CAF06 - MFA Book Autumn 2024

CA
PAPER
CAF 06
Managerial and
Financial Analysis
(MFA)
 Complete coverage of ICAP Study Text
and Question Bank
 Complete Chapter-wise Past Papers
 Suggested Solutions of Past Papers
 Extra Practice Questions with Solutions From
ACCA/ICAEW/CPA etc.
Autumn 2024 EDITION

BY: ZIA UL HAQ
ABOUT THE AUTHOR
The author, Mr. Zia Ul Haq, ACA is an associate member of Institute of Chartered Accountants
in England and Wales (ICAEW), and FCCA (fellow member of Association of Chartered Certified
Accountant (ACCA) UK). He is also an MBA from Anglia Ruskin University UK.
He has worked with Deloitte UK, (audit and assurance department) at managerial level and
Sainsbury’s UK (a leading UK based supermarket chain) in HR department.
Having served the firm and industry for 5 years, he has adapted teaching as profession on full
time basis in 2011.
Currently he is working with RISE School of Accountancy and teaching CA

(CAF-04 Business Law,
CAF-06 Managerial & Financial Analysis,
CAF-08 Audit and Assurance,
CFAP-03 Business Management & Strategy,
CFAP-06 Audit, Assurance and Related Services,
MSA-1, MSA-2)
as well as at ACCA level.
Chapter 1: Political Environment and Business
CONTENTS
Chapters Page no.

1 Political environment and business 3
2 Economy and the business perspective 10
3 Impact of social and legal environment on business 19
4 Information and communication technologies 26
5 Technological disruption and business environment 39
6 Comprehensive examples of Chapter 1 to 5 42
7 Competitive forces 47
8 Internal analysis 67
9 Ethical decision making 91
10 Sources of finance 100
11 Cost of finance 114
12 Identifying and assessing risk 146
13 Financial risk management 151
14 Budgeting and forecasting 175
15 Working capital management 228
16 Introduction to project appraisal 241
Answers to practice questions 280
Multiple Choice Questions (MCQs) 451
ICAP Past Papers Analysis 475
RISE School of Accountancy Page 1

Managerial and Financial Analysis
Areas of Syllabus
Grid Chapters Weighting
1, 2, 3, 4, 5, 6, 7,
Managerial Analysis 30 --- 40
8, 9
Financial Analysis and Risk Management 10, 11, 12, 13, 30 --- 40
Budgeting and Projection 14, 15, 16 25 --- 35
Total 100
CAF 06 – Managerial & Financial Analysis (FMA)
Managerial Analysis Financial Analysis & Budgeting and

Risk Management Projection
(30---40) (30---40) (25---35)
External Analysis Ethical Financial and Budgeting

+ Decision Risk Analysis
Internal Analysis Making - Sources of Finance - Working Capital
IT and Controls - WACC
- Risk Management - Project Appraisal
NPV, IRR, Payback
Statistics of ICAP MFA Examination Result
Attempt Students appeared Students passed

Autumn 2023 3838 1822 (48%)
Spring 2023 2815 1395 (50%)
Autumn 2022 2578 1179 (46%)
Spring 2022 1248 467 (37%)

CHAPTER 1
Political Environment and Business
Environment
It describes anything outside an organisation (industry / market) that affects what it does or how it
acts.
Environmental scan/analysis
It includes:
 analysing the environment,
 identifying factors in the environment that create threats or opportunities,
 recognising which are the most significant, and
 deciding how the organisation should respond to them.
Understanding the environment should be an on-going activity.
Threats Opportunities
These are factors in the environment that These are developments that provide
might prevent the organisation from opportunities for the organisation, so that it
achieving its business objectives and create an can achieve its objectives more successfully.
adverse risk for the entity’s future prospects.
Methods for Environmental scan/analysis

There are two methods for analysing environmental factors:
1. Porter’s 5 forces model (Industry Analysis)
2. PESTEL analysis (Country/Region/Macro environment Analysis)
Michael Porter’s 5 forces model PESTEL analysis

Five factors (‘five forces’) that determine Grouping them environmental factors into four
competition in an industry: (PEST) or six categories:
 Threats from potential entrants  Political
 Threats from substitute products or services  Economic
 The bargaining power of suppliers  Social, cultural and demographic
 The bargaining power of customers  Technological
 Competitive rivalry within the industry or  Environmental/Ecological
market  Legal

POLITICAL FACTORS:
The scope of political and legal influence on business

Political decisions and changes in the law can affect any aspect of business activities. Multinational
companies have the additional problem as they operate in many different countries, their activities
may be affected by political and legal changes in each of the different countries. A few examples:
Nationalisation of
Transport and Taxation and Environmental
industry and Education
infrastructure subsidies policy
privatisation
In some countries Businesses rely Governments may Business In most
industry is on the transport use taxation to entities might countries the
nationalised system to move influence be affected by government is
(owned wholly or their goods (and activities such as changes in the responsible for
partly by the state) employees), and increasing tax on environmental most of the
or a government the quality of the fuel to discourage policy of a education
might introduce a road transport fuel consumption government, system.
policy of de- system depends or on disposal of such as policy Education policy
nationalising on the waste to to reduce levels affects the
(privatising the infrastructure of encourage of pollution in quality and skills
industry) so roads. As this recycling of the air, water or of individuals
transferring system can be waste. land. who make up
ownership of state- operated by Governments the workforce
owned businesses commercial sometimes of business
to commercial companies but encourage entities and
companies. most of it is state- activities by helps ensure that
owned. Thus offering all employees
when sate owned, subsidies, such as comply with
policy of on cost of legal
Government on particular skills requirements.
transport and training.
building roads or
rail networks can
affect business.
Example:
- In 2007, a large shipment of corn from the US to Europe was found to include genetically-
modified corn. Although this was legal in the US, it was illegal in the European Union. The
shipment had to be returned to the US.
- In 1970s private sector was nationalized in Pakistan, through Nationalization Act 1970.
The political setup in any country depends upon various factors such as,
• Political ideology of the ruling political party.
• There are several political ideologies propounded in the previous three centuries that govern the
modern world. All of them have their origin in Europe.
o Pre-existing laws and regulations
o Socio-religious constraints.
o Political opposition and their economic agendas.

THE SPECTRUM OF POLITICAL IDEOLOGIES
Communism Conservatism Right Fascist Capitalism

Liberals Left Wing
Extreme Left Extreme Left
wing Centre Moderates Laissez Faire
Radicals Dictatorial
Democratic Democracy Democratic
Dictatorial Capitalism
Socialism Capitalism
socialism Reactionaries
All means of Most and important They want No individual
Free market, open
production must means of change but not at freedom.
competition
be in the hands of production in the the cost of
hands of state with tradition. Authoritarian rule.
state Elitist and
few exceptions are oligarchy (rule by Private property as
No private allowed. State must play
the few rich and prescribed by the
property the role of powerful)
Private property guardian for all. ruling regime.
Distribution of is allowed. Law favors the
Individual Extreme
state earnings on elite.
the basis of the It recognizes the freedom is inequalities.
need of people. distinction recognized. Maximum private Protection of
amongst people property with least national interest at
Production by the based on their Full religious ownership of
freedom. all costs.
state industries ability and their means of
would be based contribution. production by Implementation of
Private property
on the needs of state. ideology through
Distribution of is allowed.
people any means
output amongst Ownership of Maintain ‘status possible, including
Egalitarian, class people should be quo’.
private and violence.
less society based on their public means of
where everyone input. Attainment of This system does
production needs
has equal national or state not allow
Challenges to be balanced.
material. goals by any dissenting opinion.
‘status quo’. They believe in means possible,
No individual including Hitler/Mussolini/
The system international
freedoms. amending the laws Franco
believe that the cooperation for
It is the benefit of all around it.
people are the Nazi Germany,
comprehensive responsibility of however they
Individual liberties Fascist Italy and
political system the state, and it also recognize are recognized
their national Spain.
which has its own needs to regulate with exceptions.
economic system. business through interests.
laws to protect Religious practice
There is no room Slow social
masses. in all forms is
for ‘organized change.
allowed.
religion’ in Religion is Canada
communism. allowed in this Large corporations
However system can flourish in this
individual system and charge
religion is They favor their consumers as
supported in change through much as they
some form. peaceful means. want.
• They consider Everyone is equal There is a

religion as in-front of the tendency of
‘opium of law. suppression and
masses.’ Implementation oppression by
• Communists majority.
of ideology
want chage
through social Attainment of
through any
means possible change. National Interest

including Major over international

violence. characteristics, cooperation.
collectivism,
Stalin/Lenin economic Power Politics.
Soviet Union equality, social Key terms of
service, characteristics;
nationalization. individualism,
private ownership,
Fabian
self-interest, open
Sweden competition,
privatization, not
much protection
from the system,
United States
Authoritarian vs. Democratic Regimes

Authoritarian and Democratic regimes are two ends of the spectrum in political ideology.
 Right wing generally wants to minimize regulations on businesses, which would allow a
business owner to have more power over their employees.
 Left wing generally wants to put the employee on a more level playing field with the
employer or dismantle the relationship entirely.
 A similar pattern appears in social policy, where the left tends to be more open to people
breaking from tradition, while the right tends to be more reverent towards tradition.

IMPACT OF POLITICAL IDEOLOGIES ON BUSINESSES

Government spending
Direction of state spending is based on its inherent political ideology.
- Govt spend on public, free health, education for all etc (Socialism)
- State spend more on defense, international security, alliances etc. (Dictatorial Capitalism)
Taxation
 Various ideologies propose different sorts of taxation i.e. direct and indirect.
 Tax policies can have a massive effect on a business’ overhead and profit margins.
 These policies may be used to:
- Reduce income of individuals and companies and thus reduce private expenditures
- Provide resources for public expenditures (roads, public schools, hospitals or parks / play
ground)
- Exercise control over the private sector investment
- Improve country’s business competitive position
Economic policies
 Different political parties or individuals enact different policies to guide national economy.
 A pro-agriculture political approach may not be able to pay attention to other sectors.
 Non-agriculture sector ideology for economic growth may manage economy that is not suitable
for agriculture sector.
Labor Laws
 Political parties often focus minimum wages, insurance requirements, labor regulation etc.
 Local labor laws are also affected by international labor regulations.
 Some Western economies do not allow imports from such countries who do not ensure labor
health policies, labor safety from fire hazard policies etc.
International relationship and policies

 International relation support ideology that welcomes foreign investments will have direct impact
on sustainability of local businesses.
 A protectionism policy to restrict import and promote own industry may have negative impact.

INTERACTION BETWEEN BUSINESSES AND THE GOVERNMENT

 Pressure groups / lobby group influence the government decisions and policies.
 Political parties need the support of businesses – especially larger, influential ones in form of
votes, contributions to economy, reduction of unemployment and party funding etc.
 Business manager should keep an eye on political parties influenced by their supporters from
business community and pressure groups of businesses.
Financial incentive strategy

 Powerful businesses may use their economic leverage to influence public policymakers.
 They can use economic power to threaten to leave a city, state, or country unless a desired
political action is taken that act in business favour.
Promoting a Constituency-Building Strategy

 Firms use advocacy advertising, public relations, and building coalitions with other affected
stakeholders.
 The Businesses may influence political environment by seeking support from organizations or
people who are also affected by policy or who are concerned with business’s position.
 Some of the influencing approaches are as follows:
(a) Stakeholder Coalitions

Businesses organize programs to get organizational stakeholders (employees, customers and
local community), acting as lobbyists or voters, to influence government officials to vote or act
in a favorable way.
(b) Advocacy Advertising

Advocacy ads focus not on a particular product or service, like most ads, but rather on an
organization’s or company’s views on controversial political issues.
Advocacy ads, also called issue advertisements, can appear in newspapers, on television, or in
other media outlets.
(c) Trade Association

Its coalitions of companies in the same or related industries to coordinate efforts in promoting
common interests of industry. They represent many businesses include companies of all sizes &
sectors. Some examples are:
 Federation of Pakistani Chambers of Commerce & Industry
 Overseas Investors Chambers of Commerce and Industry (OICCI)
 Pakistan Automotive Manufacturers Association (PAMA)
 All Pakistan Textile Manufacturers Association (APTMA) voiced its concerns over load
shedding and hike in industrial tariffs since.
Public Affairs Department

 In many organizations, managing political activity falls to department of public affairs
 Role of the public affairs department is to manage the firm’s interactions with governments at all
levels and to promote the firm’s interests in the political process.
 Creation of public affairs units is now a global trend
 Typical public affairs executive spends most of the day direct lobbying with politicians, hosting
visits by politicians to the company’s locations, or attending fund-raising activities.
Nothing is permanent in this world except change

PRACTICE QUESTIONS
Q.1 (Autumn 2022 - Q.2)

WMB is a large multi-national automobile company that has automobile assembly plants in over
twenty-four countries including Rawada where it holds the largest market share by reach and revenue.
Rawada’s government is considering to put a complete ban on imports of all automobiles and their
parts in order to promote local automobile manufacturers, which is going to have an adverse impact
on WMB’s operations in Rawada.
Required:
Explain any four approaches that WMB can use to influence government to re-think its stance of
complete ban on imports of all automobiles and their parts. Also provide an example for each approach.
08)

CHAPTER 2
Economy and the Business Perspective
ECONOMIC ENVIRONMENT
The economic environment refers to external factors and the broader economic trends that can
impact a business. Economic environment can be classified into microeconomic and macroeconomic
environment.
Economics
It is the study of how to allocate scare resources to satisfy potentially unlimited wants. The subject
of economics might be split into:
Microeconomics
Micro means small. It deals with the behaviour of an individual and a firm.
Macroeconomics
Macro means large. It is a study of economy as a whole. It is concerned with national income,
economic growth, rate of inflation, employment and the level of unemployment.
The focus of this chapter is macro-economic factors that are analysed on the basis of economic
indicators.
INDICATORS OF PHASES OF ECONOMIC / BUSINESS CYCLE

The economic cycle: It is the natural fluctuation of economy between periods of growth and
recession. Factors such as GDP, interest rate, level of unemployment and consumer spending can
help to determine the current stage of economic cycle.
 When national income increases from one year to the next, there is economic growth.
 When national income falls from one year to the next, there is economic recession (or in extreme
cases, economic decline)

Chapter 2: Economy and the Business Perspective
PHASES OF ECONOMIC / BUSINESS CYCLE

Characteristics of Four Phases of Business Cycle: Summary
Boom / Recession/ Recovery/

Trough/
Peak / Downturn/ Upturn/
Depression
Prosperity Contraction Expansion
Level of GDP/Output High Decreasing Low Increasing
Level of Employment and Income High Decreasing Low Increasing
General Price Level High Decreasing Low Increasing
Level of Demand and Consumption High Decreasing Low Increasing
Level of Interest Rates High Decreasing Low Increasing
Level of Bank Credits High Decreasing Low Increasing
Level of Confidence of Businessmen Optimist Decreasing Pessimist Increasing
Indicators of Growth/Recession:
Leading Economic Indicators:
Economic indicators that change just before the economy starts to follow a particular phase. These
factors predict economic trends. The nature of these indicators is that they are used to forecast at what
stage the economy will be in, at some time in the future. These in particular give an indication for
whether a peak or trough will be reached in the following 3-12 months.
 Average weekly hours of labour-force.
 Manufacturer’s new orders for capital goods
 New building permits for private housing
 Index and prices of Stock Market
 Money supply
Coincident Economic Indicators:

Economic indicators that show where an economy is. These occur at the same time when a particular
economic trend occurs. These indicators are events and measures that occur at the same time as a peak
or trough occurs. They are used by governments to assess at what stage in the cycle the economy is in.
 Number of workers in employment
 Aggregate Personal incomes
 Industrial production Index
 Manufacturing and trade sales
Lagging Economic Indicators:

Economic indicators that change after the economy has entered into a particular phase. These confirm
the economic trends but don’t predict them. These indicators are used to assess whether an economy
has reached a peak or trough 3-12 months after it would have occurred.
 Average duration of unemployment
 Inventory-to-sales ratio
 Change in unit labour costs
 Interest rates
 Overdue commercial and industrial loans
 Consumer Price Index (i.e. level of inflation)

ECONOMIC FACTORS
GDP/National Income (NI) - an aggregate market value of all final goods/services produced within
boundaries of a country in a given period.
It is a measure of economic performance of country and for comparison with various periods and
other countries. It tells status of consumption and savings in a country and also contribution of
various sectors of economy to national income.
Methods of Calculation of NI
Spending by all sectors during the year
GDP = C + I + G + (X-M)
C = Private consumption of goods and services

I = Private investment in long-term assets
G = Government spending
X = Exports of goods and services
M = Imports of goods and services
Government economic policy aims

The aim of government policy is normally achieving economic growth, nearly full employment,
stable prices and a sustainable balance of payments (BoP). If economic growth and full employment
are achieved, the wealth of the country as a whole will increase, aim is therefore to increase
aggregate demand.
Increases in any item in this equation might lead increase in AD but also to a reduction in other
items. For example, Crowding-out effect i.e. an increase in G provides an increase in AD or NI, but
if the extra government spending comes from higher taxation, and higher taxation leads to reduction
in C and I, the end result might not be beneficial.
A link between national income growth and inflation

There are limits to rate of increase in national income annually because a country does not have the
resources to grow in ‘real terms’ above a certain rate. When total spending in the economy increases
at a faster rate than the economy can grow in real terms, the inevitable result is price inflation. For
example, if NI (measured by expenditure method) grows by 8% but the ‘real’ economy (measured by
output method) increases by 2%, the difference of 6% must be inflation
The GDP for a particular year is measured by two ways, nominal GDP and real GDP.
• Nominal GDP is the value of GDP evaluated at current prices in a specific time period, this
includes the impact of inflation and is normally higher than the GDP.
• Real GDP is an inflation adjusted value of GDP. Since it is an inflation-corrected figure so it is
deemed to be an accurate indicator of economic growth.
As reported in SBP’s quarterly reports on Pakistan’s economy, the recovery in Pakistan's economy
gained further traction in the third quarter of FY21. The growing momentum over the three quarters
of FY21 is reflected in the provisional estimates of GDP growth of 3.9 percent for the full year.

Impact of inflation
Inflation
Inflation is a continuous or persistent increase in price levels over time. The rate of inflation is
measured using one or more price indexes or cost indexes, such as a consumer prices index or a retail
prices index or an index of wages costs.
Rate of inflation
It is a percentage increase in P level as compared to the prior year.
A quick glance on inflation rates in Pakistan

According to the Pakistan Bureau of Statistics (“PBS”), CPI inflation surged by 9.70% on a year-
on-year basis in June 2021 vs. 8.60% last year.
The inflation rate remained high throughout the fiscal year 2020-21, it reached a peak of 11.1% in
the month of April 2021 and achieved a significant dip of 9.7% in June 2021
Types of inflation
Cost-push Inflation (‘inflationary spiral’) Demand pull Inflation
When prices of goods and services rise due to When AD for goods persistently exceeds their
persistent increase in the cost of production supply.
goods while D remains constant.
↑P of raw material, labour - ↑P of products - ↓Taxes, ↑G, ↓Interest rates
↑wages
NI and Employment tends to fall Usually occurs in full employment situation
Implications of high inflation

 It causes measured NI growth in money terms only also while economic recession (refer last
page).
 An inflationary expectation is the rate of inflation that businesses and individuals expect in the
future. When the inflation rate is high inflationary expectations are high which affect demands
for wage rises, and decisions by businesses to raise their prices.
 There is undesirable redistribution of income between lenders (receivables) and borrowers
(payables) as lenders will receive less value and borrowers will pay less value.
 The real value of households on fixed incomes or incomes that rise by less than the rate of
inflation each year, such as many pensioners. The rich might get richer (because their income is
often protected against inflation, for example by salary rises) whilst the poor get poorer.
 At such times wage demand increases which may result in wage-price spiral or inflationary
spiral.
 Balance of trade may also suffer as exports become expensive and imports become relatively
cheaper that will affect employment in export/import industries.
 A risk of economic recession.
 Fall in the exchange rate for the country’s currency

Impact of unemployment
Unemployment: Unemployed is that part of a population available for work and actively searching
for it but unable to find it.
High levels of unemployment Very low level of unemployment
Loss of output and NI as for underperformance of Firms that want to take on more labour might
economy struggle to find suitable people
Burden on govt. for social security benefits
May result in social cost (e.g. depression, suicide, Might push up the cost of wages and salaries
crimes)
Shortage of skilled labour
Corresponding to the technological complexity of industry increases, the demand for low-skilled jobs
fall and for skilled labour rises. A shortage of skilled labour can only be overcome through:
 better standards of education
 more training
 if necessary, moving jobs to other countries where there is a better supply of skilled labour
Impact of economic stagnation

Economic stagnation occurs when:
 Economic activity is at a much lower level than it could be.
 Economic resources are underused such as land and capital equipment, unemployment is high
and there is little or no new capital investment.
 National income is not increasing but should be possible.
Consequences
When a country/region of the world suffers from economic stagnation it is becoming poorer
relative to those other countries enjoying economic growth. Households may therefore live in
relative poverty, and many individuals might look for ways of migrating to other countries where
economic wealth is greater.
Depressed countries of the world that suffer from economic stagnation often need help from
wealthier countries to develop their national economies.
Worldwide economic recession

When the rate of economic growth in the world as a whole is falling, individual countries might still
try to increase their own national income. If the world economy is not growing than any increase in a
national economy has got to be at the expense of other national economies.
Trade wars and protectionism

Protectionism is the economic policy of restraining trade between states (countries) against foreign
competition by government through methods such as:
 imposition of tariffs (high import taxes) on imported goods
 setting quota limits on the amount of goods that can be imported
 embargo (ban on imports) of some types of goods
 exchange rate control
 political campaigns advocating domestic consumption
Impact of protectionism
The doctrine of protectionism contrasts with the doctrine of free trade, where governments reduce
as much as possible the barriers to trade. Impact of protectionism on economic growth (and on
economic welfare in general) is largely negative, although the impact on specific industries and
groups of people may be positive. The World Trade Organisation (WTO) attempts to promote free
trade internationally.

International payments and international payments disequilibrium

International payments
International payments are the flows of money between different countries. Its main elements are:
a. payments for international trade of goods and services (balance of trade or balance of payments)
and
b. movements of capital between countries.
For every country:
SBP’s foreign exchange reserves rose by US$ 1.4 billion to a 3-year high of S$ 13.5 billion, resulting
in a 10% Rupee appreciation and reduced forward liabilities of SBP.
Balance of Payment
 It measures the financial transactions made between consumers, businesses and the government
in one country with others.
 It is calculated by adding up the value of all the goods that are exported (i.e. sold to other
countries) and imported (i.e. bought from other countries).
 It is made up by a combination of:
- the current account
- the capital account
- official financing account
 For any country, Surplus/deficit on trade = Net outflow or inflow of capital.
 Balance of payments (BOP) data is an important indicator for investment managers, government
policymakers, State bank, businessmen, etc.
 Businesses use BOP to examine market potential of a country, especially in the short term.
 A country with a large trade deficit is not as likely to import much
National economic policies

A national government has responsibility for economic policy and to achieve economic growth it
might be necessary to achieve some economic targets first, such as:
 low rate of inflation
 stable exchange rate (or target exchange rate against major world currencies such as US dollar or
euro)
Governments sometimes use economic policies to achieve political, social or economic objectives.
Fiscal policy Monetary policy

It is government policy on government Policies of central bank to influence AD or NI
spending to influence aggregate demand or by encouraging long-term economic growth.
national income.
Fiscal policy works through different tools It is applied by
such as: 1. Keeping inflation rate within limits
1. Taxation 2. Controlling interest rates and
2. Borrowing 3. Changing S of money within an economy
3. Encouraging investment by the private As the central bank is able to control short-term
sector such as Companies by offering interest rates
special tax incentives or subsidies-cash
payments.

The effect of managing interest rates

It slowly works through the national economy. What the central bank do to its own interest rates,
other commercial banks do the same to their interest rates. Thus:
Central Effect on Investment Consumption Effect on
bank Borrowing Inflation
Raising Decreases Decreases Decreases Decreases
short- Higher borrowing Due to higher long For both imports and Some of the
term costs causes term investment domestically- inflationary
interest individuals/ rates and also produced goods) as pressures thus
rates companies less falling market value everyone feels less worked out of the
willing to borrow of shares and bonds wealthy economy
Reducing Increases Increases Increases Increases
Interest
rate
Impact of Stock Market Returns

 Stock market is considered as one of the leading indicators
 Performance of a stock market is measured through stock market index.
 Stock market index is the index of the market capitalization of a section of stock market.
Market capitalization is market value of a publicly traded company's outstanding shares.

 It is equal to share price multiplied by the number of shares outstanding.
 It reflects what investors are willing to pay for its stock.
 It’s a tool used by investors to describe market and to compare return on investments.
 It measures a company’s worth on the open market and its perceived future prospects
Market capitalization could be based on:
• Full-cap (includes all of the shares issued by a company)
• Free-Float (proportion of total shares issued by a company that are readily available
for trading at the Stock Exchange, excluding shares held by controlling directors,
sponsors, promoters, government and other locked shares)
Stock Exchange Indices

KSE-100 index
 The most recognized index of Pakistan Stock Exchange
 It includes the largest companies on the basis of market capitalization.
 The index represents 85% of all the market capitalization of the exchange.
 It is calculated using Free Float Market Capitalization methodology.
 The KSE100 has a base value of 1000 as of November, 1991.
All Share Index

It consists of all listed companies on PSX based on Full Cap methodology.
Stock Exchanges Indices and Business Decisions

Stock market's movements can impact companies in a number of ways.
 Rise and fall of share price values affects a company’s market capitalization.
 Businesses also consider stock performance in decisions related to issue of shares.
 If a stock is performing well, a company might be encouraged to issue more shares because they
will be able to raise more capital at a higher value.
 Market value of a company is also an important factor when considering mergers etc.

 Companies may hold shares as cash equivalents and value fall can lead to funding problem.
 Increase in stocks’ value may generate interest for new products or businesses
Change in Economic Indices and Some common Business Responses

Change Consumers Businesses
Higher May spend less, as fewer people May lower prices in order to encourage
unemployment are earning people to buy
Lower May increase their spending, as May increase prices as demand increases
unemployment more people are in work
Increased interest May spend less, as they are May reduce products’ sizes but leave the
rates encouraged to save price unchanged, increasing the profit
margin. (i.e. shrinkflation)
Decreased interest May spend more, as there is less May launch bigger versions of products to
rates incentive to save charge higher prices
Increased value May spend more on imported May target new domestic markets for
of Pak Rupee goods, as they are relatively cheap their products to attract new customers
(exchange rate)
Decreased value of May spend less on imported May target new international markets for
Pak Rupee goods, as they are relatively their products as exports are cheaper
(exchange rate) more expensive
The impact of economic policy measures

Macroeconomic policies of government, and changes in the condition of the national and world
economies, affect businesses and individuals directly. As you should imagine, firms and individuals
will react to economic changes according to the circumstances and the nature of the change.
Examples
1. The government raises tax on income from 20% to 25%. How would you expect individuals or
households to react?
2. The government increases interest rates from 4% to 5%. How would you expect companies to
react?
3. A company believes strongly that the national economy will grow strongly in the next few
years, and that profits in its own industry and markets will grow. What do you think the
company should do?
Suggested Answers:
1. Higher taxation means less after-tax earnings for spending. Individuals must either reduce their
consumption or borrow more. In practice, at least for the short term, they might do both
2. Companies are only affected if they borrow money at a variable rate of interest from their
bank, with a bank loan or overdraft. After a large increase in interest rates, they might try to
borrow less (but reducing borrowings might take some time). They might try to pass on some
of the higher costs to customers by raising the prices of their products or services. Or they
might try to cut some costs, such as reducing labour costs by making some employees
redundant.
3. The company should review its strategic position, make plan about future and consider
increasing its investment in the industry.

PRACTICE QUESTIONS
Q.1
A Country's government has a major role to play in the success or failure of its economy. A number of factors
influence a country's balance of trade. Discuss. (05)
Q.2
The president of Japanese car making company Honda recently stated that his company would not expand its
production capacity any further at its factory in the UK. This factory produces Honda cars for the European
market. He explained that the reason for this decision was the currency risk. The company was concerned
about its competitiveness in the European market. It had a 5% share of the UK cars market, but only a 1%
share of the market in the rest of Europe.
Explain what the company president meant by the ‘currency risk’. (04)
Q.3
Explain how a manufacturer of computer games might be affected by a 0.5% rise in interest rates by the
central bank. (04)
Q.4
Explain why monopoly control over a market might be undesirable and suggest three ways in which the
government might act against monopolies. (05)
Success is simple. Do what's right, the right way, at the right time.

Chapter 3: Impact of Social and Legal Environment on Business
CHAPTER 3
Impact of Social and Legal
Environment on Business
1. SOCIAL AND DEMOGRAPHIC FACTORS
It’s a marketing concept in business that all successful businesses must keep up to date with and
aware of social and demographic change, and respond accordingly. If they do not, they will continue
to offer products and services that are increasingly less relevant to the needs of customers.
Example: Social and demographic factors

a. People concerned about health and weight. Interest in fitness, healthy eating and diets has
increased
b. Outing and dining out habits of a particular area or particular region.
c. Social media addiction has changed dynamics of societies.
d. People interested and concerned with their looks, and attend social gatherings.
Effect of Social factors on business organisation

Business organisations are affected by such changes, and by government policy. As a population
changes, in age or ethnic origin, the needs and wants of consumers will change. Businesses must
respond to those changes. In addition, the nature of the workforce – its age distribution,
availability and skills – will also change. Issues such as education and training take on importance
for ageing/young employees, if companies intend to employ them beyond their normal retirement
age.
Social Factors
Attitudes and Lifestyle
 Consumer attitudes and lifestyles are continually changing due to education, globalization,
urbanization, social media, advancements in technology and advertisements.
 These factors rapidly impact the dressing, house decor and food preferences.
 Therefore, businesses must understand the dynamics of different cultures. Eg. A tea
manufacturer would do better in Pakistan rather than US (who are coffee lovers)
Social values
 Social values include common behaviors of a society that determine the boundaries of what is
permissible (acceptable) and prohibited (undesirable).
 For a business, it is important to be aligned with social values of the society
 Therefore, the policies, products, marketing pitch, stakeholder relationship of a business must be
in line with the norms of the society. E.g. Insurance companies’ plans for higher education and
marriage to parents in a society will work where parents are the decision makers and financial
supporter of their children.

Demography
 It is study of key statistics about the segments of a society, such as, age, gender, race and
ethnicity and location. i.e. type of society
 It help the businesses define the markets for their products and services.
 It also determines the size and composition of the workforce according to:
a) Age groups
 People born after 1996 are of over 40% and born after 1980 are over 60% of world
population and are much important element
 They have seen dramatic changes of technology in the world as compared to the earlier
generation.
 Because of such exposure they prefer innovation.
 They are used to of smart phone and internet and they acquire instant online information.
 Another thing to consider is the varying nature of needs and preferences as per age group
b) Gender
 Business Decisions about product development, marketing strategies, hiring policies and
selection of business locations are significantly impacted by the gender it plans to attract.
 E.g. marketing of baby products and households should be directed to women exclusively.
 Companies should also have proper social analysis of their market about:
- the influence on domestic decision making
- gender-wise loyalty patterns
- gender-wise spending patterns
c) Ethnicity
 It is the segmentation or identification of people based on their cultural distinctiveness like
language, values, religion, ritual, origin and ancestry.
 Companies should recognize the way different ethnic groups behave or react.
Wealth distribution
 Businesses have to define their target markets around different income groups.
 Production plans of companies are made on basis of the affordability of relevant market.
Education
 Level of educated in a society directly impacts the strategy of a business
 Good supply of educated and skilled work force helps companies to acquire good talent.
 Companies also adapt their advertising and communication according to the literacy level
Law and Order situation

 Law & order situation in either a specific vicinity, city or entire country affects the business.
 Some negative effects of an unfavorable law and order situation:
- Loss of staff and customers
- High Insurance/security costs
- Loss of profits due to stolen goods
- More spending on installing effective security measures e.g. alarms.
- Foreign investment is discouraged and tourism is reduced.

2. LEGAL FACTORS
The Role of Legislation in Business
 Legal system of a country is very important to businesses and changing from time to time.
 Law regulates business practices, defines business policies, rights and obligations involved in
business transactions like:
 Make a business or a transaction illegal
 Impose conditions on certain businesses
 Regulate the rights and duties of people carrying out business to ensure fairness
 Protect people dealing with business
 Ensure the protection of employees from unfair treatment
 Protect investors, creditors and consumers
 Regulate dealings between business and its suppliers
 Ensure a fair competition in businesses
Different types of Laws affecting businesses

Health and safety law
 The purpose of Health and Safety law is to provide safe workplace to employees where they are
not exposed to any danger, injury, risk to health
 This also means a work place where employees are not subjected to discrimination or bullying.
 These are about minimum health and safety requirements that employers must provide in their
place of business and for their employees.
 Within well-developed economies, health and safety standards are usually high.
 These regulations can impose significant requirements on employers, and the legal
consequences of failure to comply with the regulations could be serious for the
company/directors/managers. In a company, BoD has the ultimate responsibility for health and
safety at work.
Data protection law
 The purpose of data protection law is to protect individuals with regard to their personal data
that is held and used by other persons and designed so that no one can collect/hold/use
information about them without their permission.
 Some countries have fairly strict data protection laws.
 Organisations that hold and use personal data of individuals are required to comply with
regulations relating to how the data is gathered, stored, kept secure from unauthorised access and
used.
 Failure to comply with the regulations could expose an organisation to legal action by the
individual concerned and/or the authorities.
Competition law
Some countries have laws to encourage fair competition in markets and avoid anti-competitive
practices. Examples include:
(a) Monopolies
Definition:
Theoretically it is 100% control of a market where one entity supplies a product or service to the
entire market. In practice, it is usually defined as a significant influence i.e control of market.
Reason for law restriction:
It might engage in unfair business practices, such as charging higher prices than they would be able
to charge in a more competitive market i.e. serious risk of anti-competitive behaviour.

Government involvement to protect the public:

 A company grows nearly to become a monopoly the government organisation might investigate
to decide whether measures should be taken.
 Two companies about to merge that would create a new monopoly, a government organisation
might investigate the proposed merger whether it should be allowed, and if so whether any
conditions should be placed on the merger.
(b) Anti-collusion regulations

Collusion occurs when two or more business entities secretly agree to do something for their mutual
benefit that is against the public interest i.e. (to raise prices, and avoid competition on process).
In many countries, collusion is a criminal offence.
(c) Price controls

Government/ government official bodies might impose price controls on certain key products or
services or essential services to consumers (water, electricity or gas) by monitoring the activities of
‘utility companies and exercising powers to restrict their activities. Like in Pakistan government
setting prices of petrol, fruits, vegetable and meat etc.
Employment law
Employment law provides protection to employees against unfair treatment or exploitation by
employers. Business organisations as employers need to be aware of the law and the consequences of
breaking the law or failing to comply with its regulations. Changes in any aspect of employment
laws could have significant implications for business organisations, especially those where labour
costs are a significant proportion of total costs.
Some of its aspects:
Minimum wage Unfair dismissal

Redundancy. is the minimum hourly An employee who is dismissed
In some countries, dismissal rate of pay that may be might bring a legal claim against
due to redundancy is not paid to any employee.. such dismissal. The employer
unfair, only when it is must demonstrate that dismissal
unbiased. However, laws was not for a reason or under
may require an employer to circumstances that the law would
consider transferring an consider ‘unfair’. If the
employee to another job employer is found guilty, it
before making him might be required to reemploy
redundant. Failure to this the individual who has been
consideration results in dismissed or (more likely) pay
unfair redundancy him or her substantial
compensation
Employment
Discrimination Working conditions
law
It is minimum acceptable
There are laws against working conditions as
showing discrimination by maximum hours of work per
employers/employees on the week or month, maximum
grounds of physical
retirement age and the
disability, gender, race,
employment of children
ethnicity, religion, and age.

