Question Paper

Strategic Financial Management (MB361F) : July 2008

Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.

1. Which of the following is a financial objective of a company?

(a) Welfare of employees
(b) Wealth maximization
(c) Leadership in Research and Development
(d) Welfare of management
(e) Welfare of the society.
2. Internal auditing often involves:
I. Collection of information pertaining to working of various parties.
II. Checking company’s compliance with quality and cost controls.
III. Determining the accuracy of reports regarding various activities.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
3. The present value of tracking error will be equal to zero if
(a) The tracking error consists of entirely unsystematic risk
(b) The tracking error consists of entirely systematic risk
(c) The tracking error consists of 50% unsystematic risk and 50% systematic risk
(d) The tracking error consists of 40% unsystematic risk and 60% systematic risk
(e) The tracking error consists of 60% unsystematic risk and 40% systematic risk.
4. Discounted cash flow can prove biased against long-term projects because
(a) Less importance is given to direct cashflows
(b) Less importance is given to indirect cashflows
(c) More importance is given to indirect cashflows
(d) Equal importance is given to direct as well as to indirect cashflows
(e) It involves qualitative parameters of the project.
5. Successive generations of original product is an example of
(a) Financial option
(b) Growth option
(c) Investment timing option
(d) Abandonment option
(e) Flexibility option.
6. Which of the following financial system analysis highlights the inter-relationships in the contents of financial
statements?
(a) Du Pont analysis
(b) Common size analysis
(c) Time series analysis
(d) Index analysis
(e) Comparative analysis.
7. Which of the following statements is/are true as per John Linter Model?
 I. The current dividend of a firm depends on its current earnings and not its past dividends.
II. A conservative firm prefers a high level of dividend stability and assigns relatively insignificant value to
weightage given to current earning.
III. An aggressive firm which attaches much significance to past dividends will give low value to weightage
given to current earning.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
8. One of the assumptions of ideal capital market is atomistic competition, it states that
I. Investor’s wealth or at least the wealth they are willing to bring to purchase a given firm’s securities is
small relative to total value of given firm’s securities.
II. Investor is able to purchase substantial portion of an individual firm’s securities.
III. Firm may possess sufficient cash to engage in substantial repurchases of outstanding securities.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) Both (II) and (III) above.
9. Which of following statements is/are true regarding Marakon Model?
I. Increase in market value to book value ratio depicts increase in firm’s value.
II. Creating internal structures for maximizing firm’s value is irrelevant.
III. Understanding of strategic forces will help to enhance the value of the firm.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
10.As per Porter’s Five Forces model of industry analysis, a firm can take an advantage over its rival firm by
I. Using constant price policy.
II. Improving the product differentiation and creative use of distribution system.
III. Exploiting relationship with suppliers.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) Both (II) and (III) above.
11.Which of the following factors is/are often considered responsible for initiation of the declining phase of product
life cycle?
I. Technical advances.
II. Change in perception, economy and technology.
III. Increase in leverage.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
12.Which of the following statements is/are true about bankruptcy models?
I. According to Wilcox model, the net liquidation value of the firm is the best indicator of the financial health
of the firm.
II. Blum Marc’s failing company model is based on liquidity ratios only.
III. According to the Beaver model, the ratio of cash flow to total debt is the single best predictor of corporate
 failure.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) All (I), (II) and (III) above.
13.Neon Ltd., is planning an investment of Rs.20 million. Its optimal capital structure is 40 percent equity and 60
percent debt. Its earnings before interest and taxes (EBIT) were Rs.36 million for the year. The firm has Rs.180
million in assets, pays an average interest of 10 percent per annum on all its debt, and faces a marginal tax rate
of 40 percent. If the firm maintains a residual dividend policy and will keep its optimal capital structure intact,
the amount of the dividends it will pay after financing its capital budget is
(a) Rs. 3.42 million
(b) Rs. 5.42 million
(c) Rs. 7.12 million
(d) Rs.12.02 million
(e) Rs.15.12 million.
