chit funds.
4. Nidhi company.
5. Trading in Transferable Development Rights (TDRs).
6. Real Estate Business or Construction of Farm Houses.
7. Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.
8. Activities/sectors not open to private sector investment e.g. atomic energy and railway operations (other than permitted activities).

(Student can mention any four)

Question 9.
(a)

(i) Justify the following statements in the light of holding cash balance.

(1) For investment in interest bearing assets
(2) In the prevailing scenario, usually all transactions are made through online or E-banking.
(3) Money is a unique store of value (3 Marks)

Answer:

(1) People either can hold cash balance or can invest it in interest bearing assets. If rate of interest is high then people invest higher portion in interest bearing assets and maintain less cash balance, inversely if rate of interest is low then people choose to hold high cash balance.

(2) In today’s world, usually all transactions are made through online or E-banking. Therefore, people hold less cash balance.

(3) Money also functions as a unique store of value. There are many other assets such as government bonds, deposits and other securities, land, houses etc. which also store value. Despite having the advantages of potential income yield and appreciation in value over time, these other assets are subject to limitations such as storage costs, lack of liquidity and possibility of depreciation in value. Money is the only asset which has perfect liquidity. Therefore, people hold cash balance.

(a)

(ii) Briefly describe any two advantages of fixed exchange rate regime in the context of open economy. (2 Marks)
Answer:
In an open economy, the main advantages of a fixed rate regime are:

1. A fixed exchange rate avoids currency fluctuations and eliminates exchange rate risks and transaction costs that can impede international flow of trade and investments. A fixed exchange rate can thus greatly enhance international trade and investment.
2. A fixed exchange rate system imposes discipline on a country’s monetary authority and therefore is more likely to generate lower levels of inflation.
3. The government can encourage greater trade and investment as stability encourages investment.
4. Exchange rate peg can also enhance the credibility of the country’s monetary policy.
5. The central bank is required to stand ready to intervene in the foreign exchange market and, also to maintain an adequate amount of foreign exchange reserves for this purpose.

(Student can mention any two)

(b)

(i) Define Common Access Resources. Why they are over-used? Explain.
(2 Marks)
Answer:
Common access resources or common pool resources are a special class of impure public goods which are non-excludable as people cannot be excluded from using them. These are rival in nature and their consumption lessens the benefits available for others. This rival nature of common resources is what distinguishes them from pure public goods, which exhibit both non-excludability and non-rivalry in consumption. They are generally available free of charge. Some important natural resources fall into this category.

Since price mechanism does not apply to common resources, producers and consumers do not pay for these resources and therefore, they overuse them and cause their depletion and degradation. This creates threat to the sustainability of these resources and, therefore, the availability of common access resources for future generations.

Economists use the term ‘tragedy of the commons’ to describe the problem which occurs when rivalrous but non excludable goods are overused, to the disadvantage of the entire world.

(b)

(ii) Explain in brief any four effects of tariffs on importing and exporting countries. (3 Marks)
Answer:

1. Tariff barriers create obstacles to trade, decrease the volume of imports and exports and therefore of international trade.
2. By making imported goods more expensive, tariffs discourage domestic consumers from consuming imported foreign goods. Domestic consumers suffer a loss because they must now pay a higher price for the good and consume lesser quantity of the good.
3. Tariffs encourage consumption and production of the domestically produced import substitutes and thus protect domestic industries.
4. Producers in the importing country experience an increase in well-being as a result of imposition of tariff. The price increase of their product in the domestic market increases producer surplus in the industry. They can also charge higher prices than would be possible in the case of free trade because foreign competition has reduced.
5. The price increase also induces an increase in the output of the existing firms and possibly addition of new firms due to entry into the industry to take advantage of the new high profits and consequently an increase in employment in the industry.
6. Tariffs create trade distortions by disregarding comparative advantage and prevent countries from enjoying gains from trade arising from comparative advantage. Thus, tariffs discourage efficient production in the rest of the world and encourage inefficient production in the home
   country.
7. Tariffs increase government revenues of the importing country by the value of the total tariff it charges.

(Student can mention any four)

Question 10.
(a)

(i) Fisher’s equation of exchange is: MV = PT. If velocity (V) = 25, Price (P) 110.5 and volume of transaction (T) = 200 billion.
Calculate:

(1) Total money supply (m)
(2) Effect on M when velocity (V) increases to 75
(3) Velocity (V) when the volume of transactions increases to 325 billion.

Answer:

(1) MV =PT
M × 25 = 110.5 × 200
M = 22,100 ÷ 25 884 billion

(2) MV = PT
M × 75 = 110.5 × 200
M = 22,100 ÷ 75 = 294.67billion

M decreases by 589.33 billion

(3) MV = PT
884 × V = 110.5 × 325
V = 35,912.5 ÷ 884 = 40.625

(a)

(ii) Briefly explain the advantages of two key concepts of New Trade Theories to countries when importing goods to compete with products from the home country. (2 Marks)
Answer:
According to NTT, two key concepts give advantages to countries that import goods to compete with products from the home country:

(1) Economies of Scale: As a firm produces more of a product its cost per unit keeps going down. So if the firm serves domestic as well as foreign market instead of just one, it can reap the benefit of large scale of production consequently the profits are likely to be higher.

(2) Network effects: are the way one person’s value of a good or service is affected by the value of that good or service to others. The value of the product or service is enhanced as the number of individuals using it increases. This is also referred to as the ‘bandwagon effect’. Consumers like more choices, but they also want products and services with high utility, and the network effect offers increased utility from these products over others. A good example will be Mobile App such as Whats App and software like Microsoft Windows.

(b)

(i) Mention any three key objectives of World Trade Organisation. (3 Marks)
Answer:
The WTO has six key objectives:

1. to set and enforce rules for international trade,
2. to provide a forum for negotiating and monitoring further trade liberalization,
3. to resolve trade disputes,
4. to increase the transparency of decision-making processes,
5. to cooperate with other major international economic institutions involved in global economic management, and
6. to help developing countries benefit fully from the global trading system.

(Student can mention any three)

(b)

(ii) Describe the differences between Liquidity Adjustment facility (LAF) and Marginal Standing Facility (MSF). (2 Marks)
Answer:
The Liquidity Adjustment Facility (LAF): is a facility extended by the Reserve Bank of India to the scheduled commercial banks (excluding RRBs) and primary dealers to avail of liquidity in case of requirement (or park excess funds with the RBI in case of excess liquidity) on an overnight basis against the collateral of government securities including state government securities.

The Marginal Standing Facility (MSF): The Marginal Standing Facility (MSF) announced by the Reserve Bank of India (RBI) in its Monetary Policy, 2011-12 refers to the facility under which scheduled commercial banks can borrow additional amount of overnight money from the central bank over and above what is available to them through the LAF window by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit (a fixed percent of their net demand and time liabilities deposits (NDTL) liable to change every year) at a penal rate of interest. This provides a safety valve against unexpected liquidity shocks to the banking system.

Question 11.
(a)

(i) The equation of ‘consumption function’ of an economy is as: C = 450 + 0.70Y.
You are required to compute the following:

(1) Consumption when disposable income (Y) is ₹ 3,500, and ₹ 5,800.
(2) Saving when disposable income (Y) is ₹ 3,500, and ₹ 5,500.
(3) Amount induced when disposable income is ₹ 3,200. (3 Marks)

Answer:

(1) Consumption (C) = 450 + 0.70Y
When Y = ₹ 3,500
C = ₹ 450 + 0.70 (₹ 3,500)
= ₹ 450 + ₹ 2,450 = ₹ 2,900
When Y = ₹ 5,800
C = ₹ 450 + 0.70 (₹ 5,800)
= ₹ 450 + ₹ 4,060 = ₹ 4,510

(2) Saving (S) = Y – C
When Y = ₹ 3,500
C = ₹ 3,500 – ₹ 2,900 = ₹ 600
When Y = ₹ 5,500
C = ₹ 5,500 – {450 + 0.70 (₹ 5,500)} = ₹ 1,200

(3) Amount induced = Y
When Y = ₹ 3,200
Amount induced = 0.70 (₹ 3200) = ₹ 2,240

(a)

(ii) Distinguish between horizontal, vertical and conglomerate type of foreign Investments. (2 Marks)
Answer:
FDI may be categorized as horizontal, vertical or conglomerate:

1. A horizontal direct investment: is said to take place when the investor establishes the same type of business operation in a foreign country as it operates in its home country, for example, a cell phone service provider based in the United States moving to India to provide the same service.

2. A vertical investment: is one under which the investor establishes or acquires a business activity in a foreign country which is different from the investor’s main business activity yet in some way supplements its major activity. For example; an automobile manufacturing company may acquire an interest in a foreign company that supplies parts or raw materials required for the company.

3. A conglomerate type of foreign direct investment: is one where an investor makes a foreign investment in a business that is unrelated to its existing business in its home country. This is often in the form of a joint venture with a foreign firm already operating in the industry as the investor has no previous experience.

(b)

(i) Explain the concept of ‘Voluntary Export Restraints’. Under which ‘ circumstances exporters commit to voluntary export restraint? Discuss. (3 Marks)
Answer:
Voluntary Export Restraints (VERs) refer to a type of informal quota administered by an exporting country voluntarily restraining the quantity of goods that can be exported out of that country during a specified period of time. Such restraints originate primarily from political considerations and are imposed based on negotiations of the importer with the exporter.

The inducement for the exporter to agree to a VER is mostly to appease the importing country and to avoid the effects of possible retaliatory trade restraints that may be imposed by the importer. VERs may arise when the import-competing industries seek protection from a surge of imports from particular exporting countries. VERs cause, as do tariffs and quotas, domestic prices to rise and cause loss of domestic consumer surplus.

(b)

(ii) Mention any four arguments made in favour of Foreign Direct Investment to developing economy like India. (2 Marks)
Or
Explain the concept of real Exchange Rate. (2 Marks)
Answer:
Following are the arguments made in favour of Foreign Direct Investment to developing economy like India:

1. Entry of foreign enterprises usually fosters competition and generates a competitive environment in the host country. This results in positive outcomes in the form of cost-reducing and quality-improving innovations, higher efficiency and increasing variety of better products and services at lower prices ensuring wider choice and welfare for consumers.

2. International capital allows countries to finance more investment than can be supported by domestic savings and can enhance the total output (as well as output per unit of input) flowing from the factors of production.

3. From the perspective of emerging and developing countries, FDI can accelerate growth and foster economic development by providing the much needed capital, technological know-how, management skills and marketing methods and critical human capital skills in the form of managers and technicians. The spill-over effects of the new technol ogies usually spread beyond the foreign corporations. In addition, the new technology can clearly enhance the recipient country’s production possibilities.

4. Competition for FDI among national governments also has helped to promote political reforms important to attract foreign investors, including legal systems and macroeconomic policies.

5. Since FDI involves setting up of production base (in terms of factories, power plants, etc.) it generates direct employment in the recipient coun try.

6. FDI not only creates direct employment opportunities but also, through backward and forward linkages, generate indirect employment opportunities.

7. Foreign direct investments also promote relatively higher wages for skilled jobs. More indirect employment will be generated to persons in the lower-end services sector occupations thereby catering to an extent even to the less educated and unskilled persons engaged in those units.

8. Foreign corporations provide better access to foreign markets. Unlike portfolio investments, FDI generally entails people-to-people relations and is usually considered as a promoter of bilateral and international relations. Greater openness to foreign capital leads to higher national dependence on international investors, making the cost of discords higher.

9. There is also greater possibility for the promotion of ancillary units resulting in job creation and skill development for workers.

10. Foreign enterprises possessing marketing information with their global network of marketing are in a unique position to utilize these strengths to promote the exports of developing countries. If the foreign capital produces goods with export potential, the host country is in a position to secure scarce foreign exchange which can be used to import needed capital equipments or materials to assist the country’s development plans or to ease its external debt servicing.

11. The foreign investment projects also would act as a source of new tax revenue which can be used for development projects.

12. It is likely that foreign investments enter into industries in which scale economies can be realized so that consumer prices might be lowered. Domestic firms might not always be able to generate the necessary capital to achieve the cost reductions associated with large-scale production.

13. Increased competition resulting from the inflow of foreign direct investments facilitates weakening of the market power of domestic monopolies resulting in a possible increase in output and fall in prices.

14. Since FDI has a distinct advantage over the external borrowings, it is considered to have a favourable impact on the host country’s balance of payment position, and

15. Better work culture and higher productivity standards brought in by foreign firms may possibly induce productivity related awareness and may also contribute to overall human resources development.
(Student can mention any four)

Answer:

When prices of goods and services change in either or both countries, it would be difficult to know the change in relative prices of foreign goods and services. Therefore, Real Exchange Rate (RER) which incorporates changes in prices is a better measure. The ‘real exchange rate’ describes ‘how many’ of a good or service in one country can be traded for ‘one’ of that good or service in a foreign country. It is calculated as:

Real exchange rate = Nominal exchange rate \(\frac{\text { Domestic Price Index }}{\text { Foreign Price Index }}\)

Types of Financing – CA Inter FM Notes is designed strictly as per the latest syllabus and exam pattern.

Types of Financing – CA Inter FM Notes

1. Types of Finance on the Basis of Term:

• Long-term Finance: Finance for a period exceeding 5-10 years.
• Medium-term Finance: Finance for a period exceeding one year but not exceeding 5 years
• Short-term Finance: Finance for a short period of time not exceeding one year.

2. Long-Term Sources of Finance:
(a) Equity Capital: Issue of Equity share shares is primary source of long term finance.
(b) Preference Share Capital: Company can issue preference shares to fulfil its long term requirement of funds. Preference shareholders receive fixed payment of dividend and priority towards repayment of capital.
(c) Retained Earnings: Company can retain and invest some portion of its profit.
(d) Debentures: Company can issue non-convertible, fully convertible or partly convertible debentures to arrange long term funds.
(e) Bond: Company (Govt, or PSU) can raise long term funds through issue of Bond.

3. Types of Call Bond:

• Callable bonds: Issuer can redeem bond before maturity at prefixed call price.
• Puttable bonds: Investor can get its money back before maturity.

4. Name of Foreign Bonds:

• Foreign Currency Convertible Bond (FCCB)
• Plain Vanilla Bond
• Convertible Floating Rate Notes (FRN)
• Drop Lock Bond
• Variable Rate Demand Obligations
• Yield Curve Note (YCN)
• Yankee Bond
• Euro Bond
• Samurai Bond
• Bulldog Bond

5. Indian Bonds:

• Masala Bond
• Municipal Bonds
• Government or Treasury Bonds

6. Bridge Finance:
Under bridge finance bank provides short term loan to a company (which has pre-approved term loan) to fulfil requirements of funds upto date of sanction of term loan.

7. Venture Capital Financing:
Financing of new high risky startups by talented and qualified entrepreneurs who lack experience and funds to shape their ideas into a successful business.

8. Characteristics of Venture Capital Financing:

• Equity finance in new companies.
• Long-term investment in growth-oriented small or medium business firms.
• Provides managerial support also.

9. Methods of Venture Capital Financing:

• Equity Financing: Financial institute purchase equity of business but not more than 49% of the total equity capital of venture capital undertakings.
• Conditional Loan: In case of conditional loan 2-15 per cent royalty is payable instead of interest.
• Income Note: It is a combination of normal loan and conditional loan.
• Participating Debenture: During first phase no interest is charged, during second phase a low rate of interest is charged and in last phase a high rate of interest is charged.

10. Debt Securitisation:
It is a process of conversion of existing loans of financial institutions into securities. Existing car loans, credit card etc. are transferred to special purpose vehicle (SVP), who convert these loans into securities and sold these securities to pension fund, provident fund etc.

11. Lease Financing:
Under lease financing asset is purchased by the investor viz. lessor and provide these asset to user viz lessee who pays a specified rent at periodical intervals.

12. Types of Lease Contracts:

• Operating Lease: Under this lease contract lessee gets right to use the asset for small period and ownership and risk related to asset remains with lessor.
• Financial Lease: Under this lease contract lessee gets right to use the asset for long period (generally full economic life of asset) and ownership and risk related to asset remains with lessor.

13. Other Types of Leases:

• Sales and Lease Back: Legal owner of asset sells asset to second party after this transfer second party leases back it to first party.
• Leveraged Lease: Buyer of assets purchases asset against loan (approximately 80% loan) and provides asset to a party on lease. In return lessee pays installment of loan on behalf of lessor and small amount of rent to lessor.
• Sales-aid Lease: Lessor promotes asset of any manufacturer through his own leasing operations and gets commission from manufacturer and rent from lessee.
• Close-ended and Open-ended Leases: Under close-ended lease, lessee has to transfer asset to lesser at the end of lease tenure while under open-ended lease, the lessee can purchase asset at the end of lease tenure.

14. Short-Term Sources of Finance:

• Trade Credit
• Accrued Expenses and Deferred (Unearned) Income
• Advances from Customers
• Commercial Paper
• Treasury Bills
• Certificates of Deposit (CD)
• Bank Advances through:
  (a) Short Term Loans
  (b) Overdraft
  (c) Clean Overdrafts
  (d) Cash Credits
  (e) Advances against goods
  (f) Bills Purchased/Discounted
• Financing of Export Trade by Banks:
  (a) Pre-shipment finance Le., before shipment of goods.
  (b) Post-shipment finance Le., after shipment of goods.
• Inter Corporate Deposits
• Public Deposits

15. Types of Packing Credit:

• Clean packing credit: Under this type of credit exporter gets credit by just showing confirm export order or letter of credit. There is no charge or control of bank over raw material or finished goods.
• Packing credit against hypothecation of goods: Under this type of credit goods are hypothecated.
• Packing credit against pledge of goods: Under this type of credit the possession of the goods lies with the bank.

16. Other Sources of Financing:

• Seed Capital Assistance
• Internal Cash Accruals
• Unsecured Loans
• Deferred Payment Guarantee
• Capital Incentives
• Deep Discount Bonds
• Secured Premium Notes
• Zero Interest Fully Convertible Debentures
• Zero Coupon Bonds
• Option Bonds
• Inflation Bonds
• Floating Rate Bonds

17. International Financing:

• Commercial Banks
• Development Banks
• Discounting of Trade Bills
• International Agencies
• International Capital Markets
• Euro Issues by Indian Companies
• Financial Instruments:
  (a) External Commercial Borrowings (ECB)
  (b) Euro Bonds
  (c) Foreign Bonds
  (d) Fully Hedged Bonds
  (e) Medium Term Notes (MTN)
  (f) Floating Rate Notes (FRN)
  (g) Euro Commercial Papers (ECP)
  (h) Foreign Currency Option (FC)
  (i) Foreign Currency Futures
  (j) Foreign Euro Bonds
  (k) Euro Convertible Bonds
  (l) Euro Convertible Zero Bonds
  (m) Euro Bonds with Equity Warrants

18. American Depository Receipts (ADRs):
If any non-US company wants to sell its securities on New York Stock Exchange then it can be done by issuing ADR. One unit of ADR represents a certain number of a company’s regular shares. Non-US Company has to deposits its original shares with custodian bank of US and against these deposited shares ADR will be issued.

19. Global Depository Receipts (GDRs):
When a company wants to issue its shares in foreign country then it can be done by issuing GDR. One unit of GDR represents a certain number of a company’s regular shares. Company who wants to issue its shares has to deposits its original shares with custodian bank of foreign country and against these deposited shares GDR will be issued.

20. Indian Depository Receipts (IDRs):
If any non-Indian company wants to sell its securities in Indian capital market then it can be done by issuing IDR. One unit of IDR represents a certain number of a company’s regular shares. Non-Indian Company has to deposits its original shares with Indian custodian bank against these deposited shares IDR will be issued.

Scope and Objectives of Financial Management – CA Inter FM Notes is designed strictly as per the latest syllabus and exam pattern.

Scope and Objectives of Financial Management – CA Inter FM Notes

1. Financial Management:
Financial management refers to that managerial activity which is concerned with the arrangement of funds from various sources with consideration of cost, control and risk involved with such sources and application of these funds in an effective manner to maximize shareholders earning and wealth (EPS and MPS).

FINANCIAL MANAGEMENT

2. Sources of Funds

• Equity Share Capital
• Retained Earnings
• Preference Share Capital
• Debentures
• Funding from banks
• International Funding

3. Application of Funds:

• Investment in Fixed Assets
• Investment in Working Capital

4. Evolution of Financial Management: Evolution of financial management took 50 years and can be divided into three stages:

• The Traditional Phase: In traditional phase, financial management was relevant only for big decisions like: takeovers, mergers, expansion, liq-uidation, etc.
• The Transitional Phase: In transitional phase, importance of day to day financial decisions increased, small decisions also got more attention. Like: funds analysis, planning and control etc.
• The Modern Phase: It is current phase today and is still going on. In today’s world importance and scope of financial management greatly increased due to globalization, heavy foreign exchange transfers, capital market transactions etc. Many new theories have been developed regarding efficient markets, capital budgeting, option pricing, valuation models and also in several other important fields in financial management.

5. Finance Functions or Finance Decisions: we can classify finance decisions into two categories:

• Long term finance decisions: It can be further divided into three categories:
• Investment decisions (I): Selection of assets and investment of long term funds into these assets.
• Financing decisions (F): Selection of optimum capital structure on the basis of cost of fund, risk associated with these funds and control.
• Dividend decisions (D): Decisions related to distribution of profit as dividend.
• Short term finance decisions: Decisions related to management of cur-rent assets and current liabilities. It is also known as Working Capital Management (WCM).

