{"id":17036,"date":"2023-03-17T15:23:39","date_gmt":"2023-03-17T09:53:39","guid":{"rendered":"https:\/\/gstguntur.com\/?p=17036"},"modified":"2023-03-17T15:46:14","modified_gmt":"2023-03-17T10:16:14","slug":"ca-inter-fm-eco-paper-dec-2021","status":"publish","type":"post","link":"https:\/\/gstguntur.com\/ca-inter-fm-eco-paper-dec-2021\/","title":{"rendered":"CA Inter FM ECO Paper Dec 2021"},"content":{"rendered":"

CA Inter FM ECO Paper Dec 2021 \u2013 CA Inter FM ECO Study Material<\/a>\u00a0is designed strictly as per the latest syllabus and exam pattern.<\/p>\n

CA Inter FM ECO Question Paper Dec 2021 Solution<\/h2>\n

Question 1.
\n(a) A factoring firm has offered a to buy it\u2019s accounts receivables. The relevant information is given below.<\/p>\n

    \n
  1. The current average collection period for the company\u2019s 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.<\/li>\n
  2. Factor will charge commission @2%.<\/li>\n
  3. The company spends \u20b9 1,00,000 p.a. on administration of debtor. These are avoidable cost.<\/li>\n
  4. Annual credit sales are \u20b9 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.
    \nShould the company enter into a factoring agreement? (5 Marks)<\/li>\n<\/ol>\n

    Answer:
    \nStatement of Evaluation
    \n\"CA
    \n* 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.<\/p>\n

    Conclusion: Yes, company should enter into factoring agreement.<\/p>\n

    \"CA<\/p>\n

    (b) Book value of capital structure of B Ltd. is as follows:<\/p>\n\n\n\n\n\n
    Sources<\/td>\nAmount<\/td>\n<\/tr>\n
    12% 6,000 Debentures @ \u20b9 100 each<\/p>\n

    Retained earnings<\/p>\n

    4,500 Equity shares @ \u20b9 100 each<\/td>\n

    		\u20b9 6,00,000
    \n\u20b9 4,50,000
    \n\u20b9 4,50,000<\/td>\n<\/tr>\n
    <\/td>\n\u20b9 15,00,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    Currently the market value of debenture is \u20b9 110 per debenture and equity share is \u20b9 180 per share. The expected rate of return to equity shareholder is 24% p.a. Company is paying tax @30%.<\/p>\n

    Calculate WACC on the basis of market value weights. (5 Marks)
    \nAnswer:
    \nStatement of WACC (Market Value Weights)<\/p>\n\n\n\n\n\n\n
    Capital Structure<\/td>\nAmount<\/td>\nWeight<\/td>\nSpecific Cost<\/td>\nCost of Capital<\/td>\n<\/tr>\n
    12% Debentures<\/td>\n6,60,000<\/td>\n0.449<\/td>\n0.0764<\/td>\n0.0343<\/td>\n<\/tr>\n
    Equity Fund including Retained earning<\/td>\n8,10,000<\/td>\n0.551<\/td>\n0.2400<\/td>\n0.1322<\/td>\n<\/tr>\n
    Total<\/td>\n14,70,000<\/td>\n1.000<\/td>\nW4CC<\/td>\n0.1665<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    WACC (K0<\/sub>) = 0.1665 or 16.65%<\/p>\n

    Working Notes:<\/strong><\/p>\n

    (1) Calculation of Market Value:
    \nMarket value of debenture = (\u20b9 6,00,000 \u00f7 \u20b9 100) \u00d7 \u20b9 110
    \nMarket value of Equity and Retained earnings:
    \n= (\u20b9 4,50,000 \u00f7 \u20b9 100) \u00d7 \u20b9 180<\/p>\n

    (2) Calculation of Kd<\/sub>:
    \nKd<\/sub> = \\(=\\frac{\\mathrm{I}(1-\\mathrm{t})}{\\mathrm{NP}}\\) \u00d7 100 = \\(\\frac{12 \\% \\text { of } 100(1-0.3)}{110}\\) \u00d7 100 = 7.64%<\/p>\n