14.To control management from taking sub-optimal decisions a firm can use which of the following internal
structure(s)?
I. The management’s compensation being linked to company’s performance.
II. Corporate governance mechanisms that specify responsibilities and hold managers accountable for their
decisions.
III. Resource allocation among projects guided by specific requirements of the projects rather than past
allocations and capital rationing.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
15.Costs associated with materials and products that fail to meet quality standards and result in manufacturing
losses are called
(a) Prevention costs
(b) Appraisal costs
(c) External failure costs
(d) Internal failure costs
(e) Quality cost.
16.Which of the following models on dividend policy emphasizes on the investor’s preference for the current
dividends?
(a) Traditional Model
(b) Walter Model
(c) Gordon Model
(d) Miller and Modigliani Model
(e) Rational expectations model.
17.Which of the following is believed to be an external factor leading to the bankruptcy of a firm?
(a) Shortage in supply of raw materials
(b) Fraudulent practices by management
(c) Labour unrest
(d) Technological obsolescence
(e) Disputes among promoters.
18.Sudan Industries Ltd., an Indian company has a subsidiary in Frankfurt and is exposed to the risk of Euro
weakening and the value of its assets, and profit contributions declining in rupee terms in its consolidated
financial statements. The company is exposed to which of the following risks?
(a) Transaction risk
(b) Translation risk
(c) Economic risk
 (d) Interest rate risk
(e) Market risk.
19.Which of the following statements is/are true?
I. Mckinsey Model identifies value drivers only at generic level.
II. Probabilistic analysis can be used at the time of recession.
III. Alcar Model uses the discounted cash flow analysis to identify value-adding strategies.
(a) Only (I) above
(b) Only (III) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) Both (II) and (III) above.
20.Theta Ltd., has Rs.1.5 of current assets for every Re.1 of its current liabilities. During the current year, it is able
to generate the sales of Rs.7 for every Re.1 of investment in inventory. If its current liabilities are Rs.2,000 and
acid-test ratio is 1.2, the total sales generated by the company for the year are
(a) Rs.2,560
(b) Rs.3,200
(c) Rs.4,200
(d) Rs.4,800
(e) Rs.5,200.
21.Which of the following is an important technique for assessing the financial strength of an organization within
the industry?
(a) Accounting analysis
(b) Time series analysis
(c) Common size statements
(d) Comparative analysis
(e) Market analysis.
22.The equity capital and total debt of Ratan Industries Ltd., are Rs.300 lakh and Rs.600 lakh respectively. The
earnings before interest and taxes of the company amounts to Rs.180 lakhs. The return on investment of the
company is
(a) 10%
(b) 12%
(c) 15%
(d) 20%
(e) 30%.
23.Xenon Ltd., earns 14% on the equity and the growth rate of dividends and earnings is 8%. The book value per
share is Rs.80. If the cost of equity is 16%, the market price of the shares of Xenon Ltd., according to the
Marakon model is
(a) Rs.46
(b) Rs.50
(c) Rs.55
(d) Rs.58
(e) Rs.60.
24.Arranging third party to pay for losses if they occur, without transferring the risk itself is known as
(a) Risk retention
(b) Risk sharing
(c) Risk financing
(d) Separation
(e) Combination.
25.Economic risk can be determined by which of the following factor(s)?
I. Location of production facilities.
II. Location of competitors.
III. Determinants of input prices.
(a) Only (I) above
 (b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above.
26.Ramprakash Ltd., has taken a term loan of Rs.27 lakh at an interest rate of 20% p.a. the cost of the term loan
assuming that the tax rate is 40% is
(a) 9%
(b) 10%
(c) 11%
(d) 12%
(e) 13%.
27.The most commonly held view of capital structure is that the weighted average cost of capital
(a) Declines steadily as more debt is used
(b) First declines with moderate amounts of leverage and then increases
(c) Increases proportionately with increases in leverage
(d) Is unaffected by the level of debt used
(e) Is minimized at a balanced capital structure of 50% equity and 50% debt.
28.The current assets and liabilities of Akash Ltd., are Rs.20,00,000 and Rs.13,00,000 respectively. The amount it
can borrow on short-term basis without reducing the current ratio below 1.1 is
(a) Rs.44 lakh
(b) Rs.49 lakh
(c) Rs.52 lakh
(d) Rs.55 lakh
(e) Rs.57 lakh.
29.The following information available for Best Ltd. :
Current Assets = Rs.500 million
Net Fixed Assets = Rs.400 million
EBIT = Rs.100 million
Return on investment = 18%.
The working capital leverage for 10% reduction in current assets will be
(a) 58.82%
(b) 60.13%
(c) 65.02%
(d) 68.22%
(e) 69.23%.
30.Suppose, the upper limit and lower limit of cash balances are Rs.80,000 and Rs.20,000 respectively. The return
point according to Miller and Orr Model will be
(a) Rs.20,000
(b) Rs.25,000
(c) Rs.30,000
(d) Rs.40,000
(e) Rs.45,000.