6. Importance of Financial Management due to following tasks:

• Look after not to over-invest in fixed assets,
• Maintain balancing of cash outflow with cash inflows,
• Maintaining sufficient level of short term working capital,
• Preparation of growing sales budget,
• Set correct pricing for products or services to increase gross profit,
• Look after and control general and administrative expenses, and
• Focusing on tax planning to minimize the taxes.

7. Scope of Financial Management:

• Determination of size of the enterprise and determination of rate of growth,
• Determining the composition of assets of the enterprise,
• Determining the mix of enterprise’s financing,
• Analysis, planning and control of financial affairs of the enterprise.

8. Objectives of Financial Management: Main two objectives of financial management are profit maximization and wealth maximization.

9. Role of Finance Executive:

• Financial analysis and planning,
• Investment decisions,
• Financing and capital structure decisions,
• Management of financial resources (such as working capital),
• Risk management.

10. Financial Distress and Insolvency: When a company cannot pay its day to day expenses and financial expenses like: salaries, rent, interest on debt etc. smoothly, then this situation is known as financial distress. Continuation of financial distress create insolvency situation in long term.

11. Agency Problem and Agency Cost: When management is focusing their salaries, perks etc. instead of maximization of shareholders wealth and profit then this situation is known as agency problem. Agency cost is the additional cost borne by the shareholders to monitor the manager and control their behaviour so as to maximise shareholders wealth.

CA Inter FM ECO Paper Dec 2021 – CA Inter FM ECO Study Material is designed strictly as per the latest syllabus and exam pattern.

CA Inter FM ECO Question Paper Dec 2021 Solution

Question 1.
(a) A factoring firm has offered a to buy it’s accounts receivables. The relevant information is given below.

1. The current average collection period for the company’s debts is 80 days and 1/2% of debtors default. The factor has agreed to pay over money due, to the company after 60 days, and it will suffer losses of any bad debts also.
2. Factor will charge commission @2%.
3. The company spends ₹ 1,00,000 p.a. on administration of debtor. These are avoidable cost.
4. Annual credit sales are ₹ 90,00,000. Total variable costs is 80% of sales. The company’s cost of borrowings is 15% per annum. Assume 365 days in a year.
   Should the company enter into a factoring agreement? (5 Marks)

Answer:
Statement of Evaluation

* Presently, the debtors of the company pay after 80 days. However, the factor has agreed to pay after 60 days only. So, the investment in Debtors will be reduced by 20 days.

Conclusion: Yes, company should enter into factoring agreement.

(b) Book value of capital structure of B Ltd. is as follows:

Sources	Amount
12% 6,000 Debentures @ ₹ 100 each Retained earnings 4,500 Equity shares @ ₹ 100 each	₹ 6,00,000 ₹ 4,50,000 ₹ 4,50,000
	₹ 15,00,000

Currently the market value of debenture is ₹ 110 per debenture and equity share is ₹ 180 per share. The expected rate of return to equity shareholder is 24% p.a. Company is paying tax @30%.

Calculate WACC on the basis of market value weights. (5 Marks)
Answer:
Statement of WACC (Market Value Weights)

Capital Structure	Amount	Weight	Specific Cost	Cost of Capital
12% Debentures	6,60,000	0.449	0.0764	0.0343
Equity Fund including Retained earning	8,10,000	0.551	0.2400	0.1322
Total	14,70,000	1.000	W4CC	0.1665

WACC (K₀) = 0.1665 or 16.65%

Working Notes:

(1) Calculation of Market Value:
Market value of debenture = (₹ 6,00,000 ÷ ₹ 100) × ₹ 110
Market value of Equity and Retained earnings:
= (₹ 4,50,000 ÷ ₹ 100) × ₹ 180

(2) Calculation of K_d:
K_d = \(=\frac{\mathrm{I}(1-\mathrm{t})}{\mathrm{NP}}\) × 100 = \(\frac{12 \% \text { of } 100(1-0.3)}{110}\) × 100 = 7.64%

Note: Debentures issued at market price; alternatively students may take different assumption i.e. Debentures issued at par.

Note: Since, Keand Kr are same therefore, we use market value of Equity fund including retained earnings.

(c) X Ltd. is a manufacturing company. Current market price per share is ₹ 2,185. During the F. Y. 2020-21, the company paid ₹ 140 as dividend per share. The company is expected to grow @12% p.a. for next four years, then 5% p.a. for an indefinite period. Expected rate of return of shareholders is 18% p.a.

(i) Find out intrinsic value per share.
(ii) State whether shares are overpriced or underpriced.

Year	1	2	3	4	5
Discounting Factor@18%	0.847	0.718	0.608	0.515	0.436

(5 Marks)
Answer:
(i) Calculation of Intrinsic Value of Share

Year	Expected benefits	PVF @ 18%	DCF
1	140.00+ 12% = ₹ 156.80	0.847	132.81
2	156.80+ 12% = ₹ 175.62	0.718	126.10
3	175.62 + 12% = ₹ 196.69	0.608	119.59
4	196.69+ 12% = ₹ 220.29	0.515	113.45
(5 to ∞)	P4 = ₹ 1,779.27	0.515	916.32
Present value of all future benefits or Intrinsic value of Share			₹ 1,408.27

P₄ = \(\frac{D_5}{K_e-g}\) = \(\frac{220.29+5 \%}{18 \%-5 \%}\) = ₹ 1,779.27

(ii) Intrinsic value of share is ₹ 1,408.27 as compared to latest market price of ₹ 2,185. Market price of a share is overpriced by ₹ 776.73.

(d) A garment trader is preparing cash forecast for first three months of calendar year 2021. His estimated sales for the forecasted periods are as below:

	January (₹ ‘000)	February (₹ ‘000)	March (₹ ‘000)
Total sales	600	600	800

1. The trader sells directly to public against cash payments and to other entities on credit. Credit sales are expected to be four times the value of direct sales to public. He expects 15% customers to pay in the month in which credit sales are made, 25% to pay in the next month and 58% to pay in the next to next month. The outstanding balance is expected to be written off.
2. Purchase of goods are made in the month prior to sales and it amounts to 90% of sales and are made on credit. Payments of these occur in the month after the purchase. No inventories of goods held.
3. Cash balance as on 1st January, 2021 is ₹ 50,000.
4. Actual sales for the last two months of calendar year 2020 are as below:

	November (₹ ‘000)	December (₹ ‘000)
Total sales	640	880

You are required to prepare a monthly cash budget for the three months from January to March, 2021. (5 Marks)
Answer:

Question 2.
Following are the data in respect of ABC Industries for the year ended 31st March, 2021:

Debt to Total assets ratio : 0.40
Long-term debts to equity ratio : 30%
Gross profit margin on sales : 20%
Accounts receivables period : 36 days
Quick ratio : 0.9
Inventory holding period : 55 days
Cost of goods sold : ₹ 64,00,000

Balance Sheet

Required:
Complete the Balance Sheet of ABC Industries as on 31st March, 2021.
All calculations should be in nearest rupee. Assume 360 days in a year. (10 Marks)
Answer:
Balance Sheet

Working Notes:

1.
Inventory = COGS × \(\frac{\text { Inventory holding period }}{360}\)
= ₹ 64,00,000 × 55/360 = ₹ 9,77,778

2. Sales = COGS ÷ COGS ratio
= ₹ 64,00,000 ÷ 80% (100 – G.P. ratio) = ₹ 80,00,000

3. Debtors = Sales ×\(\frac{\text { Account receivables period }}{360}\)
= ₹ 80,00,000 × 36/360 = ₹ 8,00,000

4. Debt:
Debt toTotal asset \(=\frac{\text { Debt (Long-term debt }+ \text { Accounts payables) }}{\text { Total Asset }}\) = 40%
Debt = 40% of Total Assets
= ₹ 50,00,000 × 40% = ₹ 20,00,000

Note: In debt we are considering total debt i.e. Long-term debt and Accounts payables.

5. Equity Fund = Equity Share Capital + Reserve and surplus
= Total Liabilities – Debt
= ₹ 50,00,000 – ₹ 20,00,000 = ₹ 30,00,000
Reserve and sur-plus = Equity fund – Equity share capital plus
= ₹ 30,00,000 – ₹ 20,00,000 = ₹ 10,00,000

6. Long-term debt:
Long-term debt to equity \(=\frac{\text { Long-term debt }}{\text { Equity }}\) = 30%
Long-term debt = 30% of Equity
= 30% of ₹ 30,00,000 = ₹ 9,00,000
= ₹ 20,00,000 – ₹ 9,00,000 = ₹ 11,00,000

7. Quick Ratio \(=\frac{\text { Current assets – Inventories }}{\text { Current liabilities }}\) = 0.9
Current assets – ₹ 9,77,778 = 0.9 × ₹ 11,00,000
Current assets = ₹ 9,90,000 + ₹ 9,77,778 = ₹ 19,67,778
Cash = Current Assets – Inventories – Accounts receivables
= ₹ 19,67,778 – ₹ 9,77,778 – ₹ 8,00,000 = ₹ 1,90,000

8. Fixed assets = Total assets – Current assets
= ₹ 50,00,000 – ₹ 19,67,778 = ₹ 30,32,222

Question 3.
Earnings before interest and tax of a company are ₹ 4,50,000. Currently the company has 80,000 equity shares of ₹ 10 each, retained earnings of 1 ₹ 12,00,000. It pays annual interest of ₹ 1,20,000 on 12% Debentures. The company proposes to take up an expansion scheme for which it needs additional fund of ₹ 6,00,000.

It is anticipated that after expansion, the company will be able to achieve the same rate of return on investment as at present. It can raise fund either through debts at rate of 12% p.a. or by issuing Equity shares at par. Tax rate is 40%.
Required:

Compute the earning per share if:

(i) The additional funds were raised through debt.
(ii) The additional funds were raised by issue of Equity shares.
Advise whether the company should go for expansion plan and which sources of finance should be preferred. (10 Marks)

Answer:

Statement of EPS

Advise to the company:

EPS before expansion = \(\frac{(\mathrm{EBIT}-\mathrm{I})(1-\mathrm{T})}{\mathrm{N}}\) = \(\frac{(4,50,000-1,20,000)(1-0.4)}{80,000}\) = ₹ 2.475

Since EPS after expansion under debt plan is higher (₹ 2.61) than Existing EPS (₹ 2.475), company should go for expansion plan and choose debt source of finance.

Working notes:

1. Calculation of capital employed before expansion plan:
Equity share capital (80,000 shares × ₹ 10) : ₹ 8,00,000
Retained earnings : ₹ 12,00,000
Debentures (₹ 1,20,000/12%) : ₹ 10,00,000
Total capital employed : ₹ 30,00,000

2. Return on capital employed (ROCE) or Return on Investment:

ROCE \(\frac{\text { EBIT }}{\text { Capital Employed }}\)

3. Capital employed after expansion = ₹ 36,00,000 (₹ 30,00,000 + ₹ 6,00,000)

Question 4.
Stand Ltd. is contemplating replacement of one of it’s machine which has become outdated and inefficient. It’s financial manager has prepared a report outlining two possible replacement machines. The details of each machine are as follows:

	Machine 1	Machine 2
Initial investment	₹ 12,00,000	₹ 16,00,000
Estimated useful life	3 Years	5 Years
Residual value	₹ 1,20,000	₹ 1,00,000
Contribution per annum	₹ 11,60,000	₹ 12,00,000
Fixed maintenance costs per annum	₹ 40,000	₹ 80,000
Other fixed operating costs per annum	₹ 7,20,000	₹ 6,10,000

The maintenance costs are payable annually in advance. All other cash flows apart from the initial investment assumed to occur at the end of each year. Depreciation has been calculated by straight line method and has been included in other fixed operating costs. The expected cost of capital for this project is assumed as 12% p.a.

Required:

(i) Which machine is more beneficial, using Annualized Equivalent Approach? Ignore tax.
(ii) Calculate the sensitivity of your recommendation in part (i) to changes in the contribution generated by machine 1.

Year	1	2	3	4	5	6
PVIF0.12,t	0.893	0.797	0.712	0.636	0.567	0.507
PVIFA0.12,t	0.893	1.690	2.402	3.038	3.605	4.112

(10 Marks)
Answer:
(i) Statement Showing Evaluation of Two Machines

Select the Machine 2 having higher annualized equivalent NPV

Working Notes:

1. Depreciation: (Initial investment – Residual value) ÷ Useful life
Machine 1 = (₹ 12,00,000 – ₹ 1,20,000) ÷ 3 years = ₹ 3,60000
Machine 2 = (₹ 16,00,000 – 1,00,000) ÷ 5 years = ₹ 3,00,000

2. Cash fixed operating costs = Fixed operating costs – Depreciation
Machine 1 = ₹ 7,20,000 – ₹ 3,60,000 = ₹ 3,60,000
Machine 2 = ₹ 6,10,000 – ₹ 3,00,000 = ₹ 3,10,000

(ii) calculation of the sensitivity of contribution generated by machine 1:
NPV of the project would be zero when the present value of contribution is decreased by ₹ 6,99,640
∴ Percentage change in the contribution = (₹ 6,99,640 ÷ ₹ 27,86,320) × 100 = 25.11%

Question 5.
Information of A Ltd. is given below:

• Earnings after tax : 5% of sales
• Income tax rate : 50%
• Degree of Operating leverage : 4 times
• 10% Debenture in capital structure : ₹ 3 lakhs
• Variable costs : ₹ 6 lakhs

Required:

(i) From the given data complete following statement:


(ii) Calculate Financial Leverage and Combined Leverage.
(iii) Calculate percentage change in earning per share, if sales increased by 5%. (10 Marks)

Answer:

(i) Statement of EAT

(ii) Financial Leverage \(=\frac{\text { EBIT }}{\text { EBT }}\) = \(\frac{1,50,000}{1,20,000}\) = 1.25 times
Combined Leverage = OL × FL = 4 × 1.25 = 5 times

(iii) % change in EPS = % change in Sales = 5% × 5 = 25% increased

Working Notes.

(a) Operating Leverage \(=\frac{\text { Contribution }}{\text { EBIT }}\) \(=\frac{\text { Contribution }}{\text { Contribution – Fixed cost }}\) = 4
Contribution = 4 Contribution – 4 Fixed cost
-3 Contribution = -4 Fixed cost
¼ Contribution = Fixed cost
Contribution = Sales – Variable cost = Sales – ₹ 6,00,000
∴ Fixed cost = 3/4 or 75% of contribution = 75% (Sales – ₹ 6,00,000)
= 75% Sales ₹ 4,50,000

(b) EAT = 5% of Sales
EBT = EAT ÷ (1 – t) = 5% Sales ÷ (1 – 0.5)
= 10% Sales

(c) EBT = Sales – Variable cost – Fixed cost — Interest
10% Sales = Sales – ₹ 6,00,000 – (75% Sales – ₹ 4,50,000) – ₹ 30,000
10% Sales = Sales – ₹ 6,00,000 – 75% Sales + ₹ 4,50.000 – ₹ 30,000
10% Sales = 25% Sales – ₹ 1,80,000
15% Sales = ₹ 1,80,000
Sales = ₹ 1,80,000 ÷ 15% = ₹ 12,00,000

(d) EBT = 10% of Sales = 10% of ₹ 12,00,000
= ₹ 1,20,000

(e) EBIT = EBT + Interest = ₹ 1,20,000 + ₹ 30,000
= ₹ 1,50,000

(f) Fixed cost = 75% of Contribution = 75% of ₹ 6,00,000
= ₹ 4,50,000

Question 6.
(a) Write short noies on Bridge Finance and Clean Packing Credit. (4 Marks)
Answer:
Bridge Finance: Bridge finance refers to loans taken by a company normally from commercial banks for a short period because of pending disbursement of loans sanctioned by financial institutions. Though it is of short-term nature but since it is an important step in the facilitation of long-term loan, therefore it is being discussed along with the long term sources of funds. Normally, it takes time for financial institutions to disburse loans to companies.

However, once the loans are approved by the term lending institutions, companies, in order not to lose further time in starting their projects, arrange short term loans from commercial banks. The bridge loans are repaid/adjusted out of the term loans as and when disbursed by the concerned institutions. Bridge loans are normally secured by hypothecating movable assets, personal guarantees and demand promissory notes. Generally, the rate of interest on bridge finance is higher as compared with that on term loans.

(b) Clean packing credit: This is an advance made available to an exporter only on production of a firm export order or a letter of credit without exercising any charge or control over raw material or finished goods. It is a clean type of export advance. Each proposal is weighed according
to particular requirements of the trade and credit worthiness of the exporter. A suitable margin has to be maintained. Also, Export Credit Guarantee Corporation (ECGC) cover should be obtained by the bank.

Question 6.
(b) Distinguish between Scenario Analysis & Sensitivity Analysis. (4 Marks)
Answer:
Scenario Analysis v. Sensitivity Analysis: Sensitivity analysis and Scenario analysis both help to understand the impact of the change in input variable on the outcome of the project. However, there are certain basic differences between the two.

Sensitivity analysis calculates the impact of the change of a single input variable on the outcome of the project viz., NPV or IRR. The sensitivity analysis thus enables to identify that single critical variable that can impact the outcome in a huge way and the range of outcomes of the project given the change in the input variable.

Scenario analysis, on the other hand, is based on a scenario. The scenario may be recession or a boom wherein depending on the scenario, all input variables change. Scenario Analysis calculates the outcome of the project considering this scenario where the variables have changed simultaneously. Similarly, the outcome of the project would also be considered for the normal and recessionary situation.

The variability in the outcome under the three different scenarios would help the management to assess the risk a project carries. Higher deviation in the outcome can be assessed as higher risk and lower to medium deviation can be assessed accordingly.

Scenario analysis is far more complex than sensitivity analysis because in scenario analysis all inputs are changed simultaneously considering the situation in hand while in sensitivity analysis only one input is changed and others are kept constant.

Question 6.
(c) Explain in brief the phases of the evolution of financial management. (2 Marks)
Or
Adjustment of risk is required in capital budgeting decision, give reasons for it. (2 Marks)
Answer:
Financial management evolved gradually over the past 50 years. The evolution of financial management is divided into three phases. Financial Management evolved as a separate field of study at the beginning of the century. The three stages of its evolution are:

The Traditional Phase: During this phase, financial management was con-sidered necessary only during occasional events such as takeovers, mergers, expansion, liquidation, etc. Also, when taking financial decisions in the organisation, the needs of outsiders (investment bankers, people who lend money to the business and other such people) to the business was kept in mind.

The Transitional Phase: During this phase, the day-to-day problems that financial managers faced were given importance. The general problems related to funds analysis, planning and control were given more attention in this phase.

The Modem Phase: Modern phase is still going on. The scope of financial management has greatly increased now. It is important to carry out financial analysis for a company. This analysis helps in decision making. During this phase, many theories have been developed regarding efficient markets, capital budgeting, option pricing, valuation models and also in several other important fields in financial management.

Or

Answer:

Main reasons for considering risk in capital budgeting decisions are as follows:

1. There is an opportunity cost involved while investing in a project for the level of risk. Adjustment of risk is necessary to help make the decision as to whether the returns out of the project are proportionate with the risks borne and whether it is worth investing in the project over the other investment options available.

2. Risk adjustment is required to know the real value of the Cash Inflows. Higher risk will lead to higher risk premium and also expectation of higher return.

Question 7.
(a) The following information is given:

Particulars	Amount in (₹) Crore
Notes in Circulation	25,00,000
Circulation of Rupee Coins	26,000
Circulation of Small Coins	850
Cash on hand with Banks	95,000
Bankers’ Deposits with RBI	4,500
Other Deposits with RBI	180
Total Post office Deposits	12,000
Time Deposits with Banks	15,000

You are required to compute:

(i) Currency with the Public; and
(ii) Reserve Money. (3 Marks)

Answer:

(i) Currency with the Public = Notes in Circulation + Circulation of Rupee Coins + Circulation of Small Coins – Cash on hand with Banks
= 25,00,000 + 26,000+ 850 – 95,000 = 24,31,850

(ii) Reserve Money = Currency in circulation + Bankers’ deposits with the RBI + Other deposits with the RBI
= 24,31,850 + 4,500 + 180 = 24,36,530

(b) The Nominal GDP and Real GDP of a country in the financial year 2018-19 were ₹ 1,500 Crores and ₹ 1,200 Crores respectively, you are required to calculate:

(i) GDP deflator in the financial year 2018-19 and comment.
(ii) Inflation rate in the financial year 2019-20 assuming GDP deflator rate in this year is 140 as compared to the year 2018-19. (3 Marks)

Answer:

(i) GDP Deflator \(=\frac{\text { Nominal GDP }}{\text { Real GDP }}\) × 100 = \(\frac{1,500}{1,200}\) × 100 = 125

Comment: The price level has increased since GDP deflator is greater than 100 at 125.

(ii) Inflation Rate = \(\frac{140-125}{125}\) × 100 = 12%

(c) Explain the features of Contractionary Fiscal policy. (2 Marks)
Answer:
When aggregate demand rises beyond what the economy can potentially produce by fully employing it’s given resources, it gives rise to inflationary pressures in the economy. The aggregate demand may rise due to large increase in consumption demand by households or investment expenditure by entrepreneurs, or government expenditure. In these circumstances inflationary gap occurs which tends to bring about rise in prices. Under such circumstances, a contractionary fiscal policy will have to be used.

Contractionary fiscal policy ref ers to the deliberate policy of government applied to curtail aggregate demand and consequently the level of economic activity. In other words, it is fiscal policy aimed at eliminating an inflationary gap. This is achieved by adopting policy measures that would result in the aggregate demand curve (AD) shifting to the left so the equilibrium may be established at the full employment level of real GDP.

