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Question 1 (a) KP Ltd. has provided the following information: (i) Estimated monthly sales: Month ` in Lakh April-2024 10 May-2024 12 June-2024 15 July-2024 10 August-2024 13 September-2024 14 (ii) Gross Profit Ratio is 20%. (iii) Cost of Goods sold is paid in next month. (iv) Sales are in credit and credit period is allowed for 2 months. (v) Indirect Expenses are paid in the same month. Monthly indirect expenses are as follows: Month ` in Lakh June-2024 1.0 July-2024 1.2 August-2024 1.0 September-2024 1.3 FINANCIAL MANAGEMENT AND STRATEGIC MANAGEMENT (vi) Dividend amounting September 2024, 3 Lakh will be paid in the month of September 2024 (vii) Cash Balance on 01/07/2024 was 1.5 Lakh. (viii)The company has to maintain minimum cash balance of 1 Lakh. If there is cash balance deficit in any month, company would take a temporary short term loan and if cash balance exceed 2 Lakh, then company would invest for short term excess amount of 2 Lakh. (ix) Ignore the interest on short term loans and short term investment. You are required to prepare Cash Budget for three months starting from July 2024. (5 Marks) (b) Following is the Balance Sheet of EXIM Ltd. as on 31stMarch, 2024: Liabilities ` Assets ` Equity Share Capital of ` 100 each 20,00,000 Fixed Assets 50,00,000 Retained Earnings 4,00,000 Current Assets 30,00,000 12.5% Debenture 40,00,000 Current Liabilities 16,00,000 80,00,000 80,00,000 The additional information is given as under: Fixed costs per annum (exclusive interest) : ` 16,00,000 Variable operating cost ratio : 70% Total Assets turnover ratio : 2.5 Income tax rate : 30% You are required to calculate: (i) Earnings Per Share (ii) Operating Leverage (iii) Financial Leverage (iv) Combined Leverage (2 + 1 + 1 + 1 = 5 Marks) (c) Following information have been provided by LP Ltd.: Profit before Tax ` 40 Lakh Tax Rate 30% Equity Share Capital (` 10) ` 40 Lakh Return on Investment 18% Cost of Equity 15% Dividend Payout Ratio 50% You are required: (i) to determine the price of Equity Share of the company as per Walter's Model; (ii) to determine the Dividend Pay-out Ratio by applying Walter's Model assuming the price of equity share of the company is ` 48. (3+2=5 Marks)

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Detailed Solution & Explanation

