UNIT -I

The following information is available for Ravi corporation

EPS - Rs 4
ROI - 18%
Rate of return required by shareholders - 15%
What will the price per share as per Walter's model if the payout ratio is 40%?

Walter's Model: Professor James E. Walter argues that the choice of dividend policies almost always affects the value of the
enterprise. His model shows clearly the importance of the relationship between the firm’s internal rate of return (r) and its
cost of capital (k) in determining the dividend policy that will maximize the wealth of shareholders.
To determine the market value of shares as suggested by Prof. Walter is as under:
P = (D/Ke) + [r(E - D)/Ke] / Ke
where,
P = Market Price Per Share
D = Dividend Per Share
r = Internal Rate Of Return
E = Earnings Per Share
Ke = Cost Of Equity Capital or Capitalization Rate

Given:
Earnings Per Share (EPS) = Rs 4 9
Payout Ratio = 40% = 0.4 0.33

Dividend per Share = 0.4 * Rs 4 0.33 x 9

= Rs 1.6 2.99

Therefore,
P = (1.6/0.15) + [0.18(4-1.6)/0.15] / 0.15 P = (2.99/0.12) + [0.18(9-2.99)/0.12] / 0.12
∴ P = 10.67 + 19.2 = 24.916 + 19.2
∴ P = Rs. 29.87 = 44.116
29.87 Rupees will be the price per share as per Walter’s model if the payout ratio is 40%.

UNIT – II
A company has the following Capital Structure.
Particulars Rs
Equity Share Capital 1,00,000
10% Preferred Share Capital 1,00,000
8% Debenture 1,25,000
The present EBIT is Rs 50000. Calculate the financial leverage assuming the company is in a 50% tax bracket.

To calculate the financial leverage, need to determine the total interest expense and the earnings before interest and taxes
(EBIT) of the company, we have the following details:

Equity:
Equity Share Capital: Rs 100,000
Preferred Share Capital: Rs 100,000
Debt:
Debenture: Rs 125,000 at 8% interest rate
Calculate the interest expense on the debenture:
Interest Expense = Debenture amount * Interest rate
az= Rs 125,000 * 0.08
= Rs 10,000
Calculate the taxable income by subtracting the interest expense from the given EBIT:
Taxable Income = EBIT - Interest Expense
= Rs 50,000 - Rs 10,000
= Rs 40,000
Calculate the income tax liability using the given tax bracket (50%):
Income Tax Liability = Taxable Income * Tax Rate
= Rs 40,000 * 0.5
= Rs 20,000
Calculate the net income available to equity shareholders by subtracting the income tax liability from the taxable income:
Net Income Available to Equity Shareholders = Taxable Income - Income Tax Liability
= Rs 40,000 - Rs 20,000
= Rs 20,000
Calculate the financial leverage using the equity multiplier:
Equity Multiplier = Total Assets / Total Equity

Total Assets = Equity Share Capital + Preferred Share Capital + Debenture

= Rs 100,000 + Rs 100,000 + Rs 125,000
= Rs 325,000
Total Equity = Equity Share Capital + Preferred Share Capital
= Rs 100,000 + Rs 100,000
= Rs 200,000
Equity Multiplier = Rs 325,000 / Rs 200,000
= 1.625

Therefore, the financial leverage of the company, assuming a 50% tax bracket, is 1.625.

UNIT -IV
1) A newly formed company has applied to the Commercial Bank for the first time for financing its working capital
requirements. The following information is available about the projections for the current year:
Particulars Rs
Raw material 40 Per unit
Direct labor 15 Per unit
Overhead 30 Per unit
Total cost 85 Per unit
Add: Profit 15 Per unit
Sales 100 Per unit

Other information:
1) Raw material in stock - average 4 weeks consumption, Work – in progress (completion stage,50 percent), on an
average half a month. Finished goods in stock - on average, one month.
 2) Credit allowed by suppliers is one month.
3) Credit allowed to debtors is two months.
4) Average time lag in payment of wages is 1½ weeks and 4 weeks in overhead expenses.
5) Cash in hand and at the bank is desired to be maintained at Rs 50,000.
6) All Sales are on a credit basis only.

You are required to prepare a statement showing an estimate of the working capital needed to finance an activity level of
96,000 units of production. Assume that production is carried on evenly throughout the year, and wages and overhead
accrue similarly. For calculation purposes, 4 weeks may be taken as equivalent to a month and 52 weeks in a year.

Solution:
Calculation of Working Capital Requirement
Particulars Rs
A) Current Assets
1) The row material for 4 weeks (96,000 x 40 x 4/52) 2,95,385
2) Work in progress for ½ month or 2 weeks
Row material (2 weeks) [96,000 x 40 x 2/52] x 50% 73,846
Direct Labour (2 weeks) [96,000 x 15 x 2/52] x 50% 27,692
Overhead (2 weeks) [96,000 x 30 x 2/52] x 50% 55,385
3) Finished Goods (4 weeks) [96,000 x 85 x 4/52] 6,27,692
4) Debtors (8 weeks) [96,000 x 100 x 8/52] 14,76,923
Cash in hand or at the bank 50,000
Total Current Assets (A) 26,06,923

B) Current Liabilities
1) Creditors (4 weeks) [96,000 x 40 x 4/52] 2,95,385
2) Lag in Payment of Wages (96,000 x 15 x 1½/52] 41,538
3) Lag in Payment of Overhead (4 weeks) (96,000 x 30 x 4/52] 2,21,538
Total Current Liabilities (B) 5,58,461
Net working capital Required (A – B) 20,48,460

2) EXE Ltd. is engaged in large-scale consumer retailing. From the following information, you are required to forecast their
working capital requirement:
i. Projected Annual Sales — Rs. 65 lakhs.
ii. Percentage of Net Profit on Cost of Sales — 25%.
iii. Average credit period allowed to Debtors — 10 weeks.
iv. Average credit period allowed by Creditors — 4 weeks.
v. Average stock carrying (in terms of sales requirement) — 8 weeks.
vi. Add 10% to computed figures to allow for contingencies.