Consumer protection Law

Most countries have legislation that aims to protect consumers of goods and services like,
Sale of goods legislation
Such legislation usually specifies certain terms in the contract that a consumer may rely on in
contracts for the purchase of goods (or services) For example:
Title – The buyer is entitled to assume that the seller of goods actually owns them (i.e. has title to
them).
Description of goods – The buyer is entitled to assume that any good they purchase correspond to
a seller’s description of those goods.
Quality – All goods supplied in the course of a business must be of satisfactory quality. This
means that they must be satisfactory for the purpose intended. If a person buys a washing
machine that does not work the seller must repair it, replace it or pay a refund to the customer.
Cyber laws
 It is the newest area of legal system. It applies to internet and internet related transactions.
 This law was enforced to safeguard the individual’s information and confidentiality of clients
where transactions are made over some network, collecting, storing, retrieving and disseminating
of individual’s data.
 It is considered that employees of any organization are the most vulnerable segment in cyber
security
Companies law
 In Pakistan, the requirements for incorporation, management, operations and winding up of
companies are provided in the Companies Act, 2017, issued by SECP.
 Companies Act regulates companies for protecting interests of shareholders, creditors, other
stakeholders and general public and inculcate principles of good governance.
 Companies are required to comply with the requirements of the Act
 Companies which do non-compliance will be subject to relevant penalties imposed by law
Partnership law
 Law relating to partnership businesses in Pakistan is Partnership Act, 1932.
 It includes process of registration and dissolution of firms, rights and duties of partners etc.
 Partnership firms have ease of doing business as they don’t have to follow those strict
requirements as imposed by Companies Act on the companies
Copyrights, Patents and Licenses

 To prevent the intellectual property of individuals
 Copyrights safeguard “original creations” such as writings, art, architecture and music from
being copied or reproduced. Owner has exclusive right to display and share that work
 A Patent is a registered right that gives the owner exclusive right to features and processes of
inventions (including its formula)
 A License is a permission to carry out certain business activities or practice under specific
government regulation or certification body.

Legal Environment and Ease of Doing Business

 Economic activity requires sensible legal system that encourages growth in business sector.
 These laws include rules that establish and clarify property rights, minimize the cost of resolving
disputes and provide protections against abuse.
 Businesses require strategic analysis to understand the dynamics of the business environment.
 A business manager examines many factors (ease of business), like overall economy
environment, financial system, market size, rule of law, and the quality of the labour force.
World Bank Ease of Doing Business Index (2003)

 This Report ranking is an assessment of business regulations across 190 economies.
 There are many other assessments as well but this annual ranking is often cited as the most
authentic indicator of the regulatory environment for business operations.
 Ease of Doing Business Index comprises 10 Indicators on basis of which ranking is issued;
o Starting a Business
o Getting credit
o Construction permit
o Getting electricity
o Registering property
o Protecting minority investors
o Resolving insolvency
o Enforcing contracts
o Trading across borders
o Paying taxes
To improve Pakistan’s ranking in this Report, many measures have been taken in Companies Act
2017 to provide ease of business as follows:
▪ Simpler and softer regime for smaller companies by waiving off certain requirements related to
filing annual return, performing annual audit and other relaxations;
▪ Introduction of maximum use of technology;
▪ Removal of unnecessary requirements for all companies etc.

PRACTICE QUESTIONS
Q.1
Organisations operate within a regulatory framework set by government which is very broad in Scope and deal
with a range of specific issues.
Required:
(a) Explain four principal aims of the government regulation of business. (08)
(b) Identify and explain, with the use of examples, any four key areas in which an organisation is affected by
government legislation and regulation. (12)
You can't cross the sea merely by standing and staring at the water

CHAPTER 4
Information and Communication Technologies
TECHNOLOGICAL FACTORS
The impact of technological change on working methods
Over the years, machines have replaced man for mechanical tasks. The impact on business
organisations can be summarised as:
 Computers have replaced man for many mental, intellectual including data processing and
information analysis tasks
 Humans have been used for the ‘higher level’ intellectual tasks and skills tasks that computers
have not been able to perform
 With ever growing technology, computers are taking over from humans even some high level
intellectual and analytical tasks.
Impact on Products and services

In order to remain competitive, companies need to maintain technological developments in:
 CAD (Computer Aided Design)
 CAM (Computer Aided Manufacturing)
 Provision of services
Example:
 Nokia is a recent example that could not update its technology and could not compete the
competitors.
 A current example has been the competition between manufacturers of televisions, such as Sony
and Toshiba, to achieve a technological lead in the development of televisions with the latest ‘flat
screen’ technology.
 Technology has shifted from manual buttons to remote and now to the touch screens.
Organisation structure and strategy

Computerisation, communications technology and other aspects of technological change have led to
major developments in business organisation and strategy such as:
 Downsizing
 De-layering
 Outsourcing
 Restructuring
To some extent, these developments in business organisation are inter-related.
Downsizing
It means the reduction in size of a business organisation. It does not (necessarily) mean that the
business organisation is selling fewer goods or services. It means that its business activities are
conducted by a smaller number of people.
Technological change makes downsizing possible, because tasks that were performed previously by
humans can now be performed by machine or computer.
De-layering
It means removing one or more levels of management in the organisation structure. It could mean
removing all layers of middle management entirely, leaving just senior managers and front-line
managers and supervisors.

Chapter 4: Information and Communication Technologies
De-layering is made possible by:

 high-quality communications
 high levels of trust
 having ability to delegate sufficient authority to junior managers
 having higher expectation that junior managers shall meet their responsibilities
When an organisation goes through a de-layering, middle managers are made redundant, and there
is consequently some downsizing.
Outsourcing
It means that instead of carrying out its operations (including administrative or management tasks)
internally by employing individuals, sub-contracting work to others for performance.
Outsourcing is made much easier by high-quality telecommunications and computer systems,
because data and information can flow easily between a business and that other organisation to
which it has outsourced.
For Example:
 A company might arrange for an external accountancy firm to take over the administration of the
payroll, and administer wages and salaries for the company’s workforce.
 A company might arrange for an external building services company to take over responsibility
for cleaning and security in all its buildings.
 A company that produces motor cars might outsource the manufacture of most (or even all) of
the component parts, so that its only ‘in-house tasks’ are product design, assembly, testing and
marketing.
 Many companies outsource their IT requirements to specialist IT firms.
 Some companies outsource most of their office administration tasks, such as record keeping and
word processing.
The reasons for outsourcing

Competitive advantage Value addition Skills /Cost-effective Time saving
Competitive advantage Outsourcing work to entities that Outsourced work might Management
over rivals can be achieved have core competencies in those areas require specialist skills can focus on its
by concentrating on its own shall be able to add value more that the entity cannot offer stregths, not the
core competencies and effectively than the entity itself would (e.g. career structure to routine and
activities. have carried out the work internally. full-time specialists) ordinary
Problems with outsourcing

 A potential problem with outsourcing is the loss of control over the outsourced activities. This can be
significant when something goes wrong, and action performance does not meet expectations.
 The nature of the relationship with suppliers of outsourced work is critical.
Let's say a company outsourced its IT work to a software company to write new software; when written, it
wasn’t functioning properly. The problem was then to manage the external relationship with the software
company, to find a satisfactory solution to the problem.
Virtual Organisation
An organisation that does not have identifiable physical existence (HO, centre of operations, full-time employee)
as have outsourced all operations. It is a network of individuals linked by computers and telecommunications
network (such as the internet) and business contacts. E.g.
 Small businesses -a house builder (core competence is his personal skill and experience)
 Large businesses - a company that sells branded footwear (core competence is its brand name)
A key to a successful virtual organisation is the successful management of all the different external
relationships, and successful co-ordination of their activities.
The virtual company has been made possible by developments in IT technology.

Restructuring
Restructuring may be vertical and horizontal both. Different organizations merge functions, sections
and departments according to the technological advancement and continuously restructure the
organizational structure. Like real time, online data availability has shifted the regional decision
making into centralized decisions.
Online Social Media

Social media has changed the business models. Personal and business entities now have become the
digital identities. Physical interactions, traditional marketing, traditional businesses have effected
through digital social media.
Big Data
Extremely large data sets are being gathered, analysed computationally to reveal patterns, fashions,
trends, associations and preferences, especially relating to human behaviour and interactions. These
big data sets are being used to take business decisions.
Artificial Intelligence
Artificial intelligence has shifted the paradigm. Different business segments are using artificial
intelligence, various services are being provided with the help of artificial intelligence. For example:
 Online assistance to the customers is being provided through the artificial intelligence.
 Frequently occurring problems are being solved using artificial intelligence.
 Routine decision making is also being done with the help of artificial intelligence.
INFORMATION TECHNOLOGY AND INFORMATION SYSTEMS
Information Technology
Information technology consists of both computer technology and communications technology.
Developments in IT have had an enormous impact on business.
 IT developments have resulted in many new products (computers, mobile telephones), and
improvements in many existing products (televisions and other domestic appliances).
 IT developments have also radically altered methods of communication. Mobile telephones and e-
mail make it possible to communicate instantly with anyone in virtually any part of the world. It is
possible to communicate with more people and more quickly. 
 The Internet has emerged as a major source of external and easily accessible information. 
 Internal databases are a major source of data that can be used by management for obtaining
information. 
 Commercial transactions can be processed more quickly. 
 E-commerce transactions are processed through the Internet. Changes in IT will continue, and
some changes will have a significant impact on business strategy for many entities.
IT as strategic support
IT and changes in IT affect every business entity. Business entities should be prepared to change as IT
changes, and to take advantage of new opportunities provided by IT, rather than try to oppose change.
IT should be used constructively as a means of setting strategic targets and implementing product
market strategies

Information systems (IS)

All organisations process and use information. Businesses depend on information technology for
everything from running daily operations to making strategic decisions. Computers are the tools of this
information age, performing extremely complex operations as well as everyday jobs such as word
processing and creating spreadsheets. The pace of change has been rapid since the personal computer
became a fixture on most office desks. Individual units became part of small networks, followed by
more sophisticated enterprise-wide networks.
 Basic transactions must be recorded and processed – a bookkeeping system, for example, is a
transaction processing system. 
 Management also use information to plan and make decisions. The quality of their planning and
decision-making, from strategic decisions to day-today operating decisions, depends on having
reliable and relevant information available. 
The main types of information system in organisations include:
Transaction processing systems. These are systems for processing routine transactions, such as
bookkeeping systems and sales order processing systems.
Management information systems. These are information systems for providing information,
mainly of a routine nature, to management. The purpose of a management information system (MIS)
is to provide management with the information they need for planning and controlling operations.
Typically, a MIS is used to provide control information by measuring actual performance and
comparing it against a plan or budget. A budgeting and budgetary control system is an example of an
MIS.
Decision support systems. A decision support system (DSS) is used by managers to help them to
make decisions of a more complex or ‘unstructured’ nature. A DSS will include a range of decision
models, such as forecasting models, statistical analysis models and linear programming models. A
DSS therefore includes facilities to help managers to prepare their own forecasts and to make
decisions on the basis of their forecast estimates. Models can also be used for scenario testing.
Executive information systems. An executive information system (EIS) is an information system

for senior executives. It gives an executive access to key data at any time, from sources both inside
and outside the organisation. An executive can use an EIS to obtain summary information about a
range of issues, and also to ‘drill down’ into greater detail if this is required. The purpose of an EIS is
to improve senior management’s decision-making by providing continual access to up-to-date
information.
Expert systems. An expert system is a system that is able to provide information, advice and
recommendations on matters related to a specific area of expertise. For example, there are expert
systems for medical analysis, the law and taxation – used mainly by doctors, solicitors and
accountants!
Enterprise Resource Planning. Enterprise resource planning (ERP) is software that allows an
organization to use a system of integrated applications to manage the business and automate many
back office functions related to technology, services and human resources.
Company-wide enterprise resource planning (ERP) systems that bring together human resources,
operations, and technology are becoming an integral part of business strategy. So is managing the
collective knowledge contained in an organization, using data warehouses and other technology
tools.

IT CONTROL & EFFECTIVENESS
Threats to systems security

Business organisations rely on IT systems to function. For example, accounting and performance
management systems are often computerised, and likely contain large amounts of confidential data.
Computer systems need to be kept secure from errors, breakdown, unauthorised access and corruption.
Maintaining system security, even for small home computers linked to the internet, is a permanent
problem and the risks must be managed continually.
Some of the major risks to IT systems are as follows:
 Human error. Individuals make mistakes. They may key incorrect data into a system. In some
cases, they may wipe out records, or even an entire file, by mistake. Human error is also a common
cause of lapses in system security – leaving computer terminals unattended is just one example.
 Technical error. Technical errors in the computer hardware, the software or the communications
links can result in the loss or corruption of data.
 Natural disasters. Some computer systems may be exposed to risks of natural disasters, such as
damage from hurricanes, floods or earthquakes.
 Sabotage/criminal damage. Systems are also exposed to risk from criminal damage, or simply
theft. Risks from terrorist attack are well- publicised. Losses from theft and malicious damage are
much more common.
 Deliberate corruption. All computer systems are exposed to risk from viruses. Hackers may also
gain entry to a system and deliberately alter or delete software or data.
 The loss of key personnel with specialist knowledge about a system. For example, the risk that
a senior systems analyst will leave his job in the middle of developing a complex new system.
 The exposure of system data to unauthorised users. For example hackers and industrial espionage.
In addition, there are risks within the computer software itself:
 The software might have been written with mistakes in it, so that it fails to process all the data
properly. 
 The software should contain controls as a check against errors in processing, such as human errors
with the input of data from keyboard and mouse. The software might not contain enough in-built
controls against the risk of input error and other processing errors.
General controls and application controls

Systems controls can be divided into two categories:
 General controls, and
 Application controls.
a) General controls are controls that are applied to all IT systems and in particular to the development,
security and use of computer programs. Examples of general controls are:
 Physical security measures and controls
 Physical protection against risks to the continuity of IT operations
 General controls within the system software such as passwords, encryption software, and software
firewalls 
 General controls over the introduction and use of new versions of a computer program

 The application of IT Standards.

b) Application controls are specific controls that are unique to a particular IT system or IT application.
They include controls that are written into the computer software, such as data validation checks on
data input.
General controls in IT
Physical access controls
Physical controls in an IT environment are the physical measures to protect the computer systems such
as:
 Putting locks on doors to computer rooms and keeping the rooms locked to prevent unauthorised
staff entering the room.
 Putting bars on windows, and shatterproof glass in computer room windows, to deter a break-in.
Computer systems are vulnerable to physical disasters, such as fire and flooding. Risk control measures
might include:
 Locating hardware in places that are not at risk from flooding and away from locations that are in
low-lying areas
 Physical protection for cables (to provide protection against fire and floods)
 Back-up power generators, in the event of a loss of power supply
 Using shatter-proof glass for windows where the computer is located
 Installing smoke detectors, fire alarms and fire doors
 Regular fire drills, so that staff know what measures to take to protect data and files in the event
of a fire
 Obtaining insurance cover against losses in the event of a fire or flooding. 
Note that in some organisations, risk measures have also been taken to counter the risk to computer
systems from terrorist attack, and ensure that the computer system will continue to operate even if
there is a damaging attack. For example, two companies might agree to allow the other to use its
mainframe systems to operate key computer systems, in the event that one of them suffers the
destruction of its system in a terrorist attack.
Passwords
 A computer password is defined as ‘a sequence of characters that must be presented to a computer
system before it will allow access to the systems or parts of a system’ (British Computer Society
definition).
 Typically, a computer user is given a prompt on the computer screen to enter his password. Access
to the computer system is only permitted if the user enters the correct password.
 Passwords can also be placed on individual computer files, as well as systems and programs.
 To gain access to a system, it may be necessary to input both a user name and a password for the
user name. For example, a manager wanting to access his e- mails from a remote location may
need to input both a user name and the password for the user name.
 However, password systems are not always as secure as they ought to be, mainly due to human
error.
Problems of password systems include the following:

 Users might give their passwords to other individuals who are not authorised to access the
system.
 Users are often predictable in their choice of passwords, so that a hacker might be able to guess,
by trial and error, a password to gain entry to a system or program or file. (Typically, users often
select a password they can remember, such as the name of their father or mother, or the month of
their birth).
 Passwords are often written down so that the user will not forget it. Copied passwords might be
seen, and used, by an un-authorised person.
 Passwords should be changed regularly, but often-poor password control management means that
passwords go unchanged for a long time.
A system of password controls should operate more successfully if certain control measures are taken.
 Passwords should be changed regularly frequently, and employees should be continually reminded
to change passwords.
 Users should be required to use passwords that are not easy to guess: for example, an organisation
might require its employees to use passwords that are at least 8 digits and include a mixture of
letters and numbers.
 A security culture should be developed within the organisation, so that the user’s staff are aware
of the security risks and take suitable precautions.
Encryption
 Encryption involves the coding of data into a form that is not understandable to the casual reader.
 Data can be encrypted (converted into a coded language) using an encryption key in the software.
 A hacker into a system holding data in encrypted form would not be able to read the data, and
would not be able to convert it back into a readable form (‘decrypt the data’) without a special
decryption key.
 Encryption is more commonly used to protect data that is being communicated across a network.
It provides a protection against the risk that a hacker might intercept and read the message.
 Encryption involves converting data into a coded form for transmission with an encryption key in
the software, and de-coding at the other end with another key. Anyone hacking into the data
transmission will be unable to make sense of any data that is encrypted.
 A widely-used example of encryption is for sending an individual’s bank details via the Internet.
 An individual buying goods or services from a supplier’s web site may be required to submit credit
card details. The on-line shopping system should provide for the encryption of the sender’s details
(using a ‘public key’ in the software for the encryption of the message) and the decryption of the
message at the seller’s end (using a ‘private key’ for the decryption).

Preventing or detecting hackers

Various measures might help to prevent hacking into a system, or to detect when a hacker has gained
unauthorised access. However, the fight against hacking is never-ending, and computer users must be
alert at all times.
Controls to prevent or detect hacking include:
 Physical security measures to prevent unauthorised access to computer terminals
 The use of passwords
 The encryption of data
 Audit trails, so that transactions can be traced through the system when hacking is suspected
 Network logs, whereby network servers record attempts to gain access to the system
 Firewalls. 
Firewalls
Firewalls are either software or a hardware device between the user’s computer and modem. Computer
users might have both.
The purpose of a firewall is to detect and prevent any attempt to gain unauthorised entry through the
Internet into a user’s computer or Intranet system.
A firewall:
 Will block suspicious messages from the Internet, and prevent them from entering the user’s
computer, and
 May provide an on-screen report to the user whenever it has blocked a message, so that the user is
aware of the existence of the messages.
In spite of the preventive measures that are taken, there is a very high risk that computers attached to
the Internet will suffer from unauthorised access. An organisation would be well advised to carry out
regular tests on its computers, to search for items that have been introduced without authority and
illegally, and to get rid of them.
Firewalls can be purchased from suppliers. Some software is provided with in- built firewall software.
Some firewall software can be downloaded free of charge from the Internet. There is no excuse for a
computer user with Internet access not to have a firewall.
Firewalls are necessary for computers with Internet access because:
 They are continually exposed to corrupt messages and unauthorised access for as long as they are
connected to the Internet (which may be 24 hours a day) and
 The volume of ‘suspicious’ messages circulating the Internet is immense.
Computer viruses
Viruses are computer software that is designed to deliberately corrupt computer systems. Viruses can
be introduced into a system on a file containing the virus. A virus may be contained:
 In a file attachment to an e-mail or
 On a backing storage device such as a CD.

Viruses vary in their virulence (the amount of damage they may cause to software or data). The most
virulent viruses are capable of destroying systems and computers by damaging its operating system.
Viruses are written with malicious intent, but they may be transmitted unwittingly. Since a virus does
not always begin to corrupt software or data immediately, there is time for a computer user to transmit
the virus to another computer user, without knowing.
New viruses are being written continually. Some software producers specialise in providing anti-virus
software, which is updated regularly (perhaps every two weeks). This includes software for dealing
with the most recently-discovered viruses.
Anti-virus software is able to:
 Detect known viruses in a file
 Report the virus to the computer user
 Isolate the virus so that it is not able to corrupt software or data in the computer.
There are a number of measures that might be taken to guard against computer viruses. These include
the following:
 The computer user should buy and install anti-virus software. Since new viruses are written daily,
the anti-virus software must be updated regularly. Providers of anti-virus software allow customers
to download updated versions of their software regularly. 
 The computer user might restrict the use of floppy disks and re-writable CDs, because these are a
source of viruses. The computer user may even install computer terminals that do not have a CD
drive or floppy disk drive, to eliminate the risk of a virus being introduced on a disk. 
 Firewall software and hardware should be used to prevent unauthorised access from the Internet.
This will reduce the risk from e-mails with file attachments containing viruses. 
 Staff should be encouraged to delete suspicious e-mails without opening any attachments.
 There should be procedures, communicated to all staff, for reporting suspicions of any virus as
soon as they appear.
When a virus is detected in the computer system, it may be necessary to shut the system down until
the virus has been eliminated.
IT Standards
A range of IT Standards have been issued. For example, the International Standards Organisation (ISO)
has issued IT security system standards. There are also IT Standards for the development and testing
of new IT systems.
IT Standards are a form of general control within IT that help to reduce the risk of IT system
weaknesses and processing errors, for entities that apply the Standards.
Application controls in IT
Application controls are controls that are designed for a specific IT system. One example of application
controls is data validation. Data validation checks are checks on specific items of data that are input to
a computer system, to test the logical ‘correctness’ of the data. If an item of data appears to be incorrect,
the system does not process the data: instead it issues a data validation report, so that the apparent error
can be checked and corrected if appropriate.
Just a few examples of data validation checks are set out below, as illustration.

 A transaction for a sales invoice input to the accounting system must include an amount for the
sales value/amount owed. If a transaction is input to the system without any value for the amount
receivable, an error report should be produced.
 A transaction for the purchase of goods from a supplier input to the accounts system should include
a code number for the supplier. If all supplier codes are in the range 2000 – 3999, an input purchase
transaction containing a supplier code outside this range can be reported as an error.
 Key code numbers can be designed to include a ‘check digit’. This is an additional digit in the code
that enables the program to check the code against an input error (such as entering a customer
account code as 12354 instead of 12345).
Application controls of this kind are unique to a particular IT system, but are a way of preventing
errors from entering the computer system for processing, and reporting errors so that they can be
corrected.
Monitoring of controls
It is important within an internal control system that management routinely review and monitor the
operation of the control system to satisfy themselves that controls remain adequate, effective and
appropriately applied.
IT controls audit
Large organisations might employ an internal audit team which is then responsible for testing and
assessing systems of internal control including IT controls. The organisation could also employ IT
auditors who specialise in a particular IT system relevant to their business.
Alternatively, IT control audit might be outsourced to a firm of independent auditors (and potentially
even the company’s current external auditors).
Organisations might perform IT controls auditing on a cyclical basis addressing different parts of the
system during each audit. For example they might assess the sales and receivables modules during the
first half of the year followed by the purchases and inventory modules during the second half.
Exception reporting
IT control systems must incorporate exception reporting to ensure management are alerted to any
control failures. This might occur on a periodic (e.g. daily / weekly / monthly) or real-time basis.
Effectiveness of IT control monitoring

The ultimate effectiveness of IT control monitoring is driven by the action taken by management to
address control failures when they occur.
For example, exception reporting has no impact if management either fail to review exception reports,
and/or fail to act on the recommendations. This applies as equally to reports (and their
recommendations) issued by both internal and external auditors.
Note that the directors have a legal duty to safeguard a company’s assets on behalf of the shareholders.
This implies they have a responsibility for implementing, maintaining and monitoring an effective
system of internal controls, including IT controls.

Data warehouse and Data marts

 Data warehouse combines many databases across whole company into 1 central database.
 With this, managers can easily access and share data across the enterprise to get a broad
overview rather than just small pieces of information.
 Data warehouses include software to extract data from databases, maintain the data in the
warehouse, and provide data to users.
 They can analyze data much faster than transaction-processing systems.
Data warehouses may contain many data marts

(special subsets of a data warehouse that each deal with particular area or department).
 Companies use data warehouses to gather, secure, and analyzing data for many purposes,
including customer relationship management, fraud detection and product-line analysis.
o Retailers might wish to identify customer demographics and shopping patterns
o Banks can more easily spot credit-card fraud, as well as customer usage patterns.

PRACTICE QUESTIONS
Q.1
Alpha, a small management consultancy firm, deals with corporate trainings on various finance
matters. It gets the required training data in an Excel format through email. The data is kept on a
central computer that can be accessed remotely through the internet with a password. Recently, a
long-standing corporate client has asked Alpha to provide consultancy on an investment decision.
Not willing to pass the opportunity, the directors at Alpha have said yes to the client as they believe
that their senior executives have the capability to perform the task. However, the directors are
concerned about the risks of handling such sensitive and confidential investment information with
the existing IT controls in place.
Required:
Briefly explain the general system software controls that Alpha should employ to protect data
confidentiality. (04)
Q.2
Al-Zamin (AZ) is a producer of cement and related products. In a recent evaluation of the existing
operations, the management of AZ is considering to adopt virtual supply chain. In the first phase, AZ
would implement e- procurement system where focus would be on e-sourcing, e-purchasing and e-
payment. If process runs smoothly, AZ would adopt a comprehensive virtual supply chain.
Required:
Suggest any two examples of data validation checks that would assist the management of AZ to
ensure that data input in the system is correct. (04)
Q.3
Superb Engineering Limited (SEL) manufactures parts and components for assembly/
manufacture of automobiles. During the past few years, the company has witnessed phenomenal
growthin its product lines and sales revenues have registered significant growth. However, the
overall profitability has not shown a corresponding increase. SEL considers that a substantial
proportion of the efforts and energies of the management and staff at various levels are expended
in handling a very wide range of diversified activities. SEL is, therefore, examining the
feasibility of outsourcing certain activities of its operations to outside parties.
You are required to identify four advantages and disadvantages each of Business Process
Outsourcing in the above situation for SEL. (06)
Q.4 (Spring 2022)

Identify and briefly explain the type of information system used in each of the following examples:
(i) Book keeping and sales processing systems.
(ii) A budgeting and budgetary control systems.
(iii) System designed to provide information, advice and recommendations on pharmaceutical
productsto doctors at a hospital.
(iv) System that includes statistical and forecast models to help managers assign annual sales targets.
(v) An integrated system that connects all departments in the organization. (07)
Q.5 (Autumn 2023-Q5)

Pak Healthcare (PH) is an expanding medical facility that has three branches across the city. To ensure
the confidentiality of information when communicating across branches, PH follows a strict policy of
protecting all data using public-private key encryption. PH uses astandalone proprietary software,
installed at each branch, for encryption. The software generates the keys and is also used to encrypt or
decrypt the data when the keys are provided. All the employees are instructed to communicate encryption

related messages through PH’s secure chat channel.

Shehzad, a newly-hired Customer Services Representative, used his own public key to encrypta file. He
then sent his private key through the secure chat channel to a colleague in another branch.
Required:
(a) Explain the process of public-private key encryption. (02)
(b) Highlight the issues with Shehzad's actions and recommend corrective measures. (04)
Q.6 (Spring 2024-Q2)

Presented below are scenarios of three entities, each confronting unique challenges necessitating
structural changes.
(i) Easy Foods (EF), a long standing frozen food items producer with a large workforce, has
started using automatic production and packaging machinery, which has greatly reduced
manual work and production time. As a result, 45% of the workforce now faces reduced
hours or no work.
(ii) Spicy Foods (SF), structured with multiple management levels, faces decision-making
challenges and delays in addressing issues. In a recent presentation to the CEO, human
resource department highlighted that technological advancements in SF have resulted in 40%
overlapping duties across many levels of management.
(iii) Shiza Autos (SA), a growing automobile assembly plant, initially hired security staff
through personal contacts and has been managing them manually, leading to
operational challenges. SA recognises its lack of expertise in this domain and
acknowledges the absence of technological tools necessary for efficient security process
management.
Required:
(a) Briefly explain the strategies of outsourcing, restructuring, downsizing and de-layering in the
context of the impact of technological changes and the need for organizational adjustments. (04)
(b) Suggest the right strategy for each of the mentioned entities, based on the strategies
explained in part (a) above. Provide reasons for your answer. (04)
Clear your mind of can’t

Chapter 5: Technological Disruption and Business Environment
CHAPTER 5
Technological Disruption and
Business Environment
Disruptive Technology
Disruptive technology relates to instances where technology is used to fundamentally change and ‘disrupt’ the
existing business model in an industry.
An example of a disruptor is the passenger service Uber which created a business model using technology
which avoided the need for licensed drivers, a vehicle fleet, local booking services etc. Instead, customers use
their internet connected device to hail a ride and all payments are handled by a smartphone app.
 The key reason for the growth of new disruptive businesses is from technology. Not only from the
technology that they employ in order to cut costs and improve efficiency, but also in the access that
consumers now have to technology in the modern on-demand economy. For example, many disruptive
businesses rely on smartphone applications or have internet-only based transactions.
 The two largest growth sectors for disruptive technology are in health services and financial services.
Financial technology (commonly known as Fintech) is, for example, completely disrupting the traditional
banking sector – long seen as a highly technical, highly regulated industry dominated by giant banks.
Fintech businesses exist which can provide investment advice, offer banking services, transfer money
internationally, provide mortgages and loans, exchange currency etc.
 Disruptive technology is an innovation that significantly alters the way consumers, industries, or
businesses operate.
Blockchain as an Example of Disruptive Technology
 Blockchain (technology behind Bitcoin) is a decentralized distributed ledger
 It records transactions between two parties and moves transactions from a centralized server-based system
to a transparent cryptographic network.
 It uses peer-to-peer agreement to record and verify transactions removing the need for manual
verification.
 Uses are many like for financial institutions such as banks and stock brokerages.
Disruptive Technologies of the digital age

 Disruptions are always first resisted by humans, but then they adopt it when see that useful..
 IT is combining with improvements in specific industry technology in almost every sector
 These days IT is moving faster than ever, driven by developments in 3 basic areas;
• Processing power,
• Communication speed
• Storage capacity.
The Internet
 One of the most visible and widely used technological innovations over the past decade has been the
Internet.
 The Internet is a global network of interconnected computers, enabling users to share information along
multiple channels linking individuals and organizations.
 Internet has revolutionized how business are conducted, education is imparted and households operate.
 In today’s, nearly every manager has a desktop or laptop, fax, voice mail, mobile phone etc.
 New ways of going online are contributing to the growing use of the Internet.

E-Business
 E-business has been defined as the transformation of key business process through the use of internet
technologies.
 E-business has grown dramatically and become a way of life for all type of businesses
 With the affordability and ease of technology, small and medium businesses have invested in e-business
and technology systems
 It gave the businesses a competitive edge over rivals by enabling them to add new services
 All businesses are more open to modify their business models with use of technology
M-Commerce
 Cell phone users all over the world have embraced mobile phone as a way of conducting commerce.
 M-commerce, commerce conducted via mobile or cell phones, provides consumers with an electronic
wallet when using their mobile phones.
 People can trade stocks or make consumer purchases of everything from hot dogs to washing machines
and countless other products.
 Today, so many companies provide the option to customers to turn their smartphones into devices for
making purchases.
Social networking
 A system using technology to connect, explore interests and share activities around world
 Many businesses use social media tools to reach out to their customers.
 It has now become a major marketing channel.
 Major online advertising tools include:
• Search Engine Optimization (SEO)
• Facebook Ads
• Google Ads and clicks
• Website banners
Blogs and Vlogs.

 A blog is a web-based journal or log maintained by an individual with regular entries of commentary,
descriptions, or accounts of events or other graphics or video etc.
 a lot of businesses (apparel, cosmetics, electronics and hospitality) use the medium of bloggers to push
their products in the market and compete with other brands.
 This is done through free products, invitations to brand launch events.
 A new generation of blogs appeared in the first decade of the 21st century, called vlogs, or video web
logs.
 All that was needed was access to a digital camera that could capture moving images and high-speed
Internet access.
EFFECTS OF DISRUPTION IN MAJOR INDUSTRIES

Technology and internet-based companies are accelerating pace of disruption at alarming rate.
 Google has completely disrupted the Yellow Pages business which was once valued at $60 billion and is
now below one billion dollars.
 Bookings.com/ Hotels.com / Airbnb, worth over $25 billion has disrupted the hotel industry by
accumulating the largest inventory of rooms without owning a single property.
 Uber, worth over $50 billion, has completely disrupted the local travel and taxi business without owning a
single car.
Mind not at ease, Opportunities hard to seize

Chapter 5: Technological Disruption and Business Environment
PRACTICE QUESTIONS
Q.1 (Spring 2023 – Q3)
(a) FabTabz (FT) designs, assembles, packages and distributes high-end tablets. FT is known for its
unique designs and recognizes it as their core product offering. Due to a recent surge in demand, FT is
facing challenges in meeting customer orders in a timelymanner without compromising on product quality.
FT is considering outsourcing someof its activities to meet the demand.
Required:
Explain outsourcing and provide reasons why FT should opt for outsourcing to meet the demand. Also,
explain which activities should FT outsource. (05)
(b) Explain what disruptive technology means. Also, state two examples of disruptive technology.
(03)

CHAPTER 6
Comprehensive example of Chapter 1 to 5
PESTEL ANALYSIS: COUNTRY OR REGION – Macro Analysis
When was a lad we made do with PEST (Political Economic, Social; Technological) before it expanded
into a SLEPT analysis (Legal was added or rather separated, out- from Political). Now another element
has been added-Ecological or Environmental.
Under the previous examiner students used to wet their knickers as to whether they should use a
PEST/SLEPT/PESTEL for external analysis or some or framework notably a Five Forces analysis. In
theory the decision should have been simple PESTEL for countries/macro environment analysis and
Five Forces for industries environment analysis but sometimes the examiner did not play by these
rules.
PESTEL contains no theory- it is simply a set of headings under which to analyses a country or regional
environment. Although they are reproduced below from the manual it is pointless to learn them! The
trick is to be able to apply them.
POLITICAL ECONOMIC
 degree of state intervention  Economic growth rates
 power holders and elites  inflation rates
 stability and continuity  exchange rates
 policies  unemployment
 income levels
 monetary policy (Interest rate)
 fiscal policy
SOCIAL
 demographic
 social structure and
inequalities ECOLOGICAL
 culture, values and beliefs  power of environmental pressure groups
 family patterns  environmental policies (e.g. specific issues
 work and leisure patterns relating to energy, pollution, greenhouse gases,
and recycling)
TECHNOLOGICAL
 degree of sophistication
 technical standards LEGAL
 rate of diffusion and impact Employment law, company law, consumer law,
 product & process technology environmental law at both the country and regional level.
 technical infrastructure

Chapter 6: Comprehensive Examples of Chapter 1 to 5
PRACTICE QUESTIONS
Q.1
Flavorsome, a US-based fast food chain has gained worldwide recognition due to unique taste,
exemplary ambiance and economy meals. It is considering to exploit an opportunity to expand its
business in major cities of Xanata.
Xanata is a developing country where demand for fast food is ever increasing and during the last
decade, local as well as international fast food chains have enjoyed substantial profits. Despite
widening wealth gap, fast food has gained immense popularity among lower and middle class.
However, social awareness groups are pressurizing health ministry to revise public health policy by
introducing stringent regulations on food industry.
The government is offering tax holiday to encourage foreign investment. This incentive is strongly
being opposed by local business community. In the past few years, Xanata has seen high inflation
rate and the government is considering to raise the minimum wage rate by 25%.
Burger Buddy, a leading local fast food chain is gaining popularity beacause of its social
contributions, advanced technologies, use of social media / mobile application for promotional
activities, etc.
Required: Identify the environmental factors relevant to the above situation and group them for the
purpose of PEST analysis. (12)
Q.2
Cure Limited (CL), a leading pharmaceutical company is considering starting its operations in
Malan, one of the developing countries. It has conducted environmental scan and summarized the
following information.
The pharmaceutical industry in Malan is regulated through Drug Regulatory Framework. The overall
health environment is not conducive. Despite of increasing rate of inflation and declining consumer
disposable income, demand for pharmaceutical products has been increasing considerably. Over 25%
of population comprises of children and old age people who are more prone to health issues.
However, interest in healthy life style is getting popularity among youth.
The Govt. of Malan has introduced many business friendly policies particularly for pharmaceutical
industry, by allowing tax holidays as incentive for new investments, and granting subsidized interest
rate loans to encourage research and development activities.
The trend of e-commerce is emerging in the country and more and more people are using mobile
apps and social media for making online orders. The key players in pharmaceutical industry have
been using social media to market their products and CSR activities, such as use of renewable
energy, conducting free public health awareness sessions, sponsoring treatment of needy patients,
etc.
Required:
(a) Perform PESTEL analysis of pharmaceutical industry in Malan (10)
(b) Briefly explain how CL may capitalize on any two available opportunities and how any two
existing threats may impact CL. (04)
Q.3
National Solutions (NS) is a privately owned high technology company established in 2002 by
computer engineer, Bill Gates. It is situated in the country of Redland, a prosperous developed
nation with a stable well established political system. Successive governments in Redland have
promoted technology by providing grants and tax incentives. Tax credits are also provided to offset
company investment in research and development. The government, like many governments
worldwide, has invested heavily in a national telecommunications Infrastructure.