### Solution to Question 1 #### (a) Preparation of Cash Budget for KP Ltd. for the Three Months Starting July 2024 **Working Notes:** 1. **Computation of Cost of Goods Sold (COGS) and Payment Schedule:** * Gross Profit Ratio = 20%\displaystyle 20\% * Therefore, Cost of Goods Sold (COGS) = 100%−20%=80%\displaystyle 100\% - 20\% = 80\% of Sales. * Since COGS is paid in the next month, the payment in month t\displaystyle t is equal to the COGS of month t−1\displaystyle t-1. * June 2024 Sales = Rs. 15 Lakhs  ⟹  COGS=80%×15=Rs. 12 Lakhs\displaystyle \text{Rs. } 15 \text{ Lakhs} \implies \text{COGS} = 80\% \times 15 = \text{Rs. } 12 \text{ Lakhs} (Paid in July 2024). * July 2024 Sales = Rs. 10 Lakhs  ⟹  COGS=80%×10=Rs. 8 Lakhs\displaystyle \text{Rs. } 10 \text{ Lakhs} \implies \text{COGS} = 80\% \times 10 = \text{Rs. } 8 \text{ Lakhs} (Paid in August 2024). * August 2024 Sales = Rs. 13 Lakhs  ⟹  COGS=80%×13=Rs. 10.4 Lakhs\displaystyle \text{Rs. } 13 \text{ Lakhs} \implies \text{COGS} = 80\% \times 13 = \text{Rs. } 10.4 \text{ Lakhs} (Paid in September 2024). 2. **Collection from Debtors:** * Sales are on credit and the credit period allowed is 2 months. Therefore, cash collection in month t\displaystyle t is equal to the credit sales of month t−2\displaystyle t-2. * July 2024 Collection = Sales of May 2024 = Rs. 12 Lakhs\displaystyle \text{Rs. } 12 \text{ Lakhs}. * August 2024 Collection = Sales of June 2024 = Rs. 15 Lakhs\displaystyle \text{Rs. } 15 \text{ Lakhs}. * September 2024 Collection = Sales of July 2024 = Rs. 10 Lakhs\displaystyle \text{Rs. } 10 \text{ Lakhs}. 3. **Borrowing and Investment Adjustments:** * The company has to maintain a minimum cash balance of Rs. 1 Lakh\displaystyle \text{Rs. } 1 \text{ Lakh}. * If the closing cash balance falls below Rs. 1 Lakh, temporary short-term borrowing is taken to restore it to exactly Rs. 1 Lakh. * If the closing cash balance exceeds Rs. 2 Lakhs, the excess over Rs. 2 Lakhs is invested, leaving the closing balance at Rs. 2 Lakhs. * In July: Closing cash balance before adjustment is Rs. 0.3 Lakh\displaystyle \text{Rs. } 0.3 \text{ Lakh}. To maintain the minimum of Rs. 1 Lakh, a borrowing of Rs. 0.7 Lakh\displaystyle \text{Rs. } 0.7 \text{ Lakh} is taken. * In August: Closing cash balance before adjustment is Rs. 7 Lakhs\displaystyle \text{Rs. } 7 \text{ Lakhs}. The excess over Rs. 2 Lakhs (Rs. 5 Lakhs\displaystyle \text{Rs. } 5 \text{ Lakhs}) is invested, leaving a closing balance of Rs. 2 Lakhs\displaystyle \text{Rs. } 2 \text{ Lakhs}. * In September: Closing cash balance before adjustment is Rs. −2.7 Lakhs\displaystyle \text{Rs. } -2.7 \text{ Lakhs}. To maintain the minimum of Rs. 1 Lakh, a borrowing of Rs. 3.7 Lakhs\displaystyle \text{Rs. } 3.7 \text{ Lakhs} is taken.
