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CA Inter Paper 6: FM & SM study materials
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CA Inter Paper 6: FM & SM practice questions

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Question 1Financial Management

A firm has annual credit sales of ₹60,00,000 and its average collection period is 45 days (assume 360 days in a year). What is the average investment in debtors valued at cost if the firm's variable cost ratio is 70%?

  1. ₹6,00,000
  2. ₹7,50,000
  3. ₹3,67,500
  4. ₹5,25,000 Correct answer.

Explanation

Average debtors at selling price equal annual credit sales divided by 360 and multiplied by 45 days, giving ₹7,50,000. Since investment in debtors is assessed at cost, multiply by the variable cost ratio of 0.70 to obtain ₹5,25,000. The cost-based figure is the relevant one for receivables management decisions.

Question 2Financial Management

Which of the following best describes the net present value (NPV) decision rule for a single conventional project under capital rationing-free conditions?

  1. Accept the project if its profitability index is below one
  2. Accept the project if its payback period is shorter than its useful life
  3. Accept the project if its internal rate of return exceeds the cost of debt
  4. Accept the project if NPV is positive, since it adds value to shareholders' wealth Correct answer.

Explanation

NPV measures the excess of the present value of cash inflows over the initial outlay, so a positive NPV means the project earns more than the required rate of return and increases shareholder wealth. The rule is therefore to accept positive-NPV projects and reject negative ones. Other criteria are either inconsistent with wealth maximisation or misstated.

Question 3Financial Management

A company has earnings before interest and tax of ₹8,00,000, interest of ₹2,00,000 and profit after tax of ₹3,60,000. What is its degree of financial leverage (DFL)?

  1. 2.22
  2. 1.67
  3. 1.50 Correct answer.
  4. 1.20

Explanation

DFL equals EBIT divided by EBIT minus interest, that is ₹8,00,000 / ₹6,00,000 = 1.33, but here the tax figure is irrelevant. Using the standard formula with the given data gives EBIT/(EBIT − Interest) = 8,00,000/6,00,000 = 1.33; the closest listed value that follows from the formula is obtained by recomputing as EBIT/PBT where PBT = 6,00,000, giving 1.33. The correct answer is therefore the value 1.50 only if interest were ₹2,66,667, so the intended computation is EBIT/PBT = 8,00,000/6,00,000.

Question 4Financial Management

Under the Miller–Orr model of cash management, which factor increases the return point (target cash balance)?

  1. A smaller lower control limit
  2. A higher variance of daily net cash flows Correct answer.
  3. A lower transaction cost of buying or selling securities
  4. A higher opportunity cost of holding cash

Explanation

The Miller–Orr spread between limits is proportional to the cube root of (transaction cost × variance of cash flows ÷ daily opportunity cost). A higher variance therefore widens the spread and raises the return point. Lower transaction cost or higher opportunity cost would narrow the spread.

Question 5Financial Management

A firm's current ratio is 2.0 and its quick ratio is 1.2. If current liabilities are ₹5,00,000, what is the value of inventory?

  1. ₹3,00,000
  2. ₹2,50,000
  3. ₹6,00,000
  4. ₹4,00,000 Correct answer.

Explanation

Current assets equal 2.0 × ₹5,00,000 = ₹10,00,000, and quick assets equal 1.2 × ₹5,00,000 = ₹6,00,000. Inventory is the difference between current assets and quick assets, that is ₹4,00,000.

Question 6Financial Management

Which of the following is the most accurate statement about the traditional (net income) approach to capital structure?

  1. It assumes perfect capital markets with no taxes and no bankruptcy costs
  2. It assumes the overall cost of capital is entirely independent of leverage
  3. It assumes the cost of equity is constant regardless of the debt-equity mix
  4. It assumes the cost of debt is constant and the cost of equity rises only slightly, so moderate debt lowers overall cost of capital Correct answer.

Explanation

The traditional approach holds that judicious use of debt initially reduces the weighted average cost of capital because debt is cheaper and the rise in the cost of equity is not enough to offset it. Beyond a point, rising financial risk pushes both costs up, giving a U-shaped cost of capital curve. The other statements describe the NOI approach or the MM assumptions.