END OF SECTION A

Section B : Problems/Caselet (50 Marks)

• This section consists of questions with serial number 1 – 5.
• Answer all questions.
• Marks are indicated against each question.
• Detailed workings/explanations should form part of your answer.
• Do not spend more than 110 - 120 minutes on Section B.

1. Serum Ltd., is a popular biotech firm which produces various antiserums for blood group
 testing. The following information is available about Serum Ltd.:
EBIT Rs.75 lakh
Interest on debentures @ 8.5% Rs.1.275 lakh
Interest on term loans @ 12 % Rs.1.92 lakh
Income tax @ 40% Rs.28.7 lakh
Number of equity shares Rs.15 lakh @ Rs.10 per share
Market price per share Rs.20
The company has undistributed reserves and surplus of Rs.40 lakh. It is in need of Rs.60 lakh
to pay the debentures and modernize plans. The company is considering the following two
plans:
Plan I. Raising the entire amount as term loans @ 12.5%.
Plan II. Issuing 1.5 lakh shares at Rs.15 per share and rest of the amount in the form of
term loan @ 12.5% per annum.
As a result of modernization, the return on capital is likely to improve by 3%. In case the total
amount is raised in the form of term loans, the P/E ratio of the company is likely to decrease
by 5%.
You are required to:
a. Advise the company on the financial plans to be selected. ( 8 marks)
b. Find out the indifference level of EBIT. ( 4 marks)
2. Duplex Solutions Ltd., a leading software company, reported earnings per share of Rs.2.10 in
the year 2007, on which it paid dividends per share of Rs.0.69. Earnings are expected to grow
15% a year from 2008 to 2012, during which period the dividend payout ratio is expected to
remain unchanged. After 2012, the earnings growth rate is expected to drop to a stable 6%,
and the payout ratio is expected to increase to 65% of earnings. Currently, the firm has a beta
of 1.40 and it is expected to have a beta of 1.10 after 2012. The risk-free rate is 4.5% and the
risk premium is 5.5%.
You are required to determine:
a. The expected price of the stock at the end of 2012. ( 5 marks)
b. The present value of the stock. ( 5 marks)
3. The following data is related to Duracell Ltd.:

(Rs. in lakhs)
Average stock of raw materials and stores 10.00
Average work-in-progress inventory 12.00
Average finished goods inventory 7.00
Average accounts receivable 13.00
Average accounts payable 8.00
Average WIP value of raw-material consumed per day 1.00
Average cost of goods sold per day 1.50
Average sales per day 2.00
Average credit purchases per day 0.55
Sales price per unit of its product is Rs.2,500 and processing cost per unit is Rs.300. The
firm’s average daily production is 150 units. The minimum cash balance to be maintained by
the firm is Rs.1.5 lakhs.
You are required to calculate:
a. The weighted operating cycle of the firm. ( 8 marks)
b. The working capital requirement of the firm based on the weighted operating cycle. ( 2 marks)
Caselet
Read the caselet carefully and answer the following questions:
4. Strategically designed changes are aimed to move the companies away from their existing
state of affairs toward some desired state of affairs in order to improve their organizational
performance by increasing their competitive advantage. Explain the various types of strategic
changes that may be undertaken by companies for improving their performance. ( 9 marks)
5. Certain conditions must be prevalent within the organizations so that they can achieve
strategic changes by bringing about a behavioural change among the employees. What are the
conditions which are generally required to bring about a behavioural change among the
employees? ( 9 marks)
Over the past 15 or so years, programs to bring in strategic changes in the corporates and
improve their organizational performance have become increasingly common. Yet, they are
notoriously difficult to carry out. Success depends on persuading hundreds or thousands of
groups and individuals to change the way they work, a transformation people will accept only
if they can be persuaded to think differently about their jobs. In effect, CEOs must alter the
mind-sets of their employees—not an easy task. CEOs could make things easier for
themselves if, before embarking on complex performance-improvement programs, they
determined the extent of the change required to achieve the business outcomes they seek. But
what if the only way a business can reach its higher performance goals is to change the way its
people behave across the board? Suppose that it can become more competitive only by
changing its culture fundamentally—from being reactive to proactive, or introspective to
externally focused, for instance. Recently, however, several companies have found that linking
all of the major discoveries together in programs to improve performance has brought about
startling changes in the behavior of employees—changes rooted in new mind-sets.
Performance-improvement programs that apply all of these ideas in combination can be just as
chaotic and hard to lead as those that don’t. But they have a stronger chance of effecting long-
term changes in business practice and thus of sustaining better outcomes.
It is generally observed that certain conditions are required to bring about a behavioural
change among the employees. Employees will alter their mind-sets only if they see the point
of the change and agree with it—at least enough to give it a try. To feel comfortable about
change and to carry it out with enthusiasm, people must understand the role of their actions in
the unfolding drama of the company’s fortunes and believe that it is worthwhile for them to
play a part. The surrounding structures (reward and recognition systems, for example) must be
in tune with the new behavior. Organizational designers broadly agree that reporting
structures, management and operational processes, and measurement procedures—setting
targets, measuring performance, and granting financial and nonfinancial rewards—must be
consistent with the behavior that people are asked to embrace. Employees must have the skills
to make relevant changes in behavior. They must be given sufficient time to be equipped with
such skills. A specialist in adult learning showed that adults can’t learn merely by listening to
instructions; they must also absorb the new information, use it experimentally, and integrate it
with their existing knowledge. Finally, they must see people they respect modeling new
behaviour actively. In any organization, people model their behavior on "significant others":
those they see in positions of influence. Within a single organization, people in different
functions or levels choose different role models—a founding partner, perhaps, or a trade union
representative, or the highest-earning sales rep.Each of these conditions is realized
independently; together they add up to a way of changing the behavior of people in
organizations by changing attitudes about what can and should happen at work.
END OF CASELET

END OF SECTION B
Section C : Applied Theory (20 Marks)
• This section consists of questions with serial number 6 - 7.
• Answer all questions.
• Marks are indicated against each question.
• Do not spend more than 25 -30 minutes on Section C.