    Note: Debentures issued at market price; alternatively students may take different assumption i.e. Debentures issued at par.<\/p>\n

    Note: Since, Keand Kr are same therefore, we use market value of Equity fund including retained earnings.<\/p>\n

    (c) X Ltd. is a manufacturing company. Current market price per share is \u20b9 2,185. During the F. Y. 2020-21, the company paid \u20b9 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.<\/p>\n

    (i) Find out intrinsic value per share.
    \n(ii) State whether shares are overpriced or underpriced.<\/p>\n\n\n\n\n
    Year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n<\/tr>\n
    Discounting Factor@18%<\/td>\n0.847<\/td>\n0.718<\/td>\n0.608<\/td>\n0.515<\/td>\n0.436<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    (5 Marks)
    \nAnswer:
    \n(i) Calculation of Intrinsic Value of Share<\/p>\n\n\n\n\n\n\n\n\n\n
    Year<\/td>\nExpected benefits<\/td>\nPVF @ 18%<\/td>\nDCF<\/td>\n<\/tr>\n
    1<\/td>\n140.00+ 12% = \u20b9 156.80<\/td>\n0.847<\/td>\n132.81<\/td>\n<\/tr>\n
    2<\/td>\n156.80+ 12% = \u20b9 175.62<\/td>\n0.718<\/td>\n126.10<\/td>\n<\/tr>\n
    3<\/td>\n175.62 + 12% = \u20b9 196.69<\/td>\n0.608<\/td>\n119.59<\/td>\n<\/tr>\n
    4<\/td>\n196.69+ 12% = \u20b9 220.29<\/td>\n0.515<\/td>\n113.45<\/td>\n<\/tr>\n
    (5 to \u221e)<\/td>\nP4<\/sub> = \u20b9 1,779.27<\/td>\n0.515<\/td>\n916.32<\/td>\n<\/tr>\n
    Present value of all future benefits or Intrinsic value of Share<\/td>\n\u20b9 1,408.27<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

    P4<\/sub> = \\(\\frac{D_5}{K_e-g}\\) = \\(\\frac{220.29+5 \\%}{18 \\%-5 \\%}\\) = \u20b9 1,779.27<\/p>\n

    \"CA<\/p>\n

    (ii) Intrinsic value of share is \u20b9 1,408.27 as compared to latest market price of \u20b9 2,185. Market price of a share is overpriced by \u20b9 776.73.<\/p>\n

    (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:<\/p>\n\n\n\n\n
    <\/td>\nJanuary (\u20b9 \u2018000)<\/td>\nFebruary (\u20b9 \u2018000)<\/td>\nMarch (\u20b9 \u2018000)<\/td>\n<\/tr>\n
    Total sales<\/td>\n600<\/td>\n600<\/td>\n800<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n
      \n
    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.<\/li>\n
    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.<\/li>\n
    3. Cash balance as on 1st January, 2021 is \u20b9 50,000.<\/li>\n
    4. Actual sales for the last two months of calendar year 2020 are as below:<\/li>\n<\/ol>\n\n\n\n\n
      <\/td>\nNovember (\u20b9 ‘000)<\/td>\nDecember (\u20b9 \u2018000)<\/td>\n<\/tr>\n
      Total sales<\/td>\n640<\/td>\n880<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

      You are required to prepare a monthly cash budget for the three months from January to March, 2021. (5 Marks)
      \nAnswer:
      \n\"CA<\/p>\n

      Question 2.
      \nFollowing are the data in respect of ABC Industries for the year ended 31st March, 2021:<\/p>\n

      Debt to Total assets ratio : 0.40
      \nLong-term debts to equity ratio : 30%
      \nGross profit margin on sales : 20%
      \nAccounts receivables period : 36 days
      \nQuick ratio : 0.9
      \nInventory holding period : 55 days
      \nCost of goods sold : \u20b9 64,00,000<\/p>\n

      Balance Sheet
      \n\"CA
      \nRequired:
      \nComplete the Balance Sheet of ABC Industries as on 31st March, 2021.
      \nAll calculations should be in nearest rupee. Assume 360 days in a year. (10 Marks)
      \nAnswer:
      \nBalance Sheet
      \n\"CA<\/p>\n