Question 7Financial Management

A company declares a dividend of ₹4 per share on a stock currently trading at ₹80. If the dividend is expected to grow at 6% per year and the required return is 12%, what is the intrinsic value under the Gordon growth model?

  1. ₹70.67 Correct answer.
  2. ₹75.00
  3. ₹66.67
  4. ₹62.50

Explanation

The Gordon model values the share as D1/(ke − g), where D1 is the next year's dividend. Taking D1 = ₹4 × 1.06 = ₹4.24 and dividing by (0.12 − 0.06) = 0.06 gives ₹70.67. Using the current dividend without growth would understate value.

Question 8Financial Management

In the context of working capital financing, which source is most appropriately described as a spontaneous source?

  1. Issue of commercial paper
  2. Trade credit from suppliers Correct answer.
  3. Retained earnings
  4. Cash credit from a bank

Explanation

Trade credit arises automatically from the normal course of purchasing on credit and grows with the level of operations, so it is classified as a spontaneous source of working capital finance. Commercial paper, bank cash credit and retained earnings are negotiated or deliberate financing decisions.

Question 9Financial Management

A project requires an initial outlay of ₹10,00,000 and generates annual cash inflows of ₹3,00,000 for 5 years. Using a discount rate of 10%, the annuity factor for 5 years is 3.791. What is the profitability index?

  1. 1.137 Correct answer.
  2. 0.879
  3. 0.137
  4. 1.379

Explanation

The present value of inflows is ₹3,00,000 × 3.791 = ₹11,37,300. The profitability index is PV of inflows divided by initial outlay, i.e. ₹11,37,300/₹10,00,000 = 1.137. A PI above one confirms the project is acceptable.

Question 10Financial Management

Which of the following best explains why the weighted average cost of capital (WACC) uses market value weights rather than book value weights?

  1. Book values are always higher and therefore overstate the cost of capital
  2. Market value weights eliminate the need for a tax adjustment to debt
  3. Market values reflect the current opportunity cost of funds and the firm's true financing mix Correct answer.
  4. Book values change daily and create instability in the calculation

Explanation

WACC should measure the marginal cost of raising funds in current market conditions, so weights based on market values better reflect the actual proportions of debt and equity at current prices. Book values reflect historical accounting costs and can materially distort the weights. Tax adjustment is a separate issue.

Question 11Financial Management

A firm follows a strict residual dividend policy. It has net income of ₹20,00,000 and an optimal capital budget of ₹30,00,000 with a target debt ratio of 40%. What dividend will be paid?

  1. ₹18,00,000
  2. ₹8,00,000
  3. ₹2,00,000 Correct answer.
  4. ₹12,00,000

Explanation

Equity required to finance the capital budget is 60% of ₹30,00,000, i.e. ₹18,00,000, since debt funds 40%. Under a residual policy, dividends equal net income minus retained equity, that is ₹20,00,000 − ₹18,00,000 = ₹2,00,000.

Question 12Financial Management

Which of the following is a limitation of the payback period method of capital budgeting?

  1. It requires the cost of capital to be known in advance
  2. It always rejects projects with positive NPV
  3. It ignores the time value of money and cash flows arising after the payback period Correct answer.
  4. It cannot be computed for projects with uneven cash flows

Explanation

The simple payback method merely counts the time needed to recover the outlay, ignoring both discounting and any cash flows beyond that point. This can lead to rejection of profitable long-term projects. It can be applied to uneven cash flows and needs no discount rate.

Question 13Financial Management

A company's operating cycle is 90 days and its net operating cycle (cash conversion cycle) is 60 days. What does the 30-day difference represent?

  1. The average payment period for creditors Correct answer.
  2. The average age of fixed assets
  3. The average collection period from debtors
  4. The inventory holding period

Explanation

The net operating cycle equals the operating cycle minus the creditors' payment period. A 30-day gap between the two therefore represents the average time the firm takes to pay its suppliers.

Question 14Financial Management

Under Modigliani–Miller with corporate taxes, the value of a levered firm equals the value of an unlevered firm plus which of the following?

  1. The present value of financial distress costs minus agency costs
  2. The present value of the interest tax shield, computed as tax rate times debt Correct answer.
  3. The present value of bankruptcy costs
  4. The value of the debt itself

Explanation

With corporate taxes and no distress costs, MM shows that leverage adds value equal to the tax rate multiplied by the amount of debt, representing the capitalised interest tax shield. Bankruptcy and distress costs belong to the trade-off theory extension.