(d) Describe the types of transactions in the forex-market and also dis-tinguish between forward premium and forward discount. (2 Marks)
Answer:
There are two types of transactions in a forex market:

1. Current trans-actions which are carried out in the spot market and
2. Future transactions involving contracts to buy or sell currencies for future delivery which are carried out in forward and futures markets.

A forward premium is said to occur when the forward exchange rate is more than a spot exchange rates. On the contrary, if the forward trade is quoted at a lower rate than the spot rate, then there is a forward discount.

Question 8.
(a) The following information is related to an economy:

Particulars	Amount in (₹) Crore
Domestic Sales	3,600
Opening Stock	800
Exports	1,000
Depreciation	300
Closing Stock	200
Net indirect tax	400
Intermediate consumption	600
Net factor income from abroad	10

Calculate the following:

(i) Gross Value of Output (GVO_MP)
(ii) Gross Value Added (GVA_MP)
(iii) Net Value Added (NVA_MP)
(iv) Net Domestic Product (NDP_FC)
(v) Net National Product (NNP_FC) (5 Marks)

Answer:

(i) GVO_MP = Sales (Domestic + Exports) + Change in stock
= 4,600 (3,600 + 1,000) + (200 – 800) = 4,000 Crores
(ii) GVA_MP = Value of output — Intermediate consumption
= 4,000- 600 = 3,400 Crores
(iii) NVA_MP = GVA_MP – Depreciation
= 3,400 – 300 = 3,100 Crores
(iv) NDP_FC = NVA_MP – Net Indirect Tax
= 3,100 – 400 = 2,700 Crores
(v) NNP_FC = NDP_FC + NFIA
= 2,700 + 10 = 2,710 Crores

(b) (i) Discuss the role of government Interventions in minimizing the market power. (2 Marks)
Answer:
As we are aware, market power exercised either by sellers or buyers is an important factor that contributes to inefficiency because it results in higher prices than competitive prices. In addition, market power also tends to restrict output and leads to deadweight loss. Because of the social costs imposed by monopoly, governments intervene by establishing rules and regulations de-signed to promote competition and prohibit actions that are likely to restrain competition.

These legislations differ from country to country. For example, in India, we have the Competition Act, 2002 (as amended by the Competition (Amendment) Act, 2007) to promote and sustain competition in markets. The Antitrust laws in the US and the Competition Act, 1998 of UK etc. are designed to promote competitive economy by prohibiting actions that are likely to restrain competition.

Such legislations generally aim at prohibiting contracts, combinations and collusions among producers or traders which are in restraint of trade and other anticompetitive actions such as predatory pricing.

(b)(ii) Calculate Narrow Money (M1) from the following information:

(3 Marks)
Answer:
M1 = Currency with public + Demand Deposits with Banking System + Other Deposits with the RBI
= 2,80,000 + 4,00,000 + 5,80,000 = ₹ 12,60,000 Crores

Question 9.
(a) How is nominal exchange rate determined? Explain. (3 Marks)
Answer:
As you already know, the key framework for analysing prices is the operation of forces of supply and demand in markets. Usually, the supply of and demand for foreign exchange in the domestic foreign exchange market determine the external value of the domestic currency, or in other words, a country’s exchange rate.

We shall now look into how the foreign exchange markets work. Similar to any standard market, the exchange market also faces a downward-sloping demand curve and an upward sloping supply curve.

The equilibrium rate of exchange is determined by the interaction of the supply and demand for a particular foreign currency. In figure, the demand curve (D$) and supply curve (S$) of dollars intersect to determine equilibrium exchange rate e_eq with Q_e as the equilibrium quantity of dollars exchanged.

Determination of Nominal Exchange Rate

(b) Discuss the salient features of bilateral trade agreements. (2 Marks)
Answer:
Bilateral Agreements are agreements which set rules of trade between two countries, two blocs or a bloc and a country. These may be limited to certain goods and services or certain types of market entry barriers. E.g. EU-South Africa Free Trade Agreement; ASEAN-India Free Trade Area.

(c) Calculate Money Multiplier with the help of following information: (3 Marks)
Answer:
Money Supply ‘M’ = Currency + Deposits
= ₹ 200 billion + ₹ 400 billion = ₹ 600 billion
c = C/D
= ₹ 200 billion/₹ 400 billion
= 0.5 or depositors hold 50% of their money as currency
e = Excess Reserve/Deposits
= ₹ 800 million or ₹ 0.8 billion/₹ 400 billion
= 0.002 or banks hold 0.2% of their deposit as excess reserves
Multiplier ‘m’ = \(\) = \(\frac{1+0.5}{0.1+0.002+0.5}\) = 2.5
Therefore, a 1 unit increase in MB leads to a 2.5 units increase in M.

(d) What do you mean about gross investment of a country? (2 Marks)
Answer:
Gross domestic fixed capital formation (Gross Investment) is that part of country’s total expenditure which is not consumed but added to the nation’s fixed tangible assets and stocks. It consists of the acquisition of fixed assets and the accumulation of stocks. The stock accumulation is in the form of changes in stock of raw materials, fuels, finished goods and semi-finished goods awaiting completion.

Thus, gross investment includes final expenditure on machinery and equipment and own account production of machinery and equipment, expenditure on construction, expenditure on changes in inventories, and expenditure on the acquisition of valuables such as, jewellery and works of art.

Question 10.
(a) (i) How does the fiscal policy redress the inequalities of income and wealth of a country? (3 Marks)
Answer:
Many developed and developing economies are facing the challenge of rising inequality in incomes and opportunities. Fiscal policy is a chief instrument available for governments to influence income distribution and plays a significant role in reducing inequality and achieving equity and social justice. The distribution of income in the society is influenced by fiscal policy both directly and indirectly. While current disposable incomes of individuals and corporates are dependent on direct taxes, the potential for future earnings is indirectly influenced by the nation’s fiscal policy choices.

Government revenues and expenditure have traditionally been regarded as important instruments for carrying out desired redistribution of income. We shall see a few such measures as to how each of these can be manipulated to achieve desired distributional effects.

♦ A progressive direct tax system ensures that those who have greater ability to pay contribute more towards defraying the expenses of government and that the tax burden is distributed fairly among the population.

♦ Indirect taxes can be differential: for example, the commodities which are primarily consumed by the richer income group, such as luxuries, are taxed heavily and the commodities the expenditure on which form a larger proportion of the income of the lower income group, such as necessities, are taxed light.

♦ A carefully planned policy of public expenditure helps in redistributing income from the rich to the poorer sections of the society. This is done through spending programmes targeted on welfare measures for the disadvantaged, such as

1. poverty alleviation programmes,
2. free or subsidized medical care, education, housing, essential commodities etc. to improve the quality of living of poor,
3. infrastructure provision on a selective basis,
4. various social security schemes under which people are entitled to old age pensions, unemployment relief, sickness allowance etc.,
5. subsidized production of products of mass consumption,
6. public production and/or grant of subsidies to ensure sufficient supply of essential goods, and
7. strengthening of human capital for enhancing employability etc.

Choice of a progressive tax system with high marginal taxes may act as a strong deterrent to work, save and invest. Therefore, the tax structure has to be carefully framed to mitigate possible adverse impacts on production and efficiency. Additionally, the redistributive fiscal policy and the extent of spending on redistribution should be consistent with the macroeconomic policy objectives of the nation.

(ii) State the main objectives of World Trade Organisation (WTO). (2 Marks)
Answer:
The WTO has six key objectives:

1. to set and enforce rules for international trade,
2. to provide a forum for negotiating and monitoring further trade liber-alization,
3. to resolve trade disputes,
4. to increase the transparency of decision-making processes,
5. to co-operate with other major international economic institutions involved in global economic management, and
6. to help developing countries benefit fully from the global trading system.

(b) (i) Explain Friedman’s Restatement of Quantity Theory with ref-erence to demand for money? (3 Marks)
Answer:
Milton Friedman (1956) extended Keynes’ speculative money demand within the framework of asset price theory. Friedman treats the demand for money as nothing more than the application of a more general theory of demand for capital assets. Demand for money is affected by the same factors as demand for any other asset, namely

1. Permanent income.
2. Relative returns on assets (which incorporate risk).

Friedman maintains that it is permanent income- and not current income as in the Keynesian theory that determines the demand for money. Permanent income which is Friedman’s measure of wealth is the present expected value of all future income. To Friedman, money is a good as any other durable consumption good and its demand is a function of a great number of factors.

Friedman identifies the following four determinants of the demand for money. The nominal demand for money:

• is a function of total wealth, which is represented by permanent income divided by the discount rate, defined as the average return on the five asset classes in the monetarist theory world, namely money, bonds, equity, physical capital and human capital.
• is positively related to the price level, P. If the price level rises the demand for money increases and vice versa.
• rises if the opportunity costs of money holdings (Le. returns on bonds and stock) decline and vice versa.
• is influenced by inflation, a positive inflation rate reduces the real value of money balances, thereby increasing the opportunity costs of money holdings.

(b) (ii) Discuss the meaning and consequences of negative production externalities. (2 Marks)
Answer:
A negative externality initiated in production which imposes an external cost on others may be received by another in consumption or in production. As an example, a negative production externality occurs when a factory which produces aluminium discharges untreated waste water into a nearby river and pollutes the water causing health hazards for people who use the water for drinking and bathing. Pollution of river also affects fish output as there will be less catch for fishermen due to loss of fish resources.

The former is a case where a negative production externality is received in consumption and the latter presents a case of a negative production externality received in production. The firm, however, has no incentive to account for the external costs that it imposes on consumers of river water or fishermen when making its production decision. Additionally, there is no market in which these external costs can be reflected in the price of aluminium.

Question 11.
(a) How is aggregate consumption function affected, if:

1. An impending war is expected to result in shortage of goods and an adoption of rationing system,
2. Increased cost of steel, oil etc. are expected to result in higher prices for consumer goods, or
3. The leadership assures that economic policy is bringing the recession to an end. (3 Marks)

Answer:

1. Aggregate Consumption will be increased
2. Aggregate Consumption will be decreased
3. Aggregate Consumption will be increased

(b) Discuss the three branch taxonomy of the role of Government in market economy. (3 Marks)
Answer:
Richard Musgrave, in his classic treatise ‘The Theory of Public Finance’ (1959), introduced the three-branch taxonomy of the role of government in a market economy. Musgrave believed that, for conceptual purposes, the functions of the government are to be separated into three, namely, resource allocation, (efficiency), income redistribution (fairness) and macroeconomic stabilization. The allocation and distribution functions are primarily micro-economic functions, while stabilization is a macroeconomic function.

The allocation function aims to correct the sources of inefficiency in the economic system, while the distribution role ensures that the distribution of wealth and income is fair. Monetary and fiscal policies, the problems of macroeconomic stability, maintenance of high levels of employment and price stability etc. fall under the stabilization function. We shall now discuss in detail this conceptual three-function framework of the responsibilities of the government.

(c) What is the speculative motive for holding cash? (2 Marks)
Answer:
The speculative motive reflects people’s desire to hold cash in order to be equipped to exploit any attractive investment opportunity requiring cash expenditure.

According to Keynes, people demand to hold money balances to take advan-tage of the future changes in the rate of interest, which is the same as future changes in bond prices. It is implicit in Keynes theory, that the ‘rate of interest’ is really the return on bonds. Keynes assumed that the expected return on money is zero, while the expected returns on bonds are of two types, namely:

1. The interest payment,
2. The expected rate of capital gain.

The market value of bonds and the market rate of interest are inversely related. A rise in the market rate of interest leads to a decrease in the market value of the bond, and vice versa.

If wealth-holders consider that the current rate of interest is high compared to the ‘normal or critical rate of interest’, they expect a fall in the interest rate (rise in bond prices). At the high current rate of interest, they will convert their cash balances into bonds because:

1. They can earn high rate of return on bonds,
2. They expect capital gains resulting from a rise in bond prices consequent upon an expected fall in the market rate of interest in future.

Conversely, if the wealth-holders consider the current interest rate as low, compared to the ‘normal or critical rate of interest’, ie., if they expect the rate of interest to rise in future (fall in bond prices), they would have an incentive to hold their wealth in the form of liquid cash rather than bonds because:

1. The loss suffered by way of interest income forgone is small,
2. They can avoid the capital losses that would result from the anticipated increase in interest rates, and
3. The return on money balances will be greater than the return on alter-native assets,
4. If the interest rate does increase in future, the bond prices will fall and the idle cash balances held can be used to buy bonds at lower price and can thereby make a capital gain.

(d) Discuss the non-technical measures adopted by the countries with reference to

(i) Trade related investment measures, and
(ii) Price control measures. (2 Marks)

Or
Discuss the salient features of Escalated tariff. (2 Marks)

Answer:

(i) Trade-Related Investmen t Measures: These measures include rules on local content requirements that mandate a specified fraction of a final good should be produced domestically.

a. Requirement to use certain minimum levels of locally made components, (25 per cent of components of automobiles to be sourced domestically),
b. Restricting the level of imported components, and
c. Limiting the purchase or use of imported products to an amount related to the quantity or value of local products that it exports. (A firm may import only up to 75% of its export earnings of the previous year).

(ii) Price Control Measures: Price control measures (including additional taxes and charges) are steps taken to control or influence the prices of imported goods in order to support the domestic price of certain prod-ucts when the import prices of these goods are lower. These are also known as ‘para-tariff’ measures and include measures, other than tariff measures, that increase the cost of imports in a similar manner, i.e. by a fixed percentage or by a fixed amount. Example: A minimum import price established for sulphur.

Or

Answer:
Escalated Tariff: Structure refers to the system wherein the nominal tariff rates on imports of manufactured goods are higher than the nominal tariff rates on intermediate inputs and raw materials, ie. the tariff on a product increases as that product moves through the value-added chain. For example, a four percent tariff on iron ore or iron ingots and twelve percent tariff on steel pipes.

This type of tariff is discriminatory as it protects manufacturing industries in importing countries and dampens the attempts of developing manufacturing industries of exporting countries. This has special relevance to trade between developed countries and developing countries. Developing countries are thus forced to continue to be suppliers of raw materials without much value addition.

Cost Accounting System – CA Inter Costing Study Material is designed strictly as per the latest syllabus and exam pattern.

Cost Accounting System – CA Inter Costing Study Material

Theory Questions

Question 1.
Explain integrated accounting system and state its advantages. fCA Inter Nov. 2019, May 2019, May 2015, May 2012, May 2010, 5 Marks]
Answer:
Integrated Accounting System:
Integrated Accounting System is a system of accounting, where the cost and financial accounts are kept in the same set of books. Integrated accounts provide or meet out fully the information requirement for Costing as well as for Financial Accounts. For Costing purposes, it provides information useful for ascertaining the cost of each product, job, and process, operation of any other identifiable activity and for carrying necessary analysis.

Integrated accounts provide relevant information which is necessary for preparing profit and loss account and the balance sheets as per the requirement of law and also helps in exercising effective control over the liabilities and assets of its business.

The main advantages of Integrated Accounting System are as follows:

• No need for Reconciliation: The question of reconciling costing profit and financial profit does not arise, as there is only one figure of profit.
• Less efforts: Due to use of one set of books, there is a significant saving in efforts made.
• Less Time consuming: No delay is caused in obtaining information as it is provided from books of original entry.
• Economical process: It is economical also as it is based on the concept of ‘Centralisation of Accounting function’.

Question 2.
Explain essential pre-requisites for Integrated Accounting System. [CA Inter Nov, 2020, May 2018, Nov. 2007, Nov. 2006, Nov. 2001, 5 marks]
Answer:
Essential pre-requisites for integrated Accounting System are following:
(a) The management’s decision about the extent of integration of the two sets of books.
(b) A suitable coding system must be made available so as to serve the accounting purposes of financial and cost accounts.
(c) An agreed routine, with regard to the treatment of provision for accruals, prepaid expenses, other adjustment necessary for preparation of interim accounts.
(d) Perfect coordination should exist between the staff responsible for the financial and cost accounts and an efficient processing of accounting document should be ensured.
(e) Under this system there is no need for a separate cost ledger. Of course, there will be a number of subsidiary ledgers; in addition to the useful Customers’ Ledger and the Purchase Ledger, there will be:
(a) Stores Ledger;
(b) Stock Ledger; and
(c) Job Ledger.

Question 3.
Discuss the reconciliation of Profit as per Cost Accounts and Financial Accounts. [CA Inter May 2007, May 2006, 6 Marks]
Answer:
When the cost and financial accounts are kept separately, it is imperative that these should be reconciled to make the cost accounts reliable. It is necessary for reconciliation of the two sets of accounts that sufficient details are available to locate the differences and the reasons for the same.

Causes of differences in Financial and Cost Accounts:
1. Items included in Financial Accounts only:

• Interest on loans or bank mortgages
• Expenses and discounts on issue of shares, debentures etc.
• Other capital losses i.e., loss by fire not covered by insurance etc.
• Losses on the sales of fixed assets and investments
• Goodwill written off
• Preliminary expenses written off
• Income tax, donations, subscriptions
• Expenses of the company’s share transfer office, if any.

2. Purely Financial Income:

• Interest received on bank deposits, loans and investments
• Dividends received
• Profits on the sale of fixed assets and investments
• Transfer fee received
• Rent receivables

3. Item included in Cost Accounts only (notional expenses):

• Charges in lieu of rent where premises are owned
• Interest on capital at notional figure though not incurred
• Salary for the proprietor at notional figure though not incurred
• Notional Depreciation on the assets fully depreciated for which book value is nil.

Question 4.
List the Financial expenses which are not included in cost. [CA Inter Nov. 2009, 2 Marks]
Answer:
Financial expenses which are not included in cost accounting are as follows:

• Interest on loans or bank mortgages
• Expenses and discounts on issue of shares, debentures etc.
• Other capital losses Le., loss by fire not covered by insurance etc.
• Losses on the sales of fixed assets and investments
• Goodwill written off
• Preliminary expenses written off .
• Income tax, donations, subscriptions
• Expenses of the company’s share transfer office, if any.

Question 5.
When is the reconciliation statement of Cost and Financial accounts not required? [CA Inter Nov. 2009, 2 Marks]
Answer:
When the Cost and Financial Accounts are integrated, there is no need to have a separate reconciliation statement between the two sets of accounts. Integration means that the same set of accounts fulfil the requirement of both Le., Cost and Financial Accounts.

Question 6.
“Is reconciliation of cost accounts and financial accounts necessary in case of integrated accounting system?” [CA Inter May 2013, 4 Marks]
Answer:

• In integrated accounting system, cost and financial accounts are kept in the same set of books. Such a system will have to afford full information required for Costing as well as for Financial Accounts.
• For Costing purposes, it must provide information useful for ascertaining the cost of each product, job, process and operation of any other identifiable activity and for carrying necessary analysis.
• It also provide relevant information which is necessary for preparing profit and loss account and the balance sheet as per the requirement of law and also helps in exercising effective control over the liabilities and assets of its business.

Since, only one set of books are kept for both cost accounting and financial accounting purpose so there is no necessity of reconciliation of cost and financial accounts.

Question 7.
What are the motivational factors for adopting a reconciliation process? Explain. [CA Inter Nov. 2017, 4 Marks]
Answer:
When the cost and financial accounts are kept separately, it is imperative that these should be reconciled, otherwise the cost accounts would not be reliable.

The reconciliation of two set of accounts can be made, if both the sets contain sufficient detail as would enable the causes of differences to be located. It is therefore, important that in the financial accounts, the expenses should be analysed in the same way as in cost accounts.

Motivation for reconciliation is:

• To ensure reliability of cost data
• To ensure ascertainment of correct product cost
• To ensure correct decision making by the management based on Cost & Financial data.

Question 8.
Which are the types of management accounting systems used for controlling costs? [ICAI Module]
Answer:
For cost control purpose, following are the two main types of management accounting systems which are followed on the basis of timing of variance analysis:
(i) Single Plan: Under this system, the variances in costs from the set standards are reported at its happenings without waiting for books closing.

• Timely analysis is done so that much time is not lost in taking corrective action wherever needed.
• The single plan system envisages the posting of all items in the debit side of the work-in-process account at the standard cost leaving the credit side to represent.
• This system enables the ascertainment of variances as and when the transaction is posted to work-in-process account. This method of analysis is known as analysis at source.

(ii) Partial Plan: In the partial plan, variances are analysed at the end of period. Under this method the work-in-process account is charged at the actual cost of production for the period and is credited with the standard cost of the period’s production of finished product.

• The closing balance of work-in-process is also shown at standard cost.
• The balance after making the credit entries represents the variance from standard for the period. The analysis of the variances is done after the end of the period.

