Institute of Chartered Financial Analysts of India %28ICFAI%29 University 2007 C.A Chartered Accountant Cost-Fm Solved - exam paper

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT

All questions are compulsory.

Wor king notes should form part of the answer.

Quest ion 1

Answer any five of the following:

(i) Discuss briefly the relevant costs with examples.

(ii) Calculate total passenger kilometres from the following information:

Number of buses 6, number of days operating in a month 25, trips made by each bus per

day 8, distance covered 20 kilometr es (one side), capacity of bus 40 passengers,

normally 80% of capacity utilization.

(iii) Explain the importance of an Escalation Clause in contract cost.

(iv) Calculate Efficiency and Capacity ratio fr om the following figures:

Budgeted production

80 units

Actual production

60 units

Standar d time per unit

8 hours

Actual hour s worked

500

(v) Explain Blanket overhead rate.

(vi) Explain the cost accounting tr eatment of unsuccessful Research and Development cost.

(10 Marks)

Answer

(i) Relevant costs are those expected future cost which are essential but differ for

alternative course or action.

( a) Historical cost or sunk costs are irrelevant as they do not play any r ole in the

decision making pr ocess.

( b) Var iable costs which will not differ under var ious alter natives are ir relevant.

(ii) Calculation of passenger kilometers:

6 25 8 2 20 40 80% = 15,36,000 passenger kms.

(iii) Dur ing the execution of a contr act, the prices of materials, or labour etc., may rise

beyond a certain limit. In such a case the contract price will be increased by an agr eed

amount. Inclusion of such a clause in a contr act deed is called an Escalation Clause.

hours

standard

of

terms

in

output

Actual

(iv) Efficiency Ratio =

100

worked

hour

Actual

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

4

480

Or 96%

100

500

worked

hours

Actual

Capacity Ratio =

100

hours

Budgeted

500

Or 78.12%

100

640

(v) Blanket overhead rate refers to the computation of one single overhead r ate for the entire

factory. This is also known as plantwise or the single overhead rate for the entire factory.

It is determined as follows:

period

the

for

factory

entire

the

for

cost

Overhead

Blanket overhead rate =

Hours)

Machine

Hours,

(Labour

period

the

for

Base

It is useful in companies producing the main product in continue process, e.g. chemical

plant, glass plant etc.

(vi) Cost of unsuccessful research is treated as factory overhead, provided the expenditure is

normal and is provided in the budget. If it is not budgeted, it is written off to the profit

and loss account. If the research is extended for long time, some failure cost is spread

over to successful research.

Quest ion 2

KPR Limited operates a system of standard costing in respect of one of its products which is

manufactured within a single cost centr e. The Standard Cost Car d of a product is as under:

Standard

Unit cost (Rs.)

Direct material 5 kgs @ Rs. 4.20

21.00

Direct labour 3 hours @ Rs. 3.00

9.00

Factory overhead Rs. 1.20 per labour hour

3.60

Total manufacturing cost

33.60

The production schedule for the month of June, 2007 required completion of 40,000 units.

However, 40,960 units were completed during the month without opening and closing work-in-

process inventories.

Purchases during the month of June, 2007, 2,25,000 kgs of material at the rate of Rs. 4.50 per kg.

Production and Sales records for the month showed the following actual results.

Material used 2,05,600 kgs.

Direct labour 1,21,200 hours; cost incurred

Rs. 3,87,840

Total factory overhead cost incurred

Rs. 1,00,000

Sales

40,000 units

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 5

Selling price to be so fixed as to allow a mark-up of 20 per cent on selling price.

Required:

(i) Calculate material variances based on consumption of material.

(ii) Calculate labour variances and the total var iance for factory over head.

(iii) Prepare Income statement for June, 2007 showing actual gross margin.

(iv) An incentive scheme is in operation in the company whereby employees are paid a

bonus of 50% of dir ect labour hour saved at standard direct labour hour rate. Calculat e

the Bonus amount.