However, in 2019 the country suffered an economic downturn that led many companies to postpone
technological investment.
In 2019, NS had three distinct product/service areas – data communication components, network
management systems and, finally, technical support.
The international market for data communication components had increased from Rs.3.3 trillion in
2015 to Rs.8.1 trillion in 2019. Forecasts for 2020 and beyond predict growth from increased sales to
currently installed networks. The maturity of the technology means that product lifecycles are
becoming shorter. NS produces components in a relatively prosperous country where there is
significant legislation defining maximum work hours and minimum wage rates. All new components
have to be approved by an appropriate government approval body in each country that NS supplies.
This approval process is both costly and time consuming.
The second product area is network management systems. The success of their product led to it being
awarded a prestigious government technology award for “technological innovation in data
communications”. This further enhanced the company’s reputation. They only have two or three
competitors in this specialist market. Unlike component manufacture, there is no requirement to seek
government approval for new network products.
Required
Evaluate the macro-environment of NS using a PEST analysis. (12)
Q.4
Business Environment of Ryde
Ryde is a rapidly growing transportation service provider. It is an app that connects users who are
interested in car pooling their way to work or around the city. People like its features such as easy
accessibility through the mobile app and sharing of commute. The company believes that it will
provide easy commute to people and also help address traffic congestion issues.
However, there are controversies such as minimum wage laws for drivers and bans by some
authorities that make it difficult to compete. Drivers have questions about its insurance policy in
case of an accident, will the company:
 hold the driver as accountable or,
 take the blame on itself.
Moreover, businesses like Ryde have given rise to a ‘shared’ economy where there is no need to
invest in physical assets or hire a large workforce for the provision of service.
A lot of factors come into play considering the environment of Ryde’s business model.
It is important to analyze the environmental factors of business. Suppose you are hired as a
consultant to plan the launch of Ryde in Pakistan and are asked to study the external business
environment of Ryde? You may quote examples to support your findings.
Q.5
Assessing the Business Environment of Froot
FROOT is a leading brand of fruit juice concentrates operating in local and international markets
such as the United States, Canada, UAE and Europe. Senior Management of FROOT is due to start
working on their next 5-year plan. The business environment of the beverages market keeps
changing and the management is of the view that a fresh environmental analysis should be carried
out before embarking the next five-year plan.
The company has faced a lot of business issues and survived a difficult time during the recent
COVID-19 pandemic. What factors in the business environment should be considered for a company
like FROOT?

Q.6
The Launch of Hike in Pakistan
Hike is globally renowned brand that manufactures and distributes world class apparel and
equipment used in hiking and mountaineering sports. The company is headquartered in Italy serving
all of Europe and North America.
Recently the GM Marketing of Hike visited the northern areas of Pakistan and saw that the country
has tremendous potential for adventure based tourism in Gilgit Baltistan. He also observed that a lot
of local as well as foreign tourists visit the northern areas for hiking expeditions and adventure
sports. Upon his return to Italy, he has suggested to his CEO that the company should enter the
Pakistani market to sell their products.
The CEO has asked for a proposal before a final decision can be made. You are required to develop
an external analysis as part of his proposal to launch in Pakistan. You may quote examples to
support your findings.
Q.7
Business Environment Analysis for InfoTech
InfoTech is a manufacturer of spare parts of information and communication technology products
such as smart phones, computers and network devices.
InfoTech is exploring new markets to diversify and expand its business. Some planning experts have
identified People’s Republic of Highland.
Highland is also one of the fastest growing countries in relation to technological advancement and
adoption since it has a literacy rate of 70% and most of the workforce are university graduates.
Highland remained under the shadows of its neighbor for a long time and remained more inclined
towards a communist political ideology. Only recently the country has started encouraging foreign
companies to invest in business and commercial infrastructure.
The government of Highland wants to promote the booming IT industry and therefore is keen to find
out more about InfoTech and its business.
Before the management of InfoTech makes a decision, they want to analyse to business environment
it will operate in. What are the elements of the business environment that InfoTech should focus on?
Q.8 (Spring 2023 – Q6)

Star Business School (SBS), a renowned world-class education provider, is offering a range ofdegree
courses in business, accounting, finance, human resource, hospitality management, marketing, and supply
chain management. The school boasts a strong faculty, high-quality research, state-of-the-art
infrastructure, and a zero-tolerance policy for quality education.
SBS has been receiving grants from the government to support its futuristic educational activities.
However, due to political instability and a deteriorating economic situation in the country, the educational
sector has experienced a decline in grants over the past year. Further,it has been under consideration that
the grant shall be given to a university only on the recommendation of the Higher Education
Commission and its related bill has recently been placed before the National Assembly.
In order to remain competitive, SBS has invested heavily in the latest software and technologyfor its
education program, to ensure smooth delivery of lectures both online and in-person. Itis also reserving
seats and offering scholarships for international students, and is working on student and faculty exchange
programs with world-class universities. SBS's long-term plans include launching various online programs
for international students and opening facilitationoffices in countries with a high potential for
collaborations and international students.
Required: Conduct PESTEL analysis on the information provided for SBS. (10)

Q.9 (Spring 2024 – Q3)

Electrik Automobile (EA), a renowned multinational company is currently considering the establishment of an
electric car assembly plant in Paland. With manufacturing and assembly plants spread across various
countries, EA aims to capture the growing market for electric vehicles. The proposal includes selling a specific
number of electric cars locally in Paland and exporting the remaining production to various parts of the world.
EA's strategic move is drivenby the absence of electric car assembly facilities in Paland, presenting an
opportunity to cater to the evolving preferences in the automotive industry.
With the evolution of the automotive industry, electric cars are positioned not only as efficient means of
transportation but also as lifestyle choices and status symbols across the world. EA's target demographic in
Paland consists of individuals seeking eco-friendly alternatives amid rising petrol prices. Despite the
somewhat unstable political and economic conditions in Paland, the government is actively working to
instill confidence among foreign investors by providing tax exemptions and strengthening emission
regulations, aligning with EA's expansion plans. This venture not only promises economic benefits and job
opportunities for the local population but also addresses the increasing environmental concerns by introducing
electric vehicles to the market.
Required:
(a) Perform PESTEL analysis of electric automobile industry in Paland. (08)

CHAPTER 7
Competitive Forces
Industry Analysis
In the analysis of strategic position, management need to recognise which industries and segments they
operate in, and also which markets they are selling to. They also need to recognise changing conditions
in industries, segments and markets, in order to decide what their product-market strategies should be
in the future.
Generic types of industry

Porter suggested that there are five generic types of industry. The strategic position of a company
depends to some extent on the type of industry it is operating in. The five industry types are as follows:
 Fragmented industries. In a fragmented industry, firms are small and each sells to a small
portion of the total market. Examples are dry cleaning services, hairdressing services, and shoe
repairs.
 Emerging industries. These are industries that have only just started to develop, and are likely
to become much bigger and much more significant in the future. Examples are the global space
travel industry and the telecommunication industry in Africa.
 Mature industries. These are industries where products have reached the mature phase of their
life cycle. (The product life cycle is described later.) Examples are automobile manufacture and
soft drinks manufacture.
 Declining industries. These are industries that are going into decline: total sales are falling and
the number of competitors in the market is also falling. An example in coal mining in Europe.
 Global industries. Some industries operate on a global scale, such as the microprocessor
industry and the professional football industry.
Convergence
Occasionally, two or more industries or industrial segments converge, and become part of the same
industry, with the same customer markets. When convergence is happening, or might happen in the
future, this can have a major impact on business strategy. Example: Communications services
Demand-led and supply-led convergence

Convergence can be either demand-led or supply-led.
 Demand-led convergence, the pressure for industry convergence comes from customers.
Customers begin to think of two or more products as interchangeable or closely complementary.
 Supply-led convergence suppliers see a link between different industries and decide to bridge
the gap between the industries. The convergence of the entertainment, voice communication and
data communication industries, discussed in the previous example, is probably supply-led,
because suppliers became aware of the technological possibilities before consumers became
aware of the convenience.

Chapter 7: Competitive Forces
The Five Forces model

Michael Porter (in The Competitive Environment) provides a model for analysing competitiveness in
an industry or market which is called the Five Forces model, because he identified five factors (‘five
forces’) that determine competitiveness. These are:
Threat from: Bargaining power of : Competitive Rivalry
Potential substitute Supplier Customer
entrants products
Refers to the It arises when When major Powerful buyers It is the rivalry
threat of new customers can supplier (e.g. such as between the
business switch easily Microsoft) or supermarkets competing business
entities to buying suppliers charge (buyers in the entities. Strong
entering the alternative high prices to market of consumer competition forces
market and products i.e. their business goods) are able to rival firms to offer
adding without substitute customers and force down prices their products at a low
much difficulty products. It these businesses from suppliers for price (relative to the
to competition. varies between are unable to pass re-sale, using the product quality) and
Competitive markets and it on to their own threat of refusing to this keeps profitability
forces are industries. customers buy and switching low.
reduced when (charging higher to other suppliers
the barriers to prices for their thus profit margins
entry (see own products) are low in the
below) are thus competition manufacturing
high. is strong. industries.
Explanation Examples Porter suggested that the force might be strong in the following
situations:
Firms already Domestic  small number  volume of their  rival firms are of
in the market heating of suppliers purchases is roughly the same
keep their systems: (gas- to the market high relative to size & economic
prices and fired, oil fired  no substitutes size of the strength
profits low. and electricity- for products supplier  there are many
fired) supplied  undifferentiated- competitors in
If prices went  supplier’s rival supplier’s industry/market
up and Transport (Air, product is an products are  fairly fixed total
company profit rail and road) important largely the same amount of sales
margins component in  low switching and customers
improved, new Food and drink the end- cost from one (slow growth in
firms would be products products that supplier to demand)
tempted to (branded are made with another supplier  undifferentiated-
come for higher coffee, other it rival firm’s
profits and manufacturers products are
competition in of coffee and largely the same
the market is also  withdrawal cost of
strong. manufacturers the industry is
of tea) very high

Barriers/Deterrents to entry:
These are factors that make it difficult for new entrants to break into the market. A number of factors
might help to create high barriers to entry:
Economies of scale
• Refers to reductions in average costs that are achieved by producing and selling an item in larger
quantities.
• An industry where economies of scale are large it is difficult for a new firm to enter the market as its
average costs will be higher than those of the existing large-scale producers and thus cannot make
their products relatively cheaper or to sell them at a lower price.
Government regulation
• Regulations within an industry, or the granting of rights, can make it difficult for new entrants
to break into a market (e.g. obtaining a licence to operate, or getting registered to operate
within an industry.
• Further the existing companies might have patent rights that prevent new competitors from
‘copying’ the products that they make.
Switching costs
• It is the costs that a buyer has to incur in switching from one supplier to a new supplier.
• In some industries, it might be high making it difficult for new entrants to break into a market
• For example, the costs for a company of switching from one audit firm to another might be
quite high, and deter a company from wanting to change its auditors.
Capital investment requirements

• Where a new entrant to the market would have to make a large capital investment in assets
(factory premises and equipment) this will act as a barrier,
• Reason behind is ‘investment risk’ (loss of substantial amount of money if new business
venture fails)
Access to distribution channels

In some markets, there are only a limited number of distribution outlets or distribution channels.
It would be difficult in gaining access to any of these distribution channels, the barriers to entry
will be high.
Know-how
It is time-consuming and expensive for a new entrant to a
market to acquire the ‘know-how’ and experience to be
successful.

STRATEGIC GROUPS AND MARKET SEGMENTATION

Strategic groups
 Another approach to analysing and understanding the competitors in a market is to group them into strategic
groups.
 A strategic group is a number of entities that operate in the same industry and that have similar strategies
or that are competing in their markets in a similar way.
 Strategic groups have been defined as: ‘Clusters of firms within an industry that have common specific
assets and thus follow common strategies in key decision variables’ (Oster).
 The strategies of all the companies in a strategic group will be similar.
 When there are only a few competitors in the same industry, the concept of strategic groups has no practical
value, because each competitor can be analysed individually.
 However, when there are many competitors in the industry, it can simplify the analysis to put them into
strategic groups of entities with similar resources and similar strategies.
 For the purpose of competitor analysis, all the entities in the same strategic group can then be treated as if
they are a single competitor. Instead of analysing each competitor individually, they can be analysed
collectively, in groups.
 Three strategic groups might be identified:
 Companies that seek to maintain their position in the market
 Companies that seek to innovate and develop new products
 Companies that consider marketing to be the key to strategic success.
The strategic priorities of the companies in each group might differ as follows.
Maintain market Marketing-based
position Innovators strategies
Priority
1 Cost reduction Consistent quality Consistent quality
2 Short lead time Rapid product Dependable
for delivery design/change delivery
3 Consistent quality Dependable delivery Cost reduction
4 Dependable Improved product Short lead time
delivery performance for delivery
Note: A lead time is the time between a customer placing an order and delivering the product to the customer.
When the strategic objective is a short lead time, the aim is to deliver the product as quickly as possible after a
customer has ordered it.
Dependable delivery means being able to state when and where a product will be delivered to the customer and
meeting this promise.
The main concerns of all manufacturing companies are broadly similar, but their priorities differ. This means
that their strategies are likely to be different, as companies in each strategic group pursue their own priorities.

Strategic space
When all the companies in an industry are put into strategic groups, and these groupings are analysed, a strategic
space might become apparent.
A strategic space is a gap in the market that is not currently filled by any strategic group. The existence
of strategic space might provide an opportunity for a company to make a strategic initiative, and attempt to fill
the space that no other rivals occupy.
Example: Price v. quantity
One way of identifying strategic groups within an entire market is to classify market position in terms of price
and quality. Some firms will offer lower-priced products, but their quality is probably not as good. Other firms
might offer higher- quality products for a higher price.
The strategic groups in a market might be mapped according to price and quality as follows:
This map indicates that there are four strategic groups, each in a different market position in relation to price
and quality. The largest group, Group 2, sells products with a middle-range price and middle-range quality.
This method of analysis can help an entity to identify possible gaps in the market– strategic space. When there
is a perceived gap in the market, an entity might decide on a strategy of filling the empty space by offering a
product with the characteristics that are needed to fill the gap.
If the positioning of entities in a market is analysed by price and quality, as above, possible strategic spaces
might be identified as follows:
In this example, an entity might decide to target a position in the market where it sells a high-quality product
for a low price, because there are no firms yet in this part of the market. Alternatively, there might be a market
for even higher-quality products at an even higher price. The entity might even decide to fill the gap between
Group 1 and Group 2.

Product differentiation
 A market can be identified as a group of customers or potential customers for a particular product or range
of related products.
 Business entities often use differentiation to make their products attractive to customers in the market – so
that customers will buy their products rather than those of competitors.
 In most markets, products are differentiated in various ways. They are similar, but there are also noticeable
differences. Differences in products include differences in:
o product design
o pricing
o branding.
 Products might also be differentiated by the way in which they are delivered to customers. For example,
banking services might be delivered through a branch network or as an internet service.
 Similarly, consumers can buy products in shops or through the internet; or they can buy a hot meal by going
to a cafeteria or restaurant, or by ordering a home-delivery meal. 
Market segmentation
 A business entity might choose instead to target its products at a particular section or segment of the market.
 A market segment is a section of the total market in which the potential customers have certain unique and
identifiable characteristics and needs.
 Instead of trying to sell to all customers in the entire market, an entity might develop products or services
that are designed to appeal to customers in a specific market segment.
 Market segmentation is the process of dividing the market into separate segments, for the purpose of
developing differing products for each segment.
 Example: Cars
The market for motor cars might be segmented according to the design of the car, for example:
 four-door or two-door family saloon car (with or without hatchback) – and with differing engine sizes
 two-seater sports cars
 people carriers
 4 × 4 vehicles
 electric-powered cars
For car dealers, the market for cars can also be segmented into the new cars market and the used cars market.
Each type of car design is intended to appeal to the needs of a different segment of car buyers.
Methods of segmenting the market

Market segmentation is important for strategic management for two main reasons:
 It provides a basis for analysing competition in a market or industry.
 It provides a basis or framework for making strategic choices. 
There are various ways of segmenting the market, and identifying different groups of customers. Methods of
segmenting the market include segmentation by:
 geographical area
 quality and performance
 function (for example, within the market for footwear, there are market segments for running shoes, football
boots, hiking boots, riding boots, snow boots, and so on)

 type of customer: for example, consumers and commercial customers

 social status or social group
 age: adults, teenagers and younger children might all buy different types of similar products, such as
computer games or music downloaded from the internet
 life style. 
Example: Socio-demographic
An entity might decide to segment a market according to the life style of customers. Possible life style segments
include single people under 30 years of age, newly-married couples with no children, married couples with
youngchildren, married couples with teenage children, married couples whose children are grown up and have
left home, retired couples, and retired single people.
This form of market segmentation can be useful for certain products and services such as:
 holidays
 motor cars
 some food and drink products
 entertainment products.
Market segmentation and strategic space

A similar analysis of strategic groups can be made to identify possible target market segments. In the example
below, the strategic groups are analysed by life style of customers.
This analysis suggests that there are possibly gaps in the market for a product, and that a product is not
currently being made and sold that might appeal specifically to individuals whose children have left home or to
individuals who have retired from working.
Having analysed the market and identified these strategic spaces, management can go on to assess whether a
strategy based on developing an amended product specifically for these gaps in the market might be strategically
desirable and financially worthwhile.
Identifying gaps in a market can be a particularly useful method of competition analysis for companies that are
considering whether or not to enter into a market for the first time.

LIFE CYCLE MODEL

A ‘life cycle’ is the period from birth or creation of an item to the end of its life. Products, companies and
industries all have life cycles. A product life cycle begins with its initial development and ends at the time that
it is eventually withdrawn from the market at the end of its life.
A life cycle is said to go through several stages. The ‘classical’ life cycle for a product, or even an entire industry,
goes through four stages or phases:
 Introduction
 Growth
 Maturity
 Decline. 
Introduction phase. During this stage of a product life cycle, there is some sales demand but total sales are
low. Firms that make and sell the product incur investment costs, and start-up costs and running costs are high.
The product is not yet profitable.
Growth phase. During the growth phase, total sales demand in the market grows at a faster rate. New entrants
are attracted into the market by the prospect of high sales and profits. At an early stage during the growth phase,
companies in the market begin to earn profits.
Maturity phase. During the maturity phase, total annual sales remain fairly stable. Prices and profits stabilise.
The opportunity for more growth no longer exists, although the life of the product might be extended, through
product updates. More companies might seek to improve profits by differentiating their products more from
those of competitors, and selling to a ‘niche’ marketsegment.
Decline phase. Eventually, total annual sales in the market will start to fall. As sales fall, so too do profits. This
leads to companies leaving the market, which continues until it is no longer possible for any company to turn a
profit from the product. When the last supplier exits the market the product lifecycle is complete.
A ‘classical’ product life cycle is shown in the following diagram.
Not all products have a classical life cycle. Unsuccessful products never become profitable. A
business entity might be able to ‘revitalise’ and redesign a product, so that when it enters a decline
phase, its sales can be increased again, and it goes into another period of growth and maturity.
The length of a product life cycle can be long or short. A broad type of product, such as a motor car, has a longer
life cycle than particular types of the product, such as a Volkswagen Beetle or a Ford Escort.
At each phase of a product’s life cycle:

 selling prices will be altered

 costs may differ 
 the amount invested (capital investment) may vary
 spending on advertising and other marketing activities may change. 
Example: Life cycle of a smartphone
The lifecycle of a smart-phone is relatively short and in some cases even less than a year due to the rapid
developments in modern technology.
Soon after announcing the imminent launch of a new model in their smart-phone range, companies like Apple,
Samsung and HTC discount the price of their existing models in order to maximise sales and clear inventory.
This attracts ‘bargain hunters’ who are happy to purchase ‘old models’ for a lower price and avoid paying the
premium required for the new models.
Cost implications of the product life cycle

Life cycle costing can be important in new product launches as a company will of course want to make a profit
from the new product and the technique considers the total costs that must be recovered. These will include:
 Research and development costs (decisions made at the development phase impact later costs);
 Training costs
 Machinery costs
 Production costs
 Distribution and selling costs
 Marketing costs
 Working capital costs
 Retirement and disposal costs
Stage Costs
Product  R&D costs
development  Capital expenditure decisions
Introduction to the  Operating costs
market  Marketing and advertising to raise product awareness
 Set up and expansion of distribution channels
Growth  Costs of increasing capacity
 Maybe learning effect and economies of scale Increased costs of
working capital
Maturity  Incur costs to maintain manufacturing capacity
 Marketing and product enhancement costs to extend maturity
Decline  Close attention to costs needed as withdrawal decision might be

expensive
Withdrawal  Asset decommissioning costs
 Possible restructuring costs Remaining warranties to be supported

Benefits of Life cycle costing

Life cycle costing compares the revenues and costs of the product over its entire life. This has many benefits.
 The potential profitability of products can be assessed before major development of the product is carried
out and costs incurred. Non-profit- making products can be abandoned at an early stage before costs are
committed.
 Techniques can be used to reduce costs over the life of the product.
 Pricing strategy can be determined before the product enters production. This may lead to better control of
marketing and distribution costs.
 Attention can be focused on reducing the research and development phase to get the product to market as
quickly as possible. The longer the company can operate without competitors entering the market the more
revenue can be earned and the sooner the product will reach the breakeven point.
 By monitoring the actual performance of products against plans, lessons can be learnt to improve the
performance of future products. It may also be possible to improve the estimating techniques used. 
Life cycle analysis as a technique for competition analysis

Life cycle analysis is also useful for assessing strategic position and the nature of competition in a market. The
number of competitors in the market ‘now’, and the number of competitors that might exist in the future, will
be influenced by the phase that the product has reached during its life cycle.
Cycle of competition
A cycle of competition is another concept for understanding the behaviour of competitors in a market.
When one company achieves some success in a market, competitors might try to do something even better in
order to gain a competitive advantage. A new initiative by one company will result in a counter-measure from
another company. Each company in the market tries to do something different and better.
A typical cycle of competition affects prices and quality. If one company has a large share of a profitable market,
a rival company might start to sell its product at a lower price. Another rival company might improve the quality
of its product, but sell it at the same price as rivals in the market. The first company might respond to these
initiatives by its rivals by improving its product quality and reducing the selling price.
The effect of a cycle of competition in a growing market is that prices fall and quality might improve.
In the maturity phase of a product’s life cycle, or in the decline phase, it becomes more difficult to lower prices
without reducing quality. Competitors might try to gain a bigger share of the market by selling at a lower price,
but the product quality might be reduced. This can lead to a ‘spiral’ of falling prices and falling quality, to the
point where the product is no longer profitable, and it is less attractive to customers.
The concept of the cycle of competition is useful for strategic analysis, because it can help to explain the
strategies of companies in a market, and to assess what future initiatives by competitors might be.

The Boston consulting group (BCG) matrix

 The two-by-two matrix classifies businesses, divisions or products according to the present market share and
future growth of that market.
 Growth is seen as the best measure of market attractiveness.
 Market share is seen to be a good indicator of competitive strength.
Relative Market Share
High
PROBLEM STAR
Market CHILD
Growth (%)
DOG CASH COW
Low
Low High
Question mark / Problem Child

 A question mark is a product with a relatively low market share in a high-growth market.
 The market is growing quickly, there is an opportunity to increase market share.
 It will require a substantial investment of cash to increase or even maintain market share.
Star
 A star has a high relative market share in a high-growth market.
 It is the market leader.
 However, a considerable investment of cash is still required to maintain its leading position.
 Over time, stars should gradually become self-financing.
 At some stage in the future, they should start to earn high returns.
Cash cow
 A cash cow is a product in a market where market growth is lower, and possibly even negative.
 It has a high relative market share, and is the market leader.
 It should be earning substantial net cash inflows, because it has high economies of scale and will
have become efficient through experience.
 Cash cows should be providing the business entity with the cash that it needs to invest in
question marks and stars.
Dog
 A dog is a product in a low-growth market that is not the market leader.
 It is unlikely that the product will gain a larger market share.
 A dog might be losing money, and using up more cash than it earns.
 However, a dog may be providing positive cash flows.
 Although the entity has a relatively small market share in a low-growth market (or declining
market), the product may be profitable.
 A strategic decision for the entity may be to choose between immediate withdrawal from the
market (and perhaps selling the business to a buyer, for example in a management buyout) or
enjoying the cash flows for a few more years before eventually withdrawing from the market.

 It would be an unwise decision, however, to invest more capital in ‘dogs’, in the hope of
increasing market share and improving cash flows, because gaining market share in a low-growth
market is very difficult to achieve.
Weaknesses in BCG model analysis

There are several criticisms of the BCG model.
 It might be difficult to define the market.
 There might be problems with defining the geographical area of the market. A market might be
defined in terms of a single country, a region of a country or as an international or global market.
 It might also be difficult to identify which products are competing with each other. For example,
the total market for cars may be divided into different categories of car, but there may be problems
in deciding which models of car belong to each category.
 A product can have a strong competitive position in market, even with a low market share.
 Competitive strength can be provided by factors such as product quality, brand name or brand
reputation, or even low costs.
 BCG matrix might be better for analysing performance of strategic business units (SBUs) and
market segments but It is not so useful for analysing entire markets

Practice Questions
Q.1
Muntaha Group (MG) is considering to introduce airline services in a developing country. The
management of MG is in the process of analysing the airline industry to determine the intensity of
competition.
Required: Explain the competitive forces that may have shaped the airline industry, considering
Portor’s Five Forces Model. Your answer should clearly mention the strength of each force with
related arguments. You may assume necessary detail.
Q.2
Identify the force of competition which is relevant in the context of Michael Porter’s Five Forces
Model of Competition in each of the scenarios presented below. Substantiate your answer by
highlighting the salient features of the Model of Competition selected by you in each of these
scenarios.
(i) Four companies of similar size and strength are engaged in the manufacture of detergent
powder for washing clothes. These companies are key market players and jointly share 95%
of the aggregate market which is not expected to witness any significant growth in the
foreseeable future.
(ii) Sound health Pharmaceuticals and Good care Pharmaceuticals are manufacturers of
two new medicines for treatment of cancer. The medicines have been developed after a long
period of research at a very substantial R&D cost and are highly effective. Both the existing
manufacturers are earning exceptionally high profits in a market which is expected to witness
growth in the future.
(iii) Lucky Coal Mines Limited is the sole supplier of coal to a cement plant located in close
proximity to the mines. The cement plant requires substantial quantities of coal for firing of its
kilns. Quality of this coal is most suitable for the cement plant and also cost- effective due to
low transportation costs. Lucky Coal Mines has several buyers who are willing to purchase the
coal because of its high calorific value. (06)
Q.3
SinoPharma (SP), is engaged in manufacturing and selling of pharmaceutical products. The
following information pertains to two of its products:
InstaB
It is a mature branded product whose patent expired at the end of 2015. Thereafter, two
competitors launched their generic products i.e. GenA and RapidA in 2016 and 2017
respectively. The table below shows sales volume of InstaB, GenA and RapidA over the years:
Year 2014 2015 2016 2017 2018 2019 2020* 2021 2022
--------------------- Sales volume in '000 ---------------------
InstaB 220 220 115 90 80 70 60 50 45
GenA - - 110 108 90 94 100 112 116
RapidA - - - 26 55 60 63 62 63
Total market size 220 220 225 224 225 224 223 224 224

* indicates current year

Azkaard
Azkaard was launched in 2012 in the market and its patent is expiring in 2022. It continues to enjoy
great returns in a mature low growth market. However, SP is concerned that Azkaard too will meet
the fate of InstaB unless proper competitive strategies are planned before its patent expires. One of
the suggestions is to discontinue Azkaard as soon as the patent expires and utilize the resources on
other products which have potential in the existing market.
Required:
By using the information provided above, analyze and recommend the strategies for InstaB and
Azkaard from the perspective of Boston Consulting Group (BCG) Matrix. (10)
Q.4 (MFA Model Paper - Q.2)

Fashionista by Agha Ansari is considering growth opportunities for its organisation which has the
followingdivisions:
Salon:
This division was a brainchild of Agha Ansari. It was established in early 1990s and got immediate
recognition and appreciation because of state-of-the-art design and highly qualified stylists. This
division has a dominant position having substantial market share. Although overall market is
maturing and has low growth rate, this division has been earning high returns on investment.
Cosmetics:
This division was established six years ago. The cosmetic industry has been emerging; however,
presently thisdivision has low market share.
Required:
According to the Boston Consulting Group Matrix:
(a) Identify and discuss the quadrants in which above divisions fall. (06)
(b) Discuss any two strategies that Fashionista may adopt for each of its divisions. (08)
Q.5
Etihad Limited manufactures and sells three products. The following information is available in this
regard:
Year Product -1 Product -2 Product -3
(See note-1) (See note-2) (See note-3)
Sales Market Sale Market Sale Market
Size s Size s Size
Actual ………. Rs. in millions ……….
2017 74 132 3 70 10 100
2018 72 134 2 71 14 120
2019 74 133 2 69 16 140
Forecasted
2020 73 135 2 68 18 160
2021 74 134 1 62 22 190
Note 1: Product 1 is a long-standing product that has been consistently selling in the same market.
Note 2: Product 2 has been consistently selling in the same market for quite some time.
Note 3: Product 3 was introduced in 2017 and is still considered new in the market.

In the current year, 2019, the market share of the biggest competitor for Product 1 is 20%,
Product 2 is 44% and Product 3 is 37%.
Required:
Analyse the information provided above and devise strategies for each of three products.
Q.6
Captain of the Sea (COS) is a state of the art cruise ship with an enormous capacity to carry5000
passengers. It has been built to display several striking features for a cruise ship. Thisincludes one of
a kind 3-storey full-length shopping mall that continues to attract a large number of customers and
repeat business.
Required:
Suggest how following the strategy, helps COS in providing a suitable defence against eachof
Porter’s five competitive forces. (05)
Q.7
Glory is a series of high-end smartphones and tablets designed, manufactured and marketed by
Marvel Group (MG). MG is highly regarded for innovative product designs and aggressive
marketing campaigns. The mobile phone industry is one of the fastest growing sectors of
economy where a number of competitors attempt to outperform each other in terms of product
designs, features and pricing.
MG is in the process of introducing new series of foldable smartphones (Glory Ultimate) that
could be a vital breakthrough in mobile phone industry. The management of MG intends to
adopt life cycle costing for Glory Ultimate.
Required:
(a) Discuss the benefits that MG may enjoy by adopting life cycle costing (03)
(b) List the costs that MG might have to incur in each phase of the life cycle of Glory
Ultimate. (04)
(c) Suggest the strategies that MG may adopt to extend the maturity phaseof Glory
Ultimate. (04)
Q.8
Discuss the relevant competitive environment in the context of Michael Porter’s Five- Forces
Model of Competition in each of the three scenarios presented below. Substantiate your answer
by stating the significant characteristics of competitiveenvironment facing the organisations in
each of the scenarios.
(i) Ocean Ship Breaking Company is located in a country which has access to skilled low-cost
manpower, convenient berthing/ship-dismantling facilities, liberal tax incentives and an
expanding domestic market for sale of steel scrap. Despite the abovefavourable factors, very
few entrepreneurs have interest in this so called ‘dirty and demanding’ business. On the other
hand, the shipping industry is facing a surplus of unserviceable vessels. These vessels have to
be scrapped as early as possible due to their high maintenance costs and port charges.
(ii) Two companies have developed genetically modified rice seeds after intensive research at
a considerable cost. These companies have also made substantial investments in physical
facilities for producing the seeds. These seeds have resulted inunprecedented increase in per
acre yields in the three countries in which these seeds have been marketed to-date. Both the

companies expect phenomenal increase in their revenues and earnings after they launch their
products in other rice growing countriesdue to the envisaged demand in these countries.
(iii) In Country PQR there are six cement manufacturers of similar strength andresourcefulness.
These manufacturers share among themselves 90 percent of the aggregate market which is
expected to remain stagnant due to lack of demand for newhousing and absence of plans for
major infrastructure projects in the country in the foreseeable future. (09)
Q.9
The advent of internet has revitalized the competition in the global markets. It has increasingly
become a vital component of business strategy and a strong catalyst for survival and growth in
a competitive environment.
In the context of retail industry, discuss the impact of internet on each of the Porter’s five
competitive forces clearly identifying whether internet has strengthened or weakened these
forces. (10)
Q.10
A company produces five different products, and sells each product in a different market. The
following information is available about market size and market share for each product. It
consists of actual data for each of the last three years and forecasts forthe next two years.
Last Current Next year

(Rs. million) Year - 2 year year Year + 1 Year + 2
Year -1
Actual Actual Actual Forecast Forecast
Product 1
Total market size 50 58 65 75 84
Product 1 sales 2 2 2.5 3 3.5
Product 2
0
Product 2 sales 78 77 80 82 82
Product 3
Product 4
Product 5
Product 5 sales 4 5 5.5 6 6.5
In the current year, the market share of the market leader, or the nearest
competitorto the company, has been estimated as follows:

Market share of market leader or the company’s nearest competitor

Market for: %
Product 1 37
Product 2 26
Product 3 12
Product 4 29
Product 5 20
Required
Using the Boston Consulting Group model, how should each of these products be
classified?
How might this analysis help the management of the company to make strategicdecisions
about its future products and markets (‘product-market strategy’)?
Q.11
Horizon Limited (HL) is engaged in the business of manufacturing and marketing of a wide
range of consumer durable products. The company’s products are at different stages of their
Product Life Cycles. Consequently, HL pursues different promotional strategies for products
depending on the stage of their Product Life Cycles.
Required
State the types of Promotional Strategies which HL may pursue for marketing of itswide
range of products in the
(i) Introduction, (ii) Growth, (iii) Maturity and (iv) Declining stages of their Product Life Cycle
Q.12
The purpose of market segmentation is to divide a market into different sections, eachwith a
distinctive group of potential customers. A segmentation strategy is thendeveloped, and a
different marketing mix is used to market a product to each segment.Typically, a different price
is charged for the product in each segment, but it may be necessary to vary the product offered
to each segment of the market, in order to meetthe needs of customers in that segment.
Required
Suggest ways in which a railway company might segment its market for rail travel.
Q.13
A tuition company provides a range of tuition services and educational publications tostudents
preparing for professional accountancy examinations.
Required
Suggest ways in which the tuition company might segment its market for teachingservices
and products.

Q.14 (Spring 2022 – Q2)

AUM manufactures and sells two products. Presented below is the information available on each of the
two product.
Product 1:
This product is the first product AUM introduced in the market and carries strong brandvalue. Its
repute carries positive influence on many other AUM business activities. Whenthe product was
introduced, its market share quickly grew to 4% and has remained steadyfor a long time now. Its
market share is 7% less than the market leader. The overall marketis growing by 2.5% year on year
basis.
Product 2:
This product has been consistently selling and enjoying high profits in the same market for quite some
time now. The annual market growth for this product is 5% and market share is merely 1.5% less than
the only competitor in the market.
Required:
For each of the products presented above:
(a) Identify the quadrant and explain the corresponding strategies from the perspective of
Boston Consulting Group (BCG) Model. (05)
(b) Highlight the relevant criticism of BCG Model and recommend future strategies
accordingly. (05)
(Note: 10% is taken as a low/high cut-off for market growth under BCG model)
Q.15
Saldia, a country in Asia, does not allow import of automobiles as a national policy. It is now
considering to dissolve this policy. Discuss the impact of allowing the import of automobiles on each
of the Porter’s five competitive forces on Saldia’s automobile industry.
Your answer should also clearly mention whether the changed policy would strengthen or weaken
each of these forces. (08)
Q.16
Introduction
Shoal plc is a well-known corporate organisation in the fish industry. It owns 14 companies
concerned with fishing and related industries.
This scenario focuses on three of these companies:
ShoalFish Ltd – a fishing feet operating in the western oceans.
ShoalPro Ltd – a company concerned with processing and canning fish.
ShoalFarm Ltd – a company with saltwater fish farms.
Shoal plc is also finalising the purchase of the Captain Haddock chain of fish restaurants.
ShoalFish
Shoal plc formed ShoalFish in 20X2 when it bought three small fishing feets and consolidated them
into one feet. The primary objective of the acquisition was to secure supplies for ShoalPro. Forty per
cent of the fish caught by ShoalFish are currently processed in the ShoalPro factories. The rest are
sold in wholesale fish markets. ShoalFish has recorded modest profits since its formation but it is
operating in a challenging market-place. The western oceans where it operates have suffered from
many years of over-fishing and the government has recently introduced quotas in an attempt to
conserve fish stocks.