      Working Notes:<\/strong><\/p>\n

      1.
      \nInventory = COGS \u00d7 \\(\\frac{\\text { Inventory holding period }}{360}\\)
      \n= \u20b9 64,00,000 \u00d7 55\/360 = \u20b9 9,77,778<\/p>\n

      2. Sales = COGS \u00f7 COGS ratio
      \n= \u20b9 64,00,000 \u00f7 80% (100 – G.P. ratio) = \u20b9 80,00,000<\/p>\n

      3. Debtors = Sales \u00d7\\(\\frac{\\text { Account receivables period }}{360}\\)
      \n= \u20b9 80,00,000 \u00d7 36\/360 = \u20b9 8,00,000<\/p>\n

      4. Debt:
      \nDebt toTotal asset \\(=\\frac{\\text { Debt (Long-term debt }+ \\text { Accounts payables) }}{\\text { Total Asset }}\\) = 40%
      \nDebt = 40% of Total Assets
      \n= \u20b9 50,00,000 \u00d7 40% = \u20b9 20,00,000<\/p>\n

      Note: In debt we are considering total debt i.e. Long-term debt and Accounts payables.<\/p>\n

      5. Equity Fund = Equity Share Capital + Reserve and surplus
      \n= Total Liabilities – Debt
      \n= \u20b9 50,00,000 – \u20b9 20,00,000 = \u20b9 30,00,000
      \nReserve and sur-plus = Equity fund – Equity share capital plus
      \n= \u20b9 30,00,000 – \u20b9 20,00,000 = \u20b9 10,00,000<\/p>\n

      6. Long-term debt:
      \nLong-term debt to equity \\(=\\frac{\\text { Long-term debt }}{\\text { Equity }}\\) = 30%
      \nLong-term debt = 30% of Equity
      \n= 30% of \u20b9 30,00,000 = \u20b9 9,00,000
      \n= \u20b9 20,00,000 – \u20b9 9,00,000 = \u20b9 11,00,000<\/p>\n

      7. Quick Ratio \\(=\\frac{\\text { Current assets – Inventories }}{\\text { Current liabilities }}\\) = 0.9
      \nCurrent assets – \u20b9 9,77,778 = 0.9 \u00d7 \u20b9 11,00,000
      \nCurrent assets = \u20b9 9,90,000 + \u20b9 9,77,778 = \u20b9 19,67,778
      \nCash = Current Assets – Inventories – Accounts receivables
      \n= \u20b9 19,67,778 – \u20b9 9,77,778 – \u20b9 8,00,000 = \u20b9 1,90,000<\/p>\n

      8. Fixed assets = Total assets – Current assets
      \n= \u20b9 50,00,000 – \u20b9 19,67,778 = \u20b9 30,32,222<\/p>\n

      \"CA<\/p>\n

      Question 3.
      \nEarnings before interest and tax of a company are \u20b9 4,50,000. Currently the company has 80,000 equity shares of \u20b9 10 each, retained earnings of 1 \u20b9 12,00,000. It pays annual interest of \u20b9 1,20,000 on 12% Debentures. The company proposes to take up an expansion scheme for which it needs additional fund of \u20b9 6,00,000.<\/p>\n

      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%.
      \nRequired:<\/p>\n

      Compute the earning per share if:<\/p>\n

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

      Answer:<\/p>\n

      Statement of EPS
      \n\"CA<\/p>\n

      Advise to the company:<\/p>\n

      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}\\) = \u20b9 2.475<\/p>\n

      Since EPS after expansion under debt plan is higher (\u20b9 2.61) than Existing EPS (\u20b9 2.475), company should go for expansion plan and choose debt source of finance.<\/p>\n

      Working notes:<\/strong><\/p>\n

      1. Calculation of capital employed before expansion plan:
      \nEquity share capital (80,000 shares \u00d7 \u20b9 10) : \u20b9 8,00,000
      \nRetained earnings : \u20b9 12,00,000
      \nDebentures (\u20b9 1,20,000\/12%) : \u20b9 10,00,000
      \nTotal capital employed : \u20b9 30,00,000<\/p>\n