(15 Marks)

Answer

(i) Mat erial variances:

( a) Direct material cost variance = Standard cost Actual cost

= 40,960 21 2,05,600 4.50

= 8,60,160 9,25,200 = 65,040 (A)

( b) Material price variance = AQ ( SP AP)

= 2,05,600 (4.20 4.50) = 61,680 (A)

( c) Material usages variance = SP ( SQ AQ)

= 4.20 ( 40,960 5 2,05,600) = 3,360 (A)

(ii) Labour variances and overhead variances:

( a) Labour cost variance = Standar d cost Actual cost

= 40,960 9 3,87,840 = 19,200 (A)

( b) Labour rate var iance = AH (SR AR)

1,21,200 (3 3.20) = 24,240 (A)

( c) Labour efficiency variance = SR (SH AH)

= 3 ( 40,960 3 1,21,200) = 5,040 (F)

( d) Total factory overhead var iance = Factory overhead absor bed factor y over head

incurred

= 40,960 3 1.20 1,00,000 = 47,456 (F)

(iii)

Preparation of income statement

Calculation of unit selling price

Rs.

Direct material

21

Direct labour

9

Factory overhead

3.60

Factory cost

33.60

Margin 25% on factory cost

8.40

Selling price

42.00

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

6

Income statement

Rs.

16,80,000

Sales 40,000 units 42

Less: Standard cost of goods sold 40,000 33.60

13,44,000

3,36,000

Less: Variances adverse

Material price variance

61,680

Material quantity variance

3,360

Labour rate variance

24,240 89,280

2,46,720

Add: Favourable variance

Labour efficiency variance

5,040

Factory overhead

47,456 52,496

Actual gross margin

2,99,216

(iv) Labour hour saved

Rs.

1,22,880

Standard labour hours 40,960 3

Actual labour hour worked

1,21,200

Labour hour saved

1,680

Bonus for saved labour = .50 (1,680 3) = 2,520.

Quest ion 3

(a) ABC Limited manufactures a product ZX by using the pr ocess namely RT. For the

month of May, 2007, the following datas ar e available:

Process RT

Material introduced (units)

16,000

Transfer to next process (units)

14,400

Work in pr ocess:

At the beginning of the month (units)

4,000

(4/5 completed)

At the end of the month (units)

3,000

(2/3 completed)

Cost r ecords:

Work in pr ocess at the beginning of the month

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 7

Material

Rs. 30,000

Conver sion cost

Rs. 29,200

Cost during the month : materials

Rs. 1,20,000

Conver sion cost

Rs. 1,60,800

Nor mal spoiled units are 10% of goods finished output tr ansferred to next pr ocess.

Defects in these units are identified in their finished state. Mater ial for the product is put

in the process at the beginning of the cycle of operation, whereas labour and other

indir ect cost flow evenly over the year. It has no realizable value for spoiled units.

Required:

( i) Statement of equivalent pr oduction ( Average cost method) ;

( ii) Statement of cost and distribution of cost;

( iii) Process accounts.

(b) A machine shop cost centre contains three machines of equal capacities. Three

operators ar e employed on each machine, payable Rs. 20 per hour each. The factor y

wor ks for fortyeight hours in a week which includes 4 hours set up time. The wor k is

jointly done by operators. The oper ators are paid fully for the fortyeight hours. In

additions they are paid a bonus of 10 per cent of productive time. Costs are reported for

this company on the basis of thirteen four -weekly period.

The company for the pur pose of computing machine hour rate includes the direct wages

of the operator and also recoups the factory overheads allocated to the machines. The

following details of factory overheads applicable to the cost centr e are available:

Depreciation 10% per annum on original cost of the machine. Original cost of the

each machine is Rs. 52,000.

Maintenance and repairs per week per machine is Rs. 60.

Consumable stores per week per machine are Rs. 75.

Power : 20 units per hour per machine at the rate of 80 paise per unit.

Apportionment to the cost centre : Rent per annum Rs. 5,400, Heat and Light per

annum Rs. 9,720, and foremans salar y per annum Rs. 12,960.

Required:

( i) Calculate the cost of running one machine for a four week period.

( ii) Calculate machine hour rate.

(8 + 8 = 16 Marks)

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

8

Answer

(a) Statement of equivalent production of Process RT

Input

Details Output

Equivalent Production

units

units

Mater ial

% Conversion cost

% units

units

4,000 Opening WIP

16,000 Introduced completed

14,400 14,400 100% 14,400 100%

and transfer to next

Normal spoilage 1,440 1,440 100% 1,440 100%

Abnormal Spoilage 1,160 1,160 100% 1,160 100%

Closing WIP 3,000 3,000 100% 2,000 66.67%

20,000

20,000 20,000 19,000

Stat ement showing cost of each element

Opening Cost in

Total Equivalent

Cost per

Process

Units

units

(Rs.) ( Rs.) (Rs.)