ShoalFish has 35 boats and this makes it the sixth largest feet in the western oceans. Almost half of
the total number of boats operating in the western oceans are individually owned and independently
operated by the boat's captain. Recent information for ShoalFish is given in Figure 1.
ShoalPro
ShoalPro was acquired nearly 20 years ago when Shoal plc bought the assets of the Trevarez
Canning and Processing Company. Just after the acquisition of the company, the government
declared the area around Trevarez a 'zone of industrial assistance'. Grants were made available to
develop industry in an attempt to address the economic decline and high unemployment of the area.
ShoalPro benefited from these grants, developing a major fish processing and canning capability in
the area. However, despite this initiative and investment, unemployment in the area still remains
above the average for the country as a whole.
ShoalPro's modern facilities and relatively low costs have made it attractive to many fishing
companies. The fish received from ShoalFish now accounts for a declining percentage of the total
amount of fish processed and canned in its factories in the Trevarez area. Recent information for
ShoalPro is given in Figure 1.
ShoalFarm
ShoalFarm was acquired in 20X4 as a response by Shoal plc to the declining fish stocks in the
western oceans. It owns and operates saltwater fish farms. These are in areas of the ocean close to
land where fish are protected from both fishermen and natural prey, such as sea birds. Fish stocks
can be built up quickly and then harvested by the fish farm owner. Shoal plc originally saw this
acquisition as a way of maintaining supply to ShoalPro.
Operating costs at ShoalFarm have been higher than expected and securing areas for new fish farms
has been difficult and has required greater investment than expected. Recent information for
ShoalFarm is given in Figure 1.
20X7 20X8 20X9
ShoalFish $m $m $m
Turnover of market sector 200.00 198.50 190.00
Turnover of ShoalFish 24.00 23.50 21.50
Gross profit 1.20 1.10 1.05
ShoalPro
Turnover of ShoalPro 16.00 16.20 16.50
ShoalFarm
Turnover of ShoalFarm 1.00 1.10 1.12
Figure 1: Financial data on individual companies 20X7–20X9
Required
In the context of Shoal plc's corporate-level strategy, assess the contribution and performance of
ShoalFish, ShoalPro and ShoalFarm. Your assessment should include an analysis of the position of
each company in the Shoal plc portfolio. (15)

Q.17 (Autumn 2022 – Q5)

Barganza Limited (BL) manufactures and markets four consumer durable products. Presented
below are the main costs incurred on each of the products:
Product A: Costs of setting up and expansion of distribution channels
Product B: Costs of withdrawals
Product C: Marketing and product enhancement costs to extend product life cycle
Product D: Increased costs of working capital
Required:
(a) Identify and explain the stage of product life cycle for each product. (06)
(b) From your answer to (a) above, for each product:
(i) provide one more cost, other than marketing and advertising cost, that is
likelyincurred. (03)
(ii) suggest a promotion strategy BL may pursue. (04)
Q.18 (Autumn 2023 – Q4)

In the bustling city of Urbana, the micro-mobility industry is a fierce battleground for major players:
SpeedyScoot, CityRiders, and GoGreenBike. Newcomers face significant challenges with high start-up
costs and strict government rules. However, customers enjoy a diverse range of micro-mobility options
from the existing players, making it easy to switch between them. To stay ahead, companies use
competitive pricing, enticing loyalty programs, and unique features. As the industry matures,
speculations of mergers and acquisitions raise the stakes in this micro-mobility showdown.
The thriving micro-mobility sector owes its success in Urbana to its convenience for short- distance
commutes. Established players compete through innovation in technology, pricing, coverage area, and
fleet quality. There are numerous suppliers, primarily small to medium- sized firms offering innovative
products. Urbana's well-planned infrastructure, with dedicatedbike lanes and convenient parking, nurtures
a culture of embracing micro-mobility for short commutes. Meanwhile, an efficient public transport
system caters seamlessly to longer journeys, providing a comprehensive transportation solution for
residents. The race for the ultimate winner in this dynamic micro-mobility market remains uncertain,
making it an exciting and intriguing market to observe.
Required:
Perform a Porter’s five forces analysis of Urbana's micro-mobility industry. Include the strength of
each force and provide supporting arguments. (09)
Q.19 (Autumn 2023 – Q6)

Suave, a renowned premium clothing brand known for offering formal office attire for men, caters to
unique styles targeting adults aged 18 to 40 years. However, in the face of intensifyingcompetition and
ever-evolving consumer preferences, Suave is contemplating narrowing its focus to a specific age group
within their target market. This shift will better utilize its limitedbudget and penetrate the market segment
for higher revenues. During an open discussion forum with the employees, Suave received the following
options for segments to target:
(i) Senior Executives: This segment consists of adults aged 45 to 60 years. They have a
high disposable income and an appreciation of stylish clothes.
(ii) Savvy Entrepreneurs: This segment consists of cost-conscious entrepreneurs aged
30 to 40 years, who are seeking stylish yet affordable attire.
(iii) College Fashionistas: This segment consists of fashion-forward college students aged
18 to 25 years. They aim to make a stylish statement on campus, despite potentially
having limited disposable income.

Required:
(a) Briefly discuss the suitability of each option. (03)
(b) Recommend a new suitable segment for Suave to consider. Provide reason(s) for your
recommendation. (02)
“Two things are infinite:

The universe and human stupidity;
And I'm not sure about the universe.”
— Albert Einstein

Chapter 8: Internal Analysis
CHAPTER 8
Internal Analysis
Value chain analysis
The concept of the value chain
It is a series of activities, each of which adds value. The total value added by the entity is the sum of
the value created by each stage along the chain. Johnson and Scholes have defined the value chain
as: ‘the activities within and around an organisation which together create a product or service.’
Michael Porter technique

A technique used by Michael Porter who pointed out that within a business entity:
o there is a primary value chain, and
o there are support activities (also called secondary value chain activities).
Primary value chain

This value chain applies to manufacturing and retailing companies, but can be adapted for companies
that sell services rather than products. Porter identified the chain of activities in the primary value
chain as follows:
Outbound
Inbound logistics logistics Service.
Operations Marketing and

sales
These are the The activities The activities These are the activities All the activities that
activities concerned concerned with concerned with the associated with the occur after the point
with purchased converting the  storage of ‘4Ps’ of marketing, of sale. Such as
material/components purchased materials finished goods namely; product,  installation,
receiving handling into an item that before sale, and place, price, and  warranties,
and storing until customers will buy.  distribution & promotion.  repairs and
needed. delivery of How to attract / maintenance,
goods (or persuade / exploit the  providing
services) to the customers and sell training to the
customers products to them. employees of
customers
In a manufacturing In a manufacturing For services it relates Aspect of service is
company it include: company it include: to often the work of
 materials  machining,  delivery of a  customer call
handling,  assembly, service at the centres
 transport from  packing, customer’s own  customer service
suppliers,  testing and premises centres
 inventory  equipment
management maintenance
and
 inventory
control
Variety
The nature of the activities in the value chain varies from one industry to another, and there are also
differences between the value chain of manufacturers, retailers and other service industries.
However, the concept of the primary value chain is valid for all types of business entity.

Secondary value chain activities: support activities

In addition to primary value chain activities, there are also support activities. These are the activities
that create value within each primary activity. For example consider how human resource
management adds value to inbound logistics, operations, outbound logistics and so on.
Activities which Porter identified those are:
Purchasing- concerned with buying the Technology development- introduction

resources for the entity. of a new IT system
Successful buying means Technology also includes acquiring
knowledge (R & D). In this sense all
lower purchase costs, or achieving a activities have some technology
secure source of supply for key content, even if this is just acquired
materials or components knowledge
Corporate infrastructure- relates to the

Human resources management -
organisation structure and its
concerned with recruiting, training,
management systems
developing and rewarding people in the
organisation. It includes planning and finance
management, quality management and
E.g. Value can be added by improving
management information systems
the skills of employees through training (MIS).
Support activities are often seen as necessary ‘overheads’ to support the primary value chain, but
value can also be created by support activities.
 Human resource can add value by improving the skills of employees through training.
 Purchasing can add value by identifying cheaper source of materials or equipment.
 Corporate infrastructure can help to create value by providing a better management

information system that helps management to make better decisions.
 Technology development can add value to operations with the introduction of a new IT
system.
Primary Activities

VALUE CHAIN
 Value relates to the benefit that a customer obtains from a product or service.
 Value is provided by the attributes of the product or service.
 Customers are willing to pay money to obtain goods or services because of the benefits they
receive. The price they are willing to pay puts a value on those benefits.
 Business entities create added value when they make goods and provide services. For example, if
a business entity buys a quantity of leather for Rs.1,000 and converts this into leather jackets, which
it sells for Rs.10,000, it has created value of Rs.9,000.
Different ways of adding value

Value is added by all the activities on the primary value chain. Out of many few are mentioned
below:
Reliable
Better Design/
Easy to Buy/ Service/
Unique Brand Quick Service
Conveniece Customer
Features
Services
A product might Value can be added That is a Value can be Value can be
be designed with by making it easier customers know added by added by
added features for the customer to that they will promoting a delivering a
that might meet buy a product. receive service: brand name. service or product
the needs of a E.g.by  on time, at Successful more quickly. For
particular type of  Providing a the promised branding might example, a private
customer better website time give customers hospital offering
than products  Placing  to a good a sense of treatment to
that are currently bookstores at standard of buying products patients more
in the market. places such as performance or services with quickly than other
airport a better quality. hospitals in the
For example, terminals. For example, region.
Accu-Check is  Delivered items Emirates For example,
known for its to their home Airlines is PepsiCo. has For example,
accurate measure known for its been branding Domino Pizza is
for diabetic For example, excellent its association known for quick
patients. availability of customer with cricketers order delivery.
products of multiple services. successfully.
brands at Amazon
with option of
online payment.

RESOURCES AND COMPETENCES

Resources
An entity uses resources to provide products or services to its customers. A resource is any asset,
process, skill or item of knowledge that is controlled by the entity.
Resources can be grouped into categories:
 Human resources. These are the leaders, managers and other employees of an entity and their
skills. 
 Physical resources. These are the tangible assets of an entity and include property, plant and
equipment and also access to sources of raw materials. 
 Financial resources. These are the financial assets of the entity and the ability to acquire additional
finance if this is required.
 Intellectual capital. This includes resources such as patents, trademarks, brand names and
copyrights. It also includes the acquired knowledge and ‘know-how’ of the entity.
Threshold resources and unique resources

A distinction can be made between threshold resources and unique resources.
 Threshold resources are the resources that an entity needs in order to participate in the industry
and compete in the market. Without threshold resources, an entity cannot survive in its industry
and markets.
 Unique resources are resources controlled by the entity that competitors do not have and would
have difficulty in acquiring. Unique resources can be a source of competitive advantage.
Competences
 Competences are activities or processes in which an entity uses its resources. They are created by
bringing resources together and using them effectively. 
 Competences are used to provide products or services, which offer value to customers. 
 A competence can be defined as an ability to do something well. 
Threshold competencies and core competencies

A distinction can be made between threshold competences and core competences.
 Threshold competences are activities, processes and abilities that provide an entity with the
capability to provide a product or service with features that are sufficient to meet customer needs
(the ability to provide ‘threshold’ product features).
 Core competences are activities, processes and abilities that give the entity a capability of meeting
the critical success factors for products or services and achieving competitive advantage.
Sustainable core competences

 Core competences might last for a very short time, in which case they do not provide much
competitive advantage.
 Competitive advantage is provided by sustainable core competences. These are core competences
that can be sustained over a fairly long period of time – over a period of time that is long enough
to achieve strategic objectives.
 Sustainable competences should be durable and/or difficult to imitate.

 Durability. Durability refers to the length of time that a core competence will continue in
existence, or the rate at which a competence depreciates or becomes obsolete.
 Difficulty to imitate. A sustainable core competence is one that is difficult for competitors to
imitate, or that it will take competitors a long time to imitate or copy.
Example of core competences
Sustainable core competences come from unique resources and a unique ability to use resources. The
core competences that give firms a competitive advantage vary enormously. Here are just a few
examples:
 Providing a good service to customers. Some entities have a particular competence in providing
good service that other entities find difficult to imitate.
 Embedded operational routines. Some entities use processes and procedures as part of their normal
way of operating, as a result of which they are able to ‘make things happen’. This competence is
sometimes described in general terms as ‘operating efficiency’.
 Management skills. The core competence of an entity might come from the ability of its
management team.
 Knowledge. Knowledge can be a key resource and a core competence is the ability to make use of
the knowledge and ‘know how’ within the entity, to create competitive advantage.
It is a useful exercise to think of any company that you would consider successful and list the unique
resources and core competences that you consider to be the main reasons why the company has
achieved its success. (You should also think about why the company has been more successful than its
main competitors.
What makes your chosen company so much better than other companies in the same industry or the
same market?)
Core competences and the selection of markets

A core competence gives a business entity a competitive advantage in a particular market or industry.
Some strategists have taken the idea of core competence further. They argue that if an entity has a
particular core competence, the same competence can be extended to other markets and other
industries, where they will be just as effective in creating competitive advantage.
Summary: resources and competences

Resources and competences are necessary to compete in a market and deliver value to the customer.
Unique resources and core competences are needed to create competitive advantage.
Resources Competences
Threshold Threshold
Resources needed to Activities, processes and abilities needed to
participate in an industry meet threshold product or service
requirements
Unique Core
Resources providing a Activities, processes and
foundation for competitive advantage abilities that give competitive advantage

CAPABILITIES AND COMPETITIVE ADVANTAGE

Competitive advantage
 Competitive advantage is any advantage that an entity gains over its competitors, that enables it to
deliver more value to customers than its competitors.
 Competitive advantage is essential for sustained strategic success.
 The result of competitive advantage should be an ability to:
o create added value in products or services, that customers will pay more to obtain,
or
o create the same value for customers, but at a reduced cost.
Capabilities
 Capabilities are the ability to do something. 
 Capabilities arise from a complex combination of resources and core competences and they are
unique to each business entity.
 These come from using and co-ordinating the resources and competences of the entity to create
competitive advantage.
 Each business entity should have capabilities that rivals cannot copy exactly, because the
capabilities are embedded in the entity and its processes and systems. 
 An entity should have capabilities for gaining competitive advantage.
Dynamic capabilities
 ‘Dynamic capabilities’ is a term used to describe the ability of an entity to create new capabilities
by adapting to its changing business environment
 renewing its resource base: getting rid of resources that have lost value and acquiring new
resources, particularly unique resources
 developing new and improved core competences. 
 Dynamic capabilities are the abilities of an entity to adapt and innovate continually in the face of
business and environmental change.
 Dynamic capabilities refer to the ability of an entity to respond to environmental change
successfully and recognise the need for change and the opportunities for innovation, through new
products, processes and services.
 Business entities operate in a continually-changing environment. Strategic success is achieved by
reacting to changes in the environment more successfully than competitors.
Cost efficiency and strategic capability

Porter has argued that in order to achieve strategic capability, an entity must gain competitive
advantage over its rivals and competitive advantage can be achieved by adding value or by reducing
costs.
Cost efficiency to an accountant means minimising costs through control over spending and the
efficient use of resources. A firm must achieve a certain level of cost efficiency if it is to be able to
compete and survive in the industry. In strategic management, cost efficiency refers to the ability not
only to minimise costs in current conditions, but to continually reduce costs over time.
The ability to reduce costs continually is often a key requirement for strategic success. Cost efficiency
has been described as a ‘threshold strategic capability’. A cost efficiency capability is the result of
both:

 making better use of resources or obtaining lower-cost resources; and

 improving competencies and capabilities (for example, improving the systems of inventory
management).
Ways of achieving cost efficiency

There are various ways in which cost efficiency can be achieved, to gain a competitive advantage over
rival companies.
 Economies of scale. Reductions in cost can be achieved through economies of scale. Economies
of scale refer to ways in which the average costs of production can be reduced by producing or
operating at a higher volume of output. In simplified terms, operating at a higher volume of output
enables a firm to spread its fixed costs over a larger volume of output units, so the average cost per
unit falls. 
 Economies of scope. In some industries, reductions in costs might be achieved by producing two
or more products, so that an entity that makes all the products achieves lower costs per unit than
competitors that produce only one of the products.
Example: Economies of scale and scope Economies of scale
Company A and Company B are building construction companies. Both companies construct
residential homes. Company A is much smaller than Company B. Company B has been able to acquire
a large share of the housing construction market because it is able to build lower-cost houses than
companies such as Company A.
Company B achieves lower costs by exploiting economies of scale. It can buy raw materials (such as
bricks and windows) at lower prices by purchasing in bulk. It can make better use of the time of its
specialised workers. It can also reduce costs by buying its own construction equipment, instead of
having to hire equipment from equipment suppliers at a higher cost (which is what Company A must
do).
Economies of scope
Company C produces curtains and carpets for both commercial customers and the retail market. It
competes with Company D, which produces curtains only and Company E, which produces carpets
only.
Company C might be able to achieve greater cost efficiencies than either Company D or Company E
because it produces both curtains and carpets and not just one product.
Cost efficiency and strategic capability

Cost efficiency can become a strategic capability, which will give the organisation competitive
advantage, for example by achieving ‘cost leadership’.
Corporate knowledge and strategic capability

Corporate knowledge or organisational knowledge is the knowledge and ‘know- how’ that is acquired
by the entity as a whole. It is created through the interaction between technologies, techniques and
people. Within organisations, knowledge comes from a combination of:
 collaboration between people, who share their knowledge and create new knowledge together
 technology, which makes it possible to store and communicate knowledge
 information systems that make use of the technology system; and
 information analysis techniques. 

Knowledge gives a company a competitive advantage. Another important characteristic of corporate

knowledge is therefore that it cannot be easily replicated by a competitor. It is something unique to the
company that owns it.
A capability in knowledge management comes from a combination of unique resources and core
competences:
 experience in an industry or market and acquiring knowledge through experience
 the knowledge that employees have or acquire, for example through training
 the management of people and success in encouraging creativity and new ideas
 the management of IS/IT systems. 
Capability / Resource Model / Resource Audit
Human resources  Size and composition of the workforce

(Part-time and  Efficiency of the workforce
full- time  Flexibility of the workforce
employees,  Rate of labour wastage/turnover
consultants, sub-
contractors etc.)  Labour relations between management and workers
 Skills, experience, qualifications
 Any particular expertise?
 Labour costs: salaries and wages
Management  Size of the management team

 Historical performance
 Skills of the managers
 Nature of management structure, the division of authority and
responsibility
Raw materials  Costs as a percentage of total costs
 Sources, suppliers
 Availability
 Future provision. Scarcity?
 Wastage rates
 Alternative materials and alternative sources of supply
Non-  What are they?
current  How old are they? What is their expected useful life?
assets  What is their current value?
 What is the amount of sales and profit per Rs.1 invested in
non-current assets?
 Are they technologically advanced or out-of-date?
 What condition are they in? How well are they repaired and
maintained?
 What is the utilisation rate for each group of non- current assets?

Intangible  Are there any intellectual rights, such as patent rights and
resources copyrights?
 Are there valuable brand names?
 Does the organisation have any identifiable goodwill?
 What is the reputation of the entity with its customers? How well does
it know them?
 Is the work force well-motivated?
Financial  What is the capital of the entity?
resources  What are its sources of new capital?
 What are the cash flows of the entity?
 What are its sources of liquidity?
 How well does it control trade receivables?
 How well does it control other elements of working capital?
Internal controls  How well does the entity control the use of its resources?
and organisation  How effective are its controls over the efficient and effective use of
assets?
 How effective are its controls over accounting and financial
reporting?
 How effective are its controls over compliance with regulations?
 How effective are its risk management systems?
 Is the entity organised in an efficient way?

STRATEGIC CAPABILITY
 Strategic capability means the ability of an entity to perform and prosper, by achieving strategic
objectives.
 It can also be described as the ability of an organisation to use its core competences to create
competitive advantage.
 Strategic capability reflects the ability of [an entity] to use and exploit the resources available to it,
through the competences developed in the activities and processes it performs, the ways in which
these activities are linked internally and externally and the overall balance of core competences
(capability) across the [entity].
 Above all the capability of the [entity] depends upon its ability to exploit and sustain its sources of
competitive advantage over time.’
 A resource-based view of the firm is based on the view that strategic capability comes from
competitive advantage, which comes in turn from the resources of the firm and the use of those
resources (competences and capabilities).
This is illustrated in the following hierarchy of requirements for strategic capability.
Achieving strategic capability
capability
Competitive
Understanding customer needs is fundamental to understanding and achieving competitive

advantage
CUSTOMER NEEDS
What are customer needs?
Customers buy products or services for a reason. When they can choose between two or more
competing products, there is a reason why they choose one product instead of another.
If the buying decision is not based entirely on price, the customer must have other needs that the
product or service provides. These could be:
 a better-quality product
 better design features
 availability: not having to wait to obtain the product
 convenience of purchase
 the influence of advertising or sales promotions.

There are many different types of customer, each with their own particular needs. A product that meets
the needs of one customer successfully might not meet the needs of another customer nearly as well.
Customers may be grouped into three broad types:
 consumers: these buy products and services for their personal benefit or use
 industrial and commercial customers: customers might include other business entities
 government organisations and agencies.
In some markets, most customers are consumers. In industrial markets, all customers are industrial and
commercial customers and possibly some government customers. In some markets, such as the markets
for military weapons, the only customers are governments.
As a general rule, the needs of different types of customer vary. Industrial and commercial customers
are more likely than consumers to be influenced by price. Consumers will often pay more for a branded
product (due to the influence of advertising) or for convenience.
The 4Ps of the marketing mix

The marketing approach is to identify customer needs and try to meet customer needs more
successfully than competitors. To do this, business entities need to offer a ‘mix’ of the four Ps that will
appeal to customers. The 4Ps are:
Product Price Place Promotion.
Product refers to the design features of the product and the product quality. In addition to the product
itself, features such as short lead time for delivery and reliable delivery could be important. Product
features also include after-sales service and warranties. For services, the quality of service might
depend partly on the technical skills and inter-personal skills of the service provider.
Price is the selling price for the product: some customers might be persuaded to purchase by a low
price or by the offer of an attractive discount.
Place refers to the way in which the customer obtains the product or service, or the ‘channel of
distribution’. Products might be bought in a shop or supermarket, from a specialist supplier, by means
of direct delivery to the customer’s premises or through the internet.
Promotion refers to the way in which product is advertised and promoted. It also includes direct selling
by a sales force (including telesales).
Marketing can be analysed at a tactical level and decisions about the marketing mix might be included
within the annual marketing budget. However, marketing issues can also be analysed at a strategic
level.
It is important in strategic analysis to understand what customers will want to buy and why some
products or services will be more successful than others.

CRITICAL SUCCESS FACTORS FOR PRODUCTS AND SERVICES

Critical success factors (CSFs) are factors that are essential to the strategic success of a business entity.
They have been defined as: ‘those components of strategy in which the organisation must excel to out-
perform competition’ (Johnson and Scholes).
Example: CSF
A firm of accountants has an office in a major Pakistani city. The partners are considering an expansion
of the business, by opening another office in another city 50 miles away.
The partners want to expand their business, but they are cautious about investing in a project that might
not succeed and might cost them a lot of money. They have a meeting to discuss the factors that would
be critical to the success of a new office. They prepare the following list of factors:
 Employing top-quality accountants for the new office.
 Obtaining a minimum number of corporate clients.
 Obtaining a minimum number of private (individual) clients.
 Offering a full range of audit and accountancy services.
 Locating the new office in attractive city-centre premises.
All these factors could be important and might help the new office to be a success. However, not all
of them might be critical to the success of the venture.
If the partners can agree which factor or factors are critical to success, they can concentrate on setting
reasonable targets for each key factor and making every effort to ensure that those targets are achieved.
When management are analysing a market and customers in the market, they should try to understand
which factors are essential to succeed in business in the market and which factors are not so important.
Strategic success is achieved by identifying the CSFs and setting targets for performance linked to
those critical factors.
Example: Parcels
A parcel delivery service (such as DHL or TCS Tezraftar) might identify critical success factors as:
 collecting parcels from customers quickly, as soon as possible after the customer has asked for a
parcel to be delivered
 providing rapid and reliable delivery.
CSFs and key performance indicators (KPIs)

Critical success factors should be identified at several stages in the strategic planning process.
 CSFs should be identified during the process of assessing strategic position. Management need to
understand the main reasons why particular products or services are successful. 
 CSFs are important in the process of making strategic choices. A business entity should select
strategies that will enable it to achieve a competitive advantage over its competitors. These are
strategies where the entity has the ability to achieve the critical success factors for its products or
services. 
 CSFs are also important for strategy implementation. Performance targets should be set for each
CSF. This involves deciding on a measurement of performance, that can be used to assess each
CSF and then setting a quantified target for achievement within a given period of time.
Measured targets for CSFs are called Key Performance Indicators (KPIs).

Johnson and Scholes: a six-step approach to using CSFs

Johnson and Scholes have suggested a six-step approach to achieving competitive advantage through
the use of CSFs.
Step 1
Identify the success factors that are critical for profitability (long-term as well as short-term). These
might include ‘low selling price’ and also aspects of service and quality such as ‘prompt delivery after
receipt of orders’ or ‘low level of sales returns’. It is useful to think about customer needs and the 4Ps
of the marketing mix when trying to identify the CSFs for products or services.
Step 2
Identify what is necessary (the ‘critical competencies’) in order to achieve a superior performance in
the critical success factors. This means identifying what the entity must do to achieve success. For
example:
 If a critical success factor is ‘low sales price’, a critical competence might be ‘strict control over
costs’.
 If a critical success factor is ‘prompt delivery after receipt of orders’, a critical competence might
be either ‘fast production cycle’ or ‘maintaining adequate inventories’.
 If a critical success factor is ‘low level of sales returns’, a critical competence might be either
‘zero defects in production’ or ‘identifying 100% of defects on inspection’.
Step 3
The entity should develop the level of critical competence so that it acquires the ability to gain a
competitive advantage in the CSF.
Step 4
Identify appropriate key performance indicators for each critical competence. The target KPIs, if
achieved, should ensure that the level of critical competence that creates a competitive advantage is
obtained in the CSF.
Step 5
Give emphasis to developing critical competencies for each aspect of performance, so that
competitors will find it difficult to achieve a matching level of competence.
Step 6
Monitor the firm’s achievement of its target KPIs and also monitor the comparative performance of
competitors.

Benchmarking
Benchmarking is a process of comparing your own performance against the performance of someone
else, preferably the performance of ‘the best’.
The purpose of benchmarking is to identify differences between your performance and the
performance of the selected benchmark. Where these differences are significant, methods of closing
the gap and raising performance can be considered. One way of improving performance might be to
copy the practices of the ‘ideal’ or benchmark.
In strategic position analysis, benchmarking is useful because it provides an assessment of how well
or badly an entity is performing in comparison with competitors.
Methods of benchmarking
There are several methods of benchmarking:
1. Internal benchmarking. An entity might compare the performance of units within the
organisation with the best-performing unit.
For example, an organisation with 30 branch offices might compare the performance of 29 of the
branches with the best-performing branch.
2. Operational benchmarking. An entity might compare the performance of a particular operation
with the performance of a similar operation in a different business entity in a different industry.
For example, a book publishing company might compare its order handling, warehousing and
despatch systems with the similar systems of a company in a different industry that has a reputation
for excellence – for example a company in the clothing manufacturing industry.
Operational benchmarking arrangements might be negotiated with another business entity.
3. Competitive benchmarking. An entity might compare its own performance and its own
products with those of its most successful competitors.
Unlike internal benchmarking and operational benchmarking, competitive benchmarking must be
carried out without the knowledge and co-operation of the selected benchmark.
4. Customer benchmarking. This is a different type of benchmark. The benchmark is a
specification of what customers expect. An entity compares its performance against what its
customers expect the performance to be.
Methods of competitor benchmarking

There are no ‘standard’ methods of competitor benchmarking.
Some of the methods that might be used by a company to compare performance with its competitors
are suggested below.
 Published financial statements of competitors should be studied, analysed and compare.
 Financial ratios obtained from the financial statements of competitor should be compared with
similar ratios for the company. 
 Where there are significant differences in performance, the possible reasons for differences should
be considered. 
 The products or services of competitors should be analysed in detail. 
 By talking to customers and potential customers who have had dealings with a competitor, and
who are willing to discuss what the competitor is offering
 Sales prices should be compared.

COMPETITIVE FACTORS
SWOT analysis/ Strategic Analysis
Internal External /
analysis/ Environmental SWOT analysis
resource analysis analysis
SWOT analysis is a technique (or ‘model’) for

 Analysing strategic position. Competitive position
 Identifying key factors that might affect business A company’s competitive position is its ability to
strategy. generate returns in comparison to those generated
by its competitors.
 Understanding competitive position.
 Development of competitive advantage.
Position analysis
 It is analysis of factors inside the organisation can be used to identify strengths and weaknesses
in the resources and systems of the organisation.
 Strengths and weaknesses are concerned with the internal capabilities and core competencies of
an entity.
 Analysis of factors outside the organisation such as opportunities and threats. (PEST analysis
and 5 Forces)
SWOT analysis is an analysis of strengths, weaknesses, opportunities and threats.

Strengths are internal strengths that come from the resources of the entity.
Weaknesses are internal weaknesses in the resources of the entity.
Opportunities are factors in the external environment that might be exploited, to the entity’s
strategic advantage.
Threats are factors in the external environment that create an adverse risk for the entity’s future
prospects.
Illustration
A SWOT analysis might be presented as four lists, in a cruciform chart, as follows. Illustrative items
have been inserted, for a small company producing pharmaceuticals
Strengths Weaknesses
Extensive research knowledge Slow progress with research projects
Highly-skilled scientists in the workforce Poor record of converting research projects into
High investment in advanced equipment new product development
Patents on six products Recent increase in labour turnover
High profit margins Increased liabilities
Owned Assets
Opportunities Threats
Strong growth in total market demand Recent merger of two major competitors
New scientific discoveries have not yet been Risk of stricter regulation of new products e.g.
fully exploited legal requirements

ANALYSING STRENGTHS AND WEAKNESSES

Resource audit
A resource audit is an initial assessment of the resources of an entity. It is carried out to establish what
resources there are, which are unique and how efficiently and effectively they are being used.
A resource audit should identify all the significant resources that are used by an entity. These will vary
according to the nature of the entity. In general, however, a resource audit should provide data about
the following resources.
Evaluating resources
Having identified its key resources, management can evaluate them and the entity’s ability to use them
efficiently and effectively to create value (competences).
A simple framework for evaluating resources is the VIRO framework:
 V: Value. Does the resource provide competitive advantage?
 I: Imitability. Would it be costly for competitors to imitate the resource or acquire it?
 R: Rarity. Do competitors own similar resources, or are the resources unique?
 O: Organisation. Is the entity organised to exploit its resources to best advantage?
SWOT analysis and strengths and weaknesses

SWOT analysis is a technique for analysing strategic position and identifying key factors that might
affect business strategy. These factors are both internal and external to the entity.
 Strengths. Strengths are resources and competences that an organisation has and the capabilities
it has developed. Strengths in resources, competences and capabilities can be exploited and
developed to create sustainable competitive advantage.
 Weaknesses. Weaknesses are resources, competences and capabilities that are deficient orlacking.
These weaknesses are preventing the entity from developing or sustaining competitive advantage.
Identifying strengths and weaknesses

To identify strengths and weaknesses, you should consider the following:
 Resources
¯ Consider all the resources of the entity and identify those that are significant and unique. Include
the skills of management and other employees in your assessment, also consider the knowledge
that the entity has acquired and its intellectual capital.
¯ Consider whether there are key resources that the entity lacks, but a competitor might have.
 Competences
¯ Consider all the activities and processes of the entity and how it uses its resources. Identify the
competences of the entity and consider whether any of these are core competences that provide
competitive advantage.
¯ Consider the competences that the entity lacks.
 Capabilities

¯ Consider the capabilities of the entity and its relative success or failure in delivering value to
the customer or in creating cost efficiency.
Preparing a SWOT analysis

If you are required to use SWOT analysis in your examination, you may be required to analyse
opportunities and threats as well as strengths and weaknesses in the strategic position.
Strengths and weaknesses are concerned with the internal capabilities and core competencies of an
entity. Threats and opportunities are concerned with factors and developments in the environment.
A SWOT analysis might be presented as four lists, in a cruciform chart, as follows. Illustrative items
have been inserted, for a small company producing pharmaceuticals.
Note that strengths and weaknesses should include competences and capabilities as well as resources.
In this example, the strengths relate to resources and the weaknesses relate to competences and
capabilities, suggesting that the entity might not be making the best use of its resources.
In order to prepare a SWOT analysis, it is necessary to:
 analyse the internal resources of the entity and try to identify strong points and weak points
 analyse the external environment and try to identify opportunities and threats.
An analysis might be prepared by a team of managers, a think tank, a risk management committee or
another group of individuals within the entity.
Interpretation of a SWOT analysis

An initial SWOT analysis is simply a list of strengths, weaknesses, opportunities and threats. The
significance or potential value/cost of each item is not considered in the initial analysis and the items
are not ranked in any order of importance.
A problem with SWOT analysis is that it can encourage very long lists of strengths, weaknesses,
opportunities and threats, without any differentiation between those that are significant and those that
are fairly immaterial.
Having prepared an initial SWOT analysis, the next step is to interpret it. Interpretation involves
identifying those strengths, weaknesses, opportunities and threats (SWOTs) that might be significant
and what their implications might be for the future. The process of interpretation therefore involves
ranking the SWOTs in some order of priority or importance.
Another problem with SWOT analysis is that it can be used to identify significant issues, but it cannot
be used for evaluation. It cannot be a substitute for a more rigorous strategic analysis.
Having identified the most significant issues facing the organisation, strategic management should
then consider:
 how major strengths (for example, core competencies) and opportunities might be exploited, to
obtain competitive advantage
 how major weaknesses and threats should be dealt with, in order to reduce the strategic risks for
the entity.