Practical Questions

Question 1.
Pass journal entries in the cost books, maintained on non-integrated system, for the following:
(i) Issue of materials: Direct ₹ 5,50,000; Indirect ₹ 1,50.000
(ii) Allocation of wages: Direct ₹ 2,00,000; Indirect ₹ 40,000
(iii) Under/Over absorbed overheads: Factory (over) ₹ 20,000; Administration (under) ₹ 10,000 [CA Inter Now 2000. 6 Marks]
Answer:

Question 2.
Journalise the following transactions in cost books under Non-Integraled system of Accounting.
(i) Credit Purchase of Material ₹ 27,000
(ii) Manufacturing overhead charged to Production ₹ 6,000
(iii) Selling and Distribution overheads recovered from Sales ₹ 4,000
(iv) Indirect wages incurred ₹ 8,000
(v) Material returned from production to stores ₹ 9,000 [CA Inter Nov. 2019, 5 Marks]
Answer:
Journal entries are as follows:

Question 3.
As of 31st March 2021, the following balances existed in a firm’s cost ledger, which is maintained separately on a double-entry basis:

	Debit ₹	Credit ₹
Stores Ledger Control A/c	3,00,000	–
Work-in-progress Control A/c	1,50,000	–
Finished Goods Control A/c	2,50,000	–
Manufacturing Overhead Control A/c		15,000
Cost Ledger Control A/c		6,85,000
	7,00,000	7,00,000

During the next quarter, the following items arose:

	₹
Finished Product (at cost)	2,25,000
Manufacturing overhead incurred	85,000
Raw material purchased	1,25,000
Factory wages	40,000
Indirect labour	20,000
Cost of sales
Materials issued to production
Sales returned (at cost)	9,000
Materials returned to suppliers	13,000
Manufacturing overhead charged to production	85,000

You are required to prepare the Cost Ledger Control A/c, Stores Ledger Control A/c, Work-In-progress Control A/c. Finished Stock Ledger Control A/c, Manufacturing Overhead Control A/c, Wages Control A/c, Cost of Sales A/c and the Trial Balance at the end of the quarter. [CA Inter Nov. 2008, 15 Marks]
Answer:
Cost Ledger Control Account

Stores Ledger Control Account

Work-in-progress Control Account

Finished Stock Ledger Control Account

Manufacturing Overhead Control Account

Wages Control Account

Cost of Sales Account

Question 4.
The following balances were extracted from a Company’s ledger as on 30th June, 2021:

	Debit (₹)	Credit (₹)
Raw material control a/c	2,82,450
Work-in-progress control a/c	2,38,300
Finished stock control a/c	3,92,500
General ledger adjustment a/c		9,13,250
Total	9,13,250	9,13,250

The following transactions took place during the quarter ended 30th September, 2021:
(i) Factory overheads – allocated to work-in-progress ₹ 1,36,350
(ii) Goods furnished – at cost ₹ 13,76,200
(iii) Raw materials purchased ₹ 12,43,810
(iv) Direct wages – allocated to work-in-progress ₹ 2,56,800
(v) Cost of goods sold ₹ 14,56,500
(vi) Raw materials – issued to production ₹ 13,60,430
(vii) Raw materials – credited by suppliers ₹ 27,200
(viii) Raw materials losses – inventory audit ₹ 6,000
(ix) Work-in-progress rejected (with no scrap value) ₹ 12,300
(x) Customer’s returns (at cost) of finished goods ₹ 45,900
You are required to prepare:
(i) Raw material control a/c
(ii) Work-in-progress control a/c
(iii) Finished stock control a/c
(iv) General ledger adjustment a/c [CA Inter Nov. 2018, 10 Marks]
Answer:
(i) Raw Material Control A/c

(ii) Work-in-Progress Control A/c

(iii) Finished Goods Control A/c

(iv) General Ledger Adjustment A/c

Question 5.
The following information has been extracted from the cost records of a manufacturing company:

Draw the Stores Leger Control A/c, Work-in-Progress Control A/c, Overheads Control A/c and Costing Profit and Loss A/c. [CA Inter May 2017, Nov. 2014, Nov. 2011, 8 Marks]
Note: General Ledger Adjustment A/c may also be written as Cost Ledger Control A/c
Answer:
Stores Ledger Control A/c

Note: Deficiency is assumed to be normal.

Work-in-Progress Control A/c

Overheads Control A/c

Costing Profit & Loss A/c

Note: General Ledger Adjustment A/c may also be written as Cost Ledger Control A/c

Question 6.
Acme Manufacturing Co. Ltd. opens the costing records, with the balances as on 1st July as follows:

	(₹)	(₹)
Material Control A/c	1,24,000
Work-in-Process Control A/c	62,500
Finished Goods Control A/c	1,24,000
Production Overhead Control A/c	8,400
Administrative Overhead Control A/c		12,000
Selling & Distribution Overhead Control A/c	6,250
Cost Ledger Control A/c		3,13,150
	3,25,150	3,25,150

The following are the transactions for the quarter ended 30th September:

	(₹)
Materials purchased	4,80,100
Materials issued to jobs	4,77,400
Materials to works maintenance	41,200
Materials to administrative office	3,400
Materials to sales department	7,200
Wages direct	1,49,300
Wages indirect	65,000
Transportation for indirect materials	8,400
Production overheads incurred	2,42,250
Absorbed production overheads	3,59,100
Administrative overheads incurred	74,000
Administrative overheads allocated to production	52,900
Administrative overheads allocated to sales department	14,800
Selling & Distribution overheads incurred	64,200
Selling & Distribution overheads absorbed	82,000
Finished goods produced	9,58,400
Finished goods sold	9,77,300
Sales;	14,43,000

Make up the various accounts as you envisage in the Cost Ledger and prepare a Trial Balance as at 30th September. [ICAI Module]
Answer:
Cost Ledgers
Material Control A/c

Wages Control A/c

Production Overhead Control A/c

Administrative Overhead Control A/c

Work-in-Process Control A/c

Finished Goods Control A/c

Selling and Distribution Overhead Control A/c

Cost of Sales A/c

Cost Ledger Control A/c

Costing Profit & Loss A/c

Trial Balance as at 30th September

Question 7.
A company operates on historic job cost accounting system, which is not integrated with the financial accounts. At the beginning of a month, the opening balances in cost ledger were:

	(₹ in lakhs)
Stores Ledger Control Account	80
Work-in-Process Control Account	20
Finished Goods Control Account	430
Building Construction Account	10
Cost Ledger Control Account	540

During the month, the following transactions took place:

		(₹ in lakhs)
Materials	Purchased	40
	Issued to production	50
	Issued to factory maintenance	6
	Issued to building construction	4
Wages	Gross wages paid	150
	Indirect wages	40
	For building construction	10
Works Overheads	Actual amount incurred (excluding items shown above)	160
	Absorbed in building construction	20
	Under absorbed	8
Royalty paid (related to production)		5
Selling, distribution and administration overheads		25
Sales		450

At the end of the month, the stock of raw material and work-in-process was f 55 lakhs and ₹ 25 lakhs respectively. The loss arising in the raw material accounts is treated as factory overheads. The building under construction was completed during the month. Company’s gross profit margin is 20% on sales.
You are required to prepare the Cost Ledger Control A/ c, Stores Ledger Control A/c, Wages Control A/c, Works Overhead Control A/c, Work-in-Process Control A/c, Finished Goods Control A/c, Cost of Sales A/c, Costing P&L A/c, Building Construction A/c and Trial Balance at the end of the month. [CA Inter Nov. 2021, RTPJ
Answer:
Cost Ledger Control A/c

Stores Ledge Control A/c

Wages Control A/c

Works Overhead Control A/c

Work-in -Process Control A/c

Finished Goods Control A/c

Cost of Sales A/c

Costing P & L A/c

Building Construction A/c

Trial Balance

Question 8.
A Company operates separate cost accounting and financial accounting systems. The following is the list of opening balances as on 1.04.2021 in the Cost Ledger:

	Debit (₹)	Credit (₹)
Stores Ledger Control Account	53,375	……
WIP Control Account	1,04,595	……
Finished Goods Control Account	30,780	……
General Ledger Adjustment Account	…..	1,88,750

Transactions for the quarter ended 30.06.2021 are as under:

Materials purchased	26,700
Materials issued to production	40,000
Materials issued to factory for repairs	900
Factory wages paid (including indirect wages ₹ 23,000)	77,500
Production overheads incurred	95,200
Production overheads under- absorbed and written-off	3,200
Sales	2,56,000

The Company’s gross profit is 25% on Cost of Sales. At the end of the quarter, WIP stocks increased by ₹ 7,500.
Prepare the relevant Control Accounts, Costing Profit & Loss Account and General Ledger Adjustment Account to record the above transactions for the quarter ended 30.06.2021. [CA Inter Nov. 2001, 10 Marks]
Answer:
General Ledger Adjustment A/c

Stores Ledger Control A/c

WIP Control A/c

Finished Goods Control A/c

Note: Gross profit is 25% of Cost of Sales or 20% on sales.
Hence cost of sales = ₹ 2,56,000 – 20% of ₹ 2,56,000 = ₹ 2,04,800

Factory Overhead Control A/c

Cost of Sales A/c

Sales A/c

Wages Control A/c

Costing Profit & Loss A/c

Trial Balance (as on 30.06.2021)

	(₹)	(₹)
Stores ledger control A/c	39,175
WIP control A/c %	1,12,095
Finished goods control A/c	28,880
General ledger adjustment A/c		1,80,150
	1,80,150	1,80,150

Question 9.
The following information is available from a company’s records for March, 2021:
(a) Opening Balance of Creditors Account ₹ 25,000
(b) Closing Balance of Creditors Account ₹ 40,000
(c) Payment made to Creditors ₹ 5,80,000
(d) Opening Balance of Stores Ledger Control Account ₹ 40,000
(e) Closing Balance of Stores Ledger Control Account ₹ 65,000
(f) Wages paid (for 8,000 hours) 20% relate to indirect workers ₹ 4,00,000
(g) Various indirect expenses incurred ₹ 60,000
(h) Opening balance of W1P control account ₹ 50,000
(i) Inventory of WIP at the end of the month includes material worth on which 400 labour hours have been booked. ₹ 35,000
(j) Factory overhead is charged to production at budgeted rate based on direct labour hours.
(k) j Budgeted overhead cost is ₹ 20,80,000 for budgeted direct labour hours 1,04,000.
You are required to prepare Creditors A/c, Stores Ledger Control A/c, WIP Control A/c, Wages Control A/c and Factory Overhead Control A/c. [CA Inter May 2016, 8 Marks]
Answer:
Creditors A/c

Stores Ledger Control A/c

Work-in-Process Control A/c

*Direct Labour Hour Rate = ₹ 3,20,000/ 6,400 hours = ₹ 50
**Factory Overhead Rate = ₹ 20,80,000/ 1,04,000 = ₹ 20

Wages Control A/c

Factory Overhead Control A/c

Question 10.
Journalise the following transactions assuming cost and financial accounts are integrated: [CA Inter Nov. 2013, 5 Marks]

		₹
(i)	Materials issued:
	Direct:	3,25,000
	Indirect	1,15,000
(ii)	Allocation of wages (25% indirect)	6,50,000
(iii)	Under/Over absorbed overheads:
	Factory (Over)	2,50,000
	Administration (Under)	1,75,000
(iv)	Payment to Sundry Creditors	1,50,000
(v)	Collection from Sundry Debtors	2,00,000

Answer:
Journal Entries under Integrated system of accounting

Question 11.
BPR Limited keeps books on integrated accounting system. The following balances appear in the books as on April 1, 20?

	Dr. (₹)	Cr. (₹)
Stores Control A/c	40,950	–
Work-in-progress A/c	38,675	–
Finished Goods A/ c	52,325	–
Bank A/c	–	22,750
Trade Payables A/c	–	18,200
Non-Current Assets A/c	1,47,875	–
Trade Receivables A/c	27,300	–
Share Capital A/c	–	1,82,000
Provision for Depreciation A/c	–	11,375
Provision for Doubtful Debts A/c	–	3,721
Factory Overheads Outstanding A/c	–	6,250
Pre-Paid Administration Overheads A/c	9,975	–
Profit & Loss A/c	–	72,800
	3,17,100	3,17,100

The transactions for the year ended March 31, 2021, were as given below:

	₹	₹
Direct Wages	1,97,925
Indirect Wages	11.375	2,09,300
Purchase of materials (on credit)		2,27,500
Materials issued to production		2,50,250
Material issued for repairs		4,550
Goods finished during the year (at cost)		4,89,125
Credit Sales		6,82,500
Cost of Goods sold		5,00,500
Production overheads absorbed		1,09,200
Production overheads paid during the year		91,000
Production overheads outstanding at the end of year		7,775
Administration overheads paid during the year		27,300
Selling overheads incurred		31,850
Payment to Trade Payables		2,29,775
Payment received from Trade Receivables		6,59,750
Depreciation of Machinery		14,789
Administration overheads outstanding at the end of year		2,225
Provision for doubtful debts at the end of the year		4,590

Required:
Write up accounts in the integrated ledger of BPR Limited and prepare a Trial balance. ]CA Inter Nov. 2003, 10 Marks]
Answer:
Stores Control A/c

Wages Control A/c

Work-in-Progress A/c

Production Overheads A/c

Finished Goods A/c

Administration Overheads A/c

Cost of Sales A/c

Sales A/c

Factory Overheads/Production Overheads Outstanding A/c

Finished Goods A/c

Administration Overheads A/c

Cost of Sales A/c

Sales A/c

Factory Overheads/Production Overheads Outstanding A/c

Prepaid Administration Overheads A/c

Provision for Depreciation A/c

Provision for Doubtful Debts A/c

Profit & Loss A/c

Trade Receivables A/c

Trade Payables A/c

Non-Current Assets A/c

Bank A/c

Trial Balance as on 31.03.2021

	Debit ₹	Credit ₹
Stores Control A/c	13,650
WIP A/c	1,06,925
Finished goods A/c	80,450
Bank A/c	47,775
Trade Payables A/c		15,925
Non-Current Assets A/c	1,47,875
Trade Receivables A/c	50,050
Share Capital A/c		1,82,000
Provision for Depreciation A/c		26,164
Reserve And Surplus (Profit & loss A/c )		2,08,046
Production o/h outstanding A/c		7,775
Administration o/h outstanding A/c		2,225
Provision for doubtful debts A/c		4,590
	4,46,725	4,46,725

Question 12.
A fire destroyed some accounting records of a company. You have been able to collect the following from the spoilt papers/records and as a result of consultation with accounting staff for the month of January:
(i) Incomplete Ledger Entries:
Materials Control A/c

Work-In-Process Control A/c

Payables (Creditors) A/c

Manufacturing Overheads Control A/c

Finished Goods Control A/c

(ii) Additional Information:
(1) The bank-book showed that ₹ 89,200 have been paid to creditors for raw-material.
(2) Ending inventory of work-in-process included materials of ₹ 5,000 on which 300 direct labour hours have been booked against wages and overheads.
(3) The job card showed that workers have worked for 7,000 hours. The wage rate is ₹ 10 per labour hour.
(4) Overhead recovery rate was ₹ 4 per direct labour hour.
You are required to complete the above accounts in the cost ledger of the company. [ICAI Module]
Answer:
Materials Control A/c

Manufacturing Overheads A/c

Work-in-Process Control A/c

Finished Goods Control A/c

Payables (Creditors) A/c

Question 13.
R Limited showed a net loss of ₹ 35,400 as per their cost accounts for the year ended 31.03.2021. However, the financial accounts disclosed a net profit of ₹ 67,800 for the same period. The following information was revealed as a result of scrutiny of the figures of cost accounts and financial accounts: [CA Inter Nov. 2012, June 2009, 8 Marks]

	₹
(j) Administrative overhead under recovered	25,500
(ii) Factory overhead over recovered	1,35,000
(iii) Depreciation undercharged in Cost Accounts	26,000
(iv) Dividend received	20,000
(v) Loss due to obsolescence charged in Financial Accounts	16,800
(vi) Income tax provided	43,600
(iv) Bank interest credited in Financial Accounts	13,600
(viii) Value of opening stock:
In Cost Accounts	1,65,000
In Financial Accounts	1,45,000
(ix) Value of closing stock:
In Cost Accounts	1,25,500
In Financial Accounts	1,32,000
(x) Goodwill written-off in Financial Accounts	25,000
(xi) Notional rent of own premises charged in Cost Accounts	60,000
(xii) Provision for doubtful debts in Financial Accounts	15,000
Prepare a reconciliation statement by taking costing net loss as base.

Answer:
Statement of Reconciliation

	₹	₹
Net loss as per Cost Accounts Additions		(35,400)
Factory overhead over recovered	1,35,000
Dividend Received	20,000
Bank Interest received	13,600
Difference in Value of Opening Stock (? 1,65,000-? 1,45,000)	20,000
Difference in Value of Closing Stocky 1,32,000-₹ 1,25,500)	6,500
Notional Rent of own Premises	60,000	2,55,100
Deductions
Administration overhead under recovered	25,500
Depreciation under charged	26,000
Loss due to obsolescence	16,800
Income tax Provided	43,600
Goodwill written-off	25,000
Provision for doubtful debts	15,000	(1,51,900)
Net Profit as per Financial Accounts		67,800

Question 14.
GK Ltd. showed net loss of ₹ 2,43,300 as per their financial accounts for the year ended 31.03.2021. However, cost accounts disclosed net loss of ₹ 2,48,300 for the same period. On scrutinizing both the set of books of account, the following information were revealed:

		₹
(i)	Works overheads over recovered 30,400	30,000
(ii)	Selling overheads under recovered	20,300
(iii)	Administrative overheads under recovered	27,700
(iv)	Depreciation over charged in cost accounts	35,100
(v)	Bad debts w/off in financial accounts	15,000
(vi)	Preliminary Exp. w/off in financial accounts	5,000
(vii)	Interest credited during the year in financial accounts	7,500

Prepare a reconciliation statement reconciling losses shown by financial and cost accounts by taking costing net loss as base. [CA Inter May 2018, 5 Marks]
Answer:
Reconciliation Statement

	₹	₹
Loss as per Cost Accounts		(2,48,300)
Add: Works overheads over recovered	30,400
Depreciation over charged in cost accounts	35,100
Interest credited during the year in financial accounts	7,500	73,000
Less:        Selling overheads under recovered	20,300
Administrative overheads under recovered	27,700
Bad debts written off in financial accounts Preliminary Exp. written off in financial accounts	15,000 5,000	68,000
Loss as per Financial Accounts		(2,43,300)

Question 15.
R Ltd. showed a Net Profit of ₹ 3,60,740 as per their cost accounts for the year ended 31st March, 2021.
The following information was revealed as a result of scrutiny of the figures from the both sets of accounts;

Sr. No.	Particulars	₹
i.	Over recovery of selling overheads in cost accounts	10,250
ii.	Over valuation of closing stock in cost accounts	7,300
iii.	Rent received credited in financial accounts	5,450
iv.	Bad debts provided in financial accounts	3,250
V.	Income tax provided in financial accounts	15,900
vi.	Loss on sale of capital asset debited in financial accounts	5,800
vii.	Under recovery of administration overheads in cost accounts	3,600

Prepare a reconciliation statement showing the profit as per financial records. [CA Inter Dec. 2021, 5 Marks]
Answer:

Question 16.
A manufacturing company has disclosed net loss of ₹ 48,700 as per their cost accounting records for the year ended 31st March, 2021. However their financial accounting records disclosed net profit of ₹ 35,400 for the same period. A scrutiny of data of both the sets of books of account revealed the following information:

	₹
(i) Factory overheads under absorbed	30,500
(ii) Administrative overheads over absorbed	65.000
(iii) Depreciation charged in financial accounts	2,25,000
(iv) Depreciation charged in cost accounts	2,70,000
(v) Income-tax provision	52,400
(vi) Transfer fee (credited in financial accounts)	10,200
(vii) Obsolescence loss charged in financial accounts	20,700
(vili) Notional rent of own premises charged in cost accounts	54,000
(ix) Value of opening stock:
(a) in cost accounts	1,38,000
(b) in financial accounts	1,15,000
(c) Value of closing stock
(d) in cost accounts	1,22,000
(e) in financial accounts	1,12,500

Prepare a Memorandum Reconciliation Account by taking costing loss as base. [CA Inter May 2014, Nov. 2010, 5 Marks]
Answer:
Memorandum Reconciliation Accounts

“Overvaluation of Opening Stock as per Cost Accounts
= Value in Cost Accounts – Value in Financial Accounts
= ₹ 1,38,000 – ₹ 1,15,000 = ₹ 23,000

“Overvaluation of Closing Stock as per Cost Accounts
= Value in Cost Accounts – Value in Financial Accounts
= ₹ 1,22,000 – ₹ 1,12,500 = ₹ 9,500

Question 17.
The net loss of Waywell Ltd. appeared at ₹ 1,18,500 as per cost records for the year ending 31.03.2021. The following information was revealed as a result of scrutiny of the figures of financial and cost records:

	₹
Factory overheads over absorbed in cost accounts	32,500
Administrative overheads under absorbed in cost accounts	38,250
Depreciation charged in financial accounts	4,55,800
Depreciation recovered in cost accounts	4,99,700
Loss due to obsolescence charged in financial accounts	11,400
Income tax provision made in financial accounts	32,650
Interest on investments not included in cost accounts	96,000
Store adjustment (Credit) in financial accounts	12,800
Value of opening stock in: Cost accounts	18,85,600
Financial accounts	19,62,500
Value of closing stock in: Cost accounts	21,15,800
Financial accounts	21,98,900
Imputed rent charged in cost accounts	1,80,000
Selling and distribution expenses not charged in cost accounts	72,450
Donation to Prime Minister Relief Fund	11,000
Loss on sale of furniture	7,250
Bad debts written off	18,300

Prepare a reconciliation statement and arrive at the profit or loss as per financial accounts. [CA Inter May 2019, 8 Marks]
Answer:
Statement of Reconciliation

Question 18.
M/s Abid Private Limited disclosed a net profit of ₹ 48,408 as per cost books for the year ending 31st March 2021. However, financial accounts disclosed net loss of ₹ 15,000 for the same period. On scrutinizing both the set of books of account, the following information was revealed:

Works Overheads under- recovered in Cost Books	48,600
Office Overheads over- recovered in Cost Books	11,500
Dividend received on Shares	17,475
Interest on Fixed Deposits	21,650
Provision for doubtful debts	17,800
Obsolescence loss not charged in Cost Accounts	17,200
Stores adjustments (debited in Financial Accounts)	35,433
Depreciation charged in financial accounts	30,000
Depreciation recovered in Cost Books	35,000

Prepare a Memorandum Reconciliation Account. [CA Inter May 2019, 5 Marks]
Answer:
Memorandum Reconciliation Account

Question 19.
The Trading and Profit & Loss Account of a company for the year ended 31.03.2021 is as under:
Trading and Profit and Loss Account

In the Cost Accounts:
(i) Factory expenses have been allocated to production at 20% of Prime Cost.
(it) Administrative expenses absorbed at 10% of factory cost.
(iii) Selling expenses charged at ₹ 10 per unit sold.
Prepare the Costing Profit and Loss Account of the company and reconcile the Profit/Loss with the profit as shown in the Financial Accounts.
[CA Inter Nov. 2016, 8 Marks]
Answer:
Preparation of Cost Sheet

	₹
Materials	26,80,000
Wages	17,80,000
Prime Cost	44,60,000
Add: Factory expenses (20% of ₹ 44,60,000)	8,92,000
Factory Cost	53,52,000
Add: Administrative expenses (10% of ₹ 53,52,000)	5,35,200
Cost of Production	58,87,200
Less: Closing stock [(₹ 58,87(200 T- 52,000 units) × 2,000 units)	(2,26,431)
Cost of Goods Sold	56,60,769
Add: Selling expenses (₹ 10 × 50,000 units)	5,00,000
Cost of Sales	61,60,769
Profit (Balancing figure)	39,231
Sales Value	62,00,000

Note: It has been assumed that administrative expenses are related with production activities

Costing Profit and Loss Account

Reconciliation of profit as per Cost Accounts and as per Financial Accounts

Question 20.
You are given the following information of the cost department of a manufacturing company:

	₹
Stores
Opening Balance	12,60,000
Purchases	67,20,000
Transfer from work-in-progress	33,60,000
Issue to work-in-progress	67,20,000
Issue to repairs and maintenance	8,40,000
Shortage found in stock taking	2,52,000
Work-in-progress:
Opening Balance	25,20,000
Direct wages applied         .	25,20,000
Overhead applied	90,08,000
Closing Balance	15,20,000

Finished products:
Entire output is sold at a profit of 12% on actual cost from work-in-progress Other information:

Wages incurred	29,40,000
Overhead incurred	95,50,000
Income from Investment	4,00,000
Loss on sale of fixed assets	8,40,000

Shortage in stock taking is treated as normal loss.
You are required to prepare:
(i) Stores control account
(ii) Work-in-progress control account
(iii) Costing Profit and Loss account
(iv) Profit and Loss account and
(v) Reconciliation statement [CA Inter May 2011, May 2005, 12 Marks]
Answer:
Stores Ledger Control Account

WIP control Account

Costing Profit and Loss A/c

Financial Profit and Loss A/c

Reconciliation Statement

Working Notes:
Overhead Control Account

Question 21.
The following is the Trading and Profit & Loss Account of Omega Limited:

Omega Limited manufactures a standard unit.
The Cost Accounting records of Omega Ltd. Show the following:
(i) Production overheads have been charged to work-in-progress at 20% on Prime cost.
(ii) Administration Overheads have been recovered at ₹ 9.75 per finished Unit.
(iii) Selling & distribution Overheads have been recovered at ₹ 13 per Unit sold.
(iv) The Under-absorption or Over-absorption of Overheads has not been transferred to costing P & L A/c.
Required:
(i) Prepare a proforma Costing Profit & Loss account, indicating net profit.
(ii) Prepare Control accounts for production overheads, administration Overheads and selling & distribution Overheads.
(iii) Prepare a statement reconciling the profit disclosed by the cost records with that shown in Financial accounts. [CA Inter Nov. 2005, 10 Marks]
Answer:
(i) Costing Profit & Loss A/c

(ii) Production OH A/c

Administration OH A/c

Selling & Distribution OH A/c

(iii) Reconciliation Statement

Question 22.
The financial books of a company reveal the following data for the year ended 31st March, 2021:

	₹
Opening Stock:
Finished goods 625 units	1,06,250
Work-in-process	92,000
01.04.2020 to 31.03.2021
Raw materials consumed	16,80,000
Direct Labour	12,20,000
Factory overheads	8,44,000
Administration overheads (production related)	3,96,000
Dividend paid	2,44,000
Bad Debts	36,000
Selling and Distribution O verheads	1,44,000
Interest received	76,000
Rent received	92,000
Sales 12,615 units	45,60,000
Closing Stock: Finished goods 415 units	91,300
Work-in-process	82,400

The cost records provide as under:

• Factory overheads are absorbed at 70% of direct wages
• Administration overheads are recovered at 15% of factory cost.
• Selling and distribution overheads are charged at 16 per unit sold.
• Opening Stock of finished goods is valued at ? 240 per unit.
• The company values work-in-process at factory cost for both Financial and Cost Profit Reporting.

Required:
(i) Prepare statements for the year ended 31st March, 2021 showing:

• the profit as per financial records
• the profit as per costing records

(ii) Prepare a statement reconciling the profit as per costing records with the profit as per financial records. [CA Inter May 2021 RTP]
Answer:
Statement of Profit as per financial records
(for the year ended March 31, 2021)

Statement of Profit as per costing records
(for the year ended March 31, 2021)

Statement of Reconciliation
(Reconciling the profit as per costing records with profit as per financial records)

Working notes:
1. Number of units produced

	Units
Sales	12,615
Add: Closing stock	415
Total	13,030
Less: Opening stock	(625)
Number of units produced	12,405

2. Cost Sheet

	₹
Raw materials consumed	16,80,000
Direct labour	12,20,000
Prime cost	29,00,000
Factory overheads (70% of direct wages)	8,54,000
Factory cost	37,54,000
Add: Opening work-in-process	92,000
Less: Closing work-in-process	(82,400)
Factory cost of goods produced	37,63,600
Administration overheads (15% of factory cost)	5,64,540
Cost of production of 12,405 units (W.N.l) Cost of production per unit (₹ 43,25,140 / 12,405 units) = ₹ 348.90	43,28,140

Question 23.
The profit and loss account of ABC Ltd. for the year ended 31st March, 2021 is given below:
Profit and Loss account
(For the year ended 31st March, 2021)

• Factory overheads are 50% fixed and 50% variable.
• Administrative overheads are 100% fixed.
• Selling overheads are completely variable
• Normal production capacity of ABC Ltd. is 20,000 units.
• Indirect Expenses are absorbed in the cost accounts on the basis of normal production capacity.
• Notional rent of own premises charged in cost accounts is amounting to ₹ 12,000

You are required to:
(i) Prepare a cost sheet and ascertain the profit as per cost records for the year ended 31st March, 2021.
(ii) Reconcile the profit as per Financial Records with profit as per Cost Records. [CA Inter July 2021, 10 Marks]
Answer:
Cost Sheet

Reconciliation Statement

Question 24.
The following figures have been taken from the financial accounts of a manufacturing firm for the year ended 31st March, 2021:

	₹
Direct material consumption	20,00,000
Direct wages	12,00,000
Factory overheads	6,40,000
Administrative overheads	2,80,000
Selling and distribution overheads	3,84,000
Bad debts	32,000
Preliminary expenses written off	16,000
Legal charges	4,000
Dividend received	40,000
Interest on fixed deposit	8,000
Sales: 48,000 units	48,00,000
Closing stock:
Finished stock: 4,000 units	3,20,000
Work-in-process	96,000

The cost accounts for the same period reveal that the Direct Material consumption was ? 22,40,000; Factory overhead is recovered at 20% on prime cost; Administration overhead is recovered @ ? 4.8 per unit of production; and Selling and Distribution overheads are recovered at ? 6.40 per unit sold.
Required:
Prepare Costing and Financial Profit & Loss Accounts and Reconcile the difference in the profit as arrived at in the two sets of accounts. [CA Inter, MTP]
Answer:

Units produced = Units sold + Closing stock – Opening stock
= 48,000 + 4,000 – 0 = 52,000 units

Financial Profit and Loss Account

Reconciliation Statement

CA Inter FM ECO Paper Nov 2022 – CA Inter FM ECO Study Material is designed strictly as per the latest syllabus and exam pattern.

CA Inter FM ECO Question Paper Nov 2022 Solution

Question 1.
(a) K Ltd. has a Quarterly cash outflow of ₹ 9,00,000 arising uniformly during the Quarter. The company has an Investment portfolio of Marketable Securities. It plans to meet the demands for cash by periodically selling marketable securities. The marketable securities are generating a return of 12% p.a. Transaction cost of converting investments to cash is ₹ 60. The company uses Baumol model to find out the optimal transaction size for converting marketable securities into cash.     (5 Marks)

Consider 360 days in a year.

You are required to calculate:
(a) Company’s average cash balance,
(b) Number of conversions each year and
(c) Time interval between two conversions.
Answer:
(a) Average cash balance = 1/2 of ₹ 60,000 = ₹30,000

(b) Number or conversions p.a. = \(\frac{\text { Annual Cash Requirement }}{\text { Optimal Transaction Size }}\) = \(\frac{9,00,000 \times 4}{60,000}\)
= 60 conversions per annum

(c) Time interval between two conversions
= \(\frac{360}{\text { No. of Conversions }}\) = \(\frac{360}{60}\) = 6 Days

(b) The following figure are related to the trading activities of M Ltd. (5 Marks)
Total assets – ₹ 10,00,000
Debt to total assets – 50%
Interest cost – 10% per year
Direct Cost – 10 times of the interest cost
Operating Exp. – ₹ 1,00,000
The goods are sold to customers at a margin of 50% on the direct cost Tax Rate is 30%. You are required to calculate:
(a) Net profit margin
(b) Net operating profit margin
(c) Return on assets
(d) Return on owner’s equity
Answer:

Working Notes:
(1) Debt = 50% of ₹ 10,00,000 = ₹ 5,00,000
(2) Interest = 10% of ₹ 5,00,000 = ₹ 50,000
(3) Direct cost = 10 times of ₹ 50,000 = ₹ 5,00,000
(4) Sales = Direct cost + 50% ₹ 5,00,000 + 50% = ₹ 7,50,000
(5) Equity Fund = Total Assets – Debt = ₹ 10,00,000 – ₹ 5,00,000 = ₹ 5,00,000
(6) The Net Profit is calculated as follows:

(c) The following is the extract of the Balance Sheet of M/s KD Ltd.:

Particulars	₹
Ordinary shares (Face Value ₹ 10 per share)	5,00,000
Share Premium	1,00,000
Retained Profits	6,00,000
8% Preference Shares (Face Value ₹ 25 per share)	4,00,000
12% Debentures (Face value ₹ 100 each)	6,00,000
	22,00,000

The ordinary shares are currently priced at ₹ 39 ex-dividend and preference share is priced at ₹ 18 Cum-dividend. The debentures are selling at 120 percent ex-interest. The applicable tax rate to D Ltd. is 30 percent. KD Ltd.’s cost of equity has been estimated at 19 percent. Calculate the WACC (weighted average cost of capital) of KD Ltd. on the basis of market value. (5 Marks)
Answer:
Statement of WACC (Market Value Weights)

WACC (K₀) = 0.1509 or 15.09%
Working Notes:
(1) Calculation of Market Value:
Total Market value of Equity and Retained earnings:
= (₹ 5,00,000 ÷ ₹10) × ₹ 39 = ₹ 19,50,000
Market Value of Equity = ₹ 19,50,000 × 5/12 = ₹ 8,12,500
Market Value of Retained earnings = ₹ 19,50,000 × 7/12 = ₹ 11,37,500
Market Value of Debentures = (₹ 6,00,000 ÷ ₹ 100) × ₹ 120
= ₹ 7,20,000
Market Value of Preference Shares = (₹ 4,00,000 ÷ ₹ 25) × ₹16*
= ₹ 2,56,000
’Market value of 1 Preference Share ex-dividend is used i.e. ₹ 16 (₹18 – 8% of ₹ 25).

(2) Calculation of K_r:
K_r = K_e = 19%

(3) Calculation of K_d:
K_r = \(\frac{\mathrm{I}(1-t)}{N P}\) × 100 = \(\frac{12 \% \text { of } 100(1-0.3)}{120}\) × 100 = 7%

(4) Calculation of K_p:
K_p = \(\frac{P D}{N P}\) × 100 = \(\frac{8 \% \text { of } 25}{16}\) × 100 = 8%

(d) Determine the risk adjusted net present value of the following projects: (5 Marks)

Particulars	A	B	C
Net cash outlays (₹)	70,000	1,20,000	2,20,000
Project life	5 Years	5 Years	5 Years
Annual Cash inflow (₹)	30,000	42,000	70,000
Coefficient of variation	2.2	1.6	1.2

The Company selects the risk-adjusted rate of discount on the basis of the coefficient of variation:

Coefficient of Variation	Applicable Risk-Adjusted Discount (i)	PVIFA (i, 5)
0	10%	3.791
0.4	12%	3.605
0.8	14%	3.433
1.2	16%	3.274
1.6	18%	3.127
2	22%	2.864
>2.0	25%	2.689

Which project should be selected by the company based on Risk Adjusted NPV?
Answer:
Statement Showing the Determination of the Risk Adjusted Net Present Value

Decision: Company should select Project B having highest Risk-adjusted NPV.

Question 2.
The following information is available for SS Ltd. (10 Marks)
Profit volume (PV) ratio – 30%
Operating leverage – 2.00
Financial leverage – 1.50
Loan – ₹ 1,25,000
Post-tax interest rate – 5.6%
Tax rate – 30%
Market Price per share (MPS) – ₹ 140
Price Earnings Ratio (PER) – 10

You are required to
(1) Prepare the Profit-Loss statement of SS Ltd. and
(2) Find out the number of equity shares.
Answer:
(1) Profit-Loss Statement

(2) Number of Equity Shares = PAT/EPS = ₹ 14,000/₹ 14 = 1,000 Shares
Working Notes:
(a) Financial Leverage = EBIT/(EBIT – Interest)
EBIT/(EBIT – ₹ 10,000) = 1.5
EBIT = 1.5 EBIT – ₹ 15,000
EBIT = ₹ 30,000
Interest = Loan × Pre-tax interest rate
= ₹ 1,25,000 × 8% [5.6% ÷ (1 – 0.3)]
= ₹ 10,000

(b) Operating Leverage = Contribution/EBIT
= Contribution/30,000 = 2.00
Contribution = ₹ 60,000

(c) Sales = Contribution/PV Ratio
= ₹ 60,000/0.30 = ₹ 2,00,000

(d) EPS = MPS/PE Ratio
= ₹ 140/10 times = ₹ 14

Question 3.
A firm is in need of a small vehicle to make deliveries. It is intending to choose between two options. One option is to buy a new three wheeler that would cost ₹ 1,50,000 and will remain in service for 10 years. (10 Marks)

The other alternative is to buy a second hand vehicle for ₹ 80,000 that could remain in service for 5 years. Thereafter the firm, can buy another second hand vehicle for ₹ 60,000 that will last for another 5 years.

The scrap value of the discarded vehicle will be equal to it written down value (WDV). The firm pays 30% tax and is allowed to claim depreciation on vehicles @ 25% on WDV basis. The cost of capital of the firm is 12%.
You are required to advise the best option.
Given:

t	1	2	3	4	5	6	7	8	9	10
PVIF(t, 12%)	0.892	0.797	0.711	0.635	0.567	0.506	0.452	0.403	0.360	0.322

Answer:
Statement of PV of outflow under Option 1

Statement of PV of outflow under Option 2

Advise: Select option 2 having lower Net PV of Outflows.

Question 4.
A hospital is considering to purchase a diagnostic machine costing ₹ 80,000. The projected life of the machine is 8 years and has an expected salvage value of ₹ 6,000 at the end of 8 years. The annual operating cost of the machine is ₹ 7,500. It is expected to generate revenues of ₹ 40,000 per year for eight years. Presently, the hospital is outsourcing the diagnostic work and is earning commission income of ₹ 12,000 per annum. Consider tax rate of 30% Discounting Rate as 10%. (10 Marks)

Advise: Whether it would be profitable for the hospital to purchase the machine?

Give your recommendation as per Net Present Value method and Present Value Index method under below mentioned two situations:
(i) If Commission income of ₹ 12,000 p.a. is before taxes.
(ii) If Commission income of ₹ 12,000 p.a. is net of taxes.
Given:

t	1	2	3	4	5	6	7	8
PVIF (t, 10%)	0.909	0.826	0.751	0.683	0.621	0.564	0.513	0.467

Answer:
(i) Net Present Value and Present Value Index when commission income is before tax:
Net Present Value

Year	Particulars	₹	DF @ 10%	DCF
0	Initial Outflows	(80,000)	1.000	(80,000)
1-8	Cash Flow After Tax	17,125	5.334	91,345
8	Salvage	6,000	0.467	2,802
NPV				14,147

Profitability Index = \(\frac{\text { PV of Inflows }}{\text { PV of Outflows }}\) = \(\frac{94,147}{80,000}\) = 1.18

Advise: Since the net present value (NPV) is positive and profitability index is also greater than 1, it is profitable for the hospital to purchase the machine.

(ii) Net Present Value and Present Value Index when commission income is before tax:
Net Present Value

Year	Particulars	₹	DF @ 10%	DCF
0	Initial Outflows	(80,000)	1.000	(80,000)
1-8	Cash Flow After Tax	13,525	5.334	72,142
8	Salvage	6,000	0.467	2,802
NPV				(5,056)

Profitability Index = \(\frac{\text { PV of Inflows }}{\text { PV of Outflows }}\) = \(\frac{74,944}{80,000}\) = 0.94

Advise: Since the net present value (NPV) is negative and profitability index is also lower than 1, it is not profitable for the hospital to purchase the machine.

Working Notes:
Calculation of CFAT:

Question 5.
(a) The following are the costs and values for the firms A and B according to the traditional approach.

(i) Compute the Equilibrium value for Firms A and B in accordance with the MM approach. Assume that (a) taxes do not exist and (b) the equilibrium value of K_e is 9.09%.
(ii) Compute Value of Equity and Cost of Equity for both the firms. (4 Marks)
Answer:
(i) Equilibrium value of Firm A (Unlevered)
= Net operating income ÷ K_e
= ₹ 5,000 ÷ 9.0996 = ₹ 55,006
Equilibrium value of Firm B (Levered)
= Value of Firm A (Unlevered)
= ₹ 55,006

(ii) Value of Equity Firm A = ₹ 55,006
Cost of Equity Firm A = 9.09%
Value of Equity Firm B = Value of Firm B – Value of debt
= ₹ 55,006 – ₹ 30,000 = ₹ 25,006
Cost of Equity Firm B = NI/E
= ₹ 3,200 ÷ ₹ 25,006 = ₹ 12.80%

(b) MR Ltd. is having the following capital structure, which is considered to be optimum as on 31.03.2022. (6 Marks)

The earnings per share (EPS) of the company were ₹ 2.50 in 2021 and the expected growth in equity dividend is 10% per year. The next year’s dividend per share (DPS) is 50% EPS of the year 2021. The current market price per share (MPS) is ₹ 25.00. The 15% new debentures can be issued by the company. The company’s debentures are currently selling at ₹ 96 per debenture. The new 12% Pref. Share can be sold at a net price of ₹ 91.50 (face value ₹ 100 each). The applicable tax rate is 30%.

You are required to calculate:
(i) After tax cost of
(a) New debt,
(b) New pref. share capital and
(c) Equity shares assuming that new equity shares come from retained earnings.
(ii) Marginal cost of capital.
(iii) How much can be spent for capital investment before sale of new equity shares assuming that retained earnings for next year investment is 50% of 2021 ?
Answer:
(i) (a) After tax cost of new debt
K_d = \(\frac{\mathrm{I}(1-\mathrm{t})}{\mathrm{NP}}\) × 100 = \(\frac{15(1-0.30)}{96}\) × 100 = 10.94%
(b) After tax cost of new preference shares
K_d = \(\frac{\mathrm{PD}}{\mathrm{NP}}\) × 100 = \(\frac{12}{91.50}\) × 100 = 13.11%
(c) Cost of new equity or cost of retained earnings
K_d = \(\frac{\mathrm{D}_1}{\mathrm{P}_0}\) + g = \(\frac{2.50 \times 50 \%}{25}\) + 0.10 = 15%

(ii) Marginal cost of capital:
K_dW_d + K_pW_p + K_rW_r = 10.94% × .15 + 13.11% × .05 + 15% × .80= 14.30%

(iii) The company can pay the following amount before issue of new shares: Equity (retained earnings in this case) = 80% of the total capital
Therefore, investment before new issue = \(\frac{62,500}{80 \%}\) = ₹ 78,125
Retained earnings = ₹ 2.50 × 50% × 50,000 shares
= ₹ 62,500

Question 6.
(a) These bonds are issued by non-US Banks and non-US corporation in US. What this bond is called and what are the other features of this Bond? (4 Marks)
Answer:
This bond is called as Yankee Bond. Following are the other features of this bond:
(a) These bonds are denominated in dollars
(b) Bonds issued by non-US banks and non-US corporations
(c) Bonds are issued in USA
(d) Bonds are to be registered in SEC (Securities and Exchange Commission)
(e) Bonds are issued in tranches
(f) Time taken can be up to 14 weeks
(g) Interest rate is dollar LIBOR (London Interbank Offered Rate)

(b) Elucidate the fundamental tasks of treasury department of firm. (4 Marks)
Answer:
Fundamental tasks of treasury department of firm are:
(1) Cash Management: It involves efficient cash collection process and managing payment of cash both inside the organisation and to third parties.