6. For developing superior strategies to gain sustainable competitive advantage,

strategic cost management uses the cost data. An integral part of strategic cost
management is Activity Based Costing (ABC). Discuss various steps involved in
ABC system. ( 10 marks)
7. It is better to reorganize a firm in financial distress rather than to liquidate it as the
firm will be more likely to repay its debts, when it is alive and operating than when it
is liquidated. Explain various steps involved in the reorganization of a financially
 distressed firm. ( 10 marks)

END OF SECTION C

END OF QUESTION PAPER

Suggested Answers
Strategic Financial Management (MB361F) : July 2008
Section A : Basic Concepts
Answer Reason
1. B Wealth maximization is a financial objective of company whereas welfare of employees,
leadership in R&D, welfare of management, welfare of society etc. are the non-financial
objectives of a company.
2. E While doing the internal auditing internal auditing team oversees the entire product
development process, provides the firm with valuable information that may include
information pertaining to whether all the parties involved in the project are working on
consensus basis, whether all workings are done according to plans and if any further
change is required to those plans. Whether the company is with quality and cost controls
and finally the reports on all activities are accurate.
3. A The use of tracking error approach is relevant for valuation when the present value of the
tracking error is zero. This is possible only when the tracking error consists entirely of
unsystematic or firm specific risks.
4. B Discounted cash flow is biased against long-term projects, this is because the use of DCF
involves the quantifiable parameters of the project thereby giving less importance to the
indirect cash flows.
5. B Successive generation of original product is an example of growth option.
6. A Analyzing return ratios is referred to as DuPont Analysis. This system highlights the inter-
relationships in the contents of financial statements. Hence, the answer is (a). The other
alternatives compare the financial statements by taking the individual items of different
financial statements and reviewing the changes that have occurred from year to year and
over the years.
7. B The Linter model states that current dividends of a firm depend on its current earnings and
past dividends. The degree of dividend stability can be deduced from the weightages in
the model. A conservative firm which prefers the high level of dividend stability will
assign relatively insignificant value to weightage given to current earnings by the firm. On
the other hand, an aggressive firm which does not attach much significance to past
dividends would give high value to weightage given to current earnings by the firm.
8. A Atomistic competition is one of the assumptions of ideal capital market which states that
all investors are atomistic i.e; their wealth or at least the wealth that they are willing to
bring to purchase the given firm’s securities is small relative to the total value of given
firm’s securities.
9. D According to Marakon model, a firm’s value is measured by ratio of its market value to
book value. An increase in this ratio depicts increase in the value of firm and reduction
reflects a reduction in the firm’s value. The model further states that a firm can maximize
its value following four steps:
• Understand the financial factors that determine the firm’s value.
• Understand the strategic forces that affect the value of the firm.
• Formulate the strategies that lead to higher value of the firm.
• Create internal structures to counter the divergence between the shareholder’s goals
and management’s goals.
10. E According to Five Forces model a firm can take an advantage over the rival firm by
changing prices raising or lowering prices to gain a temporary advantage, improving
product differentiation, creatively use of distribution system and exploiting relationship
 with suppliers.
11. C The declining phase may be caused by following factors:
• Technical advances leading to product substitution
• Change in perception like the change in fashion and taste
• The average length of product life cycle is tending to shorten as a result of economic,
social and technological change.
12. D The Wilcox model considers the net liquidation value of the firm as the best indicator of a
firm’s financial health. Blum Marc’s failing company model is based on a set of 12 ratios
divided into liquidity, profitability and variability ratios. The Beaver model identifies the
cash flow to total debt as the single best indicator of a firm’s financial health.
13. C Interest cost:
Total assets = Rs.180M; debt = 60% × Rs.180M = Rs.108 million in debt.
Interest cost = Rs.108M × 0.10 = Rs.10.8 million.
Net income (in millions):
EBIT Rs.36.0
less: Interest – 10.8
EBT Rs.25.2
less: Taxes (@40%) – 10.08
Net income Rs.15.12
The portion of project financed with retained earnings:
Retained earnings portion: 20M x 0.40 = Rs.8.0 million
Debt portion = Rs.20M x 0.60 = Rs.12.0 million
The residual available for dividends = Rs.15.12M – Rs.8.0M = Rs.7.12 million in
dividends
14. E A firm needs internal structures which can control the tendency of management to take
suboptimal decisions. These internal structures may include:
• The management’s compensation being linked to company’s performance
• Corporate governance mechanisms that specify responsibilities and hold managers
accountable for their decisions
• Resource allocation among projects guided by specific requirements of the projects
rather than the past allocations and capital rationing
• A mechanism for making sure that the various projects undetaken from part of a
strategy, rather than being disjointed, discrete projects
15. D Costs that arise due to materials and products that fail to meet quality standards and result
in manufacturing losses are called internal failure costs
16. C Gordon argued that the investors would prefer the income that they earn currently to that
income in future that may or may not be available. Hence, they prefer to pay a higher
price for the stocks which earn them current dividend income and would discount those
stocks, which either reduce or postpone the current income. For that reason, this model
emphasizes the entire weight on the dividends, while other models consider the dividend
payment and the retained earnings. Hence, option (c) is correct.
17. A Shortage in supply of raw materials is an external factor, others are internal factors.
18. B The example given in the question is of translation risk. The risk arises from the
translation of balance sheets and income statements in foreign currencies to the currency
of the parent company for financial reporting purposes.
19. E Mckinsey Model identifies value drivers at generic level, department level and grass root
level. Statement (I) is not true.
Probabilistic analysis can be used at the time of recession. Statement (II) is true.
Alcar Model uses the discounted cash flow analysis to identify value-adding strategies.
Statement (III) is true.
20. C Current assets = Current liabilities x Current ratio =2000 x 1.5 = Rs.3000
Current assets – Inventories = Current liabilities x Acid test ratio = 2000 x 1.2 = Rs.2400
 Or , Inventories = 3000 -2400 = Rs.600
Sales = Inventories x Inventories turnover ratio = 600 x 7 = Rs.4200.
21. D Comparative analysis is an important tool for assessing the financial strength of an
organization within the industry.
22. D Return on investment (ROI) = EBIT / Total assets
Total assets = Debt + Equity = 600 + 300 = Rs.900 lakhs
EBIT = Rs.180 lakhs (given)
∴ ROI = 180 / 900 = 20%.