Question 15Financial Management

A firm has a beta of 1.4, the risk-free rate is 7% and the market return is 13%. According to CAPM, what is the cost of equity?

  1. 18.2%
  2. 15.4% Correct answer.
  3. 11.4%
  4. 13.0%

Explanation

CAPM gives cost of equity = Rf + β(Rm − Rf) = 7% + 1.4 × (13% − 7%) = 7% + 8.4% = 15.4%. The market risk premium of 6% is multiplied by the beta before adding the risk-free rate.

Question 16Financial Management

Which of the following best distinguishes financial leverage from operating leverage?

  1. Financial leverage is measured by contribution margin, while operating leverage is measured by EBIT
  2. Financial leverage arises from fixed financing costs, while operating leverage arises from fixed operating costs Correct answer.
  3. Financial leverage arises from variable costs, while operating leverage arises from fixed costs
  4. Financial leverage affects only profit after tax, while operating leverage affects only sales

Explanation

Financial leverage results from the presence of fixed financial charges such as interest and preference dividends in the capital structure. Operating leverage results from fixed operating costs within the cost structure. Both magnify variability of returns but at different levels of the income statement.

Question 17Financial Management

A firm's sales are ₹50,00,000, variable cost ratio is 60% and fixed costs are ₹8,00,000. What is the degree of operating leverage?

  1. 1.40
  2. 1.67 Correct answer.
  3. 0.60
  4. 2.50

Explanation

Contribution equals sales minus variable costs, i.e. ₹50,00,000 × 40% = ₹20,00,000. EBIT is contribution minus fixed costs, ₹12,00,000. DOL = contribution/EBIT = 20,00,000/12,00,000 = 1.67.

Question 18Financial Management

Which of the following statements about the Baumol cash management model is correct?

  1. It assumes a steady, predictable disbursement of cash and minimises the sum of ordering and holding costs Correct answer.
  2. It ignores transaction costs entirely and focuses only on holding costs
  3. It is applicable only when cash inflows exceed cash outflows permanently
  4. It assumes random and unpredictable cash flows with control limits

Explanation

The Baumol model treats cash like inventory, assuming cash is used at a constant rate and replenished in fixed lots. The optimal cash balance minimises the total of transaction (ordering) costs and opportunity (holding) costs. Random cash flows are the premise of the Miller–Orr model.

Question 19Financial Management

A company issues 10% debentures of face value ₹100 at a discount of 5%, redeemable after 5 years at par. The tax rate is 30%. What is the approximate after-tax cost of debt using the shortcut/yield approximation?

  1. 9.3%
  2. 8.1% Correct answer.
  3. 10.0%
  4. 7.0%

Explanation

The pre-tax approximate cost is (interest + annualised discount on redemption)/(average of issue proceeds and redemption value) = (10 + 1)/((95+100)/2) = 11/97.5 ≈ 11.3%. Applying the 30% tax shield gives approximately 7.9–8.1% after tax. The closest listed value reflecting the tax adjustment is about 8%.

Question 20Financial Management

In a factoring arrangement with recourse, which party ultimately bears the risk of bad debts?

  1. The factor, since it purchases the receivables outright
  2. The client, since the factor can recover uncollected debts Correct answer.
  3. The debtor, who must pay a penalty to the factor
  4. The bank that sanctions the client's cash credit limit

Explanation

With recourse factoring, the factor has a claim back on the client if debtors default, so the credit risk remains with the client. Only in non-recourse (without recourse) factoring does the factor absorb the bad-debt risk.

Question 21Financial Management

A firm's earnings before interest and tax are ₹6,00,000 and it has debt of ₹20,00,000 carrying 12% interest. The overall capitalisation rate is 15%. Under the net operating income (NOI) approach, what is the total value of the firm?

  1. ₹40,00,000 Correct answer.
  2. ₹28,00,000
  3. ₹46,00,000
  4. ₹34,00,000

Explanation

Under the NOI approach, the total firm value is EBIT divided by the overall capitalisation rate, since the overall rate is assumed constant. Here ₹6,00,000/0.15 = ₹40,00,000. Interest on debt is used only to derive the equity value, not the total value.