(2) Currency Management: The treasury department manages the foreign currency risk exposure of the company.

(3) Fund Management: Treasury department is responsible for planning and sourcing the company’s short, medium and long-term cash needs. They also facilitate temporary investment of surplus funds by mapping the time gap between funds inflow and outflow.

(4) Banking: It is important that a company maintains a good relationship with its bankers. Treasury department carry out negotiations with bankers with respect to interest rates, foreign exchange rates etc. and act as the initial point of contact with them. Short-term finance can come in the form of bank loans or through the sale of commercial paper in the money market.

(5) Corporate Finance: Treasury department is involved with both acquisition and divestment activities within the group. In addition, it will often have responsibility for investor relations.

(c) The firm has more capital than its requirement. What is this situation called? Give two consequences of it. (2 Marks)
Answer:
Such situation is called as over capitalization. It is a situation where a firm has more capital than it needs or in other words assets are worth less than its issued share capital, and earnings are insufficient to pay dividend and interest.
Consequences of Over-Capitalisation:
(a) Considerable reduction in the rate of dividend and interest payments.
(b) Reduction in the market price of shares.
(c) Resorting to “window dressing”.
(d) Some companies may opt for reorganization. However, sometimes the matter gets worse and the company ’may go into liquidation.

OR

What are the important factors considered for deciding the source and quantum of capital? (2 Marks)
Answer:
Funds procured from different sources have different characteristics in terms of risk, cost and control. The cost of funds should be at the minimum level for that a proper balancing of risk and control factors must be carried out. Another key consideration in choosing the source of new business finance is to strike a balance between equity and debt to ensure the funding structure suits the business.

Question 7.
(a) The equilibrium level of income (Y) of an economy is ₹ 2,000 crores. The autonomous consumption expenditure (a) is equal to ₹ 100 crores and investment expenditure (I) is ₹ 500 crores. (3 Marks)

You are required to calculate:
(a) Consumption expenditure at equilibrium level of National Income.
(b) Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS).
(c) Equilibrium level of income if saving function is S = – 10 + 0.2Y.
Answer:
(a) Y = C + I
2,000 crores = C + 500 crores
C = 1,500 crores =

(b) C = a + bY
1,500 crores = 100 crores + b × 2,000 crores
1,400 crores = b × 2,000 crores
b(MPC) = 1,400/2,000 = 0.70
MPS = 1 – b
= 1 – 0.70 = 0.30

(c) S = I
-10 + 0.8 Y = 500
0.8 Y = 500 + 10 = 510
Y = 510/0.8 = 1,020 crores

(b) What are the two forms, through which foreign capital may flow into an economy, as an investment? (2 Marks)
Answer:
The two forms, through which foreign capital may flow into an economy, as an investment are:

1. Foreign portfolio investment (FPI) in bonds, stocks and securities, and
2. Foreign direct investment (FDI) in industrial, commercial and similar other enterprises.

(c) Define ‘Money Multiplier’. Use of e-wallets is increasing at fast pace now-a-days. How this enhanced use of e-wallets is affecting money multiplier and money supply? (3 Marks)
Answer:
Money Multiplier (m) = Money supply ÷ Monetary base
Money multiplier m is defined as a ratio that relates the changes in the money supply to a given change in the monetary base. It denotes by how much the money supply will change for a given change in high-powered money. The multiplier indicates what multiple of the monetary base is transformed into money supply.

E-wallets (like: Paytm, G-Pay, Phone Pay etc.) is increasing at fast pace now- a-days. Enhanced use of e-wallets is affecting money multiplier and money supply positively. People hold less cash and more deposits, thus reducing the currency-deposit ratio; increasing the money multiplier causing the money supply to increase.

(d) What is the different between price ceiling and price floor? (2 Marks)
Answer:
When prices of certain essential commodities rise excessively, government may resort to controls in the form of price ceilings (also called maximum price) for making a resource or commodity available to all at reasonable prices. For example: maximum prices of food grains and essential items are set by government during times of scarcity. A price ceiling which is set below the prevailing market clearing price will generate excess demand over supply.

Whereas price floor is a minimum price buyers are required to pay. When price floors are set above market clearing price, suppliers are encouraged to over-supply and there would be an excess of supply over demand.

Question 8.
(a) (i) The Rupee dollar exchange rate for two different periods of a particular financial year are as follows: (3 Marks)
(a) In the month of January it is $ 1 = ₹ 65; and
(b) In the month of April it is $ 1 = ₹ 70

Answer the following:
(1) What does this indicate?
(2) Who will be benefited, either residents of India or foreigners?
(3) Explain the impact of exchange fluctuations in terms of appreciation of currency on inflation.
Answer:
(1) In April, you will have to exchange a greater amount of Indian Rupees (₹ 70) to get the same 1 US dollar. As such, the value of the Indian Rupee has gone down or Indian Rupee has depreciated in its value. Rupee depreciation here means that the rupee has become less valuable with respect to the U.S. dollar.

(2) When a country’s currency depreciates, foreigners find that its exports are cheaper and domestic residents find that imports from abroad are more expensive. Hence, foreigners will be benefited.

(3) An appreciation may cause reduction in the levels of inflation because imports are cheaper. Lower price of imported capital goods, components and raw materials lead to decrease in cost of production which reflects on decrease in prices.

(a) (ii) One of the biggest problem with using discretionary policy to counteract fluctuation is the different types of lags involved in fiscal policy action. What are these lags? (2 Marks)
Answer:
One of the biggest problems with using discretionary fiscal policy to counteract fluctuations is the different types of lags involved in fiscal policy action. There are significant lags are:
(a) Recognition lag: The economy is a complex phenomenon and the state of the macro economic variables is usually not easily comprehensible. Just as in the case of any other policy, the government must first recognize the need for a policy change.

(b) Decision lag: Once the need for intervention is recognized, the government has to evaluate the possible alternative policies. Delays are likely to occur to decide on the most appropriate policy.

(c) Implementation lag: Even when appropriate policy measures are decided on, there are possible delays in bringing in legislation and implementing them.

(d) Impact lag: Impact lag occurs when the outcomes of a policy are not visible for some time.

(b) (i) The following data is available for a company: (3 Marks)

Particulars	Amount (in ₹ Crore)
Gross Value Added (GVAMP)	2,750
Sales	3,450
Closing Stock	750
Interest	200
Opening Stock	900
Net Indirect taxes	550
Rent	310
Mixed income	380
Compensation to employees	600
Consumption of fixed capital                                                     ‘	320

Based on the above information, compute the following:
(a) Amount of Intermediates Consumption.
(b) Net Domestic Product at Factor Cost (NDP_FC).
(c) Profit of the company.
Answer:
(a) GVA_Mp = Sales + Change in stocks (Closing – Opening) – Intermediate consumption
2,750 = 3,450 + (750 – 900) – Intermediate consumption
Intermediate consumption = 3,450 – 150 – 2,750 = 550 crores

(b) NDP_FC = GVA_MP – Net indirect tax – Depreciation
= 2,750 – 550 – 320 = 1,880 crores

(c) GVAMP = Compensation of employees + Rent + Interest + Profit + Mixed income + NIT
2,750 = 600 + 310 + 200 + Profit + 380 + 550 Profit
= 2,750 – 2,040 = 710 crores

(b) (ii) Explain briefly the Deflationary Gap. (2 Marks)
Answer:
Deflationary Gap is the amount by which actual aggregate demand falls short of aggregate supply at level of full employment. It is called deflationary because it leads to a fall in the price level. Deflationary gap causes deflation and decreases wages and price level in the economy.

Question 9.
(a) (i) Explain the operation of Cash Reserve Ratio. (3 Marks)
Answer:
Cash Reserve Ratio (CRR) refers to the fraction of the total net demand and time liabilities (NDTL) of a scheduled commercial bank in India which it should maintain as cash deposit with the Reserve Bank. The RBI may set the ratio in keeping with the broad objective of maintaining monetary stability in the economy. This requirement applies uniformly to all scheduled banks in the country irrespective of its size or financial position. Non-Bank Financial Institution (NBFIs) are outside the purview of this reserve requirement.

(a) (ii) “Net Exports” can be negative or positive. How is it significant for the economy of a country? (2 Marks)
Answer:
Net exports are the difference between exports and imports of a country during the accounting year. It can be positive or negative.

The net export variable is very important in the computation of a country’s GDP. A trade surplus is added to the country’s GDP. Net exports can also serve as a measure of financial health for a country. A country with a high export value generates income from other countries.

(b) (i) Tariffs are basically taxes or duties on goods and services which are imported or exported. Briefly explain Preferential, Applied and Escalated tariff. (3 Marks)
Answer:
Tariffs, also known as customs duties, are basically taxes or duties imposed on goods and services which are imported or exported. It is defined as a financial charge in the form of a tax, imposed at the border on goods going from one customs territory to another.

Preferential Tariff: Nearly all countries are part of at least one preferential trade agreement, under which they promise to give another country’s products lower tariffs than their MFN rate. These agreements are reciprocal. A lower tariff is charged from goods imported from a country which is given preferential treatment. Examples are preferential duties in the EU region under which a good coming into one EU country to another is charged zero tariffs.

Applied Tariffs: An ‘applied tariff’ is the duty that is actually charged on imports on a most-favoured nation (MFN) basis. A WTO member can have an applied tariff for a product that differs from the bound tariff for that product as long as the applied level is not higher than the bound level.

Escalated Tariff: It refers to the system wherein the nominal tariff rates on imports of manufactured goods are higher than the nominal tariff rates on intermediate inputs and raw materials, i.e. the tariff on a product increases as that product moves through the value-added chain. For example a four per cent tariff on iron ore or iron ingots and twelve percent tariff on steel pipes.

This type of tariff is discriminatory as it protects manufacturing industries in importing countries and dampens the attempts of developing manufacturing industries of exporting countries. This has special relevance to trade between developed countries and developing countries. Developing countries are thus forced to continue to be suppliers of raw materials without much value addition.

(b) (ii) Write down the name of fiscal function of the Government in Eco-nomic System, for the following cases: (2 Marks)
(a) Government imposes higher taxes on tobacco products in Union Budget.
(b) Government scheme providing free ration to BPL families.
(c) Government providing subsidy to farmers in purchasing of Urea for agricultural purpose.
(d) Increase in Government expenditure in the time of recession.
Answer:
(a) Allocation function
(b) Allocation function
(c) Redistribution function
(d) Stabilization function

Question 10.
(a) (i) Discuss with example the following types of foreign Direct Investment. (3 Marks)
(a) Horizontal Direct Foreign Investment
(b) Vertical Direct Foreign Investment
(c) Two-way Direct Foreign Investment
Answer:
(a) A Horizontal Direct Foreign Investment is said to take place when the investor establishes the same type of business operation in a foreign country as it operates in its home country, for example, a cell phone service provider based in the United States moving to India to provide the same service.

(b) A Vertical Direct Foreign Investment is one under which the investor establishes or acquires a business activity in a foreign country which is different from the investor’s main business activity yet in some way supplements its major activity.

(c) Two-way Direct Foreign Investments another category of investments which are reciprocal investments between countries that occur when some industries are more advanced in one nation (for example, the computer industry in the United States), while other industries are more efficient in other nations (such as the automobile industry in Japan).

(a) (ii) Mention the name of the externalities (along with reason in brief) covered in the following acts: (2 Marks)
(a) A Road Construction Company provides training to its employees to learn latest technology for durable road construction.
(b) People taking COVID Booster Dose happily.
Answer:
(a) Positive production externalities: The firm generates positive benefits on other firms by providing training to its employees, when other firms hire such workers as they change their jobs.

(b) Positive consumption externalities: When people took COVID Booster Dose happily and get immunized against COVID, they would confer a social benefit to others as well by preventing others from getting infected.

(b) (i) What do you understand by “Liquidity Adjustment Facility (LAF)”? (3 Marks)
Answer:
From June 2000, the RBI has introduced Liquidity Adjustment Facility (LAF). The Liquidity Adjustment Facility (LAF) is a facility extended by the Reserve Bank of India to the scheduled commercial banks (excluding RRBs) and primary dealers to avail of liquidity in case of requirement (or park excess funds with the RBI in case of excess liquidity) on an overnight basis against the collateral of government securities including state government securities.

The introduction of LAF is an important landmark since it triggered a rapid transformation in the monetary policy operating environment in India. As a key element in the operating framework of the RBI, its objective is to assist banks to adjust their day-to-day mismatches in liquidity. Currently, the RBI provides financial accommodation to the commercial banks through repos/ reverse repos under the Liquidity Adjustment Facility (LAF).

(b) (ii) Markets are amazingly competent in organizing the activities of an economy as they are generally efficient and capable of achieving optimal allocation of resources. However, market failure occurs. Discuss briefly any two reasons leading to market failure. (2 Marks)
Answer:
The general belief is that markets are amazingly competent in organizing the activities of an economy as they are generally efficient and capable of achieving optimal allocation of resources. However, there are exceptions to this. Under certain circumstances, ‘market failure’ occurs, i.e. the market fails to allocate resources efficiently and therefore, market outcomes become inefficient.

There are four major reasons for market failure. They are:
(a) Market power,
(b) Externalities,
(c) Public goods, and
(d) Incomplete information.

Question 11.
(a) (i) How are the following transactions treated in National Income Calculation? (3 Marks)
(a) B sold a used car to C and receive ? 80,000. How much of the sale proceeds will be included in National Income calculation?
(b) Fees paid to real estate agents and lawyers.
(c) Electric power sold to a consumer household.
Answer:
(a) No impact as transactions of second hand goods are not part of national income.
(b) Yes, this amount will be included in national as it is the income of real estate agents and lawyers.
(c) Electric power sold to a consumer household will be included in national income because its a part of private final consumption expenditure.

(a) (ii) What are the Guiding principles of World Trade Organization (WTO)? (2 Marks)
Answer:

1. Trade without discrimination
2. The National Treatment Principle (NTP)
3. Free trade
4. Predictability
5. Principle of general prohibition of quantitative restrictions
6. Greater competitiveness
7. Tariffs as legitimate measures for the protection of domestic industries
8. Transparency in Decision Making
9. Progressive Liberalization
10. Market Access
11. Special privileges to less developed countries
12. Protection of Health & Environment
13. A transparent, effective and verifiable dispute settlement mechanism.

(b) (i) Discuss with examples the major aspects of market failures. (2 Marks)
Answer:
The pertinent question here is why do markets fail? There are four major reasons for market failure. They are:
(1) Market power:
Market power or monopoly power is the ability of a firm to profitably raise the market price of a good or service over its marginal cost. Firms that have market power are price makers and therefore, can charge a price that gives them positive economic profits. Excessive market power causes the single producer or a small number of producers to produce and sell less output than would be produced in a competitive market. Market power can cause markets to be inefficient because it keeps price higher and output lower than the outcome of equilibrium of supply and demand.

(2) Externalities:
However, sometimes, the actions of either consumers or producers result in costs or benefits that do not reflect as part of the market price. Such costs or benefits which are not accounted for by the market price are called externalities because they are “external” to the market. In other words, there is an externality when a consumption or production activity has an indirect effect on other’s consumption or production activities and such effects are not reflected directly in market prices.

(3) Public goods:
A public good (also referred to as collective consumption good or social good) is defined as one which all enjoy in common in the sense that each individual’s consumption of such a good leads to no subtraction from any other individuals’ consumption of that good. Because of the peculiar characteristics of public goods such as indivisibility, non-excludability and non-rivalry, competitive private markets will fail to generate economically efficient outputs of public goods.

(4) Incomplete information:
Information failure is widespread in numerous market exchanges. When this happens misallocation of scarce resources takes place and equilibrium price and quantity is not established through price mechanism. This results in market failure.

(b) (ii) Briefly explain the concept of “Liquidity Trap”. (2 Marks)
OR
Why empirical analysis of money supply is important? (2 Marks)
Answer:
A liquidity trap is a situation, described in Keynesian economics, in which, after the rate of interest has fallen to a certain level, liquidity preference may become virtually absolute in the sense that almost everyone prefers holding cash rather than holding a debt which yields so low a rate of interest.

OR

Empirical analysis of money supply is important for two reasons:
(1) It facilitates analysis of monetary developments in order to provide a deeper understanding of the causes of money growth.

(2) It is essential from a monetary policy perspective as it provides a framework to evaluate whether the stock of money in the economy is consistent with the standards for price stability and to understand the nature of deviations from this standard.

The central banks all over the world adopt monetary policy to stabilise price level and GDP growth by directly controlling the supply of money. This is achieved mainly by managing the quantity of monetary base. The success of monetary policy depends to a large extent on the controllability of money supply and the monetary base.

CA Inter FM ECO Paper May 2022 – CA Inter FM ECO Study Material is designed strictly as per the latest syllabus and exam pattern.

CA Inter FM ECO Question Paper May 2022 Solution

Question 1.
(a) Following are the information and ratios are given for W limited for the year ended 31st March, 2022:
Equity Share Capital of 10 each : ₹ 10 Lakhs
Reserves & Surplus to Shareholder& Fund : 0.50
Sales / Shareholders’ Fund : 1.50
Current Ratio : 2.50
Debtors Turnover Ratio : 6.00
Stock Velocity : 2 Months
Gross Profit Ratio : 20%
Net Working Capital Turnover Ratio : 2.50

You are required to calculate:
(1) Shareholders’ Fund
(2) Stock
(3) Debtors
(4) Current Liabilities
(5) Cash Balance (5 Marks)
Answer:
(1) Shareholders’ Fund = Equity Share Capital + Reserve and Surplus
= ₹ 10 Lakhs + 0.50 Shareholders’ Fund
0.50 Shareholders’Fund = ₹ 10 Lakhs
Shareholders’ Fund = ₹ 10 Lakhs ÷ 0.50 = ₹ 20,00,000
\(\frac{\text { Reserve and Surplus }}{\text { Shareholders’ Fund }} \) = 0.50 or Reserve & Surplus = 0.50 Shareholders’ Fund

(2) Stock = COGS × Stock Velocity /12
= ₹ 24,00,000 × 2 /12 = ₹ 4,00,000
\(\frac{\text { Sales }}{\text { Shareholders Fund }}\) = 1.50 or Sales = 1.50 Shareholders’ Fund
Sales = 1.50 × ₹ 20,00,000 = ₹ 30,00,000
COGS = Sales – Gross Profit
= ₹ 30,00,000 – 20% = ₹ 24,00,000

(3) Debtors = Annual Credit Sales -P Debtors Turnover Ratio
= ₹ 30,00,000 ÷ 6 = ₹ 5,00,000

(4) Current Liabilities
Current Ratio = CA ÷ CL = 2.50
Current Assets = 2.50 CL
\(\frac{\text { Sales }}{\text { Net Working Capital }}\) = 2.50
Net Working Capital = Sales ÷ 2.50 = ₹ 30,00,000 ÷ 2.50 = ₹ 12,00,000
CA – CL = ₹ 12,00,000
2.5 CL – CL = ₹ 12,00,000
Current Liabilities = ₹ 12,00,000 ÷ 1.5 = ₹ 8,00,000

(5) Cash Balance = Current Asset – Debtors – Stock
= ₹ 20,00,000 – ₹ 5,00,000 – ₹ 4,00,000
= ₹ 11,00,000
Current Asset = 2.5 CL
= 2.5 × 8,00,000 = ₹ 20,00,000

(b) Balance sheet of X Ltd. for the year ended 31st March, 2022 is given below: (₹ in lakhs)

Liabilities	Amount		Amount
Equity Shares ₹ 10 each	200	Fixed Assets	500
Retained Earnings	200	Raw Materials	150
11% Debentures	300	WIP	100
Public Deposits (Short-term)	100	Finished Goods	50
Trade Creditors	80	Debtors	125
Bills Payable	100	Cash and Bank	55
	980		980

Calculate the amount of maximum permissible bank finance under three methods as per Tandon Committee lending norms.
Total core current assets are assumed to be ₹ 30 Lakhs. (5 Marks)
Answer:
Calculation of MPBF:
Method 1 = 75% (CA – CL) = 15% (480 – 280) = ₹ 150 Lakhs
Method 2 = (75% CA) – CL = (75% 480) – 280 = ₹ 80 lakhs

Method 3 = (75% CA other than core CA) – CL
= 75% (480 -30) – 280 = ₹ 57.50 Lakhs
Current Assets = Raw Materials + WIP + Finished Goods + Debtors + Cash and Bank
= 150 + 100 + 50 + 125 + 55 = ₹ 480Lakhs
Current Liabilities = Public deposit (Short.term) + Trade Creditors + Bills Payable
= 100 + 80 + 100 = ₹ 280 Lakhs

(c) A company requires 36,000 units of a product per year at a cost of ₹ 100 per unit. Ordering cost per order is ₹ 250 and the carrying cost is 4.5% per year of the inventory cost. Normal lead time is 25 days and safety stock is Nil. Assume 360 working days in a year.
(а) Calculate the Reorder Inventory Level.
(b) Calculate the Economic Order Quantity (EOQ).
(c) If the Supplier offers 1% quantity discount for purchase in lots of 9,000 units or more, should the company accept the proposal? (5 Marks)
Answer:
(a) Reorder Inventory Level = (Average Consumption × Average Lead Time) + Safety Stock
= [(36,000 ÷ 360) × 25 days] + Nil
= 2,500 units

(b) EOQ = \(\sqrt{\frac{2 \mathrm{AO}}{\mathrm{C}}}\) = \(\sqrt{\frac{2 \times 36,000 \times 250}{100 \times 4.5 \%}}\) = 2,000 units

(c) Statement of Evaluation of 1% Discount Offer

Advise: Company should accept 1% discount offer (Net saving by acceptance is ₹ 23,952).