23. E B( r − g)
P0 = K − g
Where, B = Current book value per share
r = return on equity
g = Growth rate in earnings and dividends
k = Cost of equity
80 ( 0.14 − 0.08 )
= ( 0.16 − 0.08 ) = Rs.60
Hence answer is (e).
24. C Arranging third party to pay for losses if they occur, without transferring the risk itself is
known as risk financing.
25. E The following are the factors that determine the economic risk:
• Difference between the location facilities and where the product is sold
• Location of competitors
• Determinants of input prices: are they determined in international markets or local
markets.
26. D Kt = I (1 − T ) = 0.20(1 − 0.40) = 0.12 = 12%
27. B According to the traditional approach to capital structure, as debt is added to the capital
structure the cost of capital declines initially because of lower post-tax cost of debt. But as
leverage is increased, the increased financial risk overweighs the benefits of low cost debt
and so the cost of capital starts increasing.
28. E 2000000 + X
= 1.1
1300000 + X
(1300000 + X ) 1.1 = 2000000 + X
0.1 X = 2000000 − 1430000 = Rs.57, 00, 000
29. A current assets
working capital leverage =
Total assets + changeincurrent assets
500
= = 58.82%
900 + ( −50)
30. D According to Miller and Orr Model the Upper limit, UL = 3RP – 2LL
Where RP means return point and LL means lower limit.
UL + 2LL 80, 000 + 2 × 20, 000
⇒ RP = 3 = 3 = Rs. 40,000.

Section B : Problems/Caselet
1. a.
(Rs. In lakhs)
EBIT 75
 interest on debentures 1.275
Interest on term loans 1.92
3.195 3.195
71.805
Tax @ 40% 28.722
PAT 43.083
No. of Equity shares 15
EPS 2.8722
Market price of the share 20
P/E ratio 6.96
Equity share capital (15 × 10) 150
Reserves and surplus 40
 1.275 
 
8.5%debentures  0.085  15
12 %term loans (1.92 / 0.12 ) 16
total capital employed 221
 75 
 
return on capital employed  221  0.34
Revised Capital Structure
(Rs. In lakhs)
Existing capital 221
less Deb. Redeemed 15
206
Add. Additional Capital to be raised 60
Total capital employed 266

Plan I : Loan Rs.60 lakh @ 12.5%

Plan II : Loan Rs.37.5 lakh @12.5%
Equity Rs.22.5 lakh (1.5 lakh shares at Rs.15 per share)
(Rs. In lakhs)
Plan 1 Plan 2
 37 
 266 × 
EBIT (34% of capital employed (i.e 34% + 3%)  100  98.42 98.42
Less interest @ 12% 1.92 1.92
Less interest on add. Term loan @12.5% 7.5 4.69
EBT 89 91.81
Less: Tax @ 40% 35.6 36.72
PAT 53.4 55.09
No. of equity shares 15 16.5
EPS 3.56 3.34
Expected P/E ratio 6.96 − ( 6.96 × 0.05 )  6.61 6.96
Expected market price per share [ EPS × P / E ratio ] 23.53 23.24
Therefore, Plan I is advisable to be adopted

b. Indifference Point:
 (EBIT-I1 )(1 − t ) (EBIT-I 2 )(1 − t )
=
n1 n2
-n1I 2 + n2 I1 ( −15 × 4.69) + (16.5 × 7.50 ) −70.35 + 123.75 53.40
EBIT= = = = = Rs.35.60 lakh
n2 − n1 16.5 − 15 1.5 1.5