      2. Return on capital employed (ROCE) or Return on Investment:<\/p>\n

      ROCE \\(\\frac{\\text { EBIT }}{\\text { Capital Employed }}\\)<\/p>\n

      3. Capital employed after expansion = \u20b9 36,00,000 (\u20b9 30,00,000 + \u20b9 6,00,000)<\/p>\n

      Question 4.
      \nStand Ltd. is contemplating replacement of one of it’s machine which has become outdated and inefficient. It\u2019s financial manager has prepared a report outlining two possible replacement machines. The details of each machine are as follows:<\/p>\n\n\n\n\n\n\n\n\n\n
      <\/td>\nMachine 1<\/td>\nMachine 2<\/td>\n<\/tr>\n
      Initial investment<\/td>\n\u20b9 12,00,000<\/td>\n\u20b9 16,00,000<\/td>\n<\/tr>\n
      Estimated useful life<\/td>\n3 Years<\/td>\n5 Years<\/td>\n<\/tr>\n
      Residual value<\/td>\n\u20b9 1,20,000<\/td>\n\u20b9 1,00,000<\/td>\n<\/tr>\n
      Contribution per annum<\/td>\n\u20b9 11,60,000<\/td>\n\u20b9 12,00,000<\/td>\n<\/tr>\n
      Fixed maintenance costs per annum<\/td>\n\u20b9 40,000<\/td>\n\u20b9 80,000<\/td>\n<\/tr>\n
      Other fixed operating costs per annum<\/td>\n\u20b9 7,20,000<\/td>\n\u20b9 6,10,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

      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.<\/p>\n

      Required:<\/p>\n

      (i) Which machine is more beneficial, using Annualized Equivalent Approach? Ignore tax.
      \n(ii) Calculate the sensitivity of your recommendation in part (i) to changes in the contribution generated by machine 1.<\/p>\n\n\n\n\n\n
      Year<\/td>\n1<\/td>\n2<\/td>\n3<\/td>\n4<\/td>\n5<\/td>\n6<\/td>\n<\/tr>\n
      PVIF0.12,t<\/sub><\/td>\n0.893<\/td>\n0.797<\/td>\n0.712<\/td>\n0.636<\/td>\n0.567<\/td>\n0.507<\/td>\n<\/tr>\n
      PVIFA0.12,t<\/sub><\/td>\n0.893<\/td>\n1.690<\/td>\n2.402<\/td>\n3.038<\/td>\n3.605<\/td>\n4.112<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

      (10 Marks)
      \nAnswer:
      \n(i) Statement Showing Evaluation of Two Machines
      \n\"CA
      \n\"CA<\/p>\n

      Select the Machine 2 having higher annualized equivalent NPV<\/p>\n

      Working Notes:<\/strong><\/p>\n

      1. Depreciation: (Initial investment – Residual value) \u00f7 Useful life
      \nMachine 1 = (\u20b9 12,00,000 – \u20b9 1,20,000) \u00f7 3 years = \u20b9 3,60000
      \nMachine 2 = (\u20b9 16,00,000 – 1,00,000) \u00f7 5 years = \u20b9 3,00,000<\/p>\n

      2. Cash fixed operating costs = Fixed operating costs – Depreciation
      \nMachine 1 = \u20b9 7,20,000 – \u20b9 3,60,000 = \u20b9 3,60,000
      \nMachine 2 = \u20b9 6,10,000 – \u20b9 3,00,000 = \u20b9 3,10,000<\/p>\n

      (ii) calculation of the sensitivity of contribution generated by machine 1:
      \nNPV of the project would be zero when the present value of contribution is decreased by \u20b9 6,99,640
      \n\u2234 Percentage change in the contribution = (\u20b9 6,99,640 \u00f7 \u20b9 27,86,320) \u00d7 100 = 25.11%<\/p>\n