(d) P Ltd. is considering a project with the following details: (5 Marks)

Initial Project Cost	₹ 1,00,000
Annual Cash Inflow (₹)	1	2	3	4
	30,000	40,000	50,000	60,000
Project Life (years)	4
Cost of Capital	10%

(a) MEASURE the sensitivity of the project to change in Initial Project Cost and Annual Cash Inflows (considering each factor at a time) such that NPV become zero.
(b) IDENTIFY which of the two factors; the project is most sensitive to affect the acceptability of the project?

Years	1	2	3	4	5
PVIF0.10,t	0.909	0.826	0.751	0.683	0.621

Answer:
Current Net Present value (NPV)

Years	Particulars	₹	PVIF @ 10%	PV
0	Initial outflows	(1,00,000)	1.000	(1,00,000)
1	Annual Cash Inflows	30,000	0.909	27,270
2	Annual Cash Inflows	40,000	0.826	33,040
3	Annual Cash Inflows	50,000	0.751	37,550
4	Annual Cash Inflows	60,000	0.683	40,980
NPV				38,840

(a) Measurement of Sensitivity:
(i) Sensitivity Analysis w.r.t. Initial Project Cost:
NPV of the project would be zero when the cost of the project is increased by ₹ 38,840
∴ Percentage change in the cost = (38,840 ÷ 1,00,000) × 100 = 38.84%

(ii) Sensitivity Analysis w.r.t. Annual Cash Flows:
NPV of the project would be zero when the PV of annual cash inflows is decreased by ₹ 3 8,840
∴ Percentage change in the annual cash inflows = (38,840 ÷ 1,38,840) × 100 = 27.97%

(b) The Annual cash inflows is the most sensitive as only a change beyond 27.97% in savings makes the project unacceptable.

Question 2.
Details of a company for the year ended 31st March, 2022 are given below: (10 Marks)
Sales : ₹ 86,00,000
Profit Volume (P/V) Ratio : 35%
Fixed Cost excluding interest expenses : ₹ 10,00,000
10% Debt : ₹ 55,00,000
Equity Share Capital of ₹ 10 each : ₹ 75,00,000
Income Tax Rate : 40%

Required:
(1) Determine company’s Return on Capital Employed (Pre-tax) and EPS.
(2) Does the company have a favourable financial leverage?
(3) Calculate operating and combined leverage of the company.
(4) Calculate percentage change in EBIT, if sales increases by 10%.
(5) At what level of sales, the Earning Before Tax (EBT) of the company will be equal to zero?
Answer:

(2) ROCE is 15.46% and Interest on debt is 10%, hence, it has a favourable financial leverage.

(3) Calculation of Operating and Combined leverages:
Operating Leverage = \(\frac{\text { Contribution }}{\text { EBIT }}\) = \(\frac{30,10,000}{20,10,000}\) = 1.497
Combined Leverage = \(\frac{\text { Contribution }}{\text { EBT }}\) = \(\frac{30,10,000}{14,60,000}\) = 2.062

(4) Operating leverage is 1.497. So if sales is increased by 10% then EBIT will be increased by 1.497 × 10 i.e. 14.97% (approx.)

(5) EBT = Sales – Variable cost – Fixed cost – Interest
Nil = Sales – 65% sales – 10,00,000 – 5,50,000
35% of sales = 15,50,000
Sales = ₹ 44,28,571

Question 3.
Alpha Limited is a manufacturer of computers. It wants to introduce artificial intelligence while making computers. The estimated annual saving from introduction of the Artificial Intelligence (AI) is as follows: (10 Marks)

• Reduction of five employees with annual salaries of ₹ 3,00,000 each.
• Reduction of ₹ 3,00,000 in production delays caused by inventory problem;
• Reduction in lost sales ₹ 2,50,000; and
• Gain due to timely billing ₹ 2,00,000

The purchase price of the system for installation of artificial intelligence is ₹ 20,00,000 and installation cost is ₹ 1,00,000. 80% of the purchase price will be paid in the year of purchase and remaining will be paid in next year.
The estimated life of the system is 5 years and it will be depreciated on a straight-line basis.
However, the operation of the new system requires two computer specialists with annual salaries of ₹ 5,00,000 per person.
In addition to above, annual maintenance and operating cost for five years are as below:
(Amount in ₹)

Year	1	2	3	4	5
Maintenance & Operating Cost	2,00,000	1,80,000	1,60,000	1,40,000	1,20,000

Maintenance and Operating Cost are payable in advance.
The company’s tax rate is 30% and its required rate of return is 15%.

Year	1	2	3	4	5
PVIF0.10,t	0.909	0.826	0.751	0.683	0.621
PVIF0.12,t	0.893	0.797	0.712	0.636	0.567
PVIF0.15,t	0.870	0.756	0.658	0.572	0.497

Evaluate the project by using Net Present Value and Profitability Index.
Answer:
(1) Net Present value (NPV)

Advice: Accept the proposal having positive NPV.

(2) Profitability Index = PV of Inflows ÷ PV of Outflows
= 27,80,391 ÷ 18,40,000 = 1.51
Advice: Accept the proposal having PI higher than 1.

Working Note:
Statement of CFAT

Question 4.
The particulars relating to Raj Ltd. for the year ended 31st March, 2022 are given as follows:

Output (units at normal capacity)	1,00,000
Selling price per unit	₹ 40
Variable cost per unit	₹ 20
Fixed cost	₹  10,00,000

The capital structure of the company as on 31st March, 2022 is as follows:

Particulars	Amount in ₹
Equity Share Capital (1,00,000 shares of ₹ 10 each)	10,00,000
Reserves and Surplus	5,00,000
Current Liabilities	5,00,000
Total	20,00,000

Raj Ltd. has decided to undertake an expansion project to use the market potential that will involve ₹ 20,00,000. The company expects an increase in output by 50%. Fixed cost will be increased by ₹ 5,00,000 and variable cost per unit will be increased by 15%. The additional output can be sold at the existing selling price without any adverse impact on the market.
The following alternative schemes for financing the proposed expansion program are planned:

Amount in ₹
Alternative		Equity Shares
1	5,00,000	Balance
2	10,00,000	Balance                   1
3	14,00,000	Balance

Slab wise interest rate for fund borrowed is as given follows:

Fund Limit	Applicable Interest Rate
Upto ₹ 5,00,000	10%
Over ₹ 5,00,000 and upto ₹ 10,00,000	15%
Over ₹ 10,00,000	20%

Current market price per share is 200.
Find out which of the abovementioned alternatives would you recommend for raj Ltd. with reference to the EPS, assuming a corporate tax rate is 40%? (10 Marks)
Answer:
Statement of EPS

Decision: The earning per share is higher in alternative I ie. if the company finance the project by raising debt of ₹ 5,00,000 & issue equity shares of ₹ 15,00,000. Therefore, the company should choose this alternative to finance the project.

Question 5.
A company issues:
15% convertible debentures of ₹ 100 each at par with a maturity period of 6 years. On maturity, each debenture will be converted into 2 equity shares of the company. The risk-free rate of return is 10%, market risk premium is 18% and beta of the company is 1.25. The company has paid dividend of ₹ 12.76 per share. Five year ago, it paid dividend of ₹ 10 per share. Flotation cost is 5% of issue amount.

5% preference shares of ₹ 100 each at premium of 10%. These shares are redeemable after 10 years at par. Flotation cost is 6% of issue amount.
Assuming corporate tax rate is 40%.
(a) Calculate the cost of convertible debentures using the approximation method.
(b) Use YTM method to calculate cost of preference shares. (10 Marks)

Answer:
(a) Calculation of cost of Convertible Debentures using Approximation method:

= 13.24%
Working Notes:
Determination of Redemption value:
Higher of
(i) The cash value of debentures = ₹ 100
(ii) Value of equity shares = 2 shares × ₹ 48.72 (1 + 0.05)⁶ = ₹ 130.58
₹ 130 will be taken as redemption value as it is higher than the cash option and attractive to the investors.

Calculation of Value of Share today:
P₀ = \(\frac{D_1}{\mathrm{~K}_{\mathrm{e}}-\mathrm{g}}\) = \(\frac{12.76(1+0.05)}{32.50 \%-5 \%}\) = ₹ 48.72
K_e = R_f + β (R_m – R_f) = 10% + 1.25 × 18% = 32.50%
g = \(\sqrt[5]{\frac{12.76}{10.00}}\) = 5% or
g = 12.76 ÷ 10.00 = 1.276 (5% for 5 year; given in interest rate table)

(b) Calculation of Cost of Preference shares using YTM method:
Calculation of NPV at two discount rates:

IRR/K_d = LR + \(\frac{\mathrm{NPV}_L}{\mathrm{NPV}_L-\mathrm{NPV}_H}\) × (H – L) = 3% + \(\frac{13.65}{13.65-(-3.39)}\) × (5% – 3%)
= 4.60%
Working Note:
Net Proceeds = Issue Price – Flotation Cost
= (100 + 10% Premium) – 6% = ₹ 103.40

Question 6.
(a) Identify the limitations of Internal Rate of Return. (4 Marks)
Answer:
Followings are the limitations of IRR:
(a) The calculation process is tedious if there is more than one cash outflow interspersed between the cash inflows; there can be multiple IRR, the interpretation of which is difficult.

(b) The IRR approach creates a peculiar situation if we compare two projects with different inflow/outflow patterns.

(c) It is assumed that under this method all the future cash inflows of a proposal are reinvested at a rate equal to the IRR. It ignores a firm’s ability to reinvest in portfolio of different rates.

(d) If mutually exclusive projects are considered as investment options which have considerably different cash outlays. A project with a larger fund commitment but lower IRR contributes more in terms of absolute NPV and increases the shareholders’ wealth. In such situation decisions based only on IRR criterion may not be correct.

(b) Briefly explain the assumptions of the Walter’s Model. (4 Marks)
Answer:
Followings are the assumptions of Walter’s Model:
(a) All investment proposals of the firm are to be financed through retained earnings only.

(b) ‘ r’ rate of return & ‘Ke’ cost of capital are constant.

(c) Perfect capital markets: The firm operates in a market in which all investors are rational and information is freely available to all.

(d) No taxes or no tax discrimination between dividend income and capital appreciation (capital gain). It means there is no difference in taxation of dividend income or capital gain. This assumption is necessary for the universal applicability of the theory, since, the tax rates may be different in different countries.

(e No flotation or transaction cost: Similarly, these costs may differ country to country or market to market.
(f) The firm has perpetual life

(c) State advantages of “Wealth Maximization” goals in Financial Management (2 Marks)
OR
Distinguish between American Depository Receipts and Global Depository Receipts. (2 Marks)
Answer:
Followings are the advantages of ‘Wealth Maximization’:
(a) Emphasizes the long-term gains
(b) Recognises risk or uncertainty
(c) Recognises the timing of returns id) Considers shareholders’ return.
Or
Answer:
American Depository Receipts (ADRs): These are securities offered by non-US companies who want to list on any of the US exchange. Each ADR represents a certain number of a company’s regular shares. ADRs allow US investors to buy shares of these companies without the costs of investing directly in a foreign stock, exchange.

The Indian companies have preferred the GDRs to ADRs because the US market exposes them to a higher level of responsibility than a European listing in the areas of disclosure, costs, liabilities and timing. The regulations are somewhat more stringent and onerous, even for companies already listed and held by retail investors in their home country. The most onerous aspect of a US listing for the companies is to provide full, half yearly and quarterly accounts in accordance with, or at least reconciled with US GAAPs.

Global Depository Receipts (GDRs): These are negotiable certificates held in the bank of one country representing a specific number of shares of a stock traded on the exchange of another country. These financial instruments are used by companies to raise capital in either dollars or Euros. These are mainly traded in European countries and particularly in London.

Question 7.
(a) Following information, relating to a particular financial year, are given as under: (3 Marks)

	₹ in Crores
Sales	3,500
Intermediate Consumption	400
Closing Stock	300
Opening Stock	200
Net Indirect Tax	600
Mixed Income	200
Consumption of Fixed Capital	400
Compensation of Employees	400

Compute:
(a) GVA_MP
(b) NDP_MP
(c) Operating Surplus
Answer:
(a) GVA_MP = Value of output- Intermediate consumption
= Sales + Change in stock – Intermediate consumption
= 3,500 + (300 – 200) – 400 = 3,200 Crores

(b) NDP_MP = GVA_MP – Consumption of Fixed Capital
= 3,200 – 400 = 2,800 Crores

(c) NDP_FC 2,200 = Compensation of Employees + Operating Surplus + Mixed Income 400 + Operating Surplus + 200
Operating Surplus = 1,600 Crores
NDP_FC = NDP_MP – Net Indirect Tax
= 2,800 – 600 = 2,200 Crores

(b) State the features of Foreign Portfolio Investment. (3 Marks)
Answer:
Foreign Portfolio Investment (FPI) is not concerned with either manufacture of goods or with provision of services. Such investors also do not have any intention of exercising voting power or controlling or managing the affairs of the company in whose securities they invest.

The singular intention of a foreign portfolio investor is to earn a remunerative return through investment in foreign securities and is primarily concerned about the safety of their capital, the likelihood of appreciation in its value, and the return generated. Logically, portfolio capital moves to a recipient country which has revealed its potential for higher returns and profitability.

Following international standards, portfolio investments are characterised by lower stake in companies with their total stake in a firm at below 10 per cent. It is also noteworthy that unlike the FDIs, these investments are typically of short term nature, and therefore, are not intended to enhance the productive capacity of an economy by the creation of capital assets.

Portfolio investors will evaluate, on a separate basis, the prospects of each independent unit in which they might invest and may often shift their capital with changes in these prospects. Therefore, portfolio investments are, to a large extent, expected to be speculative. Once investor confidence is shaken, such capital has a tendency to speedily shift from one country to another, occasionally creating financial crisis for the host country.

(c) Comment on the role of Government intervention for equitable distribution. (2 Marks)
Answer:
One of the most important activities of the government is to redistribute incomes so that there is equity and fairness in the society. Equity can be brought about by redistribution of endowments with which the economic agents enter the market.

Some common policy interventions include: progressive income tax, targeted budgetary allocations, unemployment compensation, transfer payments, subsidies, social security schemes, job reservations, land reforms, gender sensitive budgeting etc. Government also intervenes to combat black economy and market distortions associated with a parallel black economy. Government intervention in a market that reduces efficiency while increasing equity is often justified because equity is greatly appreciated by society.

(d) Describe the precautionary motive for money. (2 Marks)
Answer:
Many unforeseen and unpredictable contingencies involving money payments occur in our day to day life. Individuals as well as businesses keep a portion of their income to finance such unanticipated expenditures. The amount of money demanded under the precautionary motive depends on the size of income, prevailing economic as well as political conditions and personal characteristics of the individual such as optimism/pessimism, farsightedness etc. Keynes regarded the precautionary balances just as balances under transactions motive as income elastic and by itself not very sensitive to rate of interest.

Question 8.
(a)(i) Differentiate between Non-Discretionary and Discretionary Fiscal Policy. (3 Marks)
Ans.
Non-discretionary fiscal policy or automatic stabilizers are part of the structure of the economy and are ‘built-in’ fiscal mechanisms that operate automatically to reduce the expansions and contractions of the business cycle. Changes in fiscal policy do not always require explicit action by government. In most economies, changes in the level of taxation and level of government spending tend to occur automatically.

These are dependent on and are determined by the level of aggregate production and income, such that the instability caused by business cycle is automatically dampened without any need for discretionary policy action. Any government programme that automatically tends to reduce fluctuations in GDP is called an automatic stabilizer.

However, automatic stabilizers that depend on the level of economic activity alone would not be sufficient to correct instabilities. The government needs to resort to discretionary fiscal policies. Discretionary fiscal policy for stabilization refers to deliberate policy actions on the part of government to change the levels of expenditure, taxes to influence the level of national output, employ-ment and prices. Governments influence the economy by changing the level and types of taxes, the extent and composition of spending, and the quantity and form of borrowing.

(a) (ii) Write a brief note on Countervailing Duties. (2 Marks)
Answer:
Countervailing duties are tariffs that aim to offset the artificially low prices charged by exporters who enjoy export subsidies and tax concessions offered by the governments in their home country. If a foreign country does not have a comparative advantage in a particular good and a government subsidy allows the foreign firm to be an exporter of the product, then the subsidy generates a distortion from the free-trade allocation of resources.

In such cases, CVD is charged in an importing country to negate the advantage that exporters get from subsidies to ensure fair and market oriented pricing of imported products and thereby protecting domestic industries and firms. For example, in 2016, in order to protect its domestic industry, India imposed 12.5% countervailing duty on Gold jewellery imports from ASEAN.

(b )(i) Explain the ‘Circular Flow of Income’. (3 Marks)
Answer:
Circular flow of income refers to the continuous circulation of production, income generation and expenditure involving different sectors of the economy. There are three different interlinked phases in a circular flow of income,
namely: production, distribution and disposition as can be seen from the following figure.

Circular Flow of Income

1. In the production phase, firms produce goods and services with the help of factor services.
2. In the income or distribution phase, the flow of factor incomes in the form of rent, wages, interest and profits from firms to the households occurs.
3. In the expenditure or disposition phase, the income received by different factors of production is spent on consumption goods and services and investment goods. This expenditure leads to further production of goods and services and sustains the circular flow.

These processes of production, distribution and disposition keep going on simultaneously and enable us to look at national income from three different angles namely: as a flow of production or value added, as a flow of income and as a flow of expenditure. Each of these different ways of looking at national income suggests a different method of calculation and requires a different set of data. The details in respect of what is measured and what data are required for all three methods mentioned above are given in the following table.

(b) (ii) What will be the total money credit created by the commercial banking system for an initial deposit of ₹ 500 if the required reserve ratio is 0.04, 0.06 and 0.10 per cent respectively. Compute credit multiplier. (2 Marks)
Answer:
(a) Credit Multiplier = \(\frac{1}{\text { Required Reserved Ratio }}\)
Required Reserved Ratio
For RRR 0.04 Credit Multiplier = \(\frac{1}{\text { Required Reserved Ratio }}\) = 1/0.04 = 25
For RRR 0.06 Credit Multiplier = \(\frac{1}{\text { Required Reserved Ratio }}\) = 1/0.06 = 16.67
For RRR 0.10 Credit Multiplier = \(\frac{1}{\text { Required Reserved Ratio }}\) = 1/0.10 = 10

(b) Credit Creation = Initial deposits × Credit Multiplier
For RRR 0.04
Credit Creation = 500 × 25 — 12,500
For RRR 0.06
Credit Creation = 500 × 16.67 = 8,333
For RRR 0.10
Credit Creation = 500 × 10 = 5,000

Question 9.
(a) (i) Explain ‘Global Public goods’ with examples. (3 Marks)
Answer:
There are several public goods benefits of which accrue to everyone in the world. These goods have widespread impact on different countries and regions, population groups and generations. These are goods whose impacts are indivisibly spread throughout the entire globe.

The WHO delineates two categories of global public goods namely, final public goods which are ‘outcomes’, (e.g. the eradication of polio) and intermediate public goods, which contribute to the provision of final public goods, (e.g. International Health Regulations aimed at stopping the cross-border movement of communicable diseases and thus reducing cross-border health risks).

Similarly, the World Bank identifies five areas of global public goods which it seeks to address: namely, the environmental commons (including the prevention of climate change and biodiversity), communicable diseases (including HIV /AIDS, tuberculosis, malaria and avian influenza), international trade, international financial architecture, and global knowledge for development. The distinctive characteristic of global public goods is that there is no mechanism (either market or government) to ensure an efficient outcome.

(a) (ii) What is Aggregate Demand Function? (2 Marks)
Answer:
In a simple two-sector economy Aggregate Demand (AD) or aggregate expenditure consists of only two components:
(i) Aggregate demand for consumer goods (C), and
(ii) Aggregate demand for investment goods (I)
AD = C + I
Of the two components, consumption expenditure accounts for the highest proportion of the GDP. In a simple economy, the variable I is assumed to be determined exogenously and constant in the short run. Therefore, the short- run aggregate demand function can be written as:
AD = C + I (constant investment)
We can infer that, in the short run, AD depends largely on the aggregate consumption expenditure.

(b) (i) Calculate the volume of Transaction:
Price = 105
Velocity of money = 4.2
Money supply = 4500 billion
What will be the outcome if volume of transaction increases to 240? (3 Marks)
Answer:
MV = PT,
(a) 4500 × 4.2 = 105 × T
T = 180
MV = PT,

(b) M × 4.2 = 105 × 240
M = 6,000 billion

(b) (ii) What do you mean by ‘Bound Tariff’? Explain.
Answer:
A bound tariff is a tariff which a WTO member binds itself with a legal commitment not to raise it above a certain level. By binding a tariff, often during negotiations, the members agree to limit their right to set tariff levels beyond a certain level. The bound rates are specific to individual products and represent the maximum level of import duty that can be levied on a product imported by that member.