Practice Questions
Q.1
Eat Smart (ES), a family owned business is being managed by Mr. & Mrs. Khan. ES has been
enjoying high profits and strong client base and is highly regarded for its premium quality diet food,
energy drinks and low carb salads. The food is prepared under the supervision of Mrs. Khan, a
foreign qualified nutritionist who has hired a team of qualified staff having sound knowledge and
experience. Mr. Khan is a marketing graduate and looks after the supply chain activities i.e. from
ordering and safe storage of ingredients to dealing with customer complaints and encouraging
feedback.
At present, ES is offering take-away and delivery services. Dine-in service is not being offered due
to the fact that Mr. & Mrs. Khan have been busy in managing routine work. ES relies on word of
mouth and social media pages for promoting the business.
Given the low set-up costs and growing demand for healthy food, number of new online businesses
have entered into the market. Some restaurants have also started to offer separate diet food menus.
‘Be Fit’ (BF), a chain of fitness center, has approached ES to partner with them in preparing diet
plans and meals for its members. Partnering with BF would mean hiring of additional staff at various
levels of operations and management.
Required:
(a) Perform SWOT analysis for ES. (08)
(b) Identify the activities forming part of primary value chain as suggested by Porter and give two
examples related to each such activity in ES. (06)
Q.2
Falcon Air (FA) is an airline that operates scheduled services to all the major cities within the
country and sixteen international destinations. FA takes pride in its excellent customer services and
is known for spacious passenger seats. It has a fleet of 12 new aircrafts and 4 aging aircrafts that it
plans to replace with new ones soon.
The ongoing COVID-19 pandemic has had grave impact on the global aviation industry and FA
operations have also taken a bad hit. It has incurred heavy losses due to international travel
restrictions and there is uncertainty in local air travel business due to the strict travel SOPs to be
followed. In an effort to support the local aviation industry, the government has waived airport tax
for local air travel for the time being. FA management welcomes the government support and is
determined to weather the storm caused by the pandemic.
Required:
(a) Conduct SWOT analysis for FA. (04)
(b) Explain whether the strength of each of porter's five forces has risen or declined for the aviation
industry due to the ongoing pandemic. Provide reasons for your answer. (06)
(c) Based on your analysis in (a) and (b) above, provide recommendations to FA with supporting
reasons. (05)
Q.3:
The following SWOT matrix is prepared by a management trainee for ProPharma (Private) Limited,
a small company manufacturing pharma products:
Strengths
- Recent merger of two major competitors
- Highly-skilled scientists in the workforce
- New scientific discoveries have not yet been fully exploited
Weaknesses
- Slow progress with existing research projects
- Extensive research knowledge of employees

- Strong growth potential of the industry

Opportunities
- Poor record of converting research projects into new product development
- High investment in advanced equipment
- Patents on six products
Threats
- High profit margins
- Stricter regulation of new products
- Recent increase in employee turnover
Required: Review the information provided in above matrix and re-classify the information under
the correct heading where necessary. (06)
Q.4
The Righton Supermarkets Group is the largest supermarket group in the country. In spite of a
decline in total consumer spending in the national economy last year, spending in the supermarket
sector as a whole increased, and Righton also increased its market share. It now has over 20% of
the market for food- and-drink shopping in the country. It is also enjoying strong growth in the
sale of non-food products such as clothing (it has its own brand of fashion clothes) and domestic
electrical goods.
The group has just announced record annual profits, and investors expect the growth in
profitability to continue, in spite of signs of weakness in the national economy.
Rival supermarket groups have been attempting to regain lost market share. Two rival groups
merged a year ago. Another competitor was acquired a few years ago by a major US supermarket
group and is pursuing an aggressive competitive strategy.
Righton’s success is due partly to its reputation for low prices and reasonable-quality products,
and its efficient in-store service.
The group continues to acquire land and to purchase retail property with the intention of building
more out-of-town stores and smaller in-town convenience stores. It does not have any business
operations outside the country. There is some concern about the possibility of government action
to prevent the group from exploiting its ‘near-monopoly’ position in the market.
Required:
(a) What is the purpose of SWOT analysis? (02)
(b) Using the information provided, carry out a SWOT analysis for the Righton Supermarket Group.
(08)
Q.5
Identify a model or techniques that you might use to carry out for:
(i) an analysis of an entity and its activities
(ii) an macro environmental analysis
(iii) an industry analysis
(iv) a strategic position analysis (04)
Q.6
ABC is a multinational company specialising in travel goods such as suitcases and travel bags. It has
a strong position in the ‘luxury goods’ section of the market, and its brand is well-known and highly-
regarded.

It has manufacturing facilities and distribution centres located around the world. Its IS/IT systems
strategy has been to allow decentralisation of systems. Each division of the company has been
allowed to develop and use its own IS/IT systems.
The company has been successful in using developments in information technology. It has EDI
links with many of its major suppliers, and it was one of the first companies in the industry to
develop a website for advertising and selling its goods directly to consumers. However, the
popularity of the website has been falling, and the number of ‘hits’ per day is now down to a third
of its peak level about three years ago.
Although the company has EDI links with suppliers, it does not yet have similar arrangements with
its major customers. However, some customers have recently suggested that improvements could be
made in their supply chain by establishing extranet links.
The company is in a highly-competitive market, and rival companies have been successful in taking
market share by offering well-designed products at lower prices.
The directors of ABC are aware that some managers have ideas for improving competitiveness, but
these ideas are spread out throughout the company, and it has been difficult for different divisions in
different countries to exchange their ideas. It has been suggested that a new intranet system could be
introduced to improve the interchange of ideas within the group.
The directors are also aware that they do not have as much information as they would like about
their competitors. Travel goods are a type of fashion accessory for many customers, and ABC
would probably benefit from learning much faster about the initiatives that its competitors are
taking in the market. It has been suggested that an information system should be developed for
senior managers, giving them access to information about competitors, including easy access to
their internet sites.
Required
Construct a simple SWOT analysis (strengths, weaknesses, opportunities and threats analysis) for
ABC. (10)
Q.7
Firebridge Tyres Ltd (FTL) is a wholly owned UK subsidiary of Gonzales Tyre Corporation (GTC)
of the USA. FTL manufactures and sells tyres under a number of different brand names.
(a) Firespeed, offering high product quality, at a price which offers good value for money
(b) Freeway, a cheap brand, effectively a standard tyre
(c) Tufload, for lorries and commercial vehicles
FTL has good relationships with car firms and distributors.

GTC is rather less focused; not only does it make tyres and some other components, but it also
owns a chain of car service centres specialising in minor maintenance matters such as tyre
replacement, exhaust fitting, and wheel balancing.
FTL has experienced a fall in sales revenue, partly as a result of competition from overseas
producers, in what is effectively a mature market. Moreover, sales of new cars have not been as
high as had been hoped, and consumers are more reluctant than before to part with their money.
FTL's managers have had meetings with GTC's managers as to how to revive the fortunes of the
company. FTL would like to export to the US and to Asia. GTC has vetoed this suggestion, as
FTL's tyres would compete with GTC's. Instead, GTC suggests that FTL imitate GTC's strategy
by running a chain of service stations similar to GTC's service stations in the US. GTC feels that
vertical integration would offer profits in its own right and provide a distribution network which
would reduce the impact of competition from other tyre manufacturers.

GTC has no shortage of cash. You are a strategic consultant to FTL.

Required:
(a) Discuss the principal factors in the external environment that would influence FTL's strategic
choice. (6)
(b) Describe the barriers to entry that FTL might face if it decided to enter the service centre
business. (6)
Q.8
Star Coffee (SC) is a USA based chain of high-end cafes. It has sixty-three state of the art cafes
mostly in the commercial areas of the country to target office workers.
Every year in October, SC orders freshly harvested and processed coffee cherries from several
growers in Guatemala – a place that is well-known for its coffee industry and offers benefits of
labour arbitrage. Along with the payment for cherries, SC pays the growers to book premium
shipping agents who can deliver the cherries to SC warehouse in USA. When the shipments arrive,
SC workers run quality checks to keep only the best quality cherries and return the rest back to the
growers. SC keeps the cherries in a highly well-maintained large storage facility at the warehouse to
ensure they stay fresh as long as possible and are carefully sent to the cafes when required.
Each SC cafe is equipped with roasters and grinders. The roasting process is quite complex but the
grinding process is fairly simple. As soon as the cherries arrive at the cafes, they are checked for
freshness and roasted into coffee beans according to SC's specific requirements. The coffee beans
carry a long shelf life and are kept at small stores in the cafes. To bring just the right flavours, the
coffee beans are crushed by grinders right when that perfect cup of coffee needs to be prepared.
SC takes pride in its proprietary quality control, roasting and grinding processes and markets them by
putting imprints on cups, placing attractive posters on cafe walls and by word of mouth through their
customers. SC is extremely particular about the customer experience at the cafes. It only hires
experienced staff, maintains cafes in immaculate condition, has a credible loyalty program and
provides free use of Wi-Fi, newspapers and magazines.
Required:
Explain how SC’s primary business activities offer value to the customers to achieve the competitive
advantage. (06)
Q.9
The AZ Group is one of the world’s leading pharmaceuticals companies. It was created five years
ago by the merger of Entity A with Entity Z. The group’s operations are based mainly in Western
Europe and North America. The North American market currently accounts for 40% of world sales
for pharmaceutical companies.
In the past two or three years, AZ has been involved in clinical trials in countries in South America
and Asia, aimed at developing new medicinal drugs. These countries were selected because
regulatory controls over medical research are less stringent than in the US, Canada or Western
Europe.
The group has suffered some setbacks in its business in the past twelve months:
(1) There have been serious concerns among the public and the medical profession about the safety
of one of AZ’s most successful drugs, Carora.
(2) A new drug developed by AZ failed to obtain regulatory approval in the US. Approval is needed
from the national regulator before it can be sold in the market.
(3) Another new drug that AZ has been developing has had disappointing clinical trials. Clinical
trials are carried out before further testing and application to the national regulators for approval.

R&D spending accounts for a substantial proportion of total annual expenditure of the AZ Group
(and other pharmaceutical companies).
Required
Using the information provided, carry out a SWOT analysis for the AZ Group. (06)
Q.10
City Express (CE) operates inter-city passenger bus service over 20 districts of Sindh. It was
incorporated in 2015 when Government of Sindh (GoS) awarded the company exclusive road
permits to operate in distant areas of Sindh. CE was an instant success because of wide area
coverage, low ticket pricing and large fleet of state-of-the-art buses. In view of the encouraging
response from general public, GoS is also considering to introduce a new inter- city train service.
GoS has been providing subsidies, granting various tax exemptions and promoting services of CE by
extensive coverage in the electronic and social media to encourage CE to operate in areas with low
profit margins. Still, certain routes are not profitable. In these routes, buses often depart late and
schedules are cancelled frequently. The management of CE is considering to negotiate with GoS to
relax restrictions on fixation of fare rates to counter increasing fuel costs.
Required:
Perform SWOT analysis for CE. (08)
Q.11
Local neighbourhood shops are finding it increasingly difficult to compete with supermarkets.
However, three years ago, the Perfect Shopper franchise group was launched that allowed these
neighbourhood shops to join the group and achieve cost savings on tinned and packaged goods,
particularly groceries. Perfect Shopper purchases branded goods in bulk from established food
suppliers and stores them in large purpose-built warehouses, each designed to serve a geographical
region. When Perfect Shopper was established it decided that deliveries to these warehouses should
be made by the food suppliers or by haulage contractors working on behalf of these suppliers. Perfect
Shopper places orders with these suppliers and the supplier arranges the delivery to the warehouse.
These arrangements are still in place. Perfect Shopper has no branded goods of its own.
Facilities are available in each warehouse to re-package goods into smaller units, more suitable for
the requirements of the neighbourhood shop. These smaller units, typically containing 50–100 tins or
packs, are usually small trays, sealed with strong transparent polythene. Perfect Shopper delivers
these to its neighbourhood shops using specialist haulage contractors local to the regional warehouse.
Perfect Shopper has negotiated significant discounts with suppliers, part of which it passes on to its
franchisees.
As well as offering savings due to bulk buying, Perfect Shopper also provides, as part of its
franchise:
 Personalised promotional material. This usually covers specific promotions and is distributed
locally, either using specialist leaflet distributors or loosely inserted into local free papers or
magazines.
 Specialised signage for the shops to suggest the image of a national chain. The signs include
the Perfect Shopper slogan 'the nation's local'.
 Specialist in-store display units for certain goods, again branded with the Perfect Shopper
logo.
Required
Describe the primary activities of the value chain of Perfect Shopper. (05)

Q.12 (Autumn 2022 – Q4)

Rauf Baweja (Rauf) is the owner of a chain of computer stores, named Complus, that sellscomputer
parts and accessories throughout the city. Rauf sources all its products from a largewholesale supplier
situated in Saddar, Karachi. The supplier has an outlet and online store where people can select and order
the products. At the start of every week, Rauf visits thesupplier’s online store, selects and orders
inventory for the rest of the week. Upon receiving the payment for products and delivery charges, the
supplier sends them directly to each Complus store according to the requirements received from Rauf.
All Complus stores follow a standardized layout. When the products reach the store, the staff places a price
tag, stacks and organises the products in a standard fashion. The standard processes make it easy to
transfer a well-trained staff member from one store to the other. Thisalso makes it easy for a customer to
walk into any Complus store and locate the desired product where they will always find a well-trained
staff ready to help.
Complus has a strong marketing team that frequently runs social media campaigns, SMSmessages and TV
adverts to inform customers about the products and discounts. Complus also has an aftersales customer
helpline that assists customers with common queries and collects their feedback. Lately, there have been
mounting customer complaints of faulty products upon first use and Rauf is looking for ways to solve
it.
Required:
(a) Perform Porter’s primary value chain analysis of Complus. Your analysis shouldinclude
explanation of each element of value chain and activities being performed under that
element. (10)
(b) Recommend a value addition activity that would reduce customer complaints of faultyproducts.
Also explain its position(s) in Porter’s primary value chain. (03)
Q.13 (Spring 2023 – Q2)

The management team at 24Seven, a call centre, notices that their call handling times, one of their critical
success factors (CSFs), have been consistently underperforming. The management determines that the
lack of proper training and inadequate staffing are the mainreasons for the declining performance. The data
shows that the desired call handling time to achieve the competitive advantage is 30 seconds, but the
actual call handling time recorded is45 seconds.
Given the importance of the issue, the management has hired 3 additional staff and emphasized on
setting ambitious training targets to resolve the matter within the next three months. The management is
closely following the progress of implementing the plan and has recorded a decrease in call handling
time to 35 seconds for the first month. For the secondmonth the target is to reduce call handling time
to 30 seconds, which will outbeat the competition, and 28 seconds in the third month to solidify their
position as a market leader incall handling times.
Required:
Identify, explain and relate Johnson and Scholes six-step approach to using CSFs from the scenario
above. (10)
Q.14 (Autumn 2023 – Q2)

Ali, a marketing manager at a software company specializing in mobile app development, hastask of
overseeing the marketing strategy for IQRA, an Arabic language learning app targetingthe Indo-Pak
region.
Despite IQRA's unique features, user-friendly interface, and cultural relevance, the fiercely competitive
market and limited brand recognition pose significant challenges. Catering to varying language learning
perceptions and localization challenges within the region adds complexity to the endeavour. The

marketing team must navigate these hurdles with a limited budget while capitalizing on factors like the
growing smartphone penetration, increasing interest in Arabic learning, and using social media and
influencer marketing. Building partnerships with educational institutions will also be crucial for reaching
the target audienceeffectively. To succeed, Ali's team must closely monitor and adapt to changing
user preferences and promptly address any negative reviews or feedback. Moreover, they need to ensure
compliance with regional legal and regulatory requirements to maintain user trust.
Required:
(a) Conduct SWOT analysis for IQRA. (06)
(b) Based on your answer in (a) above, suggest how each identified threat could be tackled using
strengths of IQRA. (Note: Clearly state the strengths used to answer the question) (04)
Q.15 (Spring 2024 – Q3)

Electrik Automobile (EA), a renowned multinational company is currently considering the establishment of an
electric car assembly plant in Paland. With manufacturing and assembly plants spread across various
countries, EA aims to capture the growing market for electric vehicles. The proposal includes selling a specific
number of electric cars locally in Paland and exporting the remaining production to various parts of the world.
EA's strategic move is drivenby the absence of electric car assembly facilities in Paland, presenting an
opportunity to cater to the evolving preferences in the automotive industry.
With the evolution of the automotive industry, electric cars are positioned not only as efficient means of
transportation but also as lifestyle choices and status symbols across the world. EA's target demographic in
Paland consists of individuals seeking eco-friendly alternatives amid rising petrol prices. Despite the
somewhat unstable political and economic conditions in Paland, the government is actively working to
instill confidence among foreign investors by providing tax exemptions and strengthening emission
regulations, aligning with EA's expansion plans. This venture not only promises economic benefits and job
opportunities for the local population but also addresses the increasing environmental concerns by introducing
electric vehicles to the market.
Required:
(b) Conduct SWOT analysis for EA (06)
Q.16 (Spring 2024 – Q4)

ZAM Accountancy School (ZAM) has been a renowned professional education provider for 35 years,
known for its quality education and impressive results. With purpose-built campuses in three major cities and
10 branches in five cities, ZAM offers both online and face-to-face classes equipped with the use of latest
technological tools that are considered best in the industry. ZAM hires highly qualified and experienced
professionals. Unlike other accountancy schools, ZAM offers crash courses before exams and free mock
exams that contribute to identifying deficiencies and improving performance. In a unique approach, ZAM
conducts career counseling sessions and offers free one-to-one advisory sessions, setting it apart from other
accountancy schools.
Required:
Briefly explain threshold resources, unique resources, threshold competencies and core competencies, and
relate them to the scenario. (10)
Perfection is not attainable, but if we chase perfection we can catch excellence.

Chapter 9: Ethical Decision Making
CHAPTER 9
Ethical Decision Making
 Ethics is a set of moral principles or values”
(This is relatively subjective since moral values vary from person to person)
 “The principles, norms and standards of conduct governing an individual or group.” (by Trevino
and Nelson)
 Manuel Velasquez states that there are no ethical standards that are true absolutely, i.e., that the
truth of all ethical standards depends on what a particular culture accepts.
 In organizations, rules of ethical conduct are developed that include corporate values, norms of
dealing with suppliers and customers, professionally accepted behavior, gift policies, and other
rules as to what is allowed or not within the working premises.
Ethics in Business
 High ethical standards require individuals and businesses to conform to the moral principles
and values.
 Just as individuals build a good character by following morals, in the same way businesses
develop an honorable reputation by conforming to ethical standards.
 A high ethical standing in corporate world consequently takes businesses to path of increased
profits and growth.
 Business committed to ethical behavior builds positivity in its relationship with employees,
customers, investors, general public & other stakeholders and bring following benefits:
⯈ Employees commitment
- Employees trust that company is working for benefit of its employees and public
- Employees who feel that their employer is not following ethical standards are more likely to
break ethical code of conduct and compromise on company’s values
⯈ Investor confidence
- Investors mainly look for financial fundamentals but they also look for a company that not just
has a large market size but also is strong on ethical ground.
- They understand that ethical culture within a company provides the right foundation and
growth for the company in the right direction.
- An organization without ethical standards is exposed to many risks and issues such as
lawsuits, bad reputation, and loss of customers and profits.
⯈ Customer satisfaction
- A company’s revenue comes from its customers
- Long lasting relationship can only be built when the customer has trust in company
⯈ Avoiding loss of profits

- Unethical decisions potentially lead to significant loss along with other litigations.
⯈ Supplier
- To maintain supply of goods suppliers should be paid on time and treat them fairly

Ethical issues and dilemmas in business

“An ethical issue is a problem, situation or opportunity that requires an individual, group or
organization to choose among several actions that must be evaluated as right or wrong, ethical or
unethical” (Definition by Fraedrich and Ferrell)
 In normal circumstances, there is a clear distinction between what is right and wrong
 On the other hand, there may be a situation when a problem requires an individual, group or
organization to choose among several wrong or right actions
 Ethical dilemmas arise when norms and values are in conflict, and alternative possibilities lie
within the two extremes of right and wrong.
- These alternatives are not entirely right and wrong but fall somewhere in between.
- Ideally, this means selecting an option that is the best among all the possibilities.
- In such situations, the decision is based on the acceptability level of an individual.
- Here decision maker is trapped in a state of confusion and needs guidance to follow.
Frameworks for Ethical Decision Making

American Accounting Association (AAA) Model
American Accounting Association (AAA) model originates from a report by Langenderfer and
Rockness in 1990. In the report, they suggest a, 7-step process for decision making
Step 1- What are the facts of the case.

 When decision-making process starts, there is no ambiguity about subject of the case.
 Leading questions about the facts will revolved around What? Who? Where? When? How?
 Efforts are made to identify what we know or need to know, to clearly define the problem.
Step 2- What are the ethical issues in the case.

 Examining the facts of the case and asking what ethical issues are at stake.
 All threats to compliance with fundamental principles are identified and explained.
Step 3- What are the norms, principles and values related to the case.
 Placing the decision in its social, ethical and (sometimes) professional behaviour context.
 In last context, professional codes of ethics or the social expectations of the profession are taken
to be the norms, principles and values.
 Discussing issue like governance, transparency, obedience, independence etc.
Step 4- What are the alternative course of action

 Compiling a complete set of major practical alternatives one can make in a given situation.
 Alternatives should not consider the norms, principles and values identified in Step 3.
 It is expected that in these alternatives one may feel or see some form of compromise
Step 5- Matching norms, principles, and values to options

 Norms, principles & values (Step 3) are matched with different alternate options (Step 4)
Step 6- What are the consequences of each course of action.

 An analysis of implications and consequences of each possible alternate course of action.
 Should be analyzed in all respects: short and long run, positive and negative.
Step 7- The decision

 Final decision requires application of professional judgment (i.e. an application of accumulated

knowledge and experience gained during initial professional development and through
continuing professional development)
 Decision taken should demonstrate that selected option is well-informed ethical decision.
Tucker provides a 5-question model

Model is used to identify best possible choice to make for shareholders and other stakeholders These
questions are to be responded in following order to assess the value shown against each:
Questions Values
Is it profitable? Market values
Is it legal? Legal values
Is it fair? Social values
Is it right? Personal values
Is it sustainable?/ Environmental values
Environmental Friendly
Value judgment
 This value analysis helps us to make a balanced decision for all stakeholders.
 The Tucker Model may be explained by understanding the following two approaches:
1) Utilitarianism (or End-Point Ethics)

- To determine whether an action is right or wrong, one must concentrate on its likely
consequences, the end point or end result.
- As opposed to Egoism approach (i.e best for me / self interest)
- Seek the greatest benefit for the greatest number of stakeholders.
- This obviously requires some compromises for certain segments of stakeholder.
2) Rule ethics
- Rule ethics intends to follow the duty and norms relevant to the problem.
- Intended decision is assessed on the basis of law of the land, professional body codes of
ethics.
Excellence is a continuous process and not an accident.

Practice Questions
Q.1
David Hunter is currently serving as a non-executive director on the board of a nationalised concern,
The Electricity Provision Corporation (EPC), in a country in Asia. EPC operates a number of coal-
fired power stations and transmits energy through a national grid which it controls. The electricity
generated is then sold to the general public by private sector electricity distribution companies.
David Hunter is concerned about the ethical implications of a couple of issues that were discussed at
EPC's most recent board meeting which was held yesterday. As a non-executive director, he believes
he has a particular responsibility to consider ethical issues carefully.
(1) A general election campaign has recently begun in this country. The governing party has
indicated that it intends to maintain EPC as a nationalised industry if it wins the general election,
although it will be seeking efficiency improvements. The opposition party has indicated that it
intends to privatise all industries that are currently nationalised. Early yesterday morning before the
board meeting, EPC's Managing Director was suddenly asked by senior civil servants in the Ministry
of Energy to provide a major commitment to cost cutting in the next ten days. The Managing
Director is aware that the Minister of Energy will be making a major election speech in a fortnight's
time.
(2) A recent United Nations report ranked EPC's home country in the Top 10 of its worst polluters,
as measured by CO2 emissions per head of population. This report has been seized upon by
environmental groups who have called for a month of action during the general election campaign.
They wish to highlight the environmental damage being caused by the government's environmental
policies and to highlight the need to switch to alternative technologies such as wind power
generation.
In the last few days small groups of protestors have broken through perimeter fences at two of EPC's
power stations and managed to delay deliveries of coal by chaining themselves across railway
tracks. There have been some reports in the press of heavy handed treatment being meted out by the
security firm hired by EPC to deal with the protests. EPC's Managing Director has dismissed these
reports, saying the protestors' solutions are impractical, they have no rights of access, and that EPC
is entitled to take whatever action is required against the protestors to protect its property and
maintain electricity supplies.
Required:
(a) Using the American Accounting Association model to support your answer, recommend to David
Hunter the course of action the board should take in responding to the civil servants' request for
information. (15)
(b) Using Tucker's model for decision-making, assess the factors that EPC's board should consider
when dealing with the current protests by environmental groups. (10)
Q.2
Opulent Furniture (Pvt) Ltd is one of the largest furniture retailers and has its manufacturing facilities
and retail shops across the globe. The company designs and sells premium quality furniture and
hardwood flooring. The company, due to the nature of its products, is aware of the deforestation it
causes in different regions where it operates. However, the company’s values and principles display a
high regard for environmental concerns as shown in their vision statement: “At Opulent Furniture our
vision is to provide the highest quality furniture for all our customers across the globe whilst integrating
environment-friendly practices in the manufacturing of our products.”

A recent report entitled “Companies Costing the Environment”, published by the Environmental
Protection Agency, suggested that Opulent Furniture was clearcutting virgin trees over thousands of
acres. If this large-scale deforestation continued, South Asia would be left with significant
environmental damage such as loss of habitat, higher stream temperatures, flooding and dying fish
which could take decades to repair.
Opulent defended itself by claiming that it sources 55% of its wood from sustainable sources and is
aiming to reach 80% in the next five years. It also referred to its heavy contribution towards forest
management and reforestation.
AIA has recently joined the company as an Assistant Internal Auditor at a very handsome salary
package. She is assigned to verify the sourcing of wood used during the last six months. She has
found that the verification process regarding supplies of Forest Stewardship Council (FSC) certified
wood is not effective. Most of the time the description on invoices for the wood is accepted as
sufficient evidence of sustainable sourcing. She also noted that the spending on forest management
includes significant amounts for staff forest visits, which in her opinion are meant for sourcing wood
rather than any supporting activities for forest management. She has taken her concerns to the CFO
who has told her this is the way business is conducted in the industry, and asked her not to highlight
these areas in her report. Two days later, the company offers her complete hardwood flooring along
with rosewood furniture for her apartment at a 50% discounted price. She is surprised, since as per
company policy this is only offered after one has been employed for more than two years.
Required: Using the American Accounting Association model to support your answer, recommend
to AIA the course of action she should take.
Q.3
SafeStores Limited (SL) is a company engaged in providing wide-ranged storage services to other
companies. Two years ago, SL rented a property for ten years in a small city, which is surrounded by
agricultural land. It built a warehouse having humidity, light and temperature control systems. It also
had some sterilized sections to store fresh pulps of fruits. This storage facility significantly helped the
villagers to store and preserve their produce.
Recently, the local Court took notice of unauthorized use of amnesty plots of land in the city and issued
an order to the authorities to demolish all unauthorized constructions and recover the land. SL, through
a 30-day demolition notice received at the storage facility, discovered that the property they rented out
was illegally constructed over the plot of land originally allotted by the government for the construction
of a school. The owner of the property built a small school on about 30% of the land and on the rest of
the land built a bulk store structure. SL storage facility was built in the said structure. The demolition
notice shocked the management of SL, as demolition in 30 days can cause substantial loss of business,
cost of damages to clients and cost of shifting and re-construction. You, as CFO of SL informed the
CEO that in order to minimize the expected losses, SL needs at least one year to properly plan re-
construction and shifting. On the instruction of CEO, you met with the lawyer and discussed the way
out. Lawyer reviewed the facts of the case and concluded that this is a lost case for the owner of the
property, whereas SL as a tenant may become an aggrieved party and can file an appeal for one-year
notice time. However, he was of the opinion that Court is likely to issue stay order in its first hearing,
but will conclude the case within one month. It is also likely that Court would not allow more than
three months. He proposed some strategies that can possibly delay the conclusion of the case and
resultantly demolition for six months. You noticed that these strategies include adjournment request
on false medical grounds, exaggeration of cost of damage to clients and showing overestimated time
and cost for shifting and re-construction. You are preparing your recommendations for CEO on
lawyer’s advice.

Required: Using Tucker's model for decision-making, assess the factors that should be considered
when dealing with the current issue. (10)
Q.4
Urban Hotels Ltd. (UH) is a leading name in the hospitality industry in Pakistan. UH recently
developed executive suites advertised at Rs. 36,000 per night. Unfortunately, even after adequate
marketing and high levels of comfort, the new rooms are rarely booked. The management is concerned
that the standard rooms are more profitable and the new suites are taking up space and becoming a
liability. Therefore, the CEO, being authorised to do so, decides to offer these suites at a reduced rate
of Rs. 18,000 per night. His decision is communicated to the concerned staff for implementation.
However, whilst completing the extra bookings resulting from the reduced rate, the data entry staff
erroneously entered the cost as Rs. 28,000, which remained unnoticed for three days. During these
three days, 118 nights were booked. The matter was presented to the CEO who finally decided that:
a) Promotional stands will be placed at the booking counter showing original reduced prices as Rs.
18,000 without mentioning an effective date.
b) In order to avoid possible negative reaction from guests who had booked during the first three days
and were yet to check out, the error would be corrected with retrospective effect in their bills. This
was applied to 48 out of the total of 118 nights booked during the first three days.
c) Any guest who had booked and left would not be refunded the excess charges. This was applicable
to 70 out of the total of 118 nights booked during the first three days.
d) Any replies by hotel staff to requests by customers for clarification on this matter will not mention
the issue is an error.
Required:
Using Tucker's model for decision-making, assess the factors that should be considered when dealing
with the current issue.
Q.5
Maham belongs to a rich family, and she is the first girl in her family to complete a Master’s degree
from Oxford University. On her return she visited her grandparents living in her native hometown.
She was amazed by the hospitality and was showered with gifts. One particular gift caught her eye- a
beautiful hand woven set of accessories and chaddar, the intricate design and masterful strokes
winning her heart.
She discovered that making hand woven fabrics and embroidery are a common pastime for the women
in the village and they are unaware of the potential value of their products. Maham decided to take a
few of the pieces and managed to sell them at a good price. Inspired by this success, she decided to
set up a distribution centre to sell the handicrafts made by women in the village to high-end customers.
She hired female workers on a daily wage basis (that conforms to the minimum wage law) and
provided them material to produce large quantities of handicrafts.
The centre was highly successful; she earned huge profits during her first year and decided to expand
the business by displaying her products at the International Heritage Fair, the biggest South Asian
Arts and Craft Exhibition. Through this exhibition she received several big orders and now she plans
to expand and run it as her main business. While planning for expansion she decided to hire women
at the monthly wage that conforms to the minimum wage law. She knows that for next few years there
would not be any competitor and workers would not have any other competitive opportunity.
Required: Apply Tucker’s Model on the wage policy of Maham’s expansion plan.

Q.6
You are a non-executive director of Precast Conc Limited (PCL) that deals in precast structures used
in buildings, bridges and as trench covers. PCL has a few medium term agreements with pre-
qualified steel suppliers. In a Board meeting, the Procurement Committee is presenting the case of a
private company, Strong Steel (Pvt.) Limited (SSL), which was pre-qualified in 2013 as a supplier of
steel. Recently, an Internal Audit report identified that a key pre-qualification criterion was not
applied in SSL’s case. The Procurement Committee, considering the exemplary contract
performance history of SSL, is suggesting a special waiver of the shortcoming for a period of the
next two years, which the Board approves.
As a normal course of SSL’s client relationship strategy, higher management and directors of PCL
regularly receive small gifts such as family passes for amusement parks and entertainment shows,
diaries, and fruit baskets.
Required: Apply the AAA model on the above scenario. (10)
Q.7
Rehan Bukhari was posted to XYZ Region as the Regional Manager in order to set up a
manufacturing subsidiary.
While attempting to set up a new headquarters and manufacturing facility, he is facing delay in
approval from the local authorities lasting many months. To resolve the issue, he met three senior
officials who indicated that setting up the subsidiary would go smoothly if Rehan’s company would
pay them Rs. 2,000,000 as a facilitation payment in addition to total official charges of Rs. 300,000.
They told him this was a reasonable amount compared to what other companies usually pay them for
the same assistance.
Rehan was dismayed since he was aware that bribery was against his company’s policies on how to
do business and that its violation would not be tolerated under any circumstances. Two days after the
meeting he receives a call from the CFO that if the delays are not resolved soon he will be replaced
by a more efficient manager.
Rehan was approached by a consultant who offered to get the approvals without further delay at a
fee of Rs. 2,800,000. There is a budget of Rs. 3,000,000 as a provision for payments to consultant for
legal and other services. He is now thinking of hiring the consultant.
Required. Apply Tucker’s model on the hiring of consultant. (05)
Q.8
Railway Development Company (RDC) was considering two options for a new railway line
connecting two towns. Route A involved cutting a channel through an area designated as being of
special scientific importance because it was one of a very few suitable feeding grounds for a colony
of endangered birds. The birds were considered to be an important part of the local environment
with some potential influences on local ecosystems.
The alternative was Route B which would involve the compulsory purchase and destruction of Eddie
Krul's farm. Mr Krul was a vocal opponent of the Route B plan. He said that he had a right to stay
on the land which had been owned by his family for four generations and which he had developed
into a profitable farm. The farm employed a number of local people whose jobs would be lost if
Route B went through the house and land. Mr Krul threatened legal action against RDC if Route B
was chosen.

An independent legal authority has determined that the compulsory purchase price of Mr Krul's farm
would be $1 million if Route B was chosen. RDC considered this a material cost, over and above
other land costs, because the projected net present value (NPV) of cash flows over a ten-year period
would be $5 million without buying the farm. This would reduce the NPV by $1 million if Route B
was chosen.
The local government authority had given both routes provisional planning permission and offered
no opinion of which it preferred. It supported infrastructure projects such as the new railway line,
believing that either route would attract new income and prosperity to the region. It took the view
that as an experienced railway builder, RDC would know best which to choose and how to evaluate
the two options. Because it was very keen to attract the investment, it left the decision entirely to
RDC. RDC selected Route A as the route to build the new line.
A local environmental pressure group, 'Save the Birds', was outraged at the decision to choose Route
A. It criticised RDC and also the local authority for ignoring the sustainability implications of the
decision. It accused the company of profiting at the expense of the environment and threatened to
use 'direct action' to disrupt the building of the line through the birds' feeding ground if Route A
went ahead.
Required: Use Tucker's 'five question' model to assess the decision to choose Route A. (10)
Q.9
Cadge is a clothing manufacturer based in Europe that supplies various large retail groups. Over the
last two years it has suffered falls in profits due to the loss of a couple of large contracts and a
general fall in demand for its clothes. Industry opinion is that Cadge has failed to innovate
sufficiently in its clothing designs.
A few days ago an unknown factory owner based outside Europe contacted Cadge's Design Director
out of the blue. He introduced himself only as 'Mr Sim', and offered to sell – for what appeared to be
a reasonable sum of money – the new up and coming season's designs belonging to one of Cadge's
key competitors who was using Sim's factories to manufacture its goods. If these designs could be
purchased by Cadge and launched onto the market before the competition could launch theirs,
Cadge's profitability for the coming year could significantly increase.
Required:
Analyse, using the American Accounting Association model, the decision of whether to accept Mr
Sim's offer. (07)
Q.10 (Autumn 2022 – Q.3)

Northern Hotels Limited (NHL) is planning to build a new resort alongside a lake in Baboon Valley
(Valley), a remote area of Pakistan. Although the Valley is known for its scenic views, it is largely cut-off
from other areas of Pakistan due to its poor infrastructure. There is no sewerage system in the Valley and
all the bio-waste created by the locals is put to organic use. People residing in the Valley have been living
there below the poverty line.
NHL has obtained all the relevant government approvals. As part of the approval, NHL will build
proper road infrastructure leading to the resort. NHL has also been able to enter a deal for the land at a
significantly lower market price.
NHL expects to achieve its objective of high profits due to very low operational costs as the labour is
available in the Valley at a significantly reduced rate. On the other hand, the locals have also foresighted
that this will bring tourism in the area and will create greater earning opportunities.
Required:
Apply the Tucker’s 5-question model on the above scenario. (06)

Q.11 (Autumn 2023 – Q.3)

Nawaz Ali, a senior consultant at Vertex Financial Advisors, uncovers financial irregularities in a
prominent client's records and promptly reports the same to the managing partner, Asif Ahmed. However,
Asif Ahmed faces a challenging decision, as taking action against the clientcould lead to financial losses
for both the firm and the client.
Required:
Apply Tucker’s 5-question model to the situation and advise an appropriate action for Asif Ahmed to
take. (06)
Q.12 (Spring 2024 – Q.5)

ANZ (Pvt) Ltd (ANZ) is in discussions with potential investors for a crucial funding round. Abrar, the
accountant, discovers that a significant portion of ANZ’s accounts receivable is likely uncollectible, which
would negatively impact the company's financial health and overall stakeholder benefits. ANZ’s management
asks Abrar to temporarily delay recognizing these bad debts to present a more positive financial picture.
Required:
Discuss end-point ethics and rule ethics in light of the scenario above. (04)
No man has a good enough memory to be a successful liar.