      \"CA<\/p>\n

      Question 5.
      \nInformation of A Ltd. is given below:<\/p>\n

        \n
      • Earnings after tax : 5% of sales<\/li>\n
      • Income tax rate : 50%<\/li>\n
      • Degree of Operating leverage : 4 times<\/li>\n
      • 10% Debenture in capital structure : \u20b9 3 lakhs<\/li>\n
      • Variable costs : \u20b9 6 lakhs<\/li>\n<\/ul>\n

        Required:<\/p>\n

        (i) From the given data complete following statement:
        \n\"CA
        \n\"CA
        \n(ii) Calculate Financial Leverage and Combined Leverage.
        \n(iii) Calculate percentage change in earning per share, if sales increased by 5%. (10 Marks)<\/p>\n

        Answer:<\/p>\n

        (i) Statement of EAT
        \n\"CA<\/p>\n

        (ii) Financial Leverage \\(=\\frac{\\text { EBIT }}{\\text { EBT }}\\) = \\(\\frac{1,50,000}{1,20,000}\\) = 1.25 times
        \nCombined Leverage = OL \u00d7 FL = 4 \u00d7 1.25 = 5 times<\/p>\n

        (iii) % change in EPS = % change in Sales = 5% \u00d7 5 = 25% increased<\/p>\n

        Working Notes.<\/strong><\/p>\n

        (a) Operating Leverage \\(=\\frac{\\text { Contribution }}{\\text { EBIT }}\\) \\(=\\frac{\\text { Contribution }}{\\text { Contribution – Fixed cost }}\\) = 4
        \nContribution = 4 Contribution – 4 Fixed cost
        \n-3 Contribution = -4 Fixed cost
        \n\u00bc Contribution = Fixed cost
        \nContribution = Sales – Variable cost = Sales – \u20b9 6,00,000
        \n\u2234 Fixed cost = 3\/4 or 75% of contribution = 75% (Sales – \u20b9 6,00,000)
        \n= 75% Sales \u20b9 4,50,000<\/p>\n

        (b) EAT = 5% of Sales
        \nEBT = EAT \u00f7 (1 – t) = 5% Sales \u00f7 (1 – 0.5)
        \n= 10% Sales<\/p>\n

        (c) EBT = Sales – Variable cost – Fixed cost \u2014 Interest
        \n10% Sales = Sales – \u20b9 6,00,000 – (75% Sales – \u20b9 4,50,000) – \u20b9 30,000
        \n10% Sales = Sales – \u20b9 6,00,000 – 75% Sales + \u20b9 4,50.000 – \u20b9 30,000
        \n10% Sales = 25% Sales – \u20b9 1,80,000
        \n15% Sales = \u20b9 1,80,000
        \nSales = \u20b9 1,80,000 \u00f7 15% = \u20b9 12,00,000<\/p>\n

        (d) EBT = 10% of Sales = 10% of \u20b9 12,00,000
        \n= \u20b9 1,20,000<\/p>\n

        (e) EBIT = EBT + Interest = \u20b9 1,20,000 + \u20b9 30,000
        \n= \u20b9 1,50,000<\/p>\n

        (f) Fixed cost = 75% of Contribution = 75% of \u20b9 6,00,000
        \n= \u20b9 4,50,000<\/p>\n

        Question 6.
        \n(a) Write short noies on Bridge Finance and Clean Packing Credit. (4 Marks)
        \nAnswer:
        \nBridge 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.<\/p>\n

        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.<\/p>\n

        (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
        \nto 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.<\/p>\n

        \"CA<\/p>\n

        Question 6.
        \n(b) Distinguish between Scenario Analysis & Sensitivity Analysis. (4 Marks)
        \nAnswer:
        \nScenario 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.<\/p>\n

        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.<\/p>\n

        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.<\/p>\n

        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.<\/p>\n

        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.<\/p>\n

        Question 6.
        \n(c) Explain in brief the phases of the evolution of financial management. (2 Marks)
        \nOr
        \nAdjustment of risk is required in capital budgeting decision, give reasons for it. (2 Marks)
        \nAnswer:
        \nFinancial 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:<\/p>\n