Mater ials 30,000 1,20,000 1,50,000 20,000 7.50

Conversion cost 29,200 1,60,800 1,90,000 19,000 10.00

Statement of apportionment of cost

Material 14,400 7.50

Units completed

Conver sion cost 14,400 10.00 2,52,000

Normal spoilage (10%)

25,200

Material

3,000 7.50

Closing stock

Conver sion cost 2,000 10.00 42,500

Material

1,160 7.50

Abnor mal stock

Conver sion cost 1,160 10.00 20,300

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 9

Process Account

Rs.

Rs.

T o Opening WIP 59,200 By Profit and Loss Account

(Abnormal)

20,300

T o Material 1,20,000 By Transfer to next process 2,77,200

T o Conversion cost 1,60,800 By Closing WIP 42,500

3,40,000

3,40,000

(b) Computation of cost of running one machine for a four week period

Rs.

Standing charges

Per annum

Rent

5,400

Heat and light

9,720

For mans salary

12,960

28,080

Rs.

4

28,080 2,880

Total expenses for one machine for four week period =

13

3

Wages: Hour s per week = 48 and hours for 4 weeks = 48 4 = 192

Wages 192 20

3,840

352

Bonus (192 16) = 176 20 .10

(i) Total standing char ges

7,072

Machine Expenses:

Rs.

1,600

4

Depr eciation = 13

10%

52,000

240

Repairs and maintenance = (60 4)

Consumable stores (75 4)

300

Power (192 16) = 176 20 .80

2,816

(ii) Total machine expenses

4,956

Total expenses (i) + ( ii)

12,028

12,028

Machine hour r ate = 68.34.

176

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

10

Quest ion 4

Answer any three of the following:

(i) Explain essential pr e-requisites for integrated accounts.

(ii) Explain, why the Last in First out (LIFO) has an edge over Fir st in First out (FIFO) or any

other method of pricing material issues.

(iii) Enumerate the r emedial steps to be taken to minimize the labour turnover.

(iv) A company produces single pr oduct which sells for Rs. 20 per unit. Variable cost is Rs.

15 per unit and Fixed overhead for the year is Rs. 6,30,000.

Required:

( a) Calculate sales value needed to earn a profit of 10% on sales.

( b) Calculate sales price per unit to bring BEP down to 1,20,000 units.

( c) Calculate margin of safety sales if profit is Rs. 60,000. (3 3 = 9 Marks)

Answer

(i) Essential pre-requisites for integrated accounts:

( a) The managements 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

pur poses of financial and cost accounts.

( c) An agreed r outine, with regard to the tr eatment of provision for accruals, prepaid

expenses, other adjustment necessar y for preparation of inter im accounts.

( d) Per fect coordination should exist between the staff responsible for the financial and

cost accounts and an efficient processing of accounting document should be

ensur ed.

(ii) LIFO has following advantages:

( a) The cost of the material issued will be reflecting the current market price.

( b) The use of the method during the period of r ising pr ices does not r eflect undue high

profit in the income statement.

( c) In the case of falling price, profit tend to rise due to lower mater ial cost, yet the

finished goods appear to be more competitive and are at market price.

( d) During the period of inflation, LIFO will tend to show the cor rect profit.

(iii) The following steps ar e useful for minimizing labour turnover:

( a) Exit interview: An interview be arranged with each outgoing employee to ascertain

the reasons of his leaving the organization.

( b) Job analysis and evaluation: to ascertain the requirement of each job.

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 11

( c) Organisation should make use of a scientific system of r ecruitment, placement and

promotion for employees.

( d) Organisation should create healthy atmosphere, providing education, medical and

housing facilities for wor kers.

( e) Committee for settling workers grievances.

(iv) ( a) Suppose sales units ar e x then

S = V + F + P

S = Sales

V = Variable Cost

F = Fixed Cost

P = Profit

20x = 15x + 6,30,000 + 2x

20x 17x = 6,30,000

6,30,000

units

2,10,000

x

3

Sales value = 2,10,000 20 = Rs. 42,00,000

( b) Sales price to down BEP 1,20,000 units

F

20.25.

Rs.

15

S

V

S

1,20,000

6,30,000

BEP

New

C

60,000

Profit

( c)

100.

V

P/

where

Sales

S

M

S

V

P/

ratio

V

P/

5

60,000

25%.