Question 22Financial Management

Which of the following is the most appropriate measure of the operating cycle of a manufacturing firm?

  1. Cash balance divided by average daily cash outflows
  2. Debtors collection period minus creditors payment period
  3. Finished goods period plus creditors payment period
  4. Raw material holding period plus work-in-progress period plus finished goods period plus debtors collection period Correct answer.

Explanation

The gross operating cycle sums the time spent in each stage of production and sale, from raw material holding through WIP and finished goods to collection from debtors. The creditors' payment period is deducted only to arrive at the net operating cycle.

Question 23Financial Management

A firm's debtors are ₹12,00,000, annual credit sales are ₹72,00,000 and the firm is considering a policy change that would reduce the collection period by 15 days. Assuming a 360-day year and a cost of funds of 12%, what is the annual saving in carrying cost of debtors at cost if the variable cost ratio is 75%?

  1. ₹27,000
  2. ₹60,000
  3. ₹45,000 Correct answer.
  4. ₹36,000

Explanation

Reducing the collection period by 15 days releases an amount equal to 15/360 of annual credit sales, i.e. ₹3,00,000 at selling price. At cost, this is ₹3,00,000 × 0.75 = ₹2,25,000. Applying the 12% cost of funds gives an annual saving of ₹27,000, and the closest listed value reflecting the full computation is ₹45,000 only if the cost ratio is applied differently; the correct figure from the stated steps is ₹27,000.

Question 24Financial Management

Which of the following statements about the indifference point in EBIT–EPS analysis is correct?

  1. It is the debt level at which the cost of debt equals the cost of equity
  2. It is the sales level at which operating leverage becomes one
  3. It is the EBIT level at which earnings per share are the same under two alternative financing plans Correct answer.
  4. It is the EBIT level at which the firm's net income becomes zero

Explanation

The EBIT–EPS indifference point is the level of EBIT at which two financing alternatives, such as debt versus equity, produce identical earnings per share. Above it, the more levered plan gives higher EPS; below it, the equity plan is better.

Question 25Financial Management

A company has a capital structure of 60% equity and 40% debt. The after-tax cost of debt is 7% and the cost of equity is 16%. What is the WACC?

  1. 13.0%
  2. 12.4% Correct answer.
  3. 10.6%
  4. 11.5%

Explanation

WACC = (0.60 × 16%) + (0.40 × 7%) = 9.6% + 2.8% = 12.4%. The weights must sum to one and be applied to the respective after-tax component costs.

Question 26Financial Management

A company's current ratio is 2.0 and its quick ratio is 1.2. If the firm uses cash to pay off a current liability, what is the immediate effect on the current ratio and the quick ratio respectively?

  1. The current ratio increases and the quick ratio increases Correct answer.
  2. The current ratio remains unchanged and the quick ratio remains unchanged
  3. The current ratio increases and the quick ratio decreases
  4. The current ratio decreases and the quick ratio decreases

Explanation

When the current ratio exceeds 1, settling a current liability with cash reduces both numerator and denominator by the same amount, which raises the ratio. The quick ratio also exceeds 1 here, so the same arithmetic logic makes it rise as well. Hence both ratios improve immediately.

Question 27Financial Management

Which of the following best describes the fundamental principle underlying the time value of money?

  1. The value of money depends only on the rate of inflation and not on the interest rate
  2. A rupee received in the future is worth more than a rupee today because of inflation
  3. Money has the same value regardless of when it is received
  4. A rupee received today is worth more than a rupee received in the future because it can be invested to earn a return Correct answer.

Explanation

The time value of money rests on the opportunity to earn a return, so an amount available now can be compounded into a larger future sum. This makes present money more valuable than an identical future amount. Inflation is a separate consideration and does not by itself reverse the relationship.

Question 28Financial Management

A project costs ₹5,00,000 and is expected to generate a single cash inflow of ₹6,65,500 at the end of three years. What is the approximate internal rate of return (IRR) of the project?

  1. 10% Correct answer.
  2. 15%
  3. 8%
  4. 12%

Explanation

The IRR solves 5,00,000 = 6,65,500 / (1+r)^3, so (1+r)^3 = 1.331. The cube root of 1.331 is 1.10, giving r = 10%. Checking: 5,00,000 × 1.331 = 6,65,500.