CHAPTER 10
Sources of Finance
There are two main sources of finance:
1. Equity
2. Debt
Factors considered before selecting source of finance

Before selecting the source of finance the company should consider different factors that are:
Amount required - Equity provides large amount
- Debt have some restrictions
Cost - Equity have issue cost (underwriting, broker etc)
- Debt (service cost)
Duration - short-term financing is used to fund short-term assets
- and long-term financing used to fund long-term assets
Security - Debt-holders demand security which company need to consider
Flexibility - in a year with low profits (or even a loss) the company could decide
not to pay a dividend to the shareholders.
- debt financing requires the payment of interest irrespective of
company performance.
Repayment - needs to carefully forecast future cash flows in order to ensure it is
able to repay debt as it falls due.
Impact on - Equity affects Earing Per Share (EPS)
financial - Debt increases the gearing (Risk)
statements
1. EQUITY
Equity shareholders exercise control through the voting rights and gain a return on their investment in
two ways:
 Capital gains – the value of their share in the company increases as the value of the company
increases
 Dividends – companies return cash to shareholders through the payment of dividends. Dividends
are typically paid once or twice per year. 
 The cost of equity is higher than other forms of finance as the equity holders carry a high level
of risk, and therefore command the highest of returns as compensation.
 New issues to new investors will dilute control of existing owners.
 Finance is raised through the sale of shares to existing or new investors (existing investors
often have a right to invest first which is called pre-emption rights). Issue costs can be high. 
 The company issues two types of shares to raise equity finance:
o The ordinary shares
o The Preference shareholders

Chapter 10: Sources of Finance
Comparison of ordinary shares and preference shares

Feature Ordinary shares Preference shares
Dividend Variable – as per profit Fixed e.g. 7% per annum
rate
Dividend Paid only if there are spare funds after Receives the dividend before ordinary
distribution the payment of a preference dividend shareholders (therefore lower risk)
Liquidation The last to be repaid in a liquidation Repaid before (in preference to) the
ordinary shareholders
Voting Normally receive the right to vote on Typically receive no right to vote on
rights major decisions. company decisions.
Redemption Their investments are not normally Their investments are normally
redeemable. redeemable.
Methods of Floatation / Issuing Shares

There are six principal methods for a company to raise equity finance:
• Initial public offer
• Private placing
• Alternate Investment Market (AIM)
• Introduction
• Right Issue
• Bonus Issue
Initial public offer (IPO)

 Public offer means share issue to public. 
 First offer by the company of its shares is called an initial public offer.
 It may be underwritten or not.
 Offer price is decided by the company and underwriter.
 Offer can made through an issuing house.
 Issuing house may be merchant bank. 
 IPO`s are expensive mode of share issue.
Private placing
 There will be maximum limit on number of shares issued in IPO
 When shares are sold through a broker to one or more financial institutions (not to general public)
is known as private placing.
 There is less risk and cost in private placing.
 Private placing is for lower value of share issue.
 Private placing will result in few numbers of shareholders.
Alternate Investment Market (AIM)

 AIM is an alternative to the main stock exchange
 more suited to companies with lower capitalization levels (Pvt, Unlisted Public co) than the very
largest of companies.

Introduction
 In introduction no new shares are made available to the market.
 Existing share are allowed to be traded on stock exchange.
 Marketability of shares will be increased in introduction.
 For introduction at least 25% of shares should be held by general public so that an image of
market already exists.
Placing as compared to Introduction
Advantages
 Placing’s are cheaper and therefore well suited to small issues.
 Placing’s are quicker to perform.
 Less disclosure is required in placing.
Disadvantages
 Control will be restricted in few hands.
Right Issue
 Shares are issued to existing shareholders.
 Offer will be in accordance with existing shareholding.
 Offer will be normally at a discount of their current M.V.
 e.g. “1 for 3” which means a shareholder can buy one new share for each tree they already own.
Bonus Issue
 Converting reserves into share capitals is known as bonus issue.
 No. of shares will be increased.
 This is normally done when company does not want to pay cash dividends.
Difference between Right issue and Bonus issue

In case of right issue, the company issues shares to its existing shares holders in exchange of
consideration that increases the assets of company normally in cash.
In case of bonus issue the company issue shares by capitalizing its existing reserves that increase the
shares of company without increasing the assets of company.
For example, if company ‘A’ limited issued 5,000 right shares to existing shares holders of Rs. 100
per share then at the same time it increases the share capital as well as cash of the company by Rs.
5,00,000.
On the other hand, if company ‘A’ issues 5,000 bonus shares to its existing shares holders then it only
increasing its share capital by Rs. 500,000.
2. DEBT
 Debt finance describes finance obtained when a company borrows money in exchange for the
payment of interest.
 Debt can be categorized between short-term and long-term depending on the length of time
between issuance and maturity. However, this classification is not a perfect science.
 Generally speaking, short term finance is used to fund short-term working capital requirements.
Long term finance is used for major long-term investments and is usually more expensive and less
flexible than short term finance (because the lender is risking their money for longer).
 Types of long and short-term debt finance include:

Short-term Long-term
• Overdraft • Bonds, loan stock, debentures

• Short-term bank loan • loan notes
• Certificate of deposit • Euro bonds
• Treasury-bill • Convertible bonds and warrants
• Trade credit • Long-term bank loan
Short-term loans are suitable for funding smaller investments and long-term loans are suitable for
funding major long-term investments.
Debt is also classified between redeemable and irredeemable:

a)
Irredeemable:
It will never be repaid. Debt holder will only receive interest income.
b) Redeemable:
Redeemable debt will be repaid and cancelled
Long Term Debts
Bank loans
 Bank loans may be long term, medium term and short term.
 Loan can be repaid in proportions on lump sum at the end of loan term.
 Both the borrower and the investor know the cost at the time of contract.
 Interest is allowable deduction for the borrower.
 Loan becomes repayable if the covenants are breached.
 May be secured or unsecured.
 Loans are backed up by a sanctioned letter.
 Bank loans are not traded in debt market
Loan Note
 It is contract for a loan that specifies when the loan must be repaid also the interest rate.
 Similar to promissory note but can be long term as well short term
 short term with maturity of less than 12 months in the case of government notes, or less than 5
years for corporate loan notes
Difference between Bank Loan and Loan Stock:

Feature Bank loans Loan stock
Flexibility Terms are flexible Terms are fixed
Confidentiality Only bank will require Customer will have to fulfil the publicity requirements
information that an issue of loan stock on the financial markets
would need
Speed Quick to arrange Slower to arrange due to the need to fulfil the
requirements of a public issue
Costs Low cost High issuance costs
Restrictions Security (collateral) and Much less restrictive
covenants are required
Financial Detailed financial No such submissions required
information information is required

Euro bonds
 A Eurobond is a bond denominated in a currency that is not native to the country where it is
issued.
 Eurobonds are normally issued by an international syndicate and are an attractive financing tool
as they normally have small par values and high liquidity.
 Eurobonds give the issuer flexibility to choose the country in which to offer their bond according
to the country’s regulatory constraints.
 Eurobonds are named after the currency they are denominated in. For example:
• A Eurodollar bond could be issued anywhere outside the USA
• A European bond could be issued anywhere outside Japan
• A Euro sterling bond could be issued anywhere outside the UK
Leases
An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments
the right to use an asset for an agreed period of time (IFRS 16).
Finance lease
A finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an asset. Title may or may not eventually be transferred.
Finance leases are capitalized and affect key ratios (ROCE, gearing)
Operating Lease
An operating lease is a lease other than a finance lease.
The tax deductibility of rental payments depends on the tax regime but typically they are tax
deductible in one way or another.
Difference between Finance Lease and Operating Lease

Finance lease Operating lease
Lease term Long (compared to the life of the asset). Short (compared to the life of
Usually for major part of the asset’s life. the asset)
Risks and rewards of Pass to the lessee Remain with the lessor
ownership
Insurance of the asset Lessee’s responsibility Lessor’s responsibility
Maintenance of the asset Lessee’s responsibility Lessor’s responsibility
Ownership The contract may allow the lessee to The contract never allows the
buy the asset at the end of the lease lessee to buy the asset at the
(often at a low price – giving the lessee end of the lease
a bargain purchase option)
In both cases:
• legal ownership of the asset remains with the lessor; but
• the lessee has the right of use of the asset in return for a series of rental payments

Warrant
 A warrant is similar to a convertible bond in that the warrant allows the holder to buy stock at a
set price (rather than convert the underlying bond into stock).
 As such the ‘stock’ part of a warrant can be separated from the bond and traded on its own
whereas a convertible bond cannot be separated.
Convertible bonds and warrants (hybrids)

A hybrid is a financial instrument that combines features of equity and debt. Convertible bonds and
warrants are examples of hybrids.
Convertible bonds
 Debt can be converted into equity at any future date
 In a predetermined ratio.
 Will enjoy interest and dividend once converted into equity.
 If not converted debt will be redeemed at redemption date.
Short Term Debts

Overdrafts
 Over draft limit is available on current account.
 It can be repayable on demand.
 Interest is an allowable deduction.
 Penalties for breaching overdraft limits can be high.
 Over draft limits are used for working capital needs.
Certificates of deposit (CDs)
 A CD is a security that is issued by a bank, acknowledging that a certain amount of money has
been deposited with it for a certain period of time (usually, a short term).
 The CD is issued to the depositor, and attracts a stated amount of interest.
 The depositor will be another bank or a large commercial organization.
 CDs are negotiable and traded on the CD market (a money market)
 if a CD holder wishes to obtain immediate cash, he can sell the CD on the market at any time.
 This secondary market in CDs makes them attractive, flexible investments for organizations with
excess cash.
Treasury bills (T-bills)
 These are issued by govt.
 These are for short term cash deficiency in govt. programs.
 These are for less than a year.
 At the end of duration full amount will be received to the holder.
Trade Credit
 Credit available from supplies is one of the easiest and cheapest sources of short term finance.
 If credit is obtained, it reduces the need for finance from other sources e.g. banks.
Advantages Disadvantages
No interest in less company defaults. Delay in payment will worsen a company`s
credit rating.
Current assets like raw materials can be purchased Additional credit is difficult if there is a
on credit from 30-90 days. current delayed.

In a period of high inflation it keeps the cost down. Penalty charges are higher than normal
interest payments.
Commercial Paper
 Is a common form of unsecured short-term debt issued by a coporation.
 Typically issued for the financing of payroll, accounts payable, inventories and meeting short term
liabilities
 Traded in money market
Factors influencing the choice of debt finance

Availability:  Listed companies can issue loan notes to public.
 Smaller companies can get loan from bank.
Duration:  Company should match loan life with asset life.
 Fixed asset financed with long term loan.
 Current asset financed with short term loan.
Fixed or  Fixed interest means rate once decided will not be changed.
floating rates:  Floating interest means rates will be changed from time to time.
Security and  Debt will be decided according to the type of security.
covenants:
Advantages and disadvantages of Debt Finance

For Investors
Investor will receive fixed income. Debt holders don’t have any voting right.
In case of non-payment of interest, debt holder can In case of high profit, debt holder will receive
appoint liquidator. fixed profit.
Debt holder normally has a security. If unsecured, debt investment risk will be high
for debt holders.
In case of liquidation, debt holders rank higher
than any other payables.
For Company
Debt interest is an allowable deduction against tax In case of low profit, fixed interest has to be
calculations. paid.
Debt holders don’t have any voting right. In case of non-payment of interest, debt holder
can appoint liquidator.
In case of high profit, company will pay fixed In case of liquidation, debt holders have to pay
interest. debt first.
There is no immediate dilution of EPS and In case of high debt future burrowing capacity
dividend. will be decreased.

Issue costs are low. The more highly geared the company, the
higher will be its risk profile.
Provides the company with a facility to raise cash.
Selection of Source of finance

Decision of selecting the source of finance by the company is very critical for its long term survival.
For evaluating the source of finance the company should consider its gearing level. ‘Gearing’
describes the balance of long-term financing between non-interest-bearing Equity and interest-
bearing Debt. The higher the proportion of interest-bearing debt, the higher the gearing. Equity
finance may be used in preference to debt finance if the company is already highly geared.
Note that as per Companies’ Act, private companies are not allowed to offer shares for sale to the
public at large. In such cases the private limited company would need to convert to a public limited
company to enable it to offer shares for sale to the public.
Bonds / loan notes / debentures / loan stock / commercial papers

Basic characteristics
1. All securities have par value.
2. Interest will be paid annually.
3. Can be traded in the market.
4. Can be fixed interest and floating interest
Specific characteristics
Commercial Very short term with a maturity of 9 months
paper:
Loan notes: Short term with maturity of less than 12 months in case of govt. notes or
less than 5 % for corporate loan notes
Debenture: Unsecured long term loan
Bond: Secured long term loan ( 5 years to 20 years )
Market value of loan stock

Unlike shares, debt is often issued at par which is Rs100 (also called nominal value). Where the
coupon (interest) rate is fixed at the time of issue, it will be set according to prevailing issuing debt.
Subsequent changes in market and company conditions will cause the market value of the bond to
fluctuate, although the coupon will stay at the fixed percentage of nominal value.
The basic principle for valuing loan stock based on future expected returns is:
(Interest earnings x (Redemption value x
Value of debt = +
annuity factor) Discounted cash flow factor)
OR
M.V. of debt= P.V of interest payments+ P.V of redemption value

The market will also take account of other market factors such as reputation, interest rate expectations
and risk when valuing debt. Detailed valuation is outside the scope of this paper.
EXAMPLE-1
interest per annum Rs. 490
Required rate of return 10%
loan agreement 5 years
interest rate 7% P.A.
loan amount 7000

Required:
Calculate Market Value of Bond.
SOLUTION:
Years Cashflow Discount Factor Present Value
Rs. @ 10% Rs.
1 490 0.909 445
2 490 0.826 405
3 490 0.751 368
4 490 0.683 335
5 7,490 0.621 4,651
6,204
Charge (mortgage) on loan stock
Loan stock may be secured through a fixed or floating charge on assets. A fixed charge may be on
specific assets such as land and buildings. The specified assets cannot be sold while the loan is
outstanding. A floating charge is a charge on a class of assets, such as inventory, receivables or
machinery. Sale of some assets of the class is permitted. When a fault arises, such as a default in
payment of interest, a floating charge converts into a fixed charge on the specific class of assets.
Interest rate on loan stock

Interest rate can be fixed (agreed at the outset) or floating (vary over the life depending on prevailing
market interest rates).
Deep discounted bonds

 Large discount on the par value.
 Debt holder will enjoy interest as well as capital gain.
Zero coupon bonds

 Zero interest rate.
 Debt holder will enjoy larger capital gain.
 E.g. commercial paper
No payment till redemption date. The advantage for lenders is restricted, unless
the rate of discount on the bonds offers a high
yield.
Exact cost is known at the date of loan receipts. ideal for investors willing to sacrifice periodic
return for a higher return at maturity.
Investor can obtain cash by selling in open
market.
Features of convertible securities

How they work
Interest is paid at an agreed rate for a specified period. At the end of the period the holder can choose
to be repaid in cash or to change the debt into equity shares. Whether or not conversion occurs
depends on the share price at the conversion date.
The issuing company will need to raise cash in order to pay back the amount if conversion is not
chosen.

Conversion rate
The conversion rate is expressed as a conversion price. i.e. the price of one ordinary share that will be
appropriated from the nominal value of the convertible bond. Conversion terms may vary over time.
Conversion value
The current market value of ordinary shares into which a loan note may be converted is known as the
conversion value. The conversion value will be below the value of the note at the date of issue, but
will be expected to increase as the date for the conversion approaches on the assumption that a
company’s shares ought to increase in market value over time.
CONVERSION VALUE
The current M.V. of shares in which one unit of debt can be converted.
Conversion value = no of shares x M.V./share in one unit
Conversion premium = M.V. of debt – conversion value
Conversion premium
A conversion premium is the difference between the market price of the convertible bond and its
conversion value. In other words, it is the difference between the market price of the convertible
bond and the market price of shares into which the bond is expected to be converted.
Factors on which market value of convertible notes depends;-

1. Price of straight debts
2. The current conversion value
3. The time length till option exercise date
4. Market expectations about returns on equity
Advantages and disadvantages of Convertible Bond

For Investors
It carries chance of fixed income from debt On conversion EPS will be reduced.
and higher returns from equity
Investors can enjoy voting rights in future On conversion there may be a reduction in
controlling power.
Investors has the time to observes the Before conversion gearing is high which change
company`s performance company risk profile.
For Company
It serves as a delayed equity which delay If converted EPS will reduce because shares
reduction in EPS are increased
Interest is allowable against tax calculations If converted control will be diluted
Fixed interest payments make financial planning Convertible debt will increase debt equity ratio
easier thus increasing financial risk
Convertible debts does not need cash redeem if
converted in to equity

CORE SOURCES OF FINANCE

An important aspect of financial management is the choice of methods of financing for a company’s
assets. Companies use a variety of sources of finance and the aim should be to achieve an efficient
capital structure that provides:
• A suitable balance between short-term and long-term funding
• Adequate working capital
• A suitable balance between equity and debt capital in the long-term capital structure
ISLAMIC FINANCE
 includes financing activities that should comply with Sharia (Islamic Law).
 Certain practices and principles under conventional financing products are strictly prohibited
under Shariah
 important principles on which the Islamic finance is based:
• Each transaction must be related to a real underlying economic transaction.
• The lender cannot charge Riba(interest) from the borrower.
• Parties entering into the contracts share profit/loss and risks associated with the transaction.
No one can benefit from the transaction more than the other party.
Murabaha
 One of the most popular modes used by banks in Islamic countries to promote riba free
transactions is Murabaha.
 kind of sale where seller expressly mentions the cost he has incurred on the commodities to be
sold
 sells it to another person by adding some profit or mark-up thereon which is known to the
buyer.
 Murabaha is a cost plus transaction where the seller expressly mentions the cost of a
commodity sold and sells it to another person by adding mutually agreed profit thereon which
can be either in lump-sum or through an agreed ratio of profit to be charged over the cost, thus
resulting in an absolute price.
Basic Features of Murabaha
1. The subject matter of sale must be existing at the time of sale.
Example:
A sells the unborn calf of his cow to B. The sale is void.
2. The subject matter of sale must be in the ownership of the seller at the time of sale, and he must
have a good title to it.
Example:
A sells to B a car, which is presently owned, by C, but A is hopeful that he will buy it from C and shall
deliver it to B subsequently. The sale is void.
3. The subject matter of sale must be in the physical or constructive possession of the seller when he
sells it to another person.
Examples:
A has purchased a car from B. B has not yet delivered it to A or to his agent. A cannot sell the car to
C. If he sells it before taking its delivery rea or constructive from B the sale is void.
4. The sale must be prompt and absolute.

5. The subject matter of sale must be a property of value.

6. The delivery of the sold commodity to the buyer must be certain and should not depend on a
contingency or chance.
Example:
A sells his car stolen by an anonymous person and the buyer purchases it under the hope that he will
manage to recover it. The sale is void.
7. The absolute certainty of price is a necessary condition for the validity of a sale.
Example:
A says to B, "if you pay within a month, the price is Rs.50/. But if you pay after two months, the price
is Rs.55/- B agrees without absolutely determining one of the two prices. In this case as the price
remains uncertain the sale is void, unless anyone of the two alternatives is settled by the parties at
the time of concluding the transaction.
8. The sale must be unconditional.
Example:
A buys a car from B, with a condition that B will employ his son in his firm. The sale is conditional,
hence invalid.
9. A sale is valid in which the parties fix the price and due date of payment in an unambiguous manner.
The due time of payment can be fixed either with reference to a particular date, or by specifying a
period of time, but it cannot be fixed with reference to a future event, the exact date of which is
unknown or is uncertain.
Ijarah
 Ijara is, in fact, lease agreement whereby a bank buys an asset and rent it out to the client.
 The bank makes a reasonable profit out of the rent.
 In Ijara, the ownership of the assets remains with lessor (financial company) whereas the lessee
enjoys the possession of the asset.
 The lessor, however, retains the right of ownership of the asset and is legally bound to bear the risks
of the asset, which also includes obligations to repair any damage caused naturally or due to wear
and tear, insurance, accidental repairs for the asset. While, actual operating/overhead expenses
related to running the asset, any damage to the asset arising out of his negligence will be borne by
the lessee.
 The lessor cannot charge late payment penalty as his income.
 Lease and Sale agreement should be separate and non-contingent.
 In conventional lease the Lessor has the unilateral right to rescind the lease contract at his sole
discretion, however, in Ijarah the lease contract can be terminated with mutual consent.
Mudaraba
 Mudaraba is a form of Islamic business in which the investment company (rab al maal) provides
financial capital whereas the manager (Mudarib) provides human capital.
 The profit is shared according to the agreed terms.
 In the case of loss, the bank loses money while the Mudarib loses his efforts.
 There are two types of Mudaraba: restrictive and unrestrictive.
Restrictive Mudaraba means that the investor has specified investment details in the Mudarabah
contract and has restricted the working partner within the scope of such specifications.

Unrestrictive Mudarabahs mean that the investor has granted the working partner the right to
undertake any lawful investment to make profits. It is the responsibility of the working partner to
avoid unlawful and high-risk investments. The working partner is liable for any losses suffered from
such investments.
Musharaka
Musharika is a form of Islamic business partnership in which both bank and client enter into a temporary
contract by providing funds on the basis of sharing profit and loss. Musharika has following
characteristics:
 Both parties (bank and client) make investment.
 The profit is shared on agreed ratio.
 The loss is restricted to the amount of investment.
 The client runs the business whereas the bank monitors and supervises it.
Other Common Source Of Finance

Venture capital
 Venture capital is normally provided to a private by a specialized investment institution.
 Management has to give a proper business plan.
 Venture capital will demand an exit route for its investment.
 Investment is typically for 3-7 years.
When venture capital is appropriate
o For startup business
o For management buyouts
o For business expansion
Business angels
 Business angels are wealthy individuals who purchase equity shares.
 They don’t participate in business management.
 They are not common.
When appropriate
o Business angels are a way of equity finance for small companies in their business startup.
Private equity funds:

 It describes equity in unquoted operating companies.
 It includes venture capitals and private equity funds.
 A private equity funds looks to take a reasonably large stake in mature business.
 In a typical leveraged buyout transaction, the private equity firms buys majority control of an
existing or mature company.
 It tries to enhance value by eliminating inefficiencies or driving growth.
When appropriate:
o If used as a source of funding a private equity fund will take a large stake (30 %) and appoint
directors.
Asset Securitization and Sale

 It’s the process of converting existing assets or future cash into marketable securities.
 Company A setup company B (Special Purpose Vehicle) and transfer as asset to it.
 Company B issues to securities to investors for cash. These investors are than entitled to the
benefits to the asset.
 The cash raised by the company B is then paid to company A.

 Conversion of current assets into marketable securities is known as asset backed securitization.
 Conversion of future cash flows into marketable securities is known as future flows securitization.
When appropriate:
o It’s used extensively in the financial services industry.
o Securitization converts non-marketable assets
Foreign Direct Investment (FDI)

 a company invests in overseas operations
 expanding existing operations overseas.

CHAPTER 11
Cost of Capital
Yield
Yield is the return of investor or debt-holder. The total earning from an investment i.e. interest rate
earned on investment is called yield.
The cost of fixed-rate debt is commonly referred to as the ‘interest yield’. The interest yield on debt
capital varies with the remaining term to maturity of the debt.
 As a general rule, the interest yield on debt increases with the remaining term to maturity. For
example, it should normally be expected that the interest yield on a fixed-rate bond with one year
to maturity/redemption will be lower than the yield on a similar bond with ten years remaining to
redemption. Interest rates are normally higher for longer maturities to compensate the lender for
tying up his funds for a longer time.
 Each item of debt finance for a company has a different cost.
 Cost of debt differs for different periods of borrowing.
 Debt capital has differing risk and return, according to
o security
o senior or subordinated debt,
o time remaining to maturity.
YIELD CURVES
The relationship between length of borrowing and interest rates is described by the yield curve.
A plot of required rates of return (yields) against maturity is called a yield curve.
The normal expectation is that the yield curve will slope upwards though this is not always the case.
Shape of the yield curve (term structure of interest rates)
Interest yields on similar debt instruments can Normal yield curve
be plotted on a graph, with the x-axis
representing the remaining term to maturity,
and the y-axis showing the interest yield.
A graph which shows the ‘term structure of
interest rates’, is called a yield curve.
Time to maturity
As indicated above, a normal yield curve slopes upwards, because interest yields are normally higher
for longer dated debt instruments.
Sometimes it might slope upwards, but with an unusually steep slope (steeply positive yield curve).
However on occasions the yield curve might slope downwards, when it is said to be ‘negative’ or
‘inverse’.
When the yield curve is inverse, this is usually Inverse yield curve
an indication that the markets expect short-term
interest rates to fall at some time in the future.

Chapter 11: Cost of Capital
 When the yield curve has a steep upward slope, this indicates that the markets expect short-term
interest rates to rise at some time in the future.
 Yield curves are widely used in the financial services industry.
 Two points that should be noted about a yield curve are that:
• Yields are gross yields, ignoring taxation (pre-tax yields).
• A yield curve is constructed for ‘risk-free’ debt securities, such as government bonds. A
yield curve therefore shows ‘risk-free yields’.
As the name implies, risk-free debt is debt where the investor has no credit risk whatsoever, because
it is certain that the borrower will repay the debt at maturity.
The market value of a bond is the present value of the future cash flows that must be paid to service
the debt, discounted at the lender’s required rate of return (pre-tax cost of debt).
The lender’s required rate of return (the pre-tax cost of debt) is the IRR of the cash flows (pre-tax)
that must be paid to service the debt.
Example: Market value of bond
A company has issued a bond that will be redeemed in 4 years. The bond has a nominal interest rate
of 6%. The required rate of return on the bond is 6%.
Required
Calculate what the market value of the bond would be if the required rate of return was 5% or 6% or
7%.
Answer
Year Cash Discount PV Discount PV (6%) Discount PV

flow factor (5%) factor factor (7%)
(5%) (6%) (7%)
1 Interest 6 0.952 5.71 0.943 5.66 0.935 5.61
2 Interest 6 0.907 5.44 0.890 5.34 0.873 5.24
3 Interest 6 0.864 5.18 0.840 5.04 0.816 4.90
4 Interest + 106 0.823 87.21 0.792 83.96 0.763 80.87
redemption
Market value 103.54 100.00 96.62
Note that there is an inverse relationship between the lender’s required rate of return and the market
value. The cash flows do not change. The investor can increase his rate of return by offering less for
the bond. If the investor offers more the rate of return falls

It follows from the above example, that if the cash flows were given as above together with a market
value of Rs.103.54, the required rate of return could have been calculated as the IRR of these
amounts, i.e. 5%. This would then be the pre-tax cost of debt.
Similarly, a market value of Rs.100 would give a cost of debt of 6% and a market value of Rs.96.62
would give a cost of debt of 7%.
The IRRs calculated in this way can be described in a number of ways including:
• lenders’ required rate of return;
• cost of debt (pre-tax);
• gross redemption yield;
• yield to maturity.
The implied yield for a market value of Rs.103.54 is 5%. This implies that an investor in the bond
discounts each of the future cash flows at 5% in order to arrive at the market value of the bond.
This is a simplification. The 5% is an average required rate of return over the life of the bond. In fact,
an investor might require a higher rate of return for the year 2 cash flows than for the year 1 cash
flows and a higher rate of return for the year 3 cash flows than for the year 4 cash flows and so on. In
other words, cash flows with different maturities are looked on differently by investors.
Bond valuation using the yield curve

Annual spot (valid on the day they are published) yield curves are published in the financial press.
The cost of new debt can be estimated by reference to a yield curve.
Example:
A company wants to issue a bond that is redeemable at par in four years and pays interest at 6% of
nominal value.
The annual spot yield curve for a bond of this class of risk is as follows:
Maturity Yield
One year 3.0%
Two years 3.5%
Three years 4.2%
Four years 5.0%
Required
Calculate the price that the bond could be sold for (this is the amount that the company could raise)
and then use this to calculate the gross redemption yield (yield to maturity, cost of debt).
Answer
An investor will receive a stream of cash flows from this bond and will discount each of those to
decide how much he is willing to pay for them.
The first year flow will be discounted at 3.0%, the second year flow at 3.5% and so on. (Note that the
two-year rate of 3.5% does not mean that this is the rate in the second year. It means that this is the
average annual rate for a flow in 2 years’ time).
Year Cash flow Discount factor PV (4%)
1 Interest 6 1/1.03 = 0.971 5.83
2 Interest 6 1/1.0352 = 0.934 5.60
3 Interest 6 1/0423 = 0.884 5.30

4 Interest + redemption 106 1/1.054 = 0.823 87.21

Market value 103.94
The company would need to issue a Rs.100 nominal value bond for Rs.103.94.
The cost of debt (gross redemption yield) of the bond can be calculated in the usual way by
calculating the IRR of the flows that the company faces.
Try 4% Try 6%
Year Cash flow Discount PV Discount PV

factor factor
0 Market value (103.94) 1.000 (103.94) 1.000 (103.94)
1 Interest 6.00 0.962 5.77 0.943 5.66
2 Interest 6.00 0.925 5.55 0.890 5.34
3 Interest 6.00 0.889 5.33 0.840 5.04
4 Interest + 106.00 0.855 90.61 0.792 83.96

redemption
NPV + 3.32 (3.94)

Using interpolation, the before-tax cost of the debt is:
4% + 3.32/(3.32 + 3.94)
(6 – 4)% = 4.91%
The cost of the debt is therefore estimated as 4.91%. This is the average cost that the entity is paying
for this debt.
Estimating the yield curve

A yield curve was provided in the previous section. The next issue to consider is how these are
constructed.
This technique is called “bootstrapping”.
Example: Estimating the yield curve
There are three bonds in issue for a given risk class.
All three bonds pay interest annually in arrears and are to be redeemed for par at maturity.
Relevant information about the three bonds is as follows:
Bond Maturity Coupon rate Market value
A 1 year 6.0% 102
B 2 years 5.0% 101
C 3 years 4.0% 97
Required
Construct the yield curve that is implied by this data.

Answer
Step 1 – Calculate the rate for one-year maturity
Work out the rate of return for bond A.
The investor will pay Rs.102 for a cash flow in one year of Rs.106.
This gives an IRR of (106/102) -1 = 0.0392 or 3.92%
Step 2 – Calculate the rate for two-year maturity
The market value bond B is made up of the present value of the year one cash flow discounted at
3.92% (from step 1) and the present value of the two-year cash flow discounted at an unknown rate.
This can be modelled as follows:
Cash Discount PV (4%)
flow factor
1 Interest 5 1/1.0392 4.81
2 Interest + redemption 105 1/(1 +r)2 96.19 (Balancing figure)
Market value (given) 101.0
Therefore:
105 × 1/(1+r)2 = 96.19
Rearranging: 105/96.19 = (1 + r)2
r = 105/96.19 - 1 = 0.0448 or 4.48%
Step 3 – Calculate the rate for three-year maturity
The market value of the three-year bond is made up of the present value of the year one cash flow
discounted at 3.92% (from step 1), the present value of the two-year cash flow discounted at 4.48%
(from step 2) and the present value of the three-year cash flow discounted at an unknown rate.
This can be modelled as follows:
t Cash flow Discount factor PV (4%)
1 Interest 4 1/1.0392 3.85
2 Interest 4 1/1.04482 3.66
3 Interest + redemption 104 1/(1 +r)3 89.49 (Balancing figure)

Market value (given) 97.0
Therefore: 104 × 1/(1+r)3 = 89.49 Rearranging:

104/89.49 = (1 + r)3
r = 3 104/89.49 - 1 = 0.051 or 5.1%
Step 4 – Summarise in a table

Maturity Yield
1 year 3.92%
2 year 4.48%
3 year 5.1%

WEIGHTED AVERAGE COST OF CAPITAL

Cost of Capital is the rate of return that the providers of capital require as compensation for their
contribution of capital. These providers include debt holders and equity holders. The rule of thumb is:
This is in line with the conclusions drawn from investment appraisal whereas we discount projects
basedon the cost of capital or compute the IRR of a certain project and compare it with the cost of
capital. The term cost of capital and the required rate of return are mostly used interchangeably.
The related term used for the cost of capital is the Weighted Average Cost of Capital (WACC) since
the sources are multiple and the average cost of all the sources of capital is included while calculating
WACC.
WACC can be commonly calculated as:
WACC = [(MVe x Ke) + {MVd x Kd(1 − t)} + (MVp x Kp)]
(MVe + MVd + MVp)
Whereas:
MVe = Market Value of Equity Ke = Cost of Equity
MVd = Market Value of Debt Kd = Cost of Debt t = Tax rate
MVp = Market Value of Preference Shares Kp = Cost of Preference Shares
If interest payments are not tax-deductible (in a rare case), then the component of (1-t) will be
eliminated. Hence it will become:
WACC = [(MVe x Ke) + (MVd x Kd) + (MVp x Kp)]
(MVe + MVd + MVp)
Let’s understand the above building blocks of the weighted average cost of capital.
CAPITAL STRUCTURE
The capital structure is the combination of debt and equity used by a company to finance its overall
operations and growth. Debt comes in the form of corporate bond issues or loans, while equity may
come in the form of ordinary shares, preference shares, and retained earnings.
While evaluating the WACC of a Company, we shall pick up market values of the debt and equity
components and not their book value.
COSTS OF THE DIFFERENT SOURCES OF CAPITAL:

Each provider of capital requires a return on the amount provided, like a shareholder requires
dividend/capital appreciation and a debt holder requires interest. This is called the cost of a certain
capital.
Each source of capital has a different cost because of differences in contractual structure, preference
inpayments and liquidation, and related risks.
These costs are termed as follows:
Source of Capital Cost of Capital

Ordinary shares Cost of Equity ‘Ke’(e.g. Dividend)
Preference shares Cost of Preference Shares ‘Kp’(e.g.Preference dividend
Debt (Bonds/loans etc.) Cost of Debt ‘Kd’(e.g. interest)

A source of the capital carrying any cost is included in ‘Capital Employed’. The target of the
Companyis to generate sufficient returns from its operations to cover the weighted average cost of all
the sourcesof capital.
TAXES AND WEIGHTED AVERAGE COST OF CAPITAL:

Payments to owners (dividend) are not tax-deductible for the Company whereas interest costs are tax-
deductible, which means they provide tax savings.
For instance, if a company pays interest of Rs 100 on a certain debt with an applicable tax rate of 30%,
the net effective cost of debt will be Rs 70 as it is claimable and will provide savings of Rs 30 (30% of
Rs100). Hence:
After-tax cost of debt = Before-tax cost of debt (1 – t)
Whereas ‘t’ denotes the tax rate and the tax savings are denoted by ‘(1 – t)’ in our calculations.
MARKET VALUE OF DEBT AND COST OF DEBT:

Before getting into further details, go through the following basic terms:
Term Description
Face value: Reference value on which coupon interest is calculated and it is defined at
the time of issuance of the debt.
Coupon Rate: The rate of interest the debt issuer will pay on the face value of the
debt instrument is expressed as a percentage.
Coupon dates: Dates on which the bond issuer will make interest payments.
Maturity Date: The date on which the debt will mature and the debt issuer will pay the
debtholder the pre-agreed redemption value of the debt.
Term to maturity: The period during which debt holders will receive interest payments on the
debt.
Redemption value: It is the value at which the debt shall be redeemed. It may or may not be equalto
the face value.
Market Value: Price at which debt holder could sell the debt instrument to another investor.
The rate required The current rate of return offered by debt instruments similar to a credit rating
by the lender (Kd): or term to maturity. It is the cost of debt.
MARKET VALUE OF DEBT:

 The market value of a debt instrument is equal to the present value of all future interest
paymentsadded to the present value of the amount at which the debt will be redeemed.
 The coupon rate is used to calculate the interest amount.
 From a discounting point of view, debt might be valued from two different viewpoints:
o The lenders’ viewpoint: discount the pre-tax cash flows (i.e. ignoring the tax relief on the
interest)at the lenders’ required rate of return (the pre-tax Kd).
o The company’s viewpoint: discount the post-tax cash flows (i.e. including the tax relief on
the interest) at the cost to the company (the post-tax Kd). This is the rate that is input into
WACC calculations.
Rule of thumb: If the fixed coupon rate offered falls below the rate required by the lender (Kd), the
market value of the debt instrument will be less than the face value, and vice versa.