2. a. Expected earnings per share in 2013 = 2.10 x (1.15)5 x 1.06 = Rs.4.48

Expected dividends per share in 2013 = Rs. 4.48 x 0.65 = Rs.2.91
Cost of Equity capital after 2013= Rf + β(Rm – Rf) = 4.5 + 1.1 x 5.5 = 10.55%
According to Dividend Discount Model
D1
Po = ke − g
2.91
Therefore, the expected price at the end of 2012 = 0.1055 − 0.06 = Rs.63.96
b.
Year EPS (in Rs.) DPS (in Rs.)
2008 2.42 0.79
2009 2.78 0.91
2010 3.19 1.05
2011 3.67 1.21
2012 4.22 1.39
Cost of equity = Rf + β(Rm – Rf) = 4.5 + 1.4 x 5.5 = 12.2 %
Present value of stock
= 0.79 x PVIF (12.2, 1) + 0.91 x PVIF (12.2, 2) + 1.05 x PVIF (12.2, 3) + 1.21 x PVIF (12.2, 4)
+ 1.39 x PVIF (12.2, 5) + 63.96 x PVIF (12.2, 5)
= Rs.35.76.
3. a.
Rs.
Average WIP value of raw material consumed per day 1,00,000.00
150× 300 22,500.00
Less: ½ (Average processing cost per day) 2
Average raw material and stores consumed per day 77,500.00
77,500 516.67
Raw material cost per unit = 150
1,50,000 1,000
Cost of goods sold per unit = 150

Durations:
Average Stock of raw materials and stores
Raw materials storage period = Drm = Average raw material and stores consumed per day

1000000
= 77500
= 12.9 days
Work-in progress = DWIP
Average WIP inventory
= Average WIP value of raw material consumed per day
 12,00,000
= 1,00,000 = 12 days
Average finished goods inventory 7,00,000
Finished goods = Dfg = Average cos t of goods sold per day = 1,50,000 =
4.67 days
Average accounts receivable
Debtors collection period = Dar = Average sales per day

13,00,000
= 2,00,000 = 6.5 days
Average accounts payable
Creditors’ payment period Dap = Average Credit purchases per day

8,00,000
= 55,000 = 14.55 days
Weights:
Raw material and stores cos t per unit 516.67
Wrm = Sales price per unit = 2500 = 0.21
Cost of goods sold per unit 1000
Wfg = Sales price per unit = 2500 = 0.40
Sales price per unit 2500
War = Sales price per unit = 2500 = 1.00
Raw material and stores cos t per unit 516.67
Wap = Sales price per unit = 2500 = 0.21
Raw material and stores cost per unit + 0.5 (Processing cost per unit)
Wwip = Sales price per unit

516.67 + 0.5(300)
= 2500 = 0.27
Weighted operating cycle = Wrm Drm + Wwip Dwip + Wfg Dfg + War Dar – Wap Dap
= 0.21 (12.9) + 0.27 (12) + 0.4 (4.67) + 1 (6.5) – 0.21 (14.55)
= 11.26 days
b. Working capital = Average sales per day × Weighted operating cycle + Minimum cash
balance
= 2,00,000 (11.26) + 1,50,000
= 24.02 lakhs.
4. Strategic Change is the movement of a company away from its present state toward some desired future
state to increase its competitive advantage. The various types of strategic change are re-engineering,
restructuring and innovation.
1. Re-engineering
Re-engineering is the fundamental rethinking and radical redesign of business processes to achieve
dramatic improvements in critical, contemporary measures of performance such as cost, quality,
service and speed. The strategists who use re-engineering must completely rethink how their
organization goes about in its business. In re-engineering, the strategic managers make business
processes the focus of attention. A business process is any activity that is vital to delivering goods and
services to customers quickly or at low cost. Some examples of business processes are order
processing, inventory control or product design.
 The organizations that take up re-engineering ignore the existing arrangement of work activities. Such
organizations start the change process by asking the customers “How can we reorganize the way we
do our work to provide the best quality and the lowest cost goods?”. Such companies realize that there
are more effective ways to reorganize their activities. Often individual jobs (that become increasingly
complex) and people are grouped into cross-functional teams (as business processes) and are
reengineered to reduce costs and increase quality.
Therefore, re-engineering adopts a different approach in optimizing its activities. This may be because
of drastic unexpected changes in the environment such as emergence of aggressive new competitors or
technological breakthroughs, etc.
2. Restructuring
Restructuring programs involve changes in the relationships between divisions and function. There are
two basic steps to restructuring. They are :