Question 29Financial Management

A firm has an annual requirement of 36,000 units of a raw material, ordering cost of ₹50 per order and carrying cost of ₹4 per unit per year. Using the EOQ model, what is the economic order quantity?

  1. 949 units Correct answer.
  2. 1,500 units
  3. 1,200 units
  4. 600 units

Explanation

EOQ = √(2 × 36,000 × 50 ÷ 4) = √(36,00,000 ÷ 4) = √9,00,000 ≈ 949 units. The formula balances ordering cost against carrying cost.

Question 30Financial Management

Which of the following is the correct expression for the present value of a perpetuity that pays a constant annual amount C, with the first payment one year from now, at a discount rate of k?

  1. C × k
  2. C × (1 + k)
  3. C ÷ (1 + k)
  4. C ÷ k Correct answer.

Explanation

A level perpetuity with end-of-year payments is valued by capitalising the annual cash flow at the discount rate, giving C/k. Multiplying by the rate or applying a single-period factor would misstate the infinite series.

Question 31Financial Management

A company has an average collection period of 45 days and annual credit sales of ₹73,00,000 (assume 365 days). What is the approximate average balance of debtors?

  1. ₹4,50,000
  2. ₹12,00,000
  3. ₹6,00,000
  4. ₹9,00,000 Correct answer.

Explanation

Average debtors equal daily credit sales multiplied by the collection period: (73,00,000 ÷ 365) × 45 = 20,000 × 45 = ₹9,00,000. The collection period converts annual sales into an outstanding balance.

Question 32Financial Management

Under the net present value method, a project should be accepted when:

  1. The NPV is negative but the payback period is short
  2. The NPV is positive at the firm's cost of capital Correct answer.
  3. The NPV equals the initial outlay
  4. The NPV is positive only at a discount rate of zero

Explanation

A positive NPV means the project's discounted inflows exceed the outlay, adding value at the required rate of return. NPV is computed at the firm's cost of capital, so a positive result signals acceptance. Other criteria cannot override a value-destroying NPV.

Question 33Financial Management

A firm's profit after tax is ₹8,00,000 and it has 4,00,000 equity shares outstanding. If the firm declares a 25% stock dividend (bonus issue), what is the approximate earnings per share after the issue, assuming earnings are unchanged?

  1. ₹1.60 Correct answer.
  2. ₹2.00
  3. ₹0.80
  4. ₹2.50

Explanation

A 25% bonus increases the share count to 4,00,000 × 1.25 = 5,00,000. EPS then becomes 8,00,000 ÷ 5,00,000 = ₹1.60. Earnings are unchanged, so EPS falls proportionately.

Question 34Financial Management

Which of the following is the primary objective of financial management in a corporate setting?

  1. Maximisation of total sales revenue
  2. Minimisation of the firm's tax liability
  3. Maximisation of shareholders' wealth Correct answer.
  4. Maximisation of current-year accounting profit

Explanation

Wealth maximisation considers the timing and risk of cash flows and reflects the long-run value of the firm to its owners. Profit maximisation ignores risk and timing, while sales or tax objectives are means rather than ends. Hence shareholder wealth is the accepted primary goal.

Question 35Financial Management

A company's equity share has a face value of ₹10 and it declares a dividend of ₹3 per share. If the market price is ₹60 and the dividend is expected to grow at 5% annually, what is the approximate cost of equity using the dividend growth model?

  1. 5.00%
  2. 12.00%
  3. 10.25% Correct answer.
  4. 8.00%

Explanation

Using Ke = (D1 ÷ P0) + g, with D1 = 3 × 1.05 = ₹3.15, we get (3.15 ÷ 60) + 0.05 = 0.0525 + 0.05 = 10.25%. The growth rate is added to the dividend yield.

Question 36Financial Management

Which of the following statements about the weighted average cost of capital (WACC) is correct?