Irredeemable debt is a debt that has no specific redemption date or maturity period. The issuing
authority or entity pays a specified interest rate periodically. Therefore, the MV of such debt can be
calculated through the present value of perpetuity interest cash flows as:
Interest (1 − t)
MV of irredeemable debt =
Kd
Alternatively, the post-tax cost of debt (Kd) can be calculated as:
Interest (1 − t)
Kd =
MV of irredeemable debt
Whereas interest is the amount of coupon interest payable on the irredeemable debt.
Redeemable debt is a debt that has no specific redemption date or maturity period. Therefore, the
MVof redeemable debt can be calculated as:
MV of redeemable debt = PV of interest cash flows + PV of redemption value
The present values are computed by discounting them with Kd. To calculate the Kd, the future cash
flowswill be plotted against the MV of redeemable debt and Kd will be calculated by using the IRR
method.
In the case of debt convertible to equity, the process will be the same as redeemable debt except that
the redemption amount shall be higher of the two i.e. redemption amount and conversion value of the
shares.
PRE-TAX AND POST-TAX COST OF DEBT (KD):
Lender’s required rate of return = Company’s pre-tax Kd

Company’s pre-tax cost Kd x (1 – t) = Company’s post-tax Kd
Exam Approach: As mentioned above, WACC calculations involve post-tax
Kd.Irredeemable debt: The post-tax Kd can be calculated as
[pre-tax Kd x (1-t)].
Redeemable debt: The approach is different since gain/loss on redemption is not taxable.
If the scenario only has lenders’ required rate of return (pre-tax Kd):
o MV of debt: Plot all pre-tax cash flows and discount with the lenders’ required rate of return.
o Post-tax Kd: Plot MV of debt, all post-tax cash flows and calculate IRR.
If the scenario provides MV of debt:

o Plot the MV of debt and post-tax cash flows, calculate the IRR.
o This is the post-tax Kd.

If the scenario provides post-tax Kd and requires MV of debt, plot post-tax cash flows, and
discountthe present values with the post-tax Kd. This is the MV of debt.
Rule of thumb: Pre-tax cash flows will be discounted with pre-tax Kd and post-tax cash flows will
be discounted with a post-tax Kd.
MARKET VALUE OF EQUITY AND COST OF EQUITY BY DIVIDEND VALUATION

MODEL
The dividend valuation model (DVM) is a quantitative method used for predicting the price of a
company's equity instrument based on the theory that its present-day price equals the sum of all of its
future dividend payments when discounted with the Cost of Equity (Ke) to their present value.
It attempts to calculate the fair value of a share irrespective of the prevailing market conditions and
takes into consideration the dividend payout factors and the market expected returns. If the value
obtained from the DVM is higher than the current trading price of shares, then the stock is
undervaluedand qualifies for a buy, and vice versa.
D0
Po =
Whereas: Ke
Po = Current market value of the share

Do = Latest dividend at time 0
Ke = Cost of equity
Dividend Growth Model

If a company is expected to pay cash dividends growing at a constant rate of ‘g’ % per annum, the
market value of its share can be computed through the dividend growth model:
D0 (1 + g)
P0 =
Ke – g
Whereas growth (‘g’) can be computed by one of the following ways:
1. Past Dividend Pattern
𝑖
( )
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑛
𝑔 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑛 𝑦𝑒𝑎𝑟𝑠 𝑎𝑔𝑜 − 1
Whereas:
n (periods of growth) = No of years − 1
2. Earning Retention Model / Gordon’s Growth Model

g =bxr
Whereas:
g = annual growth rate in dividends in perpetuity
b = proportion of earnings retained
r = rate of return on equity or return the company will make on its investments

Points to remember:
In case multiple growth rates are given, the market value of shares can be computed by adding up the
present value of all the future dividends discounted at the cost of equity.
Through the dividend valuation model, the price of the equity instrument calculated is always ex-
dividend. (whereas cum-dividend price means inclusive of dividend).
When Ke is calculated through the dividend valuation model, the prices to be taken are also ex-
dividend

Practice Questions
Question 1
Avari Limited is financed by shareholders and debt holders who contributed
Shareholders Equity 100,000
Debt Finance (loans) 40,000
Required rate of returns by:

Shareholders 15.00%
Lenders 8.00%
Required: Calculate the Weighted Average cost of capital of Ansari Limited.
Question 2
Ansari pvt Limited wishes to estimate its WACC in order to decide as to which investment
opportunities to invest in.
The company has the following capital structure:
Shareholders’ Equity 145,000

Debt Finance 58,000
Required returns of shareholders and debt holders:
Shareholders 16%
Debt holders 10%
The company has the following investment opportunities available to it:
Probability Expected Returns

A B C
30.00% 16.00% 12.00% 16.00%
40.00% 18.00% 10.00% 18.00%
30.00% 20.00% 15.00% 12.00%
Required:
a) Calculate the WACC of the company.
b) Calculate the expected returns of the above projects.
c) Find out which projects the company should invest in.
Question 3
If a company has a WACC of 19% and has the following capital structure:
Equity 165,000
Debt 60,000
Required: Calculate its cost of debt assuming that equity holders need a return of 22%.

Methods to calculate Market Value (MV)

1. Shares X Market Price per share
2. BV of Co. X Price to Book value Ratio
3. R / i (PV of Dividend Method)
Question 4
Multan Limited has the following extracts from its statement of financial position.
Total Assets 4,658,000

Total Liabilities 1,350,000
The company has issued 50,000 shares in the market.
Required:
If the price to book ratio is 2.78 calculate the market value of
a. Entire company
b. Per share
Question 5
Following is the data relating to two companies:
Mamoon Hamdani
Share capital
(Rs. 10 per share) 1,400,000 1,680,000
Reserve 3,500,000 600,000
Equity (Book Value) 4,900,000 2,280,000
Market Value per share for Masoon Limited is Rs. 60

Price to book ratio for Hamdani is 3.89
Required:
Calculate the market value of both companies.
Question 6
Calculate the present value of the following cash flows
Years CFs 1 CFs 2 CFs 3

1 100 150 120
2 - 150 120
3 - 150 120
4 - 150 120
5 - 150 120
Till infinity
Discount rate is 12.5%

Question 7
Calculate the market values of the following companies
A B C
Annual Dividend 150 250 280
Ke 12% 10% 22%
All these companies paid a constant dividend.
Question 8
Complete the following table:
Scrips A B C D
Profits 460,000 3,000,000 250,000 1,800,000
Shares 2,5000 75,000 12,500 60,000
MV per share ? 250.00 88.89 ?
Cost of Equity 12.50% ? ? 8.00%
Total MV of Equity ? 18,750,000 1,111,111 ?
Question 9
Following extracts were taken from the financial statements of Mangol Limited
Sales 4,000,000
Cost of Sales 1,800,000
Operating Expenses 300,000
Interest 496,000
Total Assets at the end of the year 20,000,000

Working Capital 6,000,000
Fixed Assets 8,000,000
Long term debt 5,000,000
Price to book ratio for equity 1.30
Find Ke, assuming the company distributes all its earnings as dividends.
Question 10
2013 2014 2015 2016 2017

Profits 654,000 758,640 834,504 901,264 1,036,454
Dividends 490,500 531,048 600,843 585,822 725,518
Required: Find Market Value of Equity, If Ke = 26%.

Question 11
You are given the following information about two companies, which are both financed entirely by
equity capital:
Trendy Ltd Jumbo Ltd

Number of ordinary shares of Rs. 1 (000) 150,000 500,000
Market value per share, ex div (Rs.) 3.42 0.65
Current earnings (total) (Rs. 000) 62,858 63,952
Current dividend (total) (Rs. 000) 6,158 48,130
Balance sheet value of capital employed (Rs. 000) 315,000 293,000
Dividend five years ago (total) (Rs. 000) 2,473 37,600
Required: Calculate Ke.
Question 12
Hussain Limited has the following capital structure at 31 December 2016:
Share Capital 1,428,000

Retained Earnings 2,750,000
Long term debt – irred 1,250,000 (10% coupon rate)
Long term debt – redeem 780,000 (12% coupon rate)
Bank O/D 500,000 (16% rate)
1. The latest P/L of the company shows the following

Profit before tax 1,410,714
Profit after tax 987,500
Profit retained 389,247
2. Dividend History
2012 2013 2014 2015 2016
Dividend per share 4,900 5,500 5,995 6,475 7,122
Required: Calculate dividend growth rate.
Question 13
The following data relates to an all-equity financed company:
Dividend just paid CU 180,000

Earning retained and invested 40%
Return on investment 15%
Cost of equity 20%
What is the market value of equity (to the nearest CU000)?
Question 14
The divided paid by Drood Ltd over the past four years are as follows:
Year 20X4 20X5 20X6 20X7

CUm CUm CUm Cum
Dividend 50 54 61 68

The company had 200 million issued shares entitled to dividends in 20X4 but made a scrip issue of 1 :
2 in January 20X7. The ex-div price per share on 1 January 20X8 is CU4.50
What is the expected return on the shares?
Question 15
The price of a company’s shares is currently CU40 ex-div. The latest dividend is CU3 per share.
If the company’s cost of equity is 10% per annum. What is the implicit constant annual dividend
growth rate?
Question 16
The summarized income statement for Bloachi Ltd Co. for the last year is as follows:
CUm
Profit before taxation 100
Taxation (40)
Profit after taxation 60
Dividend on ordinary shares (40)
Retained Earnings 20
Shareholder’s equity of CU556 million is shown in the balance sheet at the beginning of the year. The
company maintains a ratio of retained earnings to dividend of 1 : 2
Required: Using the Gordon’s growth model, what is the dividend growth rate?
Question 17
Face value of the Debt issued Rs. 100
Coupon rate 10%
Market interest rate (post tax) 6%
Term of maturity 3 Years
Redemption value Rs. 100
Tax rate 30%
Required: Calculate the market value of the debt.
Question 18
Coupon rate 12%
Market interest rate (post tax) 8%
Tax rate 30%
Required: Calculate the market value of the debt.
Question 19
A company’s shares are currently valued at Rs.8.20 and the company is expected to pay an annual
dividend of Rs.0.70 per share for the foreseeable future.
Required: Calculate the cost of equity in the company.

Question 20
A company has recently paid a dividend Rs. 3 per share and the dividend is expected to grow by 5%
into the foreseeable future. The next annual dividend will be paid in one year’s time.
The shareholders require an annual return of 12%.
Required: Calculate the market value of each equity share?
Question 21
A company’s share price is Rs.8.20. The company has just paid an annual dividend of Rs.0.70 per
share, and the dividend is expected to grow by 3.5% into the foreseeable future. The next annual
dividend will be paid in one year’s time.
Required: Calculate the cost of equity in the company?
Question 22
The price of a company's share is currently Rs. 80. The latest dividend is Rs. 12 per share.
If the company's cost of equity is 15% per annum, what is the annual dividend growth rate?
Question 23
The summarised profit and loss account for a company for the last year is as follows:
Rs. in "million"
Profit before tax 200
Tax (80)
Profit after tax 120
Dividends (80)
Retained earnings 40
Shareholder's equity of Rs. 1,120 million is shown in the balance sheet at the beginning of the year.
The company maintains a ratio of retained earnings to dividends of 3 : 4
Required: Using the Gordon growth model, what is the dividend growth rate?
Question 24
An all equity financed company distributes 80% of its earning each year and reinvests the balance.
The return on it's projects is a constant 15% per annum.
If the company's current market capitalisation is Rs. 1.5 million and it's earnings are Rs.
125,000, calculate the required rate of return for the ordinary shareholders.
Question 25
A company has just declared a dividend of Rs. 39.25 per share. Previous dividends have been as
follows:
Rupees
Four years ago 30
Three years ago 32.4
Two years ago 34.5
One year ago 36.5
The current market value per share is Rs. 831.
Required: What is the estimated cost of equity.
Question 26
The following data relates to an all equity financed company:
Dividend just paid Rs. 80 per share
Earnings retained and invested 40%
Return on investments 15%
Cost of equity 20%
Market rate of debt (post tax) 9%
Share capital (Rs. 15 each) 15,000,000
Required: What is the market value of the company?
Question 27
Four years ago a company paid a dividend of Rs. 610,000 on a share capital of 4 million ordinary
shares of Rs. 0.5 each.
It has just paid a dividend of Rs. 960,000 on the same share capital, and the current market price of
the shares is Rs. 3
Required: What is the cost of equity?
Question 28
Chintu Limited maintains a ratio of retained earnings to dividends of 1 : 3. It's summarised profit and
loss account for the year ended 31 December 2021 was as follows:
Rupees in ‘000’
Profit before tax 500
Tax (100)
400
Dividends (300)
The shareholder's equity is Rs. 4.5 million.

Required: What is the dividend growth rate per annum computed via the Gordon growth model?
Question 29
Zozo Limited has just paid a dividend of Rs. 1.2 per share. The last accounts show that its earnings
per share were Rs. 2.5 and that the value of its assets was Rs. 6 million. There are 500,000 shares in
issue currently quoted at Rs. 8 per share.
Required: What is the cost of capital of Zozo Limited?
Question 30
The ordinary dividend growth rates of Pathan Company, on an annual basis, for the past ten years
have been as follows:
Years Dividend growth rate
20X0 to 20X4 5%
20X5 26%
20X6 to 20X9 10%
The ordinary shares have been listed since January 20X5
Required: What is the appropriate dividend growth rate to use when estimating the cost of equity
capital at 31 December 20X9.

Question 31
Coupon rate 13%
Market value 103.64
Tax rate 30%
Required: Calculate the post tax market rate applicable to the debt.
Question 32
Coupon rate 9%
Market value 101.88
Tax rate 40%
Required: Calculate the post tax market rate applicable to the debt.
Question 33
Mango Ltd has the following detail:
Equity
Dividend per share now 16
Dividend per share 5 years ago 11
Ke 24%
No. of shares 200,000
Debt
Bond 10,000 (Face value 100)
Coupon Rate 10%
Term 4 Years
Market value of bond 102.5
Required: Calculate WACC for Mango Ltd.
Question 34
Orange Ltd has the following detail:
Share Capital (10,000 shares of Rs. 10 each) 100,000
Reserve 50,000
10% Redeemable Debt (Term 3 Years) 25,000
12% Irredeemable Debt 20,000
Cost of Equity 16%
Dividend growth rate 5%
Last dividend paid Rs. 9.50 per share
Post tax Kd for Redeemable debt 8%
Post tax Kd for Irredeemable debt 9%
Tax rate observed in the country is 30%
Required: Calculate WACC for Orange Ltd.

Question 35
Lychee Ltd has the following detail:
Share Capital (50,000 shares of Rs. 10 each) 500,000
Reserve 1,000,000
17% Long Term Debt (Term 3 Years) 400,000
Cost of Equity 24%
Dividend growth rate 6%
Last dividend paid 16 per share
Post tax Kd 10%
Tax rate observed in the country 30%
Required: Calculate WACC for Lychee Ltd.
Question 36
Banana Limited has the following capital structure:
Share Capital (Rs. 10 per share) 150,000
Reserve 550,000
12% Long term Debt (Term 3 Years) 165,000
Cost of Equity 24%
Dividend growth rate observed in last 5 years 6%
Last dividend paid Rs. 9.20 per share
Post tax cost of debt 8%
Tax rate observed in the country 30%
The company is considering to initiate a new project and wishes to finance it through long term loans
only.
Its cost of debt shall be 9% after tax. The project would be needing Rs. 100,000 and would result in
the following cash flows:
Years Cash Flows

1 50,000
2 55,000
3 90,000
Due to increased financial risk the share holders would require and additional return of 2.5%
Required:
(a) Calculate the current WACC for Banana Ltd.
(b) Calculate the marginal WACC for evaluation of the project
(c) Calculate the NPV of new project
(d) Calculate the new WACC of Banana Ltd.
Question 37
A company is issuing a ten year 7% redeemable debenture at par in a market where similar securities
are yielding 10% per annum.
Required:
What is the minimum redemption premium on Rs. 100 of debt that the company must offer?

Question 38
A company issued its 10% irredeemable debentures at 95. The current market price is 90.
Tax rate is 30%.
Required: Calculate the current cost of debentures.
Question 39
A company has 15% debentures of 100 nominal value. Investors require a gross yield of 12% on such
debentures.
If tax rate is 30%, what is the cost of debentures to the company?
Question 40
A company's capital structure is as follows:
Rs. In 'million'
10 million Rs. 1 ordinary shares 0
Reserves 4
13% loan stock 2021 7
21
The loan stock is redeemable at par in 2021. Current market price for the company's securities are as
follows:
Rupees
Rs. 1 ordinary shares 2.8
13% loan stock 2021 100
Tax rate is 30%.

The company's cost of equity is 12%.
Required: Calculate WACC of the company.
Question 41
Earnings and interest payments for the following firm are constant in perpetuity.
The firm has 100 million shares issued of Rs. 0.25 each and have a market value of Rs. 1.2.
The dividend per share just paid is Rs. 0.24.
The issued debt consists of Rs. 160 million of irredeemable bond with a coupon rate of 6%. The bond
is currently traded at Rs. 50 per Rs. 100 nominal value. Tax rate is 30%.
Required: Calculate WACC

Question 42
Shareef Limited’s capital structure is as follows:
Rs in 'million
15 million shares of Rs.1 ordinary shares 15
Reserves 8
12% debentures 20X0 6
The debentures are redeemable at par in 20X0. The current market prices for the company's securities
are as follows:
Rupees
Rs.1 ordinary shares 1.6
12% debentures 20X0 100
The company is paying corporation tax at the rate of 30%. The cost of the company's equity capital
has been estimated at 16% per annum. What is the weighted average cost of capital.
Question 43
Hamid Limited company has 10 million Rs. 0.25 ordinary shares in issue with a current price of
Rs. 1.55 cum-div. An annual dividend of Rs. 0.09 has just been proposed.
The company has adopted a policy of no interim dividend payments for some years and those annual
dividends have been growing at a steady rate of 6% per annum.
The company's other major source of funds is a bank loan of Rs. 7 million which has an annual cost of
13%.
Tax rate is 30%, calculate post tax WACC.
Question 44
A company is considering an investment which will require an initial outlay of Rs. 300,000 and will
produce cash inflows of Rs. 125,000 in perpetuity. Other details are as follows:
Authorised share capital 10 million Rs. 0.25 shares
Issued share capital 5 million Rs. 0.25 shares
Current market price per share (cum-div) Rs. 1.25
Normal annual dividend Rs. 0.25
If the company accepts the project and finances it by reducing the forthcoming dividend, what will be
new (cum-div) share price.
Question 45
An all equity financed company has in issue 50 million shares with a nominal value of Rs. 0.5 per
share and a market value of Rs. 1.05 per share.
The company is contemplating raising Rs. 10 million via a rights issue with a subscription price of Rs.
0.8 per share in order to finance a project with a net present value of Rs. 2.5 million.
What will be the new market price of the share?

Question 46
Guava Limited has demonstrated a constant growth in dividend of 4% for several years. One year ago
the dividend was Rs. 0.25 per share and the most recent dividend is due to be paid shortly.
The shares have a nominal value of Rs. 1 and a market value of Rs. 1.98 cum div
Required: What is the cost of equity capital.
Question 47
The following is KKR Limited’s summary of the results for five year:
2021 2020 2019 2018 2017

Rs in million
Net assets 1,585 1,486 1,390 1,301 1,223
Share capital 560 560 560 560 560
Share premium 280 280 280 280 280
Retained profits 745 646 550 461 383
1,585 1,486 1,390 1,301 1,223
Profit after tax 124 118 111 98 92

Dividend 25 22 22 20 19
Profit retained 99 89 89 78 73
The share capital is made up entirely of Rs. 1 ordinary shares. The share price is currently quoted at
Rs. 0.61 ex-div.
Required: Calculate the cost of equity?
Question 48
A company’s profit after tax for the year just ended is Rs. 282,000. Out of this a dividend of Rs.
95,880 will be paid. At year end shareholders’ funds totaled Rs. 3,711,120. Equity capital consists of
426,000 Rs. 1 ordinary shares each valued at Rs. 1.475 cum div.
Question 49
A company’s dividend history is as detailed below:
Rs. In Million
20X6 19.2
20X7 19.9
20X8 20.6
20X9 21.3
20Y0 21.9
20Y1 (just paid) 22.7
The company has 336 million Rs. 1 ordinary shares valued at par.

Question 50
Apple Limited has paid the following dividends over recent years:
Rupees
20X8 520,000
20X9 551,000
20Y0 584,300
20Y1 100,000
20Y2 619,300
The current market capitalization is Rs. 6,587,100. This reflects the 20Y2 dividend due to be paid
shortly.
Question 51
Pumpkin Limited dividends in recent years can be summarized as follows:
Rupees in ‘000’
20X0 860
20X1 1,020
20X2 610
20X3 670
20X4 738
20X5 813
20X6 895
20X7 980
20X8 1,082
20X9 1,190
20Y0 474
20Y1 2,100
Current market capitalization of equity is Rs. 22.63 million, the 20Y1 dividend having been paid
recently.
The dividends paid in 20Y0 and 20Y1 were wholly uncharacteristic and it is widely believed that
former trends will be re-established in 20Y2.
Question 52
A company’s capital structure includes 50 million 8% irredeemable debentures valued at Rs. 85 per
100 nominal value.
Corporation tax is charged at 30%.
Required: Calculate cost of debt?
Question 53
A company has in issue 20 million 7.5% irredeemable debentures. Debt investors currently demand a
return of 6%. Interest is paid annually and the last payment was made several weeks ago. Tax rate is
30%.

Question 54
A company has in issue Rs. 20 million 7% debentures redeemable at par in eight years’ time.
Interest is paid annually and qualifies for immediate tax relief at 30%. Investors require a return of
10%.
Question 55
CSK Ltd’s Market value of equity is Rs 1,250m, market value of debt is Rs 750m and market value of
Preference shares is 500m. Cost of equity (Ke) is 15%, cost of debt (Kd) is 10% and cost of
preference shares is 11%. Tax rate is 30%.
Required: Compute WACC?
Question 56
Tomato Ltd paid a dividend of $25 each this year. The current return to shareholders of
companies in the same industry is 12%, although it is expected that an additional risk
premium of 2% will be applicable to the company, being a smaller and unquoted company.
Compute the expected valuation of Tomato Ltd, if:
Required:
(a) The current level of dividend is expected to continue into the foreseeable future, or
(b) The dividend is expected to grow at a rate of 4% pa into the foreseeable future.
Question 57
Potato Ltd’s current dividend per share is Rs 16. It will grow at the rate of 5% per annum till infinity.
Cost of equity is 12%. Compute current share price of Potato Ltd?
Question 58
Onion Ltd’s current share price cum dividend is Rs 40 and dividend per share is Rs 5. If
dividends are expected to grow at the rate of 4% per annum, compute the cost of equity?
Question 59
Lilly Ltd’s current dividend is Rs 5 per share. Dividends will increase by 3% per annum for next
2 years and then rise by 5% per annum till infinity. If Ke is 12%, compute market price?
Question 60
Peas Ltd just paid divided of Rs 24/share for the year 2018 and has forecasted growth rates
of dividends and profits as follows:
Year Dividend growth rates
2019 to 2021 4%
2022 2%
2023 & 2024 7%
2025 and onwards 6%
Cost of equity is 20%, compute share price as of end of 2018?

Question 61
Carrot Ltd has paid divided of Rs 30 share for the year 2019 and has forecasted growth rates of
dividends as follows:
Year Dividend growth rates
2020 to 2021 3%
2022 to 2025 7%
2026 and onwards 2%
Cost of equity is 13%, compute current share price (year 2019)?
Question 62
Risk free rate is 7% and current market rate is 11%. Compute expected rate of return of shareholders
of Shahi Ltd if it has a beta of 1.2 and of Delta Ltd having beta of 1.5?
Question 63
The rate of return available for investors on government bonds is 4%. The average return on market
investments is 7%. The company’s equity beta is 0.92. Calculate return of shareholders.
Question 64
Stockholders have an expected rate of return of 9% from ordinary shares in Abu Dhabi Ltd, which
have a beta of 1.25. The expected returns to the market are 8%.
What will be the expected rate of return from ordinary shares in Dubai Ltd, which have a beta of 1.8?
Question 65
A company’s shares have a current market value of Rs.13.00. The most recent annual dividend has
just been paid. This was Rs.1.50 per share.
Required
Estimate the cost of equity in this company in each of the following circumstances:
a) Using the DVM and when the annual dividend is expected to remain Rs.1.50 into the foreseeable
future.
b) Using the DVM and when the annual dividend is expected to grow by 4% each year into the
foreseeable future
c) The CAPM is used, the equity beta is 1.20, the risk-free cost of capital is 5% and the expected
market return is 14%.
Question 66
The risk-free rate of return is 6%. The average market return is 10%.
i. What will be the return expected from a share whose beta factor is 1.1?
ii. What would be the share's expected value of Kamran Ltd if it is expected to earn an annual
dividend of 8.9 cents, with no capital growth?
iii. What would be the expected share price of Kamran Ltd if expected dividend for the next
year is 12 cents and it is expected to grow at 3% per annum till inifinity?

Question 67
Asha Ltd’s shares have a current market value of $40. The most recent annual dividend $8 per share
has just been paid.
Required:
Estimate the cost of equity in each of the following circumstances:
i. Using the DVM and when the annual dividend is expected to remain $ 8 into the
foreseeable future.
ii. Using the DVM and when the annual dividend is expected to grow by 3% each year into
the foreseeable future
iii. The CAPM is used, the equity beta is 1.15, the rate on government securities is 5% and
risk premium is 8%.
Question 68
A company has issued 4% convertible bonds that can be converted into shares in two years’ time at
the rate of 25 shares for every Rs.100 of bonds (nominal value). It is expected that the share price in
two years’ time will be Rs.4.25. If the bonds are not converted, they will be redeemed at par after four
years. The yield required by investors in these convertibles is 6%.
Required: What is the value of convertible bond?
Question 69
The current market value of a company’s 7% convertible debenture is Rs.108.70. Annual interest has
just been paid.
The debenture will be convertible into equity shares in three years’ time, at a rate of 40 shares per
debenture.
The current ordinary share price is Rs.3.20 and the rate of taxation on company profits is 30%.
Required:
Calculate the post-tax cost of the bonds.
Question 70
A company has 10 million shares each with a value of Rs.4.20, whose cost is 7.5%.
It has Rs.30 million of 5% bonds with a market value of 101.00 and an after-tax cost of 3.5%.
It has a bank loan of Rs.5 million whose after-tax cost is 3.2%.
It also has 2 million 8% preference shares of Rs.1 whose market price is Rs.1.33 per share and whose
cost is 6%.
Required: Calculate the WACC.
Question 71
Educare plc is listed on the Karachi Stock Exchange.
The company’s statement of financial position at 31 August 20X3 showed the following long-term
financing:
Rs. m
1.2 million ordinary shares of Rs. 25 each 30
Reserves 55
85
9% loan stock 20X5 30
On 31 August 20X3 the shares were quoted at Rs. 121 cum div, with a dividend of Rs. 5.2 per share
due very shortly. Over recent years, dividends have increased at the rate of about 5% a year. This rate
expected to continue in the future.
The loan stock is due to be redeemed at par on 31 August 20X5. Interest is payable annually on 31
August. The post-tax cost of the loan stock is 5.5%.
The company’s corporation tax rate is 30%.
Required
Determine the company’s WACC at 31 August 20X3.
Question 72
Zimba plc is a listed all-equity financed company which makes parts for digital cameras. The
company pays out all available profits as dividends. Zimba plc has a share capital of 15 million
ordinary shares. On 30 September 20X0 it expects to pay an annual dividend of Rs. 20 per share. In
the absence of any further investment the company expects the next three annual dividend payments
also to be Rs. 20p, but thereafter a 2% per annum growth rate is expected in perpetuity. The
company’s cost of equity is currently 15% per annum. The company is considering a new investment
which would require an initial outlay of Rs.500 million on 30 September 20X0.
If this investment were financed by a 1 for 3 rights issue it would enable the share dividend per share
to be increased to Rs. 21 on 30 September 20X1 and all further dividends would be increased by 4%
per annum.
The new investment is, however riskier than the average of existing investments, as a result of which
the company’s overall cost of equity would increase to 16% per annum were the company to remain
all-equity financed.
Required.
(a) Assuming the Zimba plc remains all-equity financed and using the dividend valuation model
calculate the expected ex-dividend price per share at 30 September 20X0 if the new investment does
not take place.
(b) Assuming the Zimba plc remains all-equity financed and using the dividend valuation model
calculate the expected ex-dividend price per share at 30 September 20X0 if the new investment does
take place.
(c) Compare the market values with and without the investment and determine whether the new
investment should be undertaken.

Question 73
Required:
Calculate the market value weighted average cost of capital of Burse Co. (10)
Question 74
Required:
Calculate the after tax weighted average cost of capital of Rupab Co. (06)

Question 75 (Spring 2022 – Q6)

Zaryaab Limited (ZL) is engaged in manufacturing and selling sports goods. Following
information has been extracted from the latest financial statements of ZL:
Rs. in '000
5,000,000 ordinary shares @ Rs. 10 each 50,000
8% bank loan 25,000
Other information:
(i) Shares of ZL are currently trading at Rs. 25 each.
(ii) The return on government bonds is 6% whereas the average return on market
investments is 10%. The average equity beta for ZL’s share is 0.9.
(iii) The tax rate applicable to ZL is 30%.
ZL is planning to set-up another factory in Peshawar for which it would need finance of Rs. 150
million for four years. Following two financing proposals are under the consideration of ZL’s
management:
(i) Issue 9% preference shares of Rs. 100 each. The preference shares would be
redeemable at par at the end of 4th year.
(ii) Issue 9% bonds of Rs. 1,000 each. The bondholders would have a right to either
convert each bond into 35 ordinary shares or redeem it at a premium of 10% at the
end of 4th year. The market value of ZL’s shares is expected to increase by 7%
per annum.
Required:
Recommend the financing proposal that would result in lower weighted average cost of
capital (WACC). (Show necessary computations) (10)
Question 76 (ICAP Model Paper – Q9)

Jamal Limited (JL) is intending to expand its existing operations and considering to issue bonds
to finance the expansion.
You have been provided with the following extracts from JL’s financial statements:
Statement of Financial Position
Rs. in '000
3 million ordinary shares of Rs. 100 each 300,000

Retained earnings 400,000
10% Long-term loan 650,000
The shares are quoted at Rs. 475 cum dividend. The dividend of Rs. 25 per share is due shortly.
JL has paid out following dividends during the past four years:
Year 20X1 20X2 20X3 20X4

Dividend 10 15 18 20
The loan was obtained from a bank 2 years ago and is repayable in 10 years' time.
The tax rate applicable to JL is 30%.
Required:
Determine JL’s weighted average cost of capital (WACC). (06)

Question 77 (Autumn 2022 – Q9)

Lahore Quotient (LQ) is engaged in manufacturing and selling of textile products. LQ is presently
considering to expand the business and needs finance of Rs. 50 million. The management is
considering the following two options:
Option I: Issuance of new shares
Finance the entire expansion by issuing new shares. However, the new project would resultin
equity beta of 1.2.
Option II: Issuance of convertible bonds
Finance the entire expansion by issuing 10% convertible bonds of Rs. 1,000 each. Each bond will be
converted into 3 shares at the end of year 4. The market value of each share is expectedto be Rs. 400
on the date of redemption.
Following information has been extracted from the latest financial statements of LQ:
Rs. in
1,000,000 ordinary shares (Rs. 100 each) '000
11% bank loan 100,000
100,000
Other information:
(i) The return on government bonds is 8% per annum, whereas, the average return on
market investments is 12% per annum. The current equity beta for LQ is 1.3.
(ii) Applicable tax rate to LQ is 30%.
(iii) The details of dividend paid during the last four years (including current year 2022) aregiven
below:
Years 2019 2020 2021 2022
Dividend per share Rs. 10 Rs. 11 Rs. 12 Rs.14
Required:
(a) Compute LQ’s existing weighted average cost of capital. (05)
(b) Recommend whether LQ should finance the new project by issuing new shares or by
issuing convertible bonds. (06)
(c) Discuss any four factors that LQ may need to consider before deciding on whether to
finance the expansion by issuing new shares or convertible bonds. (04)

International Packaging Limited (IPL) is in business of packaging material for a range of food
products. Following information has been extracted from IPL’s financial statements as on31
December 2022:
Rs. in
'000
Ordinary share capital (Rs. 10 each) 100,400
Irredeemable preference share capital (Rs. 100 each) 20,400
9% redeemable bonds (Rs. 100 each) 30,200
Additional information:
Existing businesses:
(i) IPL distributes 60% of its earnings as cash dividend. Following is the trend of its earing per
share (EPS) for the preceding six years:

For the year ended 31 2017 2018 2019 2020 2021 2022
December
EPS (Rs.) 16 19 21 24 26 28
(ii) The return on government securities is 9% per annum whereas market risk premium is5%
per annum. IPL’s current equity beta is 1.2.
(iii) IPL pays Rs. 20 as annual dividend on each preference share every year. The current
market price of preference shares is Rs. 185 each.
(iv) 9% redeemable bonds will be redeemed on 31 December 2025 at 15% premium. The
current market price of these bonds is Rs. 110 each.
(v) Applicable tax rate is 30%.
New business:
(i) IPL is planning to setup one more packaging unit. Total cost of the project is estimated to be
Rs. 45 million which will be financed by issuing 15% redeemable preference sharesof Rs.
100 each at par value. These shares will be redeemed after 4 years at a premiumof 20%
above par value.
(ii) IPL estimates that, as a result of this new investment, the equity beta will increase to 1.3.
Required:
(a) Compute IPL’s weighted average cost of capital (WACC) of the existing business. (07)
(b) Calculate the impact of new business on IPL’s existing WACC. Also discuss the effect of the
revised WACC on the overall market value of the company. (05)
Question 79 (Autumn 2023 – Q8)

Plasto Plastic Limited (PPL) is an all equity financed company. Following information has
been extracted from PPL’s financial statements as at 30 June 2023:
(i) PPL has ordinary share capital of Rs. 150 million with a face value of Rs. 10 per share.
(ii) On 30 June 2023, PPL paid an annual dividend of Rs. 25 per share.
(iii) PPL expects the next three annual dividend payments to be Rs. 25 per share. Thereafter,a
3% per annum growth rate is expected in perpetuity.
(iv) The equity beta of PPL’s share is 0.8, and the average return on the stock market is 21%.
The return on government bonds is 12%.
PPL is considering a new investment which would require an initial outlay of Rs. 600 million
and is considering financing it with a 1-for-3 rights issue. The following additional information
is available regarding the new investment:
(i) The investment would enable PPL to increase the dividend to Rs. 26 per share on
30 June 2024 and all subsequent dividends would increase by 5% per annum in
perpetuity.
(ii) The investment is riskier than the average of PPL’s existing investments and, therefore,
the beta would increase to 1.05.
Required:
Using the dividend valuation model, determine whether PPL should undertake the new
investment. (11)


Arctic Meridian Limited (AML) specializes in the establishment, maintenance and operation of
a fiber optic cable system. Following information has been extracted from the latest financial
statements of AML:
Rs. in '000
10 million ordinary shares @ Rs. 10 each 100,000
11% bank loan 15,000
The risk-free rate of return is 9%, while the risk premium is 6%. The equity beta for AML’s share is
1.1. The market value of AML’s share is Rs. 45 each and is expected to grow by 5% per annum.
Expansion plan
AML is all set to expand its business by acquiring a local fiber optic business for Rs. 240
million. For this venture AML’s management is considering either of the following two financing
proposals:
Issue right shares at a premium of Rs. 10 per share. The equity beta would remain
unchanged under this proposal.
Issue 13% convertible bonds at par value of Rs. 1,000 each. The bondholders would
have a right to either convert each bond into 15 ordinary shares or redeem it at par at the
end of the third year. This proposal would result in an increase in equity beta to 1.2.
The tax rate applicable to AML is 30%.
Required:
Recommend the financing proposal that would result in a lower weighted average cost of
capital (WACC). (12)