In the first step, the organization reduces its level of differentiation and integration by eliminating
divisions, departments or levels in the hierarchy.
Next, it downsizes by reducing the number of its employees to reduce operating costs.
There are many reasons as to why organizations go in for restructuring. Sometimes, unforeseen
changes might occur in the business environment. For example, worldwide recession can reduce the
demand for the firm’s products. Sometimes, organizations have excess capacity because customers do
not want its products. At times, firms on top position restructure to build and improve their
competitive position (so that they can stay on top). Also, organizations downsize because over time
they have grown too tall and bureaucratic and due to this operating costs increase to a large extent.
Moreover, companies are forced to downsize because they have not paid attention to the need to
reengineer themselves. In such a situation, restructuring becomes the only way they can survive and
compete in an increasingly competitive environment.
3. Innovation
Innovation is a process by which organizations use their skills and resources to create new
technologies or products, innovation is required because organizations can change and better respond
to the needs of their customers. It can result in a spectacular success of the organization. For example,
Apple Computer changes the computer industry when it introduced its personal computers. The
outcomes of research and development activities are often uncertain. Due to this, innovation is
associated with a high level of risk.
Moreover, innovation is one of the most difficult change processes to manage. This is because, when
organizations rely on innovation as the source of their competitive advantage they need to adopt
flexible structures. Also, functions need to coordinate their activities and work together if innovation
is to be successful. Of all the kinds of change programs, innovation has the prospects for the greatest
long-term success but also the greatest risks. Thus, if organizations are to avoid being left behind in
the competitive race to produce new products, they must take steps to introduce them or develop new
technologies to produce those products reliably and at low cost.
5. The conditions which are generally required to bring about a behavioural change among the employees are
explained below:
A purpose to believe in
To feel comfortable about change and to carry it out with enthusiasm, people must understand the role of
their actions in the unfolding drama of the company’s fortunes and believe that it is worthwhile for them to
play a part. It isn’t enough to tell employees that they will have to do things differently. Anyone leading a
major change program must take the time to think through its "story"—what makes it worth undertaking—
and to explain that story to all of the people involved in making change happen, so that their contributions
make sense to them as individuals.
Reinforcement systems
The organizational structures such as reward and recognition systems, reporting structures, management and
operational processes, and measurement procedures (setting targets, measuring performance, and granting
financial and nonfinancial rewards) must be consistent with the behavior that people are asked to adopt.
When a company’s objectives for new behavior are not reinforced, employees are less likely to adopt it
consistently; if managers are urged to spend more time coaching junior staff, for instance, but coaching
doesn’t figure in the performance scorecards of managers, they are not likely to bother.
Adoption of skills to make relevant changes in behaviour
 Employees must be given sufficient time to be equipped with the skills to make relevant changes in
behavior. In practice, this means that one cannot teach everything there is to know about a subject in one
session. It is much better to break down the formal teaching into chunks, with time in between for the
learners to reflect, experiment, and apply the new principles. Large-scale change happens only in steps.
Consistent role models
In any organization, people model their behavior on those they see to be in positions of influence. Within
the same organization, people in different functions or levels choose different role models such as a
founding partner, or a trade union representative, or the highest-earning sales representative. So to change
behavior consistently throughout an organization, it is not enough to ensure that people at the top are in line
with the new ways of working; the role models at every level must follow the same with letter and spirit.
The way role models deal with their tasks can vary, but the underlying values informing their behavior must
be consistent. Behavior in organizations is deeply affected not only by role models but also by the groups
with which people identify. Role modeling by individuals must therefore be confirmed by the groups that
surround them if it is to have a permanent or deep influence.
Section C: Applied Theory
6. Activity Based Costing
Applying overhead costs to each product or service based on the extent to which that product or
service causes overhead cost to be incurred is the primary objective of accounting for overhead
costs. In many production processes, overhead is applied to products using a single predetermined
overhead rate based on a single activity measure. With Activity-Based Costing (ABC), multiple
activities are identified in the production process that are associated with costs. The events within
these activities that cause work (costs) are called cost drivers. Examples of overhead cost drivers
are machine set-ups, material-handling operations, and the number of'steps in a manufacturing
process. Examples of cost drivers in non-manufacturing organizations are hospital beds occupied,
the number of take-offs and landing for an airline, and the number of rooms occupied in a hotel.
The cost drivers are used to apply overhead to products and services when using ABC.
The following five steps are used to apply costs to products under an ABC system,
i. Choose appropriate activities
ii. Trace costs to activities
iii. Determine cost drivers for each activity
iv. Estimate the application rate for each cost driver
v. Apply costs to products.
These steps are discussed in more detail below.
CHOOSE APPROPRIATE ACTIVITIES
The first step of ABC is to choose the activities that result in incurring of overhead costs. These
activities do not necessarily coincide with existing departments but rather represent a group of
transactions that support the production process. Typical activities used in ABC are designing,
ordering, scheduling, moving materials, controlling inventory, and controlling quality.
Each of these activities is composed of transactions that result in costs. More than one cost pool
can be established for each activity. A cost pool is an account to record the costs of an activity with
a specific cost driver.
TRACE COSTS TO ACTIVITIES
Once the activities have been chosen, costs must be traced to the cost pools for different activities.
To facilitate this tracing, cost drivers are chosen to act as vehicles for distributing costs. These cost
drivers are often called resource drivers. A predetermined rate is estimated for each resource driver.
Consumption of the resource driver in combination with the predetermined rate determines the
distribution of the resource costs to the activities.