**Cash Budget for July to September 2024 (Rs. in Lakhs)** | Particulars | July 2024 | August 2024 | September 2024 | | :--- | :---: | :---: | :---: | | **Opening Cash Balance** | **1.50** | **1.00** | **2.00** | | **Add: Receipts** | | | | | Collection from Debtors | 12.00 | 15.00 | 10.00 | | **Total Cash Available (A)** | **13.50** | **16.00** | **12.00** | | **Less: Payments** | | | | | Payment of COGS (from previous month) | 12.00 | 8.00 | 10.40 | | Payment of Indirect Expenses | 1.20 | 1.00 | 1.30 | | Payment of Dividend | — | — | 3.00 | | **Total Payments (B)** | **13.20** | **9.00** | **14.70** | | **Closing Balance before adjustments (A - B)** | **0.30** | **7.00** | **-2.70** | | Less: Short-term investment of excess cash | — | (5.00) | — | | Add: Short-term borrowing for deficit | 0.70 | — | 3.70 | | **Closing Cash Balance (After adjustments)** | **1.00** | **2.00** | **1.00** | --- #### (b) Calculation of Leverages and EPS for EXIM Ltd. **Working Notes:** 1. **Total Assets** = Fixed Assets+Current Assets=50,00,000+30,00,000=Rs. 80,00,000\displaystyle \text{Fixed Assets} + \text{Current Assets} = 50,00,000 + 30,00,000 = \text{Rs. } 80,00,000. 2. **Total Sales:** Sales=Total Assets×Total Assets Turnover Ratio=80,00,000×2.5=Rs. 2,00,00,000 (Rs. 200 Lakhs)\text{Sales} = \text{Total Assets} \times \text{Total Assets Turnover Ratio} = 80,00,000 \times 2.5 = \text{Rs. } 2,00,00,000 \text{ (Rs. 200 Lakhs)} 3. **Variable Operating Cost** = 70%\displaystyle 70\% of Sales = 70%×2,00,00,000=Rs. 1,40,00,000 (Rs. 140 Lakhs)\displaystyle 70\% \times 2,00,00,000 = \text{Rs. } 1,40,00,000 \text{ (Rs. 140 Lakhs)}. 4. **Contribution** = Sales−Variable Cost=2,00,00,000−1,40,00,000=Rs. 60,00,000 (Rs. 60 Lakhs)\displaystyle \text{Sales} - \text{Variable Cost} = 2,00,00,000 - 1,40,00,000 = \text{Rs. } 60,00,000 \text{ (Rs. 60 Lakhs)}. 5. **Earnings Before Interest & Tax (EBIT):** EBIT=Contribution−Fixed Cost=60,00,000−16,00,000=Rs. 44,00,000 (Rs. 44 Lakhs)\text{EBIT} = \text{Contribution} - \text{Fixed Cost} = 60,00,000 - 16,00,000 = \text{Rs. } 44,00,000 \text{ (Rs. 44 Lakhs)} 6. **Interest on 12.5% Debentures:** Interest=12.5%×40,00,000=Rs. 5,00,000 (Rs. 5 Lakhs)\text{Interest} = 12.5\% \times 40,00,000 = \text{Rs. } 5,00,000 \text{ (Rs. 5 Lakhs)} 7. **Earnings Before Tax (EBT or PBT):** PBT=EBIT−Interest=44,00,000−5,00,000=Rs. 39,00,000 (Rs. 39 Lakhs)\text{PBT} = \text{EBIT} - \text{Interest} = 44,00,000 - 5,00,000 = \text{Rs. } 39,00,000 \text{ (Rs. 39 Lakhs)} 8. **Tax @ 30%** = 30%×39,00,000=Rs. 11,70,000\displaystyle 30\% \times 39,00,000 = \text{Rs. } 11,70,000. 9. **Profit After Tax (PAT):** PAT=PBT−Tax=39,00,000−11,70,000=Rs. 27,30,000 (Rs. 27.3 Lakhs)\text{PAT} = \text{PBT} - \text{Tax} = 39,00,000 - 11,70,000 = \text{Rs. } 27,30,000 \text{ (Rs. 27.3 Lakhs)} 10. **Number of Equity Shares** = Equity Share CapitalFace Value=20,00,000100=20,000 shares\displaystyle \frac{\text{Equity Share Capital}}{\text{Face Value}} = \frac{20,00,000}{100} = 20,000 \text{ shares}.
**Calculations:** **(i) Earnings Per Share (EPS):** EPS=PATNumber of Equity Shares=27,30,00020,000=Rs. 136.50\text{EPS} = \frac{\text{PAT}}{\text{Number of Equity Shares}} = \frac{27,30,000}{20,000} = \text{Rs. } 136.50 **(ii) Operating Leverage (OL):** Operating Leverage=ContributionEBIT=60,00,00044,00,000=1.3636≈1.36\text{Operating Leverage} = \frac{\text{Contribution}}{\text{EBIT}} = \frac{60,00,000}{44,00,000} = 1.3636 \approx 1.36 **(iii) Financial Leverage (FL):** Financial Leverage=EBITPBT=44,00,00039,00,000=1.1282≈1.13\text{Financial Leverage} = \frac{\text{EBIT}}{\text{PBT}} = \frac{44,00,000}{39,00,000} = 