Financial Daily from THE HINDU group of publications
Monday, May 10, 2004
Financial Daily from THE HINDU group of publications Monday, May 10, 2004 |
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Mentor
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Accountancy Project-ranking for decision-making P. V. Ratnam
A COMPANY can make either of the following two investments at the beginning of the next financial year 2004 (see Table 10). It is estimated that each of the alternative projects will require an additional input of working capital at the start of the project which will be received back at the expiry of the project life. There will be no realisable residual scrap value of the investments at the end of the project. Depreciation has been calculated on straight-line basis in estimating the cash flows. Cost of finance to the company is to be taken as 10 per cent. The present value of Re 1 to be received at the end of each year at 10 per cent is as follows: Year 1, 0.91; year 2, 0.83; year 3, 0.75; year 4, 0.68; and year 5, 0.62. Evaluate the investment proposal using the net present value and profitability index methods.
The ranking of the projects are shown in Table 11. Note: i) Amount of additional input of working capital is not required for decision-making because it is the same for both the projects. ii) In case of unequal lives of the projects, the annual equivalent value is to be worked out before final decision is taken. AEV = NPV / Annuity Factor Project I: 2290 / 3.17 = Rs 722.40 Project II: 3016 / 3.79 = Rs 795.78 Hence, Project II will be better because of its higher AEV.
MPBF
Total current assets — Rs 1,50,000 Less: Current liabilities — Rs 30,000 Working capital gap — Rs 1,20,000 Less: Borrower's contribution (25 per cent of Rs 1,20,000) = Rs 30,000 MPBF 90000 Hence answer at (a) above is correct.
MBO
management chart; b) budget; c) organisation chart; d) none of the above A quantitative expression of MBO is budget.
BE point
PV ratio = S - V/S x 100 6 lakh - 3 lakh / 6 lakh x 100 = 50 per cent BEP = F/PV ratio, that is, 1,80,000 / 50 per cent = Rs 3,60,000 Hence, option (a) is correct.
EPS, PE ratio
Seven per cent preference shares of Re 1 each — Rs 6,00,000 Equity shares of Re 1 each — Rs 16,00,000 Following additional information are available for the just concluded financial year: Profit after taxation (at 35 pr cent) — Rs 5,40,000 Equity dividend paid — at 20 per cent Depreciation — Rs 1,20,000 Market price of equity shares — Rs 4 Capital commitments — Rs 2,40,000 You are required to work out the following: i) the cover for preference and equity shares; ii) the earnings yield; iii) the price-earning ratio (P/E); iv) the priority percentage; v) the net cash flow. Working notes: a) equity dividend paid 20 per cent of Re 1 = Re 0.20 per share b) Profit after tax = Rs 5,40,000 Less: Preference dividend 7 per cent on 6 lakh = Rs 42,000 Profit to equity shareholders = Rs 4,98,000 c) EPS = PAT - pref. dividend / No. of equity shares 540,000 - 42,000 / 16,00,000 = Re. 0.31125 d) Equity dividend paid 16,00,000 x 0.20 = Rs 3,20,000 Solution: i) Cover for preference and equity shares: PAT / pref. dividend + equity dividend = 5,40,000 / 42,000 + 3,20,000 = 1.492 times ii) Earnings yield = EPS / market price 0.31125 / 4.00 x 100 = 7.78 per cent iii) Price-earnings ratio = market price / EPS 4.00 / 0.31125 = 12.85 times iv) Priority percentages: (i) and (iii) as worked out above.
v) The net cash flow is presented in Table 9.
Profitability check
The total fixed overhead amount to Rs 4,80,000 and is allocated in the ratio of 1:2 between Products A and B respectively. Work out: i) the statement showing operating results of the period; ii) whether the company should increase the sale of Product A or B; iii) what will be the effect on profitability when the units of sale of Product A is either increased by 20 per cent or decreased by 10 per cent. You may assume any other data, if necessary.
The statement showing operating results is presented in Table 13. Working notes: i) Total fixed overheads Rs 4,80,000 allocated in the ratio of 1:2, that is, Rs 1,60,000 to Product A and Rs 3,20,000 to Product B. Fixed overhead is Rs 4 and Rs 8 per unit respectively in respect of A and B as given in the question. Hence, number of units produced: Product A: 1,60,000 / 4 = 40,000 units Product B: 3,20,000 / 8 = 40,000 units ii) Whether company should increase the sale of Product A or B? An increase in the sales of one depresses the sale of the other equally on an unit basis and vice versa (as given in the question). The sale of Product B should be increased because its CPU is Rs 14 which is higher than that of A: CPU on B = Rs 14 Less CPU on A (foregone) = Rs 12 Increase in CPU = Rs 2 (iii)(a) Profitability when the units of sale of Product A increased by 20 per cent. Contribution: A: 40,000 + 20 per cent = 48,000 x 12 = 5,76,000 B: 40,000 - 20 per cent = 32,000 x 14 = 4,48,000 Total contribution = Rs 10,24,000 Less: Fixed overheads = Rs 4,80,000 Profit = Rs 5,44,000 This will result in lower profit, by Rs 16,000 (Rs 5,60,000 - Rs 5,44,000), as compared to current profit. (iii)(b) Profitability when the units of sale of Product A decreased by 10 per cent.
The contribution is shown in Table 14. This will result in higher profit, by Rs 8,000 (Rs 5,68,000 - Rs 5,60,000), as compared to the current profit. Note: Sale of Product B should be increased as discussed in (ii) above. Even when one extra unit of Product B is sold higher, it will result in a higher net contribution of Rs 2 per unit. (Concluded) (Suggested answers to December 2003 ICWA (Final) paper on advanced financial management.)
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