Solution:

Projected Annual Sales: Rs. 65,00,000

Projected Sales per Week: Rs. 65,00,000 / 52 = Rs. 1,25,000
Less: Net Profit @25 on Cost or 20% on Sale
(Rs. 1,25,000 x 20%) Rs. 25,000
--------------------------------
Projected Cost per Week Rs. 1,00,000
--------------------------------

Working Capital Requirement Forecast

Current Assets:
Stock (8 weeks): Rs. 1,00,000 x 8 = Rs. 8,00,000
Debtors (10 weeks): Rs. 1,00,000 x 10 = Rs. 10,00,000
Add: Profit @25% on cost Rs. 2,30,000
--------------------------------
Rs. 12,50,000 Rs. 12,50,000
--------------------------------
Rs. 20,50,000

Less: Current Liabilities:

Creditors (4 weeks): Rs. 1,00,000 x 4 4,00,000
--------------------------------
Working Capital 16,50,000
Add: 10% for Contingencies 1,65,000
--------------------------------
The total requirement of Working Capital 18,15,000

3) A Company has applied for a short-term loan to a commercial bank for financing its working capital requirement. You
are asked by the bank to prepare an estimate of the requirement of the working capital for that company. Add 10% to
your estimated figure to cover unforeseen contingencies. The information about the project Profit and Loss A/c of the
company is as under:
Particular Rs.
Sales 21,00,000
Less: Cost of goods sold 15,30,000
Gross Profit 5,70,00
Administrative expenses 1,40,000
Selling expenses 1,30,000 2,70,000
--------------------------------
Profit before Tax 3,00,000
Less: Provision for Tax 1,00,000
--------------------------------
Profit after tax
2,00,000

Note: The cost of goods sold has been derived as follows:

Particular Rs.
Materials used 8,40,000
Wages and Manufacturing expenses 6,25,000
Depreciation 2,35,000
17,00,000
Less: Stock of finished goods (10% of total production) 1,70,000
15,30,000
The figure given above relates only to the goods that have been finished and not to W.I.P; goods which are equal to 15%
of the year’s production (in terms of physical units) on average, requiring full materials but only 40% of the other expenses.
The company believes in keeping 2 months consumption of material in stock.
All expenses are paid one month in arrears. Suppliers of materials extend 1½ months credit. Sales are 20% cash, rest are at
2 months credit. You can make such other assumptions as you deem necessary for estimating working capital requirements.

Solution:
1. Current Assets:
Stock of Raw Materials (2/12 of 8,40,000) Rs. 1,40,000

Work-in-progress:
Raw materials (15/100 of 8,40,000) Rs. 1,26,000
Wages and manufacturing (6,25,000 × 40% × 15%) 37,000 1,63,500
The stock finished goods: [10% of (8,40,000 + 6,25,000)] 1,46,500

Debtors (2 months):
Cost of goods sold 15,30,000
-Depreciation (2,35,000–23,500) 2,11,500
--------------------------------
13,18,500
Adm. Expenses 1,40,000
Selling Expenses 1,30,000
--------------------------------
Total Cost 15,88,500
–Cash sales @ 20% 3,17,700
--------------------------------
12,70,800
Debtors (2/12 of 12,70,800) 2,11,800
--------------------------------
6,61,800
--------------------------------

2. Current Liabilities:
Creditors (8,40,000/12×1½) 1,05,000
O/S Wages and Manufacturing exp. (1/12 of 6,25,000) 52,083
O/S Administrative expenses (1/12 of 1,40,000) 11,667
Selling expenses (1/12 of 1,30,000) 10,833 1,79,583
-------------------------------- --------------------------------
Excess of current assets over current liabilities 4,82,217
+10% for contingencies 48,222
--------------------------------
Working capital requirement 5,30,43
--------------------------------

UNIT -V

1) The company is earning Rs. 12 on each share. The capitalization rate is 20% and the rate of return on investment is
40%, what should be the price per share at a 60% dividend pay-out ratio according to Walter's model? As per
Walter's model, is this the optimum payout ratio?

Solution:
To determine the market value of shares as suggested by Prof. Walter is as under:
P = (D + r/ Ke (E - D)) / Ke
where,
P = Market Price Per Share
D = Dividend Per Share
r = Internal Rate of Return = 40% = 0.40
E = Earnings Per Share = Rs. 12
Ke = Cost of Equity Capital or Capitalization Rate = 20% = 0.20

EPS = Rs. 12
∴ D = EPS x Dividend Pay-out ratio
D = 12 x 60% = 12 x 0.6 = Rs. 7.2

∴ P = (7.2 + 0.4/0.2 (12 – 7.2))/0.2

P = 7.2 + 2 (4.8) / 0.2
P = Rs. 84
∴ 84 Rupees will be the price per share as per Walter’s model if the payout ratio is 60%.