Financial ManagementQuestion 5540 of 217
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Question 1 (a) The following information is available for S Ltd. for the year ended 31st March, 2025: Raw Material consumed: 20% of COGS Raw Material Inventory turnover ratio: 4.00 Finished Goods Inventory holding period: 0.75 month Gross profit (based on COGS): 12.50% Debtor collection period (all sales are credit sales): 3 months Proprietary ratio: 0.3125 Fixed Assets turnover ratio (based on sales): 3.00 Fixed Assets to Total Assets: 40% Fixed Assets = ₹12,00,000; Long-term Debt = ₹15,00,000 Prepare a Balance Sheet as on 31st March, 2025. (5 Marks) (b) Y Ltd. produces energy drinks. Rate of return on earnings = 25%. Currently retains 60% and distributes rest. Current P/E ratio = 8, EPS = ₹10. According to Gordon's Model: (i) Retention ratio if company wants P/E = 12, Ke = 20%? (2 Marks) (ii) Expected price per share after one year if targeted P/E of 12 is achieved? (1 Mark) (iii) Change in retention ratio if P/E = 10 and Ke = 17.50%? (2 Marks) (c) A Ltd. for year ended 31st March, 2025: P/V ratio = 24%, Operating leverage = 2.00, Financial leverage = 1.50 Interest Expenses = ₹12,000, Tax rate = 30%, No. of Equity Shares = 1,000 (i) Prepare Income Statement. (ii) Calculate EPS. (iii) % change in EPS if sales increase by 5%. (2+1+2 = 5 Marks)

Options

A
B
C
D
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Correct Answer

✅ Option descriptive — Correct Option

All Options:

  • A
  • B
  • C
  • D

Detailed Solution & Explanation

## Part (a): Balance Sheet of S Ltd. as on 31st March, 2025

**Step 1 — Calculate Sales, COGS and Gross Profit**

Fixed Assets Turnover Ratio (based on Sales):
\\\text{Fixed Assets Turnover} = \\frac{\\text{Sales}}{\\text{Fixed Assets}} \
\3 = \\frac{\\text{Sales}}{12{,}00{,}000} \\Rightarrow \\text{Sales} = \\textbf{₹36,00,000} \

Gross Profit is 12.5% on COGS, which means Sales = 112.5% of COGS:
\\\text{COGS} = 36{,}00{,}000 \\times \\frac{100}{112.5} = \\textbf{₹32,00,000} \
\textGrossProfit=32,00,000times12.5\\text{Gross Profit} = 32{,}00{,}000 \\times 12.5\\% = \\textbf{₹4,00,000} \

**Step 2 — Stock of Raw Material**

\textRawMaterialConsumed=32,00,000times20\\text{Raw Material Consumed} = 32{,}00{,}000 \\times 20\\% = ₹6{,}40{,}000 \
\\\text{RM Inventory Turnover} = \\frac{\\text{RM Consumed}}{\\text{RM Stock}} = 4 \
\\\text{RM Stock} = \\frac{6{,}40{,}000}{4} = \\textbf{₹1,60,000} \

**Step 3 — Debtors**

\\\text{Debtor Collection Period} = 3 \\text{ months} \
\\\text{Debtors} = 36{,}00{,}000 \\times \\frac{3}{12} = \\textbf{₹9,00,000} \

**Step 4 — Total Assets**

\textFixedAssets=40\\text{Fixed Assets} = 40\\% \\text{ of Total Assets} \\Rightarrow \\text{Total Assets} = \\frac{12{,}00{,}000}{0.40} = \\textbf{₹30,00,000} \

**Step 5 — Stock of Finished Goods**

\\\text{FG Holding Period} = 0.75 \\text{ months} \
\\\text{FG Stock} = 32{,}00{,}000 \\times \\frac{0.75}{12} = \\textbf{₹2,00,000} \

**Step 6 — Cash Balance**

\\\text{Current Assets} = 30{,}00{,}000 - 12{,}00{,}000 = ₹18{,}00{,}000 \
\\\text{Cash} = 18{,}00{,}000 - (1{,}60{,}000 + 2{,}00{,}000 + 9{,}00{,}000) = \\textbf{₹5,40,000} \

**Step 7 — Shareholders' Fund**

\\\text{Proprietary Ratio} = \\frac{\\text{Shareholders' Fund}}{\\text{Total Assets}} = 0.3125 \
\\\text{Shareholders' Fund} = 30{,}00{,}000 \\times 0.3125 = \\textbf{₹9,37,500} \

**Step 8 — Current Liabilities (Balancing Figure)**

\\\text{CL} = 30{,}00{,}000 - 9{,}37{,}500 - 15{,}00{,}000 = \\textbf{₹5,62,500} \