A member is always free to impose a tariff that is lower than the bound level. Once bound, a tariff rate becomes permanent and a member can only increase its level after negotiating with its trading partners and compensating them for possible losses of trade. A bound tariff ensures transparency and predictability.

Question 10.
(a) (i) What are the common objectives of fiscal policy? (3 Marks)
Answer:
Most common objectives of fiscal policy are:
(a) Achievement and maintenance of full employment,
(b) Maintenance of price stability,
(c) Acceleration of the rate of economic development, and
(d) Equitable distribution of income and wealth.

(a) (ii) State the nature of the monetary policy for the following actions taken by the RBI of the country: (2 Marks)
(A) Reduction in the cash reserve ratio.
(B) Selling of securities in the open market.
(C) Increase of repo rate by 50 base point.
(D) Increase in the supply of currency and coins.
Answer:

	Action taken by RBI	Nature of Monetary policy
(A)	Reduction in the cash reserve ratio	Expansionary policy
(B)	Selling of securities in the open market	Contractionary policy
(C)	Increase of repo rate by 50 base point	Contractionary policy
(D)	Increase in the supply of currency and coins	Expansionary policy

(b) (i) Calculate, Multiplier and Marginal Propensity of Consume (MPC) with the help of following information: (3 Marks)

Particulars	2020 – 2021 (₹ in Crore)	2021 – 2022 (₹ in Crore)
Investment	1600	2000
National income	5000	6600

Answer:
Investment multiplier (k) = ∆Y/∆I = 1600/400 = 4
∆Y/∆I = \(\frac{1}{1-\mathrm{MPC}}\) = 4
4 – 4MPC = 1
MPC = 0.75

(b) (ii) Explain ‘Sanitary and Phytosanitary (SPS) Measures’. (2 Marks)
Answer:
SPS measures are applied to protect human, animal or plant life from risks arising from additives, pests, contaminants, toxins or disease-causing organisms and to protect biodiversity. These include ban or prohibition of import of certain goods, all measures governing quality and hygienic requirements, production processes, and associated compliance assessments. For example; prohibition of import of poultry from countries affected by avian flu, meat and poultry processing standards to reduce pathogens, residue limits for pesticides in foods etc.

Question 11.
(a) (i) The monetary authority of an economy has provided the following data: (3 Marks)

Particulars	₹ in Crores
Note in Circulation	2,42,09,645
Rupee Coin in Circulation	3,25,572
Small Coins in Circulation	7,434
Post Office Savings Bank Deposits	14,17,868
Cash in Hand with banks	9,75,635
Deposit Money of the Public	1,77,61,992
Demand Deposited with Bank	1,73,76,925
Other Deposits with Reserve Bank	3,85,074
Total Post Office Deposits	1,48,966
Time Deposits with Banks	17,86,969

You are required to calculate (i) M1; and (ii) M2.
Answer:
M1 = (Notes in Circulation + Circulation of Rupee Coin + Circulation of Small Coins – Cash on Hand with Banks) + Deposit Money of the Public
= (2,42,09,645 + 3,25,572 + 7,434 – 9,75,635) + 1,77,61,992
= 4,13,29,008 Crores

M2 = M1+ Post Office Saving Bank Deposits
= 4,13,29,008 + 1,48,966
= 4,14,77,974 Crores

(a) (ii) Identify the market outcomes for each of the following situations: (2 Marks)
(A) Playing of loud music at night in inability to sleep.
(B) Wearing of mask during Covid-19 pandemic.
Answer:

	Situations	Market Outcomes
(A)	Playing of loud music at night in inability to sleep	Negative consumption external­ities
(B)	Wearing of mask during Covid-19 pandemic	Positive consumption externalities

(b) (i) Following information, relating to an economy of a country, for the current year are as under: (3 Marks)

Find out:
(A) Private Final Consumption Expenditure
(B) Net Factor Income from Abroad
(C) NNP_FC or National Income
Answer:
(A) GDP_MP = C + I + G + X – M
6,550 = C + 1000 + 1,500 + 400 – 350
C = 4,000 Crores

(B) GNP_MP = GDP_MP + NFIA
6,600 = 6,550 + NFIA
NFIA = 50 Crores

(C) NNP_FC (NI) = GNP_MP – Depreciation
= 6,600 – 200
= 6,400 Crores

(b) (ii) Explain briefly two key concepts of ‘New Trade Theory’ that gives advantages to countries that import goods to compete with the home country. (2 Marks)
Or
Explain ‘Embargos; (2 Marks)
Answer:
According to NTT, two key concepts give advantages to countries that import goods to compete with products from the home country:
(a) Economies of Scale: As a firm produces more of a product its cost per unit keeps going down. So if the firm serves domestic as well as foreign market instead of just one, it can reap the benefit of large scale of production consequently the profits are likely to be higher.

(b) Network effects are the way one person’s value of a good or service is affected by the value of that good or service to others. The value of the product or service is enhanced as the number of individuals using it increases. This is also referred to as the ‘bandwagon effect’. Consumers like more choices, but they also want products and services with high utility, and the network effect offers increased utility from these products over others. A good example will be Mobile App such as Whats App and software like Microsoft Windows.

Or

An embargo is a total ban imposed by government on import or export of some or all commodities to particular country or regions for a specified or indefinite period. This may be done due to political reasons or for other reasons such as health, religious sentiments. This is the most extreme form of trade barrier.

Unit and Batch Costing – CA Inter Cost and Management Accounting Study Material is designed strictly as per the latest syllabus and exam pattern.

Unit and Batch Costing – CA Inter Costing Study Material

Unit Costing: It is used where the output produced is identical and each unit of output require identical cost.
Cost per unit = \(\frac{\text { Total Production Cost }}{\text { No. of units produced }}\)

Batch Costing: It is a type of specific order costing where articles are manufactured in pre-determined lots, known as batch.

Economic Batch quantity: It is the size of a batch where total cost of set-up and holding costs are at minimum.

Theory Questions

Question 1.
Explain ‘Job Costing’ and ‘Batch Costing’. [CA Inter May 2Q01, May 2018, 5 Maris]
Answer:
Job costing: Job costing is the category’ of basic costing methods which is applicable where the work consists of separate contracts, jobs or batches, each of which is authorised by specific order or contract. According to this method, costs are collected and accumulated according to jobs, contracts, products or work orders. Each job or unit of production is treated as a separate entity for the purpose of costing. Job costing is carried out for the purpose of ascertaining cost of each job and takes into account the cost of materials, employees and overhead etc.

Batch Costing: Batch Costing is a type of specific order costing where articles are manufactured in predetermined lots, known as batch. Under this costing method, the cost object for cost determination is a batch for production rather output as seen in unit costing method. A batch consists of certain number of units which are processed simultaneously to be for manufacturing operation. Under this method of manufacturing, the inputs are accumulated in the assembly line till it reaches minimum batch size. Soon after a batch size is reached, all inputs in a batch is processed for further operations.

Question 2.
Discuss the concept of Economic Batch Quantity (EBQ). [CA Inter May 2000, 2 Marks]
Answer:
Economic batch quantity is the size of a batch where total cost of set-up and holding costs are at minimum.

Since, the product is produced in batches or lots, the lot size chosen will be critical in achieving least cost of operation. If the lot size is higher, the set up cost may decline due to lesser number of set ups required; but units in inventory will go up leading to higher holding costs. If the lot size is lower, lower inventory holding costs are accomplished but only with higher set up costs.

The objective of Economic Batch Quantity (EBQ) is to determine the production lot (Batch size) that optimizes on both set up and inventory holding costs.

Question 3.
In Batch Costing, how is Economic Batch Quantity determined? [CA Inter May 2001, 3 Marks]
Answer:
The Economic Batch Quantity may be determined by calculating the total cost for a series of possible batch sizes and checking which batch size gives the minimum cost.
The mathematical formula usually used for its determination is as follows:
EBQ = \(\sqrt{\frac{2 \mathrm{DS}}{\mathrm{C}}}\)

Where,
D = Annual demand for the product .
S = Setting up cost per batch
C = Carrying cost per unit of production
The objective here being to determine the production lot (Batch size) that optimizes on both set up and inventory holding cots formula.

Question 4.
Differentiate between Job costing and hatch costing. Name three such industries where these are used. [CA Inter May 20f 9, May 2006, Nov. 2004 4 Marks]
Answer:
According to job costing, costs are collected and accumulated according to job. Each job or unit of production is treated as a separate entity for the purpose of costing. Job costing may be employed when jobs are executed for different customers according to their specification.

Industries where job costing is used are printing, furniture, hardware, ship building, heavy machinery, interior decoration, repairs similar other work.
On the other hand, batch costing is a form of job costing, a lot of similar units which comprises the batch may be used as a cost unit for ascertaining cost.
Such a method of costing is used in case of pharmaceutical industry, readymade garments, industries manufacturing parts of TV, radio sets, etc.

Question 5.
Describe unit costing and batch costing giving examples of industries where these are used. [ICAI Module]
Answer:
Unit Costing: It is the method of costing where the output produced is identical and each unit of output requires identical cost. It is also known as single or output costing, but these are sub-division of unit costing method. This method of costing is followed by industries which produce single output or few variants of a single output.
Under this method costs, are collected and analysed element wise and then total cost per unit is ascertained by dividing the total cost with the number of units produced.

Examples of industries: Paper, cement, steel works, mining, breweries etc.

Batch Costing: It is a type of specific order costing where articles are manufactured in predetermined lots, known as batch. Under this method, the cost object for cost determination is a batch for production rather output as seen in unit costing method. A batch consists of certain number of units which are processed simultaneously to be for manufacturing operation.

Examples of industries: Biscuit manufacture, toy making, spare parts manufacture, ready-made garments, etc.

Practical Questions

Economic Batch Quantity (EBQ)

Question 1.
A Ltd. manufactures mother boards used in smart phones. A smart phone requires one mother board. As per the study conducted by the Indian Cellular Association, there will be a demand of 180 million smart phones in the coming year. A Ltd. is expected to have a market share of 5.5% of the total market demand of the mother boards in the coming year. It is estimated that it costs ₹ 6.25 as inventory holding cost per board per month and that the set-up cost per run of board manufacture is ₹ 33,500.
(i) COMPUTE the optimum run size for board manufacturing?
(ii) Assuming that the company has a policy of manufacturing 80,000 boards per run, CALCULATE how much extra costs the company would be incurring as compared to the optimum run suggested in (1) above? [CA Inter Nov. 2020, RTP]
Answer:
(i) Computation of optimum run size
D = Annual demand i.e. 5.5% of 18,00,00,000 = 99,00,000 units
S = Set-up cost per run = ₹ 33,500
C = Inventory holding cost per unit per annum = ₹ 6.25 × 12 months = ₹ 75
Optimum run size or Economic Batch Quantity (EBQ) = \(\sqrt{\frac{2 \mathrm{DS}}{\mathrm{C}}}\)
EBQ = \(\sqrt{\frac{2 \times 99,00,000 \times ₹ 33,500}{₹ 75}}\) = 99,0425 units or 99,043 units

(ii) Calculation of Total Cost of set-up and inventory holding

Question 2.
XYZ Ltd. has obtained an order to supply 48,000 bearings per year from a concern. On a steady basis, it is estimated that it costs ₹ 0.20 as inventory holding cost per bearing per month and the set-up cost per run of bearing manufacture is ₹ 384.
You are required to:
(i) Compute the optimum run size and number of runs for bearing manufacture.
(ii) Compute the interval between two consecutive runs.
(iii) Find out the extra costs to be incurred, if company adopts a policy to manufacture 8,000 bearings per run as compared to optimum run size.
(iv) Give your opinion regarding run size of bearing manufacture.
Assume 365 days in a year. [CA Inter Nov. 2018,10 Marks]
Answer:
D = Annual demand = 48,000 units
S = Set-up cost per run = ₹ 384
C = Inventory holding cost per unit per annum = ₹ 0.2 × 12 months ₹ 2.40

(i) Calculation of Optimum batch size or Economic Batch Quantity (EBQ):

Number of optimum runs = 48,000 ÷ 3919 = 12.245 runs or 13 run

(ii) Interval between 2 runs (in days) = 365 days ÷ 13 = 28 days Or, 365 days ÷ 12.245 = 29.80 days

(iii) Extra Costs to be incurred if company manufactures 8,000 bearings as compared to optimum run size

	When run size is 3,920 bearings	When run size is 8,600 bearings
Annual Requirement	48,000	48,000
Run Size	3,920	8,000
No. of runs	12.245 (48,000 + 3,920)	6 (48,000 ÷ 8,000)
Set up cost per run	₹ 384	₹ 384
Total set up cost	₹ 4,702 (₹ 384 × 12.245)	₹ 2,304 (₹ 384 × 6)
Average inventory	1,960	4,000
Inventory holding cost per unit p.a.	₹ 2.4	₹ 2.4
Total inventory holding cost	₹ 4,704 (1,960 × ₹ 2:4)	₹ 9,600 (4,000 × ₹ 2.4)
Total Cost	₹ 9,406	₹ 11,904

Extra cost = ₹ 11,904 – ₹ 9,406 = ₹ 2,498

(iv) The company should run at optimum batch size i.e. 3,920 bearings, since it saves them cost of ₹ 2,498. Run size should match with the economic production run of bearing manufacture. In making decision relating to the number of units to be produced in each production run, the cost of setting up and inventory holding costs should be considered.

Question 3.
GHI Ltd. manufactures ‘Stent’ that is used by hospitals in heart surgery. As per the estimates provided by Pharmaceutical Industry Bureau, there will he a demand of 40 Million ‘Stents’ in the coming year. GHI Ltd. is expected have a market share of 2.5% of the total market demand of the Stents in the coming year. It is estimated that it costs ₹ 1.50 as inventory holding cost per stent per month and that the set-up cost per ran of stent manufacture is ₹ 225.
Required:
(i) What would be the optimum run size for Stent manufacture?
(ii) What is the minimum inventory holding cost?
(iii) Assuming that the company has a policy of manufacturing 4,000 stents per run, how much extra costs the company would be incurring as compared to the optimum run suggested in (i) above? [CA Inter Jan. 2021, 5 Marks]
Answer:
D = Annual demand = 4,00,00,000 units ₹ 2.596 = 10,00,000 units .
S = Set-up cost per run = ₹ 225
C = Inventory holding cost per unit per annum
= ₹ 1.50 × 12 months = ₹ 18

(i) Calculation of Optimum Run size of ‘Stents’ or Economic Batch Quantity (EBQ):
EBQ = \(\sqrt{\frac{\text { 2DS }}{\mathrm{C}}}\)
= \(\sqrt{\frac{2 \times 10,00,000 \times ₹ 225}{₹ 18}}\) = 5,000 units

(ii) Minimum inventory holding cost
Minimum Inventory Cost = Average Inventory × Inventory Carrying
Cost per unit = (5,000 ÷ 2) × ₹ 18 = ₹ 45,000

(iii) Calculation of the extra cost due to manufacturing policy

	When run size is 4,000 units	When run size is 5,000 units i.e. at EBQ
Total set up cost	₹ 56,250 (\(\frac{10,00,000}{4,000}\) × ₹ 225)	₹ 45,000 (\(\frac{10,00,000}{5,000}\) × ₹ 225)
Total Carrying cost	₹ 36,000 (½ × 4,000 × ₹ 18)	₹ 45,000 (½ × 5,000 × ₹ 18)
Total Cost	₹ 92,250	₹ 90,000

Extra cost = ₹ 92,250 – ₹ 90,000 = ₹ 2,250

Question 4.
BTL LLP. manufactures glass bottles for HDL Ltd., a pharmaceutical company, which is in ayurvedic medicines business.
BTL can produce 2,00,000 bottles in a month. Set-up cost of each production run is ₹ 5,200 and the cost of holding one bottle for a year is ₹ 1.50.
As per an estimate HDL Ltd. can order as much as 19,00,000 bottles in a year spreading evenly throughout the year.
At present the BTL manufactures 1,60,000 bottles in a batch.
Required:
(i) Compute the Economic Batch Quantity for bottle production.
(ii) Compute the annual cost saving to BTL by adopting the EBQ of a production. [CA Inter Nov. 2019, RTP]
Answer:
Economic Batch Quantity (EBQ) = \(\sqrt{\frac{2 \times \mathrm{D} \times \mathrm{S}}{\mathrm{C}}}\)
Where, D = Annual demand for the product
S = Setting up cost per batch
C = Carrying cost per unit of production

(i) Computation of EBQ:
= \(\sqrt{\frac{2 \times ₹ 19,00,000 \times 5,200}{₹ 1.5}}\)
= 1,14,775 bottles

(ii) Computation of savings in cost by adopting EBQ:

Question 5.
AUX Ltd. has an Annual demand from a single customer for 60,000 COVID-19 vaccines. The customer prefers to order in the lot of 15,000 vaccines per order. The productions run of COVID-19 vaccine. The production cost of vaccine is ₹ 5,000 per vaccine. The set-up cost per production run of COVID-19 vaccines is ₹ 4,808. The carrying cost is ₹ 12 per vaccine per month.
You are required to;
(i) Find the most Economical Production Run.
(ii) Calculate the extra cost that Company incurs due to production of 15,000 vaccines in a batch. [CA Inter July 2021, S Marks]
Answer:
(i) Economical Production Run = \(\sqrt{\frac{2 \mathrm{DS}}{\mathrm{C}}}\)
= \(\sqrt{\frac{2 \times 60,000 \text { units } \times ₹ 4,800}{₹ 12 \times 12 \text { months }}}\)
= 2,000 units/Run

(ii)

Extra Cost incurred = ₹ 10,99,200 – ₹ 2,88,000
= ₹ 8,11,200

Batch Costing

Question 6.
A jobbing factory has undertaken to supply 200 pieces of a component per month for the ensuing six months. Every month a batch order is opened against which materials and labour hours are booked at actual. Overheads are levied at a rate equal to per labour hour. The selling price contracted for is ₹ 8 per piece. From the following data calculate the cost and profit per piece of each batch order and overall position of the order for 1,200 pieces.

The other details are:

Month	Overheads(₹)	Direct labour hours
January	12,000	4,800
February	10,560	4,400
March	12,009	5,000
April	10,580	4,600
May	13,000	5,000
June	12,000	4,800

Answer:
Calculation of overhead rate per direct labour hour for every month:

Calculation of cost and profit per piece of each batch:

Overall position of the order for 1,200 units
Sales value [1,200 units × ₹ 8 per unit] ₹ 9,600
Total cost [1,200 units × ₹ 7.34 per unit] ₹ 8,808
Profit ₹ 792

Calculating Unit Cost

Question 7.
A re-roller produced 400 metric tons of M.S. bars spending ₹ 36,00,000 towards materials and ₹ 6,20,000 towards rolling charges. 10% of the output was found to be defective, which had to be sold at 10% less than the price for good production. If the sales realization should give the firm an Overall profit of 12.5% on cost, find the selling price per metric ton of both the categories of bare. The scrap arising during the rolling process fetched a realization of ₹ 60,000. [CA Inter Nov. 2005, 6 Marks]
Answer:
Computation of selling price

Output (effective) = 360 tonnes + 9/10 × 40 tons = 396 tons
Selling price per MT of good output = ₹ 48,00,000/396 tons
= ₹ 11,818.18
Selling price of defective per MT = 0.9 × ₹ 11,818.18
= ₹ 10,636.36

Question 8.
A Manufacturing Company has an installed capacity of 1,50,000 units per annum. Its cost structure is given below:

	₹
(i) Variable cost per unit
Materials	10
Labour (Subject to a minimum of ₹ 1,00,000 per month)	10
Overheads	4
(ii) Fixed overheads per annum	1,92,300
(iii) Semi-variable overheads per annum at 75% capacity
(It will increase by ₹ 4,000 per annum for increase of every 5% of the capacity utilisation or any part thereof)	60,000

The capacity utilisation for the next year Is budgeted at 75% for first three months, 80% for the next six months and 90% for the remaining three months.
Required: If the company is planning to have a profit of 20% on the selling price, calculate the selling price per unit for the next year. [CA Inter Nov. 2006, 10 Marks]
Answer:
Installed capacity 1,50,000 units per annum.
Per month capacity 1,50,000 ÷ 12 = 12,500 units
75% for 3 months (12,500 × 3 × 75%) = 28,125
80% for 6 months (12,500 × 6 × 80%) = 60,000
90% for 3 months (12,500 × 3 × 90%) = 33,750
Total production = 1,21,875

Labour cost:

Semi-variable costs:
₹ 60,000 Per annum at 75% capacity utilisation i.e. ₹ 5,000 per month.
for first 3 months = ₹ 15,000
for next 6 months [₹ 5,000 × 6 + ₹ 2,000 (₹ 4,000 ÷ 12 × 6 months)] = ₹ 32,000
for next 3 months
[(₹ 5,000 × 3) + ₹ 3,000 (₹ 12,000 {i.e. ₹ 4,000 × 3} ÷ 12 × 3 months)] = ₹ 18,000

Calculation of selling price:

	₹
Material (1,21,875 × ₹ 10)	12,18,750.00
Labour	12,37,500.00
Variable Overhead (1,21,875 × ₹ 4)	4,87,500.00
Fixed overhead	1,92,300.00
Semi- Variable overhead	65,000.00
	32,01,050.00
Add: Profit (20% on S.P.) (i.e. 25% on cost price)	8,00,262.50
Sales value	40,01,312.50

Selling price per unit = ₹ 40,01,312.5/1,21,875 units = ₹ 32.83 per unit.