100

Or

2,40,000

100

20

25

Quest ion 5

Answer any five of the following:

(i) Explain the concept of leveraged lease.

(ii) Discuss the features of deep discount bonds.

(iii) What is optimum capital structur e? Explain.

(iv) A firm has Sales of Rs. 40 lakhs; Variable cost of Rs. 25 lakhs; Fixed cost of Rs. 6 lakhs;

10% debt of Rs. 30 lakhs; and Equity Capital of Rs. 45 lakhs.

Required:

Calculate operating and financial leverage.

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

12

(v) The demand for a certain product is random. It has been estimated that the monthly

demand of the product has a nor mal distribution with a mean of 390 units. The unit price

of pr oduct is Rs. 25. Ordering cost is Rs. 40 per or der and inventor y carr ying cost is

estimated to be 35 per cent per year.

Required:

Calculate Economic Order Quantity (EOQ).

(vi) Explain the concept of Indian depository r eceipts. (5 2 = 10 Marks)

Answer

(i) Concept of Leveraged Lease: Leveraged lease involves lessor , lessee and financier.

In leveraged lease, the lessor makes a substantial borrowing, even upto 80 per cent of

the assets purchase price. He provides remaining amount about 20 per cent or so as

equity to become the owner . The lessor claims all tax benefits related to the ownership of

the assets. Lender s, generally large financial institutions, provide loans on a non-

r ecourse basis to the lessor. Their debt is served exclusively out of the lease proceeds.

To secure the loan provided by the lenders, the lessor also agrees to give them a

mor tgage on the asset. Lever aged lease ar e called so because the high non-recourse

debt cr eates a high degree of leverage.

(ii) Features of Deep Discount Bonds: Deep discount bonds are for m of zer o interest

bonds. These bonds ar e sold at discounted value and on matur ity; face value is paid to

the investors. In such bonds, ther e is no inter est payout during the lock- in period. IDBI

was the fir st to issue deep discount bonds in India in January 1993. The bond of a face

value of Rs. 1 lakh was sold for Rs. 2700 with a maturity period of 25 years.

(iii) Opt imum Capital Structure: Optimum capital str ucture deals with the issue of right mix

of debt and equity in the long-ter m capital str ucture of a firm. Accor ding to this, if a

company takes on debt, the value of the firm increases upto a certain point. Beyond that

value of the fir m will start to decrease. If the company is unable to pay the debt within

the specified period then it will affect the goodwill of the company in the market.

Therefore, company should select its appropriate capital structure with due consider ation

of all factor s.

(iv) Calculation of Operating and Financial Leverage

Rs.

Sales

40,00,000

Less: Var iable cost

25,00,000

Contr ibution (C)

15,00,000

Less: Fixed cost

6,00,000

EBIT

9,00,000

Less: Interest

3,00,000

EBT

6,00,000

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 13

15,00,000

C

Operating lever age = 1.67

9,00,000

EBIT

EBIT

Financial leverage = 1.50

6,00,000

9,00,000

EBT

(v) Calculation of Economic Order Quantity (EOQ)

The mean of monthly demand = 390 units, Annual demand (A) = 390 12 = 4,680 units

Order ing cost ( O) = Rs. 40 per order, Cost per unit = Rs. 25.

Inventory car rying cost of one unit (CC) = Rs. 25 35% = Rs. 8.75

2AO

40

EOQ

4,680

2 = 206.85 or 207 units

CC

8.75

(vi) Concept of Indian Deposit ory Receipts: The concept of the depository receipt

mechanism which is used to raise funds in for eign currency has been applied in the

Indian capital mar ket through the issue of Indian Depository Receipts (IDRs). Foreign

companies can issue IDRs to r aise funds from Indian mar ket on the same lines as an

Indian company uses ADRs/GDRs to raise foreign capital. The IDRs are listed and

traded in India in the same way as other Indian securities are traded.

Quest ion 6

The Balance Sheet of X Ltd. as on 31st March, 2007 is as follows:

Liabilities Rs. ( 000) Assets

Rs. (000)

Equity shar e capital 6,000 Fixed Assets (at cost) 16,250

8% Preference share

capital

3,250 Less: Depreciation wr itten

5,200 11,050

off

Reserves and Surplus 1,400 Stock

1,950

10% Debentur es 1,950 Sundry debtor s

2,600

Sundry Creditors 3,250 Cash

250

Total

15,850

15,850

The following additional information is available:

(i) The stock tur nover ratio based on cost of goods sold would be 6 times.