DETERMINE COST DRIVERS FOR ACTIVITIES
Cost drivers for activities are sometimes called activity drivers. Activity drivers represent the event
that causes costs within an activity. For example, activity drivers for the purchasing activity include
negotiations with vendors, ordering materials, scheduling their arrival, and perhaps inspection.
Each of these activity drivers represents costly procedures that are performed in the purchasing
activity. An activity driver is chosen for each cost pool. If two cost pools use the same cost driver,
then the cost pools could be combined for product-costing purposes.
Cooper has developed several criteria for choosing activity drivers. First, the data on the cost driver
 must be easy to obtain. Second, the consumption of the activity implied by the activity driver
should be highly correlated with the actual consumption of the activity. The third criterion to
consider is the behavioral effects induced by the choice of the activity driver. Activity drivers
determine the application of costs, which in turn can affect individual performance measures.
The judicious use of more activity drivers increase the accuracy of product costs. Ostrenga
concludes that there is a preferred sequence for accurate product costs. Direct costs are the most
accurate in applying costs to products. The application of overhead costs through cost drivers is the
next most accurate process. Any remaining overhead costs must be allocated in a somewhat
arbitrary manner, which is less accurate.
ESTIMATE APPLICATION RATES FOR EACH ACTIVITY DRIVER
An application rate must be estimated for each activity driver. A predetermined rate is estimated by
dividing the cost pool by the estimated level of activity of the activity driver. Alternatively, an
actual rate is determined by dividing the actual costs of the cost pool by the actual level of activity
of the activity driver. Standard costs, could also be used to calculate a predetermined rate.
APPLYING COSTS TO PRODUCTS
The application of costs to products is calculated by multiplying the application rate times the
usage of the activity driver in manufacturing a product or providing a service.
7. Reorganization
The steps involved in reorganization of a firm are
• Techno- economic viability study
• Formulation and execution of the reorganization plan
• Monitoring the activities of the firm
Techno-economic Viability Study
A reorganization plan is worked out on the basis of a techno-economic viability study of the firm.
This study sets out to identify the strengths and weaknesses of the firm, the causes of failure, the
viability of future operations and the course of action to be taken to bring about a turnaround. The
techno-economic viability study is undertaken by the operating agencies assigned to the firm.
These operating agencies are generally financial institutions and banks such as IDBI , IFCI, ICICI,
IRBI, SBI, PNB, etc.
The techno-economic viability study covers all the functional areas of a firm: management,
finance, production and marketing.
Management: The effectiveness and ability of the management is one of the most important
factors that determines the success or failure of a firm. A detailed study is done in terms of the
objectives of the firm, both short-term and long-term, the corporate strategy, the corporate culture,
the management-labor relations, the organizational hierarchy, the decision-making process, etc.
The study tries to determine the effectiveness of management and its integrity. The areas of
mismanagement are also determined.
Finance: Finance is the main functional areas of business. It is a measurable indicator of the firm’s
health and performance. A thorough analysis of the firm’s Balance Sheet and Profit/Loss statement
is made.
These statements when properly analyzed give the financial stability and liquidity of the firm;
profitability and uses of funds. The analysis also identifies the capital structure and the sources of
funds. The analysis gives insight into working capital management and management of earnings.
Production and Technology: Production and Technology function assumes immense importance in
the viability study. The various areas that are looked into are, the firm’s equipment and machinery,
the maintenance of the equipment, the technology used in production, the production capacity and
utilization, the products being offered by the firm, the quality control system, production planning
and inventory control.
Marketing: A number of firms have failed because of lack of good marketing management. The
various areas of marketing that are studied are, the product mix of the firm, the past sales of the
product in terms of quantity and value, the market share of the firm, the demand for the product
range, the study of the customer profile, the price of the products, the distribution channels being
used, the kind of promotion-mix being used and the most important of all is the marketing team.
This study is done in comparison with the competitors.
Formulation and Execution of the Plan
The viability study serves as the basis for formulation of a rehabilitation plan. A thorough study of
the various functional areas of the firm reveals the strengths, weaknesses, opportunities and threats
of the firm. It gives a comprehensive idea about the status of the firm, the viability of the firm both
technically and economically and the additional funds required for rehabilitation.
The formulation plan involves the changes and action to be taken regarding the various functions
of the firm. It may decide to make changes in the management, if it is not found competent. Some
of the labour may be retrenched/recruited depending on the situation. The amount of financial
assistance to be given is determined and arrangements are made to secure the loan. Various steps
are taken to improve the production function in terms of new machinery and new technology. The
viable level of operations are determined and steps are taken to achieve this production level. The
product-mix, the pricing, the quality of the products, distribution channels and the promotion-mix
are to be changed to suit the needs of the customers, to achieve the desired sales levels. Once the
plan is formulated, the plan is carefully executed. All the necessary changes prescribed by the plan
are made. The funds are disbursed in a phased manner as and when required. The necessary
concessions and reliefs are provided. A close watch is kept on the activities of the firm and a
continuous evaluation is done.
Monitoring
Monitoring is a very important part of a rehabilitation plan. It is done to evaluate the execution of
the plan. Regular meetings are held between the firm, the bankers, the financial institutions and
other concerned parties to verify and evaluate the process of execution. Monitoring is one to ensure
the proper utilization of funds and adherence to the terms of rehabilitation plan. It also ensures the
proper working of the firm. Feedback is obtained and remedial measures are taken as and when the
situation demands. The impact of rehabilitation becomes evident in a short period. Once the
success of the firm becomes evident, the role of agencies and banks is confined to constantly hold
meetings to assess and review the process. This continues till the firm is successful. In case the
firm is found incapable of making a turnaround despite the plan, then the steps to liquidate the firm
are undertaken