        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.<\/p>\n

        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.<\/p>\n

        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.<\/p>\n

        Or<\/p>\n

        Answer:<\/p>\n

        Main reasons for considering risk in capital budgeting decisions are as follows:<\/p>\n

        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.<\/p>\n

        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.<\/p>\n

        Question 7.
        \n(a) The following information is given:<\/p>\n\n\n\n\n\n\n\n\n\n\n\n
        Particulars<\/td>\nAmount in (\u20b9) Crore<\/td>\n<\/tr>\n
        Notes in Circulation<\/td>\n25,00,000<\/td>\n<\/tr>\n
        Circulation of Rupee Coins<\/td>\n26,000<\/td>\n<\/tr>\n
        Circulation of Small Coins<\/td>\n850<\/td>\n<\/tr>\n
        Cash on hand with Banks<\/td>\n95,000<\/td>\n<\/tr>\n
        Bankers\u2019 Deposits with RBI<\/td>\n4,500<\/td>\n<\/tr>\n
        Other Deposits with RBI<\/td>\n180<\/td>\n<\/tr>\n
        Total Post office Deposits<\/td>\n12,000<\/td>\n<\/tr>\n
        Time Deposits with Banks<\/td>\n15,000<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

        You are required to compute:<\/p>\n

        (i) Currency with the Public; and
        \n(ii) Reserve Money. (3 Marks)<\/p>\n

        Answer:<\/p>\n

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

        (ii) Reserve Money = Currency in circulation + Bankers\u2019 deposits with the RBI + Other deposits with the RBI
        \n= 24,31,850 + 4,500 + 180 = 24,36,530<\/p>\n

        (b) The Nominal GDP and Real GDP of a country in the financial year 2018-19 were \u20b9 1,500 Crores and \u20b9 1,200 Crores respectively, you are required to calculate:<\/p>\n

        (i) GDP deflator in the financial year 2018-19 and comment.
        \n(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)<\/p>\n

        Answer:<\/p>\n

        (i) GDP Deflator \\(=\\frac{\\text { Nominal GDP }}{\\text { Real GDP }}\\) \u00d7 100 = \\(\\frac{1,500}{1,200}\\) \u00d7 100 = 125<\/p>\n

        Comment: The price level has increased since GDP deflator is greater than 100 at 125.<\/p>\n

        (ii) Inflation Rate = \\(\\frac{140-125}{125}\\) \u00d7 100 = 12%<\/p>\n

        (c) Explain the features of Contractionary Fiscal policy. (2 Marks)
        \nAnswer:
        \nWhen 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.<\/p>\n

        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.<\/p>\n

        (d) Describe the types of transactions in the forex-market and also dis-tinguish between forward premium and forward discount. (2 Marks)
        \nAnswer:
        \nThere are two types of transactions in a forex market:<\/p>\n

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

          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.<\/p>\n

          Question 8.
          \n(a) The following information is related to an economy:<\/p>\n\n\n\n\n\n\n\n\n\n\n\n
          Particulars<\/td>\nAmount in (\u20b9) Crore<\/td>\n<\/tr>\n
          Domestic Sales<\/td>\n3,600<\/td>\n<\/tr>\n
          Opening Stock<\/td>\n800<\/td>\n<\/tr>\n
          Exports<\/td>\n1,000<\/td>\n<\/tr>\n
          Depreciation<\/td>\n300<\/td>\n<\/tr>\n
          Closing Stock<\/td>\n200<\/td>\n<\/tr>\n
          Net indirect tax<\/td>\n400<\/td>\n<\/tr>\n
          Intermediate consumption<\/td>\n600<\/td>\n<\/tr>\n
          Net factor income from abroad<\/td>\n10<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

          Calculate the following:<\/p>\n

          (i) Gross Value of Output (GVOMP<\/sub>)
          \n(ii) Gross Value Added (GVAMP<\/sub>)
          \n(iii) Net Value Added (NVAMP<\/sub>)
          \n(iv) Net Domestic Product (NDPFC<\/sub>)
          \n(v) Net National Product (NNPFC<\/sub>) (5 Marks)<\/p>\n