(ii) The cost of fixed assets to sales ratio would be 1.4.

(iii) Fixed assets costing Rs. 30,00,000 to be installed on 1st April, 2007, payment would be

made on March 31, 2008.

(iv) In March, 2008, a dividend of 7 per cent on equity capital would be paid.

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

14

(v) Rs. 5,50,000, 11% Debentures would be issued on 1st April, 2007.

(vi) Rs. 30,00,000, Equity shares would be issued on 31st March, 2008.

(vii) Creditors would be 25% of materials consumed.

(viii) Debtors would be 10% of sales.

(ix) The cost of goods sold would be 90 per cent of sales including material 40 per cent and

depreciation 5 per cent of sales.

(x) The profit is subject to debenture inter est and taxation @ 30 per cent.

Required:

(i) Prepare the projected Balance Sheet as on 31st Mar ch, 2008.

(ii) Prepar e projected Cash Flow Statement in accordance with AS-3. (15 Marks)

Answer

(i) Calculation of Sales

Fixed assets Rs. (1,62,50,000 + 30,00,000) = 1,92,50,000

0

1,92,50,00

0

1,37,50,00

Sales

1.4

Cost of goods sold = 1,37,50,000 .90 = 1,23,75,000

Mater ial = 1,37,50,000 .40 = 55,00,000

Depreciation = 1,37,50,000 .05 = 6,87,500

Net profit = 1,37,50,000 .10 = 13,75,000

Calculation of Net Fixed Assets

Rs.

Opening balance

1,62,50,000

Add: Purchases

30,00,000

1,92,50,000

Less: Accumulated Depreciation 52,00,000

Additional Depr eciation

6,87,500 58,87,500

Closing balance of fixed assets

1,33,62,500

Calculation of Closing St ock

sold

goods

of

Cost

stock

Average

ratio

turnover

Stock

0

1,23,75,00

20,62,500

6

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 15

stock)

Closing

stock

(Opening

stock

Average

2

stock)

Closing

(19,50,000

20,62,500

2

Closing stock = 41,25,000 19,50,000 = 21,75,000

Calculation of Debtor s = 1,37,50,000 .10 =13,75,000

Calculation of Creditors = 55,00,000 .25 =13,75,000

Calculation of Int erest and Provision f or Taxation

Net profit

13,75,000

Less: Interest (19,50,000 10%)

2,55,500

(5,50,000 11%)

11,19,500

Less: Taxes

3,35,850

Net profit available for dividend

7,83,650

Less: Preference shar e dividend

2,60,000

Less: Equity dividend @ 7%

4,20,000

Transfer to r eserves and surplus

1,03,650

Reserves and Surplus

Opening balance

14,00,000

Add: Current balance

1,03,650

15,03,650

Project ed Cash Flow St atement

( i) Cash flow f rom Operat ing Act ivit ies

Profit after taxation

7,83,650

Depreciation added back

6,87,500

14,71,150

Add: Increase in current liabilities and decrease in current assets

Provision for taxation

3,35,850

Debtors (26,00,000 13,75,000)

12,25,000

Less: Incr ease in curr ent assets and decrease in current liabilities

Stock (21,75,000 19,50,000) (2,25,000)

Creditors ( 13,75,000 32,50,000) ( 18,75,000) (21,00,000)

Net Cash f rom Operat ing Act ivit ies

9,32,000

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

16

( ii) Cash flow f rom Investing Act ivities

Pur chase of Fixed Assets

(30,00,000)

( iii) Cash flow f rom Financing Activities

Issue of Debenture

5,50,000

Issue of equity share capital

30,00,000

Dividend paid

(6,80,000) 28,70,000

Net increase in cash

8,02,000

Opening balance of cash

2,50,000

Closing balance

10,52,000

Projected Balance Sheet as on 31st March, 2008

Liabilities Rs. ( 000) Assets

Rs. ( 000)

Equity shar e capital 9,000 Fixed Assets (at

19,250

cost)

8% Preference share

capital 3,250

Less: Depreciation

written off 5,887.5 13,362.5

Reserves & Surplus 1,503.65 Stock

2,175

10% & 11%

Debentures 2,500

Sundry debtor s

Cash

1,375

1,052

Sundry Cr editor s 1,375

Provision for taxation 335.85

_______

Total 17,964.5 Total

17,964.5

Quest ion 7

(a) A newly for med company has applied to the Commer cial Bank for the first time for

financing its working capital requirements. The following information is available about

the projections for the cur rent year:

Per unit

Elements of cost:

(Rs.)

