CA INTER FM
FINANCIAL
MANAGEMENT
Revised & Updated
ICAI Study Material Coverage
Includes Examination Questions
Published By
FINANCIAL MANAGEMENT
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INDEX
CHAPTERS PAGE NO.
1. RISK ANALYSIS & CAPITAL BUDGETING…………………………………….01 – 36
2. COST OF CAPITAL…………………………………………………………………37 – 59
3. CAPITAL STRUCTURE…………………………………………………………….60 – 81
4. LEVERAGE ………………………………………………………………………….82 –106
5. DIVIDEND……………………………………………………………………………107–122
6. WORKING CAPITAL …………………………………………………….…………123–180
7. RATIO ANALYSIS ………….………………………………………………………181 – 207
[CAPITAL BUDGETING]
CHAPTER – 01
RISK ANALYSIS IN CAPITAL
BUDGETING
(1) BASICS
QUESTION – 01
The Management of a Company has two alternative proposals under consideration.
Project A requires a capital outlay of ₹ 12,00,000 and project „B” requires ₹ 18,00,000.
Both are estimated to provide a cash flow for five years:
Project A ₹ 4,00,000 per year and Project B ₹ 5,80,000 per year. The cost of capital is
10%. Show which of the two projects is preferable from the view point of (i) Net present
value method, (ii) Present value index method (PI method), (iii) Internal rate of return
method.
The present values of Re. 1 of 10%, 18% and 20% to be received annually for 5 years
being 3.791, 3.127 and 2.991 respectively.
(Ans. (i) NPV – (A) 3,16,400 (B) 3,98,780 (ii) PI- (A) 1.264 (B) 1.222 (iii) IRR- (A)
19.868% (B) 18.364%)
QUESTION – 02
A company proposes to install a machine involving a Capital Cost of ₹ 3,60,000. The
life of the machine is 5 years and its salvage value at the end of the life is nil. The
machine will produce the net operating income after depreciation of ₹ 68,000 per
annum. The Company‟s tax rate is 45%.
The Net Present Value factors for 5 years are as under:
Discounting Rate: 14 15 16 17 18
Cumulative factor: 3.34 3.35 3.27 3.20 3.13
You are required to calculate the internal rate of return of the proposal.
(Ans. IRR= 15.74%)
QUESTION – 03
A Company is considering a proposal of installing a drying equipment. The equipment
would involve a Cash outlay of ₹ 6,00,000 and net Working Capital of ₹ 80,000. The
expected life of the project is 5 years without any salvage value. Assume that the
1
[CAPITAL BUDGETING]
company is allowed to charge depreciation on straight-line basis for Income-tax
purpose. The estimated before-tax cash inflows are given below:
Year Before-tax Cash inflows (₹’000)
1 2 3 4 5
240 275 210 180 160
The applicable Income-tax rate to the Company is 35%. If the Company‟s opportunity
Cost of Capital is 12%, calculate the equipment‟s discounted payback period, payback
period, net present value and internal rate of return.
The PV factors at 12%, 14% and 15% are:
Year 1 2 3 4 5
PV factor at 12% 0.8929 0.7972 0.7118 0.6355 0.5674
PV factor at 14% 0.8772 0.7695 0.6750 0.5921 0.5194
PV factor at 15% 0.8696 0.7561 0.6575 0.5718 0.4972
(Ans. (i) Discounting Payback period= 4 years and 9.28 months (ii) Payback
Period = 3 Years and 6.25 months (iii) NPV= -20.26 (iv) IRR = 13.77%)
QUESTION – 04
A company is considering the proposal of taking up a new project which requires an
investment of ₹ 400 lakhs on machinery and other assets. The project is expected to
yield the following earnings (before depreciation and taxes) over the next five years:
Year Earnings (₹ in lakhs)
1 160
2 160
3 180
4 180
5 150
The cost of raising the additional capital is 12% and assets have to be depreciated at
20% on „Written Down Value‟ basis. The scrap value at the end of the five years‟ period
may be taken as zero. Income-tax applicable to the company is 50%.
You are required to calculate the net present value of the project and advise the
management to take appropriate decision. Also calculate the Internal Rate of Return of
the Project.
Note: Present values of Re. 1 at different rates of interest are as follows:
Year 10% 12% 14% 16%
1 0.91 0.89 0.88 0.86
2 0.83 0.80 0.77 0.74