1.1282 \approx 1.13 **(iv) Combined Leverage (CL):** Combined Leverage=Operating Leverage×Financial Leverage=1.3636×1.1282≈1.5385≈1.54\text{Combined Leverage} = \text{Operating Leverage} \times \text{Financial Leverage} = 1.3636 \times 1.1282 \approx 1.5385 \approx 1.54 *(Alternatively: Combined Leverage=ContributionPBT=60,00,00039,00,000=1.5385≈1.54\displaystyle \text{Combined Leverage} = \frac{\text{Contribution}}{\text{PBT}} = \frac{60,00,000}{39,00,000} = 1.5385 \approx 1.54)* --- #### (c) Share Price and Dividend Payout for LP Ltd. using Walter's Model **Working Notes:** 1. **Profit Before Tax (PBT)** = Rs. 40 Lakhs\displaystyle \text{Rs. } 40 \text{ Lakhs}. 2. **Tax Rate** = 30%  ⟹  Tax=40×0.3=Rs. 12 Lakhs\displaystyle 30\% \implies \text{Tax} = 40 \times 0.3 = \text{Rs. } 12 \text{ Lakhs}. 3. **Earnings for Equity Shareholders (PAT)** = 40−12=Rs. 28 Lakhs\displaystyle 40 - 12 = \text{Rs. } 28 \text{ Lakhs}. 4. **Number of Equity Shares** = 40,00,00010=4 Lakh shares\displaystyle \frac{40,00,000}{10} = 4 \text{ Lakh shares}. 5. **Earnings Per Share (E)** = 28,00,0004,00,000=Rs. 7 per share\displaystyle \frac{28,00,000}{4,00,000} = \text{Rs. } 7 \text{ per share}. 6. **Cost of Equity (Ke\displaystyle K_e)** = 15%=0.15\displaystyle 15\% = 0.15. 7. **Return on Investment (r\displaystyle r)** = 18%=0.18\displaystyle 18\% = 0.18. 8. **Dividend Payout Ratio** = 50%  ⟹  Dividend Per Share (D)=50%×7=Rs. 3.50\displaystyle 50\% \implies \text{Dividend Per Share (D)} = 50\% \times 7 = \text{Rs. } 3.50.
**Calculations:** **(i) Price of Equity Share (P\displaystyle P) as per Walter's Model:** Walter’s Model Formula: P=D+rKe(E−D)Ke\text{Walter's Model Formula: } P = \frac{D + \frac{r}{K_e}(E - D)}{K_e} Substituting the values: P=3.50+0.180.15(7−3.50)0.15P = \frac{3.50 + \frac{0.18}{0.15}(7 - 3.50)}{0.15} P=3.50+1.20×3.500.15=3.50+4.200.15=7.700.15≈Rs. 51.33P = \frac{3.50 + 1.20 \times 3.50}{0.15} = \frac{3.50 + 4.20}{0.15} = \frac{7.70}{0.15} \approx \text{Rs. } 51.33 **(ii) Price of Equity Share is Rs. 48. Determine Dividend Payout Ratio:** Let the dividend per share be D\displaystyle D. 48=D+0.180.15(7−D)0.1548 = \frac{D + \frac{0.18}{0.15}(7 - D)}{0.15} 48×0.15=D+1.20(7−D)48 \times 0.15 = D + 1.20(7 - D) 7.20=D+8.40−1.20D7.20 = D + 8.40 - 1.20D 7.20=8.40−0.20D7.20 = 8.40 - 0.20D 0.20D=8.40−7.20=1.200.20D = 8.40 - 7.20 = 1.20 D=1.200.20=Rs. 6.00 per shareD = \frac{1.20}{0.20} = \text{Rs. } 6.00 \text{ per share} Dividend Payout Ratio=Dividend Per Share (D)Earnings Per Share (E)×100=6.007.00×100≈85.71%\text{Dividend Payout Ratio} = \frac{\text{Dividend Per Share (D)}}{\text{Earnings Per Share (E)}} \times 100 = \frac{6.00}{7.00} \times 100 \approx 85.71\%

Key Concepts to Understand

Balance Sheet

A statement showing the financial position of a business at a particular date, listing all assets on one side and all liabilities and capital on the other side. It is not an account but a statement.

Gross Profit

The profit earned from the core trading activities of a business, calculated as Net Sales minus Cost of Goods Sold (COGS). It reflects how efficiently a company uses its direct resources.

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