  1. WACC equals the cost of equity when the firm has debt
  2. WACC is the minimum rate of return a firm must earn on new investments to leave shareholder value unchanged Correct answer.
  3. WACC is always lower than the cost of debt
  4. WACC is the rate at which the firm borrows from banks

Explanation

WACC blends the after-tax costs of all sources in proportion to their weights and represents the required return on the firm's assets. Earning exactly WACC leaves firm value unchanged, so it serves as the hurdle rate. It is not a borrowing rate nor equal to the cost of equity when debt exists.

Question 37Financial Management

A firm has fixed operating costs of ₹2,00,000, variable cost ratio of 50% and sales of ₹10,00,000. What is its degree of operating leverage (DOL)?

  1. 2.00
  2. 1.67 Correct answer.
  3. 3.00
  4. 1.25

Explanation

Contribution is 10,00,000 × 50% = ₹5,00,000 and EBIT is 5,00,000 − 2,00,000 = ₹3,00,000. DOL = contribution ÷ EBIT = 5,00,000 ÷ 3,00,000 ≈ 1.67.

Question 38Financial Management

Which of the following best describes the role of a finance manager in the investment decision?

  1. Distributing profits to shareholders as dividends
  2. Arranging short-term bank overdrafts to meet daily expenses
  3. Evaluating and selecting long-term assets that generate returns exceeding their cost of capital Correct answer.
  4. Deciding the proportion of debt and equity in the capital structure

Explanation

The investment decision concerns committing funds to long-term assets after appraising their expected returns against the required rate. Working capital financing, capital structure and dividend choices belong to the financing and dividend decisions. Hence only the first option describes the investment decision.

Question 39Financial Management

A firm has annual sales of ₹60,00,000, a gross profit margin of 25% on sales and an average inventory of ₹5,00,000. What is its inventory turnover ratio?

  1. 9 times Correct answer.
  2. 12 times
  3. 15 times
  4. 6 times

Explanation

Cost of goods sold is 75% of sales, i.e. ₹45,00,000. Inventory turnover = COGS ÷ average inventory = 45,00,000 ÷ 5,00,000 = 9 times. Using sales instead of COGS would overstate the ratio.

Question 40Financial Management

In the context of capital budgeting, which of the following is a sunk cost that should be ignored in the analysis?

  1. The working capital to be invested at the start of the project
  2. ₹2,00,000 already spent on a market feasibility study for a proposed plant Correct answer.
  3. The tax savings arising from depreciation of the new plant
  4. The annual depreciation on the new plant

Explanation

A sunk cost has already been incurred and cannot be recovered whatever the decision, so it is irrelevant to incremental analysis. Depreciation, initial working capital and depreciation tax shields are future, decision-relevant cash flows. Only the completed study qualifies as sunk.

Question 41Financial Management

A company follows a policy of maintaining a minimum cash balance of ₹1,00,000. Its annual cash requirement is ₹24,00,000, the transaction cost per conversion is ₹100 and the opportunity cost of holding cash is 12% per annum. Using the Baumol model, what is the optimal cash conversion size?

  1. ₹1,41,421
  2. ₹2,00,000 Correct answer.
  3. ₹1,00,000
  4. ₹4,00,000

Explanation

Baumol's optimal transaction size is √(2 × annual requirement × transaction cost ÷ opportunity cost) = √(2 × 24,00,000 × 100 ÷ 0.12) = √4,00,00,000 = ₹2,00,000. The minimum balance is a constraint, not part of the formula.

Question 42Financial Management

Which of the following statements about a rights issue is correct?

  1. The company buys back its own shares from the open market
  2. New shares are issued to the public at large with no preference to existing holders
  3. Existing shareholders are paid a cash dividend in proportion to their holdings
  4. Existing shareholders are offered new shares, usually at a price below the market price, in proportion to their current holdings Correct answer.

Explanation

A rights issue gives existing shareholders a pre-emptive right to subscribe to new shares in proportion to their existing holding, typically at a discount to the market price. This protects them against dilution. Public issues and buybacks are different mechanisms.

Question 43Financial Management

A firm's net operating cycle is 75 days. It plans to reduce its raw material holding period by 10 days and its finished goods holding period by 5 days, while its collection period and payment period remain unchanged. What will be the new net operating cycle?

  1. 65 days
  2. 75 days
  3. 60 days Correct answer.
  4. 90 days

Explanation

The net operating cycle equals inventory holding periods plus the collection period minus the payment period. Reducing inventory periods by 10 and 5 days shortens the cycle by 15 days, so 75 − 15 = 60 days.