**Balance Sheet of S Ltd. as on 31st March, 2025**

| Liabilities | ₹ | Assets | ₹ |
|---|---|---|---|
| Shareholders' Fund | 9,37,500 | Fixed Assets | 12,00,000 |
| Long-term Debt | 15,00,000 | Stock of Raw Material | 1,60,000 |
| Current Liabilities (Balancing Figure) | 5,62,500 | Stock of Finished Goods | 2,00,000 |
| | | Debtors | 9,00,000 |
| | | Cash | 5,40,000 |
| **Total** | **30,00,000** | **Total** | **30,00,000** |

---

## Part (b): Gordon's Model — Y Ltd.

**Given:** r = 25% (return on earnings), Current b = 60%, P/E = 8, EPS = ₹10

**Gordon's Justified P/E Formula:**
\\\frac{P}{E} = \\frac{1 - b}{K_e - b \\cdot r} \

**(i) Retention ratio for P/E = 12, Ke = 20%**

\12 = \\frac{1 - b}{0.20 - 0.25b} \
\12(0.20 - 0.25b) = 1 - b \
\2.4 - 3b = 1 - b \
\2.4 - 1 = 3b - b \
\1.4 = 2b \\Rightarrow \\boxed{b = 0.70 = 70\\%} \

The retention ratio required to maintain P/E of 12 is **70%**.

**(ii) Expected Price per Share after One Year (P/E = 12 achieved)**

Current Market Price at P/E = 12:
\P_0 = P/E \\times EPS = 12 \\times 10 = ₹120 \

New growth rate with b = 70%:
\g=btimesr=0.70times0.25=17.5g = b \\times r = 0.70 \\times 0.25 = 17.5\\% \

\P_1 = P_0 \\times (1 + g) = 120 \\times 1.175 = \\boxed{₹141} \

The expected price per share after one year is **₹141**.

**(iii) Retention Ratio for P/E = 10, Ke = 17.50%**

\10 = \\frac{1 - b}{0.175 - 0.25b} \
\10(0.175 - 0.25b) = 1 - b \
\1.75 - 2.5b = 1 - b \
\0.75 = 1.5b \\Rightarrow \\boxed{b = 0.50 = 50\\%} \

**Yes**, there will be a change. The retention ratio decreases from 70% (for P/E = 12) to **50%** (for P/E = 10). The company must retain only 50% of earnings to maintain a P/E ratio of 10 with Ke = 17.5%.

---

## Part (c): Income Statement & Leverage Analysis — A Ltd.

**Step 1 — Find EBIT using Financial Leverage**

\\\text{Financial Leverage} = \\frac{EBIT}{EBT} = \\frac{EBIT}{EBIT - \\text{Interest}} \
\1.5 = \\frac{EBIT}{EBIT - 12{,}000} \
\1.5 \\times (EBIT - 12{,}000) = EBIT \
\0.5 \\times EBIT = 18{,}000 \\Rightarrow \\boxed{EBIT = ₹36{,}000} \

**Step 2 — Find Contribution using Operating Leverage**

\\\text{Operating Leverage} = \\frac{\\text{Contribution}}{EBIT} \
\2 = \\frac{\\text{Contribution}}{36{,}000} \\Rightarrow \\text{Contribution} = ₹72{,}000 \

**Step 3 — Find Sales using P/V Ratio**

\\\text{Sales} = \\frac{\\text{Contribution}}{P/V \\text{ Ratio}} = \\frac{72{,}000}{0.24} = ₹3{,}00{,}000 \

**Step 4 — Fixed Cost**
\\\text{Fixed Cost} = \\text{Contribution} - EBIT = 72{,}000 - 36{,}000 = ₹36{,}000 \

**(i) Income Statement of A Ltd. for the year ended 31st March, 2025**

| Particulars | ₹ |
|---|---|
| Sales | 3,00,000 |
| Less: Variable Cost (76%) | 2,28,000 |
| **Contribution** | **72,000** |
| Less: Fixed Cost | 36,000 |
| **EBIT** | **36,000** |
| Less: Interest | 12,000 |
| **EBT** | **24,000** |
| Less: Tax @ 30% | 7,200 |
| **EAT (Profit after Tax)** | **16,800** |

**(ii) EPS Calculation**

\EPS = \\frac{\\text{Profit after Tax}}{\\text{No. of Equity Shares}} = \\frac{16{,}800}{1{,}000} = \\boxed{₹16.80} \

**(iii) % Change in EPS if Sales Increase by 5%**

\\\text{Degree of Combined Leverage (DCL)} = \\text{DOL} \\times \\text{DFL} = 2 \\times 1.5 = 3 \

Alternatively: \\displaystyle DCL = \\frac{\\text{Contribution}}{EBT} = \\frac{72{,}000}{24{,}000} = 3 \

\\\% \\text{ change in EPS} = DCL \\times \\% \\text{ change in Sales} = 3 \\times 5\\% = \\boxed{15\\%} \

If sales increase by 5%, EPS will increase by **15%**.

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