          Answer:<\/p>\n

          (i) GVOMP<\/sub> = Sales (Domestic + Exports) + Change in stock
          \n= 4,600 (3,600 + 1,000) + (200 – 800) = 4,000 Crores
          \n(ii) GVAMP<\/sub> = Value of output \u2014 Intermediate consumption
          \n= 4,000- 600 = 3,400 Crores
          \n(iii) NVAMP<\/sub> = GVAMP<\/sub> – Depreciation
          \n= 3,400 – 300 = 3,100 Crores
          \n(iv) NDPFC<\/sub> = NVAMP<\/sub> – Net Indirect Tax
          \n= 3,100 – 400 = 2,700 Crores
          \n(v) NNPFC<\/sub> = NDPFC<\/sub> + NFIA
          \n= 2,700 + 10 = 2,710 Crores<\/p>\n

          (b) (i) Discuss the role of government Interventions in minimizing the market power. (2 Marks)
          \nAnswer:
          \nAs 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.<\/p>\n

          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.<\/p>\n

          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.<\/p>\n

          (b)(ii) Calculate Narrow Money (M1) from the following information:
          \n\"CA
          \n(3 Marks)
          \nAnswer:
          \nM1 = Currency with public + Demand Deposits with Banking System + Other Deposits with the RBI
          \n= 2,80,000 + 4,00,000 + 5,80,000 = \u20b9 12,60,000 Crores<\/p>\n

          \"CA<\/p>\n

          Question 9.
          \n(a) How is nominal exchange rate determined? Explain. (3 Marks)
          \nAnswer:
          \nAs 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\u2019s exchange rate.<\/p>\n

          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.<\/p>\n

          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 eeq<\/sub> with Qe<\/sub> as the equilibrium quantity of dollars exchanged.<\/p>\n

          Determination of Nominal Exchange Rate<\/p>\n

          \"CA<\/p>\n

          (b) Discuss the salient features of bilateral trade agreements. (2 Marks)
          \nAnswer:
          \nBilateral 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.<\/p>\n

          (c) Calculate Money Multiplier with the help of following information: (3 Marks)
          \nAnswer:
          \nMoney Supply \u2018M\u2019 = Currency + Deposits
          \n= \u20b9 200 billion + \u20b9 400 billion = \u20b9 600 billion
          \nc = C\/D
          \n= \u20b9 200 billion\/\u20b9 400 billion
          \n= 0.5 or depositors hold 50% of their money as currency
          \ne = Excess Reserve\/Deposits
          \n= \u20b9 800 million or \u20b9 0.8 billion\/\u20b9 400 billion
          \n= 0.002 or banks hold 0.2% of their deposit as excess reserves
          \nMultiplier ‘m’ = \\(\\) = \\(\\frac{1+0.5}{0.1+0.002+0.5}\\) = 2.5
          \nTherefore, a 1 unit increase in MB leads to a 2.5 units increase in M.<\/p>\n

          (d) What do you mean about gross investment of a country? (2 Marks)
          \nAnswer:
          \nGross domestic fixed capital formation (Gross Investment) is that part of country\u2019s total expenditure which is not consumed but added to the nation\u2019s 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.<\/p>\n

          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.<\/p>\n

          Question 10.
          \n(a) (i) How does the fiscal policy redress the inequalities of income and wealth of a country? (3 Marks)
          \nAnswer:
          \nMany 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\u2019s fiscal policy choices.<\/p>\n

          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.<\/p>\n

          \u2666 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.<\/p>\n

          \u2666 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.<\/p>\n

          \u2666 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<\/p>\n

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

            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.<\/p>\n

            (ii) State the main objectives of World Trade Organisation (WTO). (2 Marks)
            \nAnswer:
            \nThe WTO has six key objectives:<\/p>\n

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

              (b) (i) Explain Friedman\u2019s Restatement of Quantity Theory with ref-erence to demand for money? (3 Marks)
              \nAnswer:
              \nMilton Friedman (1956) extended Keynes\u2019 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<\/p>\n

                \n
              1. Permanent income.<\/li>\n
              2. Relative returns on assets (which incorporate risk).<\/li>\n<\/ol>\n