Raw material

40

Dir ect labour

15

Overhead

30

Total cost

85

Profit

15

Sales

100

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 17

Other infor mation:

Raw mater ial in stock : average 4 weeks consumption, Work in pr ogress ( completion

stage, 50 per cent), on an average half a month. Finished goods in stock : on an

average, one month.

Credit allowed by suppliers is one month.

Credit allowed to debtors is two months.

Average time lag in payment of wages is 1 weeks and 4 weeks in overhead expenses.

Cash in hand and at bank is desir ed to be maintained at Rs. 50,000.

All Sales are on credit basis only.

Required:

( i) Prepare statement showing estimate of wor king capital needed to finance an activity

level of 96,000 units of production. Assume that production is car ried on evenly

throughout the year, and wages and over head accrue similar ly. For the calculation

pur pose 4 weeks may be taken as equivalent to a month and 52 weeks in a year.

( ii) From the above information calculate the maximum permissible bank finance by all

the three methods for working capital as per Tondon Committee nor ms; assume the

core curr ent assets constitute 25% of the current assets.

(b) XYZ Ltd. is planning to introduce a new product with a project life of 8 years. The project

is to be set up in Special Economic Zone (SEZ), qualifies for one time (at starting) tax

free subsidy from the State Government of Rs. 25,00,000 on capital investment. Initial

equipment cost will be Rs. 1.75 crores. Additional equipment costing Rs. 12,50,000 will

be purchased at the end of the thir d year from the cash inflow of this year. At the end of

8 years, the original equipment will have no resale value, but additional equipment can

be sold for Rs. 1,25,000. A working capital of Rs. 20,00,000 will be needed and it will be

r eleased at the end of eighth year. The project will be financed with sufficient amount of

equity capital.

The sales volumes over eight years have been estimated as follows:

Year 1 2 3 4 5 6 8

Units 72,000 1,08,000 2,60,000 2,70,000 1,80,000

A sales pr ice of Rs. 120 per unit is expected and variable expenses will amount to 60%

of sales revenue. Fixed cash operating costs will amount Rs. 18,00,000 per year. The

loss of any year will be set off from the profits of subsequent two years. The company is

subject to 30 per cent tax rate and considers 12 per cent to be an appropr iate after tax

cost of capital for this pr oject. The company follows str aight line method of depreciation.

Required:

Calculate the net present value of the project and advise the m anagement to take

appropriate decision.

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

18

Note:

The PV factor s at 12% are

Year 1 2 3 4 5 6 7 8

.893 .797 .712 .636 .567 .507 .452 .404

(8 + 8 = 16 Marks)

Answer

(a) Calculation of Working Capital Requirement

( A) Current Assets

Rs.

(i) Stock of mater ial for 4 weeks ( 96,000 40 4/52) 2,95,385

(ii) Work in progress for month or 2 weeks

Material (96,000 40 2/52) .50 73,846

Labour (96,000 15 2/52) .50 27,692

Over head (96,000 30 2/52) .50 55,385 1,56,923

(iii) Finished stock (96,000 85 4/52)

6,27,692

(iv) Debtors for 2 months (96,000 85 8/52)

12,55,385

Cash in hand or at bank

50,000

Investment in Current Assets

23,85,385

( B) Current Liabilit ies

(i) Creditors for one month (96,000 40 4/52) 2,95,385

(ii) Average lag in payment of expenses

Overheads (96,000 30 4/52) 2,21,538

Labour (96,000 15 3/104) 41,538 2,63,076

Current Liabilities

5,58,461

Net working capital ( A B)

18,26,924

Minimum Permissible Bank Finance as per Tandon Committ ee

Method I : .75 (Current Assets Current Liabilities)

.75 (23,85,385 5,58,461)

.75 (18,26,924) 5,58,461 = Rs. 13,70,193

Method II : .75 Current Assets Cur rent Liabilities

.75 23,85,385 5,58,461

17,89,039 5,58,461 = Rs. 12,30,578

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 19

Method III: .75 (Current Assets CCA) Curr ent Liabilities

.75 (23,85,385 5,96,346) 5,58,461

.75 (17,89,039) 5,58,461

13,41,779 5,58,461 = Rs. 7,83,318

(b)

(Rs. 000)

Year Sales VC FC D ep. Profit Tax PAT Dep. Cash

inflow

1 86.40 51.84 18 21.875 (5.315)

21.875 16.56

2 129.60 77.76 18 21.875 11.965

1.995 4.655 21.875 26.53

(5.315) =

6.65 After

adjustment

of loss

3 312.00 187.20 18 21.875 84.925 25.4775 59.4475 21.875 81.3225

4 5 324.00 194.40 18 24.125 87.475 26.2425 61.2325 24.125 85.3575

6 8 216.00 129.60 18 24.125 44.275 13.2825 30.9925 24.125 55.1175

Rs.