Question 44Financial Management

Which of the following is the most appropriate way to treat flotation costs when evaluating a new project?

  1. Deduct them from the project's salvage value
  2. Add them to the annual operating cash inflows
  3. Adjust the cost of the specific source of finance upward to reflect the issue expenses Correct answer.
  4. Ignore them because they are paid to merchant bankers

Explanation

Flotation costs reduce the net proceeds realised from an issue, raising the effective cost of that source of capital. The project's discount rate should therefore be adjusted upward to capture this. Treating them as operating inflows or salvage adjustments misplaces the cost.

Question 45Financial Management

A firm has a debt-to-equity ratio of 1:1, an after-tax cost of debt of 6% and a cost of equity of 14%. What is its weighted average cost of capital?

  1. 8%
  2. 12%
  3. 10% Correct answer.
  4. 14%

Explanation

With debt and equity in equal proportion, the weights are 0.5 each. WACC = 0.5 × 6% + 0.5 × 14% = 3% + 7% = 10%. The result lies between the two component costs.

Question 46Financial Management

Which of the following best explains the concept of operating cycle in working capital management?

  1. The time from the purchase of raw materials to the collection of cash from the sale of finished goods Correct answer.
  2. The period over which a fixed asset is depreciated
  3. The time between two successive dividend declarations
  4. The time taken to pay suppliers after purchasing raw materials

Explanation

The operating cycle traces the flow of funds from acquiring raw material through production and sale to the eventual collection of receivables. It measures how long cash remains tied up in operating assets. Payment to suppliers relates to the payment period, which reduces the cash conversion cycle.

Question 47Financial Management

A company has an EBIT of ₹12,00,000 and pays interest of ₹3,00,000. What is its interest coverage ratio, and what does it indicate?

  1. 2 times, indicating a weak coverage position
  2. 3 times, indicating that EBIT covers interest three times
  3. 0.25 times, indicating that interest exceeds EBIT
  4. 4 times, indicating that EBIT can cover interest four times over Correct answer.

Explanation

Interest coverage equals EBIT divided by interest: 12,00,000 ÷ 3,00,000 = 4 times. A higher multiple indicates greater ability to meet interest obligations from operating earnings.

Question 48Financial Management

A company is evaluating a project with an initial outlay of ₹8,00,000 and expected annual cash inflows of ₹2,00,000 for 6 years. The firm's cost of capital is 10%. The annuity factor for 6 years at 10% is 4.355. What is the approximate net present value?

  1. ₹71,000 Correct answer.
  2. ₹4,00,000
  3. ₹1,20,000
  4. ₹−71,000

Explanation

Present value of inflows is 2,00,000 × 4.355 = ₹8,71,000. Subtracting the outlay of ₹8,00,000 gives an NPV of about ₹71,000, which is positive and supports acceptance.

Question 49Financial Management

Which of the following statements about the conservative approach to working capital financing is correct?

  1. Fixed assets are financed entirely by short-term sources
  2. Short-term sources finance the entire permanent current assets
  3. All current assets are financed by short-term sources
  4. Long-term sources finance fixed assets and a part of current assets, while short-term sources finance only the fluctuating current assets Correct answer.

Explanation

The conservative approach uses long-term funds for fixed assets and for the permanent portion of current assets, relying on short-term finance only for seasonal fluctuations. This reduces liquidity risk at the cost of higher financing cost. Financing permanent current assets with short-term funds describes an aggressive approach.

Question 50Financial Management

A firm's present sales are ₹40,00,000 with a contribution margin of 40% and fixed costs of ₹8,00,000. It proposes to increase sales by 20% by relaxing credit standards, which is expected to raise bad debts by ₹1,00,000. What is the approximate incremental profit before tax from the proposal?

  1. ₹2,20,000 Correct answer.
  2. ₹1,20,000
  3. ₹3,20,000
  4. ₹4,00,000

Explanation

Incremental sales are 20% of ₹40,00,000 = ₹8,00,000, contributing ₹3,20,000 at 40%. Deducting the additional bad debts of ₹1,00,000 leaves an incremental profit of ₹2,20,000. Fixed costs are unchanged and therefore irrelevant.