                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\u2019s 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.<\/p>\n

                Friedman identifies the following four determinants of the demand for money. The nominal demand for money:<\/p>\n

                  \n
                • 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.<\/li>\n
                • is positively related to the price level, P. If the price level rises the demand for money increases and vice versa.<\/li>\n
                • rises if the opportunity costs of money holdings (Le. returns on bonds and stock) decline and vice versa.<\/li>\n
                • is influenced by inflation, a positive inflation rate reduces the real value of money balances, thereby increasing the opportunity costs of money holdings.<\/li>\n<\/ul>\n

                  (b) (ii) Discuss the meaning and consequences of negative production externalities. (2 Marks)
                  \nAnswer:
                  \nA 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.<\/p>\n

                  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.<\/p>\n

                  \"CA<\/p>\n

                  Question 11.
                  \n(a) How is aggregate consumption function affected, if:<\/p>\n

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

                    Answer:<\/p>\n

                      \n
                    1. Aggregate Consumption will be increased<\/li>\n
                    2. Aggregate Consumption will be decreased<\/li>\n
                    3. Aggregate Consumption will be increased<\/li>\n<\/ol>\n

                      (b) Discuss the three branch taxonomy of the role of Government in market economy. (3 Marks)
                      \nAnswer:
                      \nRichard Musgrave, in his classic treatise ‘The Theory of Public Finance\u2019 (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.<\/p>\n

                      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.<\/p>\n

                      (c) What is the speculative motive for holding cash? (2 Marks)
                      \nAnswer:
                      \nThe speculative motive reflects people\u2019s desire to hold cash in order to be equipped to exploit any attractive investment opportunity requiring cash expenditure.<\/p>\n

                      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:<\/p>\n

                        \n
                      1. The interest payment,<\/li>\n
                      2. The expected rate of capital gain.<\/li>\n<\/ol>\n

                        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.<\/p>\n

                        If wealth-holders consider that the current rate of interest is high compared to the \u2018normal or critical rate of interest\u2019, 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:<\/p>\n

                          \n
                        1. They can earn high rate of return on bonds,<\/li>\n
                        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.<\/li>\n<\/ol>\n

                          Conversely, if the wealth-holders consider the current interest rate as low, compared to the \u2018normal or critical rate of interest\u2019, 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:<\/p>\n

                            \n
                          1. The loss suffered by way of interest income forgone is small,<\/li>\n
                          2. They can avoid the capital losses that would result from the anticipated increase in interest rates, and<\/li>\n
                          3. The return on money balances will be greater than the return on alter-native assets,<\/li>\n
                          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.<\/li>\n<\/ol>\n

                            (d) Discuss the non-technical measures adopted by the countries with reference to<\/p>\n

                            (i) Trade related investment measures, and
                            \n(ii) Price control measures. (2 Marks)<\/p>\n

                            Or
                            \nDiscuss the salient features of Escalated tariff. (2 Marks)<\/p>\n

                            Answer:<\/p>\n

                            (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.<\/p>\n

                            a. Requirement to use certain minimum levels of locally made components, (25 per cent of components of automobiles to be sourced domestically),
                            \nb. Restricting the level of imported components, and
                            \nc. 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).<\/p>\n

                            (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 \u2018para-tariff\u2019 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.<\/p>\n

                            Or<\/p>\n

                            Answer:
                            \nEscalated 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.<\/p>\n

                            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.<\/p>\n","protected":false},"excerpt":{"rendered":"

                            CA Inter FM ECO Paper Dec 2021 \u2013 CA Inter FM ECO Study Material\u00a0is 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\u2019s accounts receivables. The relevant information is given below. The current …<\/p>\n

                            CA Inter FM ECO Paper Dec 2021<\/span> Read More »<\/a><\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"spay_email":"","footnotes":""},"categories":[167],"tags":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/17036"}],"collection":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/comments?post=17036"}],"version-history":[{"count":8,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/17036\/revisions"}],"predecessor-version":[{"id":17258,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/17036\/revisions\/17258"}],"wp:attachment":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/media?parent=17036"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/categories?post=17036"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/tags?post=17036"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}