Cost of New Equipment

1,75,00,000

Less: Subsidy

25,00,000

Add: Working Capital

20,00,000

Outflow

1,70,00,000

Calculation of NPV

Year

Cash inflows PV factor NPV

(Rs.)

( Rs.)

1

16,56,000 .893 14,78,808

2

26,53,000 .797 21,14,441

3 81,32,250 12,50,000 = 68,82,250 .712 49,00,162

4

85,35,750 .636 54,28,737

5

85,35,750 .567 48,39,770

6

55,11,750 .507 27,94,457

7

55,11,750 .452 24,91,311

8 55,11,750 + 20,00,000 + 1,25,000 = 76,36,750 .404 30,85,247

Net Present Value 2,71,32,933

PROFESSIONAL COMPETENCE EXAMINATION : NOVEMBER, 2007

20

NPV

2,71,32,933

Less: Out flow

1,70,00,000

Saving

1,01,32,933

Advise: Since the project has a positive NPV, therefore, it should be accepted.

Quest ion 8

Answer any three of the following:

(i) Explain the assumptions of Net Operating Income appr oach (NOI) theory of capital

structure.

(ii) Explain the limitations of profit maximization objective of Financial Management.

(iii) Explain the methods of venture capital financing.

(iv) Z Ltd.s oper ating income (before interest and tax) is Rs. 9,00,000. The fir ms cost of

debt is 10 per cent and curr ently firm employs Rs. 30,00,000 of debt. The over all cost of

capital of firm is 12 per cent.

Required:

Calculate cost of equity.

(3 3 = 9 Marks)

Answer

(i) Assumptions of Net Operating Income ( NOI) Theory of Capital Structure

Accor ding to NOI approach, there is no r elationship between the cost of capital and value

of the firm i.e. the value of the firm is independent of the capital structure of the firm.

Assumptions

( a) The corporate income taxes do not exist.

( b) The market capitalizes the value of the fir m as whole. Thus the split between debt

and equity is not important.

( c) The incr ease in proportion of debt in capital str ucture leads to change in r isk

per ception of the shar eholders.

( d) The overall cost of capital (Ko ) remains constant for all degr ees of debt equity mix.

(ii) Limitations of Profit Maximisation Object ive of Financial Management

( a) Time factor is ignored.

( b) It is vague because it is not clear whether the term relates to economic pr ofit,

accounting profit, profit after tax or before tax.

( c) The term maximization is also ambiguous.

( d) It ignores the r isk factor.

PAPER 4 : COST ACCOUNTING AND FINANCIAL MANAGEMENT 21

(iii) Some Common Methods of Venture Capital Financing

( a) Equity financing: The venture capital under taking requir es long-term funds but is

unable to provide returns in initial stage so equity capital is the best option.

( b) Conditional Loan: A conditional loan is repayable in the form of a royalty after the

venture is able to generate sales. No interest is paid on such loans.

( c) Income note: It is hybr id secur ity; the entrepr eneur has to pay both interest and

royalty on sales but at substantially low rates.

( d) Par ticipating debenture: Such security carr ies charges in three phases - in the start-

up phase, no interest is charged, next stage a low rate of inter est up to a particular

level of operation is charged, after that, high rate of inter est is requir ed to be paid.

(iv) Calculation of Cost of Equity

EBIT

Calculation of value of firm (v) =

K

capital

of

cost

Overall

o

9,00,000

00

Rs.75,00,0

0.12

Mar ket value of equity (S) = V Debts

= 75,00,000 30,00,000 = Rs. 45,00,000

Mar ket value of debts (D) = 30,00,000

K

K

equity)

of

(Cost

K

S

D

S

V

d

o

e

0.10

0.12

45,00,000

30,00,000

45,00,000

75,00,000

= 0.20 .067 = .133 100

Ke = 13.3%.