Chapter 12: Identifying and Assessing Risk
CHAPTER 12
Identifying and Assessing Risk
Risk management
Risk management is the process of managing both downside risks and business risks. It can be
defined as the culture, structures and processes that are focused on achieving possible opportunities
yet at the same time control unwanted results.
Risk management is a corporate governance issue. The board of directors have a responsibility to
safeguard the assets of the company and to protect the investment of the shareholders from loss. The
board should therefore keep strategic risks within limits that shareholders would expect, and to avoid
or control operational risks.
The Board is responsible for defining the company’s risk policy, risk appetite and risk limits as well
as ensuring that these are integrated into the day-to-day operations of the company’s business.
Strategic Risks Operational Risks

These are risks associated with adopting a particular These are risks arising from business
strategy operations
 A company aiming to achieve growth by  Potential loss in business (through
acquisitions have more risk compared to the failed or inadequate internal processes,
company growing through slow and gradual increase people and systems)
in sales  Risk of fraud by employee
 Developing new products is more risky than to  Poor quality of production / lack of
enhance the existing ones. production (stock out)
 Strategic risks should be identified by the senior
management
Elements of a risk management system

The elements of a risk management system should be similar to the elements of an internal control
system:
 There should be a culture of risk awareness within the company. Managers and employees should
understand the ‘risk appetite’ of the company.
 There should be a system and processes for identifying, assessing and measuring risks. When risks
have been measured, they can be prioritised, and measures for controlling or containing the risk
can be made.
 There should be an efficient system of communicating information about risk and risk management
to managers and the board of directors.
 Strategies and risks should be monitored, to ensure that strategic objectives are being achieved
within acceptable levels of risk.
Organising for risk management

 The responsibilities for risk management and the management structures vary between
organisations. Some companies employ risk management specialists and have well- structured
risk management systems.
 It is useful to be aware of differences in organisation structures and responsibilities.
 The board of directors of large public companies may be expected to review the risk management
system within their company on a regular basis, and report to shareholders that the system remains
effective.
 If there are material weaknesses in the risk management system, a company may be required to
provide information to shareholders.
 Codes of corporate governance typically suggest that the Board of Directors establish a Risk
Management Committee to review the adequacy and effectiveness of risk management and
controls at least annually and to report on the effectiveness of the controls to shareholders
 A company may decide that it needs a Risk management committee to monitor risks.
 This management committee may be chaired by the CEO and consist of the other executive
directors and some other senior managers, risks managers or the senior internal auditor.
 The function of this executive committee would be to co-ordinate risk management throughout the
organisation.
• It would be responsible for identifying and assessing risks, and reporting to the board. It
may also formulate possible business risk management strategies, for recommendation to
the board.
• It should also agree on programmes for the design and implementation of internal controls.
• It should monitor the effectiveness of risk management throughout the company (both
business risk management and the control of internal control risks).
Risk management should therefore happen at both board level (with the involvement of independent
NEDs) and at operational level (with the involvement of senior executives and risk managers).
RISK MANAGEMENT - THE BUSINESS BENEFITS

Risk management allows an organization to ensure that it knows and understands the risks it faces.
The adoption of an effective risk management process within an organization will have benefits in a
number of areas, examples of which include:
• Increased likelihood of achieving objectives
• Encouraged proactive management
• Awareness of the need to identify and treat risk throughout the organization
• Improved identification of opportunities and threats
• Compliance with relevant legal and regulatory requirements and international norms
• Improved mandatory and voluntary reporting
• Improved governance
• Improved stakeholder confidence and trust
• Establishment of a reliable basis for decision making and planning
• Improved controls
• Effective allocation and use of resources for risk treatment
• Improve financial information
• Minimizes losses
• Improve business managment

Embedded Risk
Embedding risk management system within the Internal Control System
 A sound system of internal control reduces but cannot eliminate risk.
 An organization should not have a separate system of risk management; they should include the
risk management processes into their system of internal controls
 The risks to business are ever changing because of evolving and expanding operations. An
effective internal control system would be able to identify existing and new threats to business
with similar efficiency.
 Risk manager (or a risk expert) needs to work closely with management while they design the
internal control system
 Risk manager should regularly review reports on monitoring of internal control to identify
whether controls are capable to identify all risks.
Embedding risk management system within the Culture and Values of Organization
Culture is:
 Commonly held and relatively stable set of attitudes, values and norms
 Basic assumptions and beliefs that are shared by members of an organization.
o Risk management needs to be incorporated in the policies and procedures of the organization
o Employees should be aware of the importance of risk management system, otherwise they will
not be able to identify potential threats or monitor risks
o The “tone at the top” gives a significant message of awareness to the staff
o An open culture (open to new ideas) will significantly increase efficiency of risk management
o Risk management function may be included in individual job descriptions.
DIFFERENT TYPES OF RISKS:

Fundamental risks are those that affect society in general, or broad groups of people, and are beyond
the control of any one individual. For example there is the risk of atmospheric pollution which can
affect the health of a whole community but which may be quite beyond the power of an individual
within it to control.
Particular risks are risks over which an individual may have some measure of control. For example
there is a risk attached to smoking and we can mitigate that risk by refraining from smoking.
Speculative risks are those from which either good or harm may result. A business venture, for
example, presents a speculative risk because either a profit or loss can result.
Pure risks are those whose only possible outcome is harmful. The risk of loss of data in computer
systems caused by fire is a pure risk because no gain can result from it.
Risk appetite describes the nature and strength of risks that an organisation is prepared to bear.
Risk attitude is the directors' views on the level of risk that they consider desirable.
Risk capacity describes the nature and strength of risks that an organisation is able to bear.
Strategic risks are risks that relate to the fundamental decisions that the directors take about the
future of the organisation.
Operational risks relate to matters that can go wrong on a day-to-day basis while the organisation is
carrying out its business.
Financial risks include reductions in revenues or profits, or incurring losses. The ultimate financial
risk is that the organisation will not be able to continue to function as a going concern.
Liquidity risk is the risk of loss due to a mismatch between cash inflows and outflows.
Gearing risks are the risks of financial difficulty through taking on excessive commitments connected
with debt.
Credit risk is the risk to a company from the failure of its debtors to meet their obligations on time.
Currency risk is the possibility of loss or gain due to future changes in exchange rates.
There are three types of currency risk.
(a) Transaction risk – arising from exchange rate movements between the time of entering
into an international trading transaction and the time of cash settlement.
(b) Translation risk – the changes in balance sheet values of foreign assets and liabilities
arising from retranslation at different prevailing exchange rates at the end of each year.
(c) Economic risk – the effect of exchange rate movements on the international
competitiveness of the organisation, eg in terms of relative prices of imports/exports, the cost
of foreign labour etc.
Market risk is a risk of gain or loss due to movement in the market value of an asset – a stock, a
bond, a loan, foreign exchange or a commodity – or a derivative contract linked to these assets.
Market risk is often discussed in the context of the stock markets.
Market risk is a risk arising from any of the markets in which a company operates, including
resource markets (inputs), product markets (outputs) or capital markets (finance).
Market risk is the risk that the fair values or cash flow of a financial instrument will fluctuate due to
market prices. Market risk reflects interest rate risk, currency risk and other price risks. (IFRS 7)
Product Risk: Product risks will include the risks of financial loss due to producing a poor quality
product.
Political risk is the risk that political action will affect the position and value of an organisation.
Probity risk is the risk of unethical behaviour by one or more participants in a particular process.
Physical risk is the risk of goods being lost or stolen in transit, or the documents accompanying the
goods going astray.
Trade risk is the risk of the customer refusing to accept the goods on delivery (due to sub-
standard/inappropriate goods), or the cancellation of the order in transit.
Liquidity risk is the inability to finance the organisation's trading activities. It generally is regarded
as a lack of short-term financing needs and a mismatch between short-term assets and liabilities.
Reputation risk is a loss of reputation caused as a result of the adverse consequences of another risk.
Industry-specific risks are the risks of unexpected changes to a business's cash flows from events or
changing circumstances in the industry or sector in which the business operates.
Residual risk is the risk remaining after actions have been taken to manage risks.

Credit Risk
There are a number tools and strategies to manage credit risk. Some key tools are as follows:
• Setting credit limits
• Regular monitoring
• Guarantees
• Credit insurance
Credit limits
The company can have a broader credit policy to set varying credit limits for different customers
based on predefined criteria. For example, the following could be a policy for credit:
Category Max. limit
• Listed companies with minimum B¯ credit rating Rs.40 million
• All other listed companies Rs.10 million
• Private companies Rs. 2 million
• Partnerships and individuals None
The credit limit for a particular customer is set within the maximum limit given in the policy based on
other factors. The data analytics tools have enabled the companies to use big data to have a predictive
analysis of a particular customer to set the credit limit.
Regular monitoring
Risk profile of a customer depends on various variables, such as, business performance, financial
ratios, credit rating and debt burden. Regular monitoring of changes in these variables helps the
companies to manage the risk specific to a particular customer. Risk can be managed by adjusting the
credit limit, asking for further securities or in extreme case discontinuing business with the customer.
Guarantees
Asking for credit guarantee is a risk sharing strategy whereby customer arranges a third party’s
guarantee (usually banks offer these services).
Credit insurance
Credit risk can be managed by shifting the risk to insurer. The credit insurance is arranged by the
company offering credit to customers, for which cost of premium is incurred.
Liquidity Risk
Companies use various methods to avoid the risk of incurring losses resulting from the failure to pay
obligations on time. Two key tools are discussed in following paragraphs.
Standing credit lines

Companies arrange credit lines and overdraft facilities to manage the liquidity risk.
Regular monitoring of working capital ratios

Companies keep a close watch on working capital trends to take timely corrective measures.
Companies regularly monitor and manage unnecessary inventory built up, lack of actions on delayed
debt recovery or addition of customers without evaluating the impact on working capital.

Practice Questions
Question 1
(a) One of the principles of ISO 31000 explains the importance of risk awareness across all levels of
the organization. Discuss how risk awareness can be embedded throughout an organization.
(b) Give examples of how risk awareness could help management in the following sectors;
(i) Health and Safety (ii) Banking Sector
Question 2
Labcoats is a charity that raises funds for investment in research into a major disease. There are four
charities in the country that raise funds for similar causes. Labcoats is the second largest, but it is much
smaller than the largest charity, Medhelp.
Medical research into the major disease has made substantial progress in recent years, but the cost of
investing in a new research projects is now much higher than it was ten years ago. One new three-
year project could require funding equal to about 75% of the annual revenue collected by Labcoats.
Labcoats has been in existence for about 25 years. A new managing director has been appointed, who
wants to introduce risk management systems. He believes that the risks facing the charity are not
sufficiently recognised, and systems should be in place for identifying and assessing risks and
devising policies and procedures for dealing with those risks.
Required
Suggest what might be the main risks facing Labcoats, and the nature of risk management measures
that might be taken to deal with them.

Chapter 13: Financial Risk Management
CHAPTER 13
Financial Risk Management
Financial Risk
Financial Risk may be explained as the effect of uncertainty on financial objectives of the business.
The term effect refers to positive or negative deviation from what is expected or planned.
Financial objectives
Some of the key financial objectives are:
• Stability of earnings trends
• Optimization of working capital
• Timely discharge of liabilities
• Timely recovery of debts
• Reduced cost of capital
The key factors causing risks of not achieving the above stated objectives could be due to uncertainty
about:
• Price of commodities or services relevant to business
• Rates of interest
• Rates of foreign exchange
• Credit worthiness of debtors
• Quality of liquidity of financial assets
• Ability of business to access financing
Types of Financial Risks:

Based on the nature of uncertainty the financial risk can be classified into the following broader
categories:
• Market Risk
• Credit Risk
• Liquidity Risk
FINANCIAL RISK MANAGEMENT TOOLS

Market Risk:
These are the financial risks that are associated with the uncertainty about the market rates and prices
at which a business can deal in commodities, services, foreign exchange and financing.
Foreign Exchange Rate Risk

The purpose of hedging an exposure to currency risk is to remove (or reduce) the possibility that a
future transaction involving a foreign currency will have to be made at a less favourable exchange
rate than expected.
Exchange rates can move up or down, and spot rates could move favourably as well as adversely.
However, many companies prefer to hedge their currency risks by fixing an exchange rate now for a
future transaction, even if this means that it will not be able to benefit from any favourable movement
in the exchange rate.

Methods of hedging exposures to foreign exchange risk

The most important methods of hedging exposures to currency risk are:
• forward exchange contracts;
• creating a money market hedge
• currency futures
• currency options
Forward rates
Banks trade in foreign currencies both for immediate delivery (either to or from the bank) at the spot
rate or for future delivery (either to or from the bank) at a forward rate.
The forward rate is the rate at which a bank is willing to trade in foreign currency at a pre-agreed date.
Banks are able to quote forward exchange rates for currencies because of the money markets (short-
term borrowing and lending markets). Forward exchange rates differ from spot rates because of the
interest rate differences between the two currencies.
Forward contracts
A forward exchange contract is a contract entered into ‘now’ for settlement at an agreed future date
(or at any time between two agreed future dates).
It is a contract between a customer and a bank for the purchase or sale of:
• a specified amount; of
• a specified foreign currency;
• for delivery at a specified future date
• at a specified rate
A bank can arrange a forward contract for settlement at any future date, but commonly-quoted
forward rates are for settlement in one month, three months, six months and possibly one year.
Money Market Hedge

A money market hedge is another method of creating a hedge against an exposure to currency risk.
Instead of hedging with a forward exchange contract, a company can create a hedge by borrowing or
lending short-term in the international money markets, to fix an effective exchange rate ‘now’ for a
future currency transaction.
The process to create a money market hedge for a future foreign currency receipt is as follows:
The company borrows an amount of the foreign currency immediately with a repayment time
matching with the time that the future foreign currency receipt will be received.
The future receipt in the foreign currency will be used to repay the loan with interest.
The amount borrowed together with the accumulated interest for the borrowing period should,
therefore, be equal to the amount of the future currency receipt.
Having borrowed the quantity of currency, the company exchanges it immediately (spot) for its
domestic currency.
The domestic currency will be deposited for the same period to earn interest in domestic currency.
At the end, the local currency deposit plus accumulated interest is used to calculate an effective
forward interest rate for the hedge of the currency exposure.
Currency futures
A foreign exchange future contract is an agreement between two parties to buy or sell a particular
currency at a particular rate.

Difference between Forward and Futures
Forward: Future:
 A forward contract is a binding agreement to  They have similar characteristics as
exchange a set amount of goods at a set date. forward contracts.
 Quantity, date and price will be decided in  Standardized quantities price and
advance. date.
 Default risk is high.  Default risk is low.
 These are particularly suited in commodity
markets such as gold, agriculture where prices
are volatile.
Advantages to Future:
a. Standardized in quantities, prices and dates.
b. Futures are marked to market.
c. Flexibility of closing a position.
d. They can be cancelled by an opposite transactions.
e. They can be arranged quickly and effectively.
f. Multiple contracts can be bought or sold.
Disadvantages to Future:
a. Margin is blocked until position is reversed.
b. Administration costs are high.
c. Continuous monitoring is required.
Currency Options
The main features of currency options have already been described.
 It gives the holder the right, but not the obligation to trade something.
 Option holder pays the option premium.
 If holder trade according to option it means he exercise option.
 Trade price in option deal is exercise price.
 Option to buy is a call option.
 Option to sell is a put option.
 If option exercise gives profit means option is in the money.
 If option exercise gives loss it means option is out of the money.
 If option exercise gives neither profit nor loss, it means at the money option.
 Option writer receives the option premium.
Intrinsic value:
Call option: underlying price – strike price
Put option: strike price – underlying price
Exchange trade options

These are standardized products traded in open market.
Advantages:
 Loan generation at lower rate.
 Restructuring of debt profile physical redemption or new debt generation.
 Access of loans in international market without exchange control restrictions.
 Hedging possibilities for a longer period.

Interest Rate Risk:

Interest rates can move up or down, although economists are often able to predict the direction of
future movements. A movement in interest rates can affect companies in either a positive or a
negative way.
• If a company has borrowed at a variable rate of interest, it will have to pay higher interest
costs if the interest rate goes up, and lower interest costs if the rate goes down.
• If a company has borrowed at a fixed rate of interest, for example by issuing bonds, it will
continue to pay the same rate of interest even if market interest rates go down.
• If company has invested in fixed rate bonds a rise in interest yields will result in a fall in the
price of existing fixed rate bonds. A fall in the market interest rate will send bond prices up.
Managing Interest Rate Risk: Interest Rate Hedging

Some organisations might wish to hedge their exposures to interest rate risk. They might also want to
take advantage, if possible, from any favourable movements in interest rates. There are several ways
in which risks can be hedged and opportunities to benefit from interest rate changes can be exploited.
Few common methods include:
• Forward rate agreements (FRAs);
• Interest rate futures; and
• Interest rate options
Forward Rate Agreements

A forward rate agreement (FRA) is a forward contract for an interest rate. FRAs are negotiated ‘over-
the-counter’ with a bank. It is a contract arranged ‘now’ that fixes the rate of interest for a future loan
or deposit period starting at some time in the future.
An FRA is a binding agreement between a bank and a customer. It is an agreement that fixes an
interest rate ‘now’ for a future interest period.
An FRA for an interest period starting at the end of month 3 and lasting until the end of month 9 is
mentioned as a 3v9 FRA or a 3/9 FRA.
Buying and selling FRAs

FRAs are bought and sold in the following manner:
• If a company wishes to fix an interest rate (cost) for a future borrowing period, it buys an
FRA. In other words, buying an FRA fixes a forward rate for short-term borrowing.
• If a company wishes to fix an interest rate (income) for a future deposit period, it sells an
FRA. Selling an FRA fixes a forward rate for a short-term deposit.
• The counterparty bank sells an FRA to a buyer and buys an FRA from a seller.
Interest Rate Futures
Futures contracts are similar to forward with more formalities and legal protection for investors.
Future contracts also offer a decided interest rate for a specified amount and dates. These contracts are
offered through third-party intermediaries.
Selling an Interest rate future creates the obligation to borrow money and the obligation to pay
interest.
Buying an Interest rate future creates the obligation to deposit money and the right to receive interest.
There are quite a few market terminologies and concepts important to understand, but at this stage the
following are important:
Future contract: There is always a standard size of future contracts. For example, size of future
contract of June 202X is Rs. 1,000,000. One can only buy or sell in multiples of Rs. 1,000,000.

Tick: A tick is the minimum price movement for a futures contract. For example:
Short-term interest futures are priced up to a theoretical maximum of 99.9999 and each tick is 0.0001
in price. A tick represents an interest rate of 0.01% per annum.
Buying and selling FRAs

A short-term interest rate future (STIR) is a contract for the purchase and sale of a notional deposit,
usually a three-month bank deposit. The futures price for STIRs is the annual interest rate. However,
the rate is deducted from 100, which means that:
• A rate of 4% per year is indicated by a futures price of 96.0000 (100 – 4)
• A rate of 5.2175% is indicated by a futures price of 94.7825
• A price of 93.5618 represents an annual interest rate for the three-month deposit of 6.4382%.
A reason for pricing STIRs in this way is that:
 when interest rates go up, the value of a future will fall, and
 when interest rates fall, the price of the future will rise.
Interest Rate Options
An interest rate option grants the buyer of the option the right, but not the obligation, to deal at an
agreed interest rate at a future maturity date. On the date of expiry of the option, the buyer must
decide whether or not to exercise the right.
The option guarantees a maximum or a minimum rate of interest for the option holder, and interest
rate options are therefore sometimes called interest rate guarantees or IRGs.
• A call option is the right to buy (in this case to receive interest at the specified rate). It
guarantees a maximum rate of interest.
• A put option is the right to sell (that is, the right to pay interest at the specified rate). It
guarantees a minimum rate of interest.
Options on interest rate futures are traded on the futures exchanges where the interest rate futures are
also traded.

Market rate risk of commodity

The risk of loss due to market price fluctuation of a commodity relevant to the business can be hedged
by using derivatives available in commodity exchanges.
The most common hedges are:
• Futures contracts
• Forward contracts
Commodity futures
Commodity futures are futures contracts for the sale and purchase of commodities, such as wheat, oil,
copper, gold, rubber, soya beans, coffee, cotton, sugar, and so on. Futures contracts have some special
features.
• They are standardised contracts. Every futures contract for the purchase/sale of a particular
item is identical to every other futures contract for the same item, with the only exception
that their settlement dates/delivery dates may differ.
• They are traded on an exchange, rather than negotiated ‘over-the-counter’.
• Such contracts cannot be tailored to the users’ requirements.
The hedging of risk attached to the fluctuation of a commodity price can be explained in the following
example.
Example:
A sugar producer estimates 14.55 tons of sugar will be available for sale in three months’ time. The
following are relevant information:
• Price needs to be hedged is Rs. 120,000 per ton.
• Futures contract on one ton of sugar with three months to expiry is at Rs. 130,000.
• Producer will sell 15 futures at Rs. 130,000, as the standard contract size is one ton.
• After three months, price of sugar is 145,000/ton.
The hedge will work in the following way:
The futures position will be closed.
Open futures position: sell at 130,000
Close position: buy at 145,000
Loss 15,000
The total loss on futures (15 contracts X 15,000) Rs. 225,000
The effective rate of sugar can be worked out as follows:
Company sells the sugar in spot market (14.55 X 145,000) Rs. 2,109,750
Less: Loss on futures Rs. (225,000)
Net receipt Rs. 1,884,750
Effective rate/ton (Rs. 1,950,000/15) 129,536
Commodity forwards
A forward contract is a contract entered into ‘now’ for settlement at an agreed future date (or at any
time between two agreed future dates).
It is an over the counter contract between a buyer and seller for:
• a specified quantity; of
• a specified commodity;
• for delivery at a specified future date
• at a specified rate
The hedging of risk attached to the fluctuation of a commodity price can be explained in the following
example.
Example:
A sugar producer estimates 14.55 tons of sugar will be available for sale in three months’ time. The
following are relevant information:
• Price needs to be hedged is Rs. 120,000 per ton.
• Forward contract on one ton of sugar with three months to expiry is available at Rs. 130,000.
• Producer will sell 14.55 tons of sugar at Rs. 130,000, as the in forward contract any quantity
can be agreed between the parties.
• After three months, price of sugar is 145,000/ton.
• The producer will have to deliver 14.55 tons of sugar at Rs. 130,000/ton. The producer could
not gain in rise in price but able to lock the rate at 130,000 as per the objectives of the
business. It means that producer was not interested in speculation business, in which producer
could have gained Rs. 145,000 after assuming the risk of fall in price of sugar when delivery
was due.

Practice Questions
Q.1
Calculate how much sterling exporters would receive or how much sterling importers would pay,
ignoringthe bank's commission, in each of the following situations, if they were to exchange currency
and sterlingat the spot rate.
(a) A UK exporter receives a payment from a Danish customer of 150,000 kroner.
(b) A UK importer buys goods from a Japanese supplier and pays 1 million yen.
Spot rates are as follows.

Bank Bank buys
sells
Danish Kr/£ 9.4340 – 9.5380
Japan Y/£ 168.650 – 170.781
Q.2
Asda is UK based company which has the following expected transactions:
Required: Calculate the expected sterling receipts in one month and in three months using the
forward market.
Q.3
Calculate receipts / payments in each of the following independent cases:
(a) A Pakistani company Q Mobile intend to receive 300,000 Lira from Turkey against export of
Mobiles. What will be theproceeds of exchange rate in Rs. against each Lira is 0.9 – 0.87
(b) Saudi company Al-Maja Ltd intends to pay Rs. 500,000 to Sapphire Ltd against import of
cloth. What will be thepayment if exchange rate in SAR against each Rupee is 1.45---1.42
(c) USA company purchased dates for SAR 30,000 for Saudi Arabia. What will be the payment
if exchange rate in SARagainst each Dollar is 2.9---2.85
(d) USA company sold cakes to Germany for 500,000 euro. What will be the receipt if exchange
rate of Dollar against Eurois 0.0458---0.0462.

Q.4
Apple Ltd has purchased a lot of refurbished laptops at the cost of US $850,000 from California. It
needs to be paid after after 90 days. The company enters into a forward contract to cover foreign
exchange risk.
3 month forward rates quotedby the bank are:
PKR 156 – 158/US$
Subsequently, due to some technical reason, the size of consignment received was just 60% of
the contract size.The actual spot exchange rate at the date of payment is as follows:
PKR 157.2 – 159.1/US$
Due to the change in payment amount, Apple Ltd closes out the forward contract partially.
Required: Calculate the net transaction cost of this import in PKR to Apple Ltd.
Q.5
A Canadian company is expecting to receive AED in
one year time.The spot rate is Canadian Dollar
5.4670 per 1 Dirham.
The company could borrow in Dirham at 9% or in

Canadian Dollar at 14%.There is no forward rate for
one year time.
Required: Predict what the exchange rate is likely to be in one year time.
Q.6
A UK company owes a Japanese supplier ¥3,500,000 which is payable in
three months time.The spot exchange rate per £1 is ¥7.5509 --- ¥7.5548.
The company can borrow in sterling for three months at 8.60% per annum and can deposit ¥
for three months at10% per annum.
Required: What is the cost in sterling pounds with a money market hedge and what effective
forward rate wouldthis represent?
Q.7
A UK based company which has no surplus cash, is due to pay Euro 2,125,000 to a company
in France in threemonths time and wants to hedge the payment using money markets.
The current spot rate is Euro 1.2230 --- 1.2270 per £.

The annual interest rates are available to the company in the UK and in France are as follows:
UK France
Borrow 5.72% 4.52%
Lend 3.64% 2.84%
Required: What would it cost the company in UK £ if it hedges its Euro exposure?

Q.8
Skans Limited is going to buy a machine from UK and has to pay 4,000,000 sterling in 3 months
time. The company is planning to go for forward contract or money market hedge.
Details are as follows:

Spot rate Rs. per Sterling 84.5—85
3 Months Forward rate Rs. per Sterling 85.6—86.2
UK Pak
Borrow 10.75% 14.5%
Deposit 7% 12%
Required: Calculate and compare cost under both options.
Q.9
A USA company is owed Lira 2,500,000 receivable in 90 days time from a Turkish company.
The spot exchange rate is Lira 1.4498—Lira 1.4510 per $.
The company can deposit in Dollar for 90 days at 8% per annum and can borrow Lira for 90 days at
7% per anuum.
Required:
What is the receipt in Dollar with a money market hedge and what effective forward rate would this
represent?
Q.10
CFE Limited whose home currency is the dollar ($) expects to receive 500,000 Takka in six months’
time from a customer in a foreign country. The following interest rates and exchange rates are
available to the company:
Spot rate 15.00 Takka per $

Six-month forward rate 15.30 Takka per $
Home country Foreign

country
Borrowing interest rate 4% per year 8% per year
Deposit interest rate 3% per year 6% per year
Required:
What is the six-month dollar value of the expected receipt using amoney-market hedge?

Q.11
Tabbani plc has bought goods from US supplier and must pay $4,000,000 for them in three month
time. The company’s finance director wishes to hedge against the foreign exchange risk and the three
methods which the company usually considers are:
 Making lead payment
 Using Forward exchange contract
 Using Money Market Hedge
The following annual interest rates and exchange rates are currently available
US$ UK£
Deposit rate Borrowing rate Deposit rate Borrowing rate
1 Month 7% 10.25% 10.75% 14.00%
3 Month 7% 10.75% 11.00% 14.25%
Exchange rate per £ 1

Spot $1.8625 ---- $1.8635
1 Month Forward $1.8565 ---- $1.8577
3 Month Forward $1.8445 ---- $1.8460
Required: Which is the cheapest method for Tabbani plc?

Q.12
Crescent Ltd (CL) is a medium sized company which carries out extensive trading (import as well as
exports) with various French companies. The management of CL is concerned about the recent
fluctuations in the exchange rate parity between Uk Sterling (£) and Euro (€) and is considering to
hedge the following transactions which it expects to undertake on December 15 2021:
Nature of Transaction Amount Due date of Payment /

Receipt
(i) Import of IT equipment € 223,500 15-June-2022
(ii) Export of Sports goods € 98,500 15-March-2022
(iii) Export of medical € 77,000 15-June-2022
instruments
(iv) Import of Machinery £ 22,500,000 15-March-2022
Other relevant information is as follows:

(i) According to CL’s bank the following exchange rates are expected to prevail on 15
December 2021.
Exchange rate per € 1
Spot £124.22 ---- £124.52
3 Month Forward £123.62 ---- £123.96
6 Month Forward £123.21 ---- £123.54
(ii) Interest rate on borrowing and lending in respective currencies are as follows:
£ €
3 Months / 6 Months Borrowing 11% 5%
3 Months / 6 Months Lending 6.5% 3%
Required:
(a) Calculate the net sterling receipt / payments that CL should expect from the above transactions
under each of the following altenatives:
- Hedging through forward cover
- Hedging through money market
(b) Determine which would be the better alternative for CL.

Q.13
MCQs
1. The current euro / US dollar exchange rate is €1 : $2. ABC Co, a Eurozone company, makes a
$1,000 sale to a US customer on credit. By the time the customer pays, the Euro has strengthened
by 20%.
What will the Euro receipt be?
A €416.67
B €2,400
C €600
D €400
2. The spot rate of exchange is £1 = $1·4400. Annual interest rates are 4% in the UK and 10% in the
USA.
The three month forward rate of exchange should be:
A. £1 = $1·4616
B. £1 = $1·5264
C. £1 = $1·5231
D. £1 = $1·4614
3. The home currency of ACB Co is the dollar ($) and it trades with a company in a foreign country
whose home currency is the Dinar. The following information is available:
Home country Foreign country
Spot rate 20.00 Dinar per $
Interest rate 3% per year 7% per year
Inflation rate 2% per year 5% per year
What is the six-month forward exchange rate?

A. 20·39 Dinar per $
B. 20·30 Dinar per $
C. 20·59 Dinar per $
D. 20·78 Dinar per $
4. An Iraqi company is expecting to receive Indian rupees in one year's time. The spot rate is 19.68
Iraqi dinar per 1 India rupee. The company could borrow in rupees at 10% or in dinars at 15%.
What is the expected exchange rate in one year's time?
A. 18.82 Iraqi dinar = 1 Indian rupee
B. 20.58 Iraqi dinar = 1 Indian rupee
C. 21.65 Iraqi dinar = 1 Indian rupee
D. 22.63 Iraqi dinar = 1 Indian rupee

Q.14
Q.15
Jafar holds 19,700 shares of PAC Ltd. He intends to sell them after AGM on 15 th December 2021.
Assume today is 10th November 2021 (date of hedge) and spot rate of share price of Rs. 32 each. Jafar
want to hedge using future contract. Price of future contract (Dec) Rs. 33 each and can only be bought
in lots of 1,000 each.
Required: Compute gain or loss due to futures on each of the following independent cases:
(a) On 15th December, PAC Ltd spot rate is Rs. 25 per share and December future price is Rs. 25.3
per share.
(b) On 15th December, PAC Ltd spot rate is Rs. 37 per share and December future price is Rs.
37.2/share.

Q.16
Mr. Naveed intends to buy 31,600 shares of CAPS Ltd on 24th December 2021.
Today is 10th November 2021, and spot rate is Rs. 20 per share. Futures are available on lots of 1,000
as per following information:
Futures Maturing on Futures’ Rate as on 10th Nov

30 Nov, 2021 21
31 Dec, 2021 22
31 Jan, 2022 23
Required:
(a) How Mr. Naveed should setup future contract.
(b) Compute hedge outcome if on 24th December 2021, spot rate is Rs 29 and future prices are
• December contract = Rs 29.5/share
• January contract =Rs 30.1/share
Q. 17
Mr. X expects to receive SAR 9,380 from export customer ART ltd on 10th January 2022.
Assume today is 10th November 2021 and spot rate is 1 SAR = Rs 45. Futures are available in lots of
300 each as per following:
Futures Maturing on Futures’ Rate as on 10th Nov

31 Dec, 2021 Rs 45.2
31 Jan, 2022 Rs 45.5
29 Feb, 2022 Rs 45.7
Required:
Compute gain / loss on hedging and hedge efficiency if following data exists on 10th January 2022.
Spot rate: 1 SAR = Rs. 40
Futures: December Rs. 40, January Rs. 40.8, February Rs. 50.1

Q. 18
SBM Traders are a large multinational trading company with operations spread in various cities
around the world. The finance director of the company wants to implement a hedging policy within
the company that would prescribe use of foreign currency futures as a hedge instrument. In order to
test this policy, the finance director has instructed his New York office to hedge the following foreign
currency transactions carried on April 200X.
Required:
(a) Compute the gain / loss on the above transactions
(i) If these were carried out without hedging
(ii) With hedging
(b) Compute the effective foreign exchange rate applicable to the hedged transactions
Q. 19
On 1s April, a US company buys goods worth € 745,000 from a company in France payable on 1st
May. The US company wants to hedge against the euro strengthening against the dollar.
Current spot is $ 0.9212 = € 1 and the June futures rate is 0.9245.
The standard size of a 3 month € futures contracts is € 125,000
On 1st may the spot rate is 0.9351
Required: Evaluate the hedge.

Q. 20
On 1st September 2019, spot rate of $ was 156 and future price of November contract is Rs 158 per $.
Saad Ltd purchases Dollars on 15th November 2019, when spot rate is Rs 158. If basis are assumed to
have reduced evenly over the period.
Required: Compute basis, remaining basis and hence futures price on 15th November.
Q. 21
An investor paid a premium of Rs. 60 to buy a put option at a market price of Rs. 300.
The current market price of the share is Rs. 260
Required:
Calculate the profit / loss of the investor if the market price of the shares on the expiry date of the
options i.e 30 days from now is:
(i) Rs. 180
(ii) Rs. 260
(iii) Rs. 380
Q. 22
An investor paid a Rs. 420 for the option to buy 500 shares in CPE Limited for Rs. 20,000 at any time
during the next three months. The investor exercised his right to buy the shares when the price in the
market was Rs. 50 per share.
Required:
(a) What is meant by the term option? (01)
(b) In the context of the above example briefly state:
(i) What is the strike price (0.5)
(ii) whether the above transaction is a call option or put option (1.5)
(c) Explain whether the above option would be termed as ‘in the money’ or ‘out the money’ when the
market price is Rs. 35 per share. (02)
Q.23
On 1 January 2022, Concodia Enterprise (CE) purchased an option for Rs. 10,000 allowing CE to buy
5,000 shares of Millennium Limited (ML) at a price of Rs. 140 per share, during the next two months.
On 12 Feb 2022, CE purchased the shares at the agreed price when the market value of ML’s share
was Rs. 180 per share.
Required:
Briefly explain each of the following terms and relate each term to the above scenario; wherever
possible:
(i) Call Option and Put Option
(ii) ‘In The Money’ and ‘Out The Money’

Q.24
Nestle Ltd has provided the following information:
Call Option Put Option

Share Oct Nov Dec Oct Nov Dec
Price
80 1.1 1.4 1.7 1.2 1.5 1.9
83 0.8 1.1 1.3 1.6 1.9 2.3
86 0.7 0.9 1.2 1.9 2.4 3.0
Standard contract size is 1,000 shares. Nestle Ltd wants to sell 16,300 shares of Engro Ltd on 15 th
December.
Required: Suggest hedge setup using Options.
Q.25
IQ Ltd requires to pay $938,000 for import of high-tech printing machine on 10th January 2022. He
intends to hedge using options:
Options Exercise Price Options Cost (Rs.)

Dec Jan Feb
Call 158.5 0.8 1.0 1.3
Put 158.5 0.75 0.9 1.2
Standard Contract size is 100,000
Required:
(a) Determine hedge setup
(b) Compute hedge outcome where actual spot rate is Rs. 161 and Rs. 163 (independently).

Q. 26
Assume that today’s date is 1 July 2022. Star Automobile Limited (STL) has imported CNG kits from
Japan and has to pay an amount of JPY 175 million in three months time.
STL intends to hedge the contract against adverse movement in foreign exchange rates and its foreign
exchange exposures. The following data are available:
Exchange rate quoted on 1 July 2022
JPY 1
Buy Sell
Spot rate Rs. 1.9223 Rs. 1.9339
One month forward rate Rs. 1.9335 Rs. 1.9451
Three month forward Rs. 1.9410 Rs. 1.9493
rate
Interest rates available to STL
Borrowing Investing
Japan 5% 3%
Pakistan 8% 5%
STL Currency Futures

Futures have a contract size of JPY 100,000 and the margin required is Rs. 1,000 per contract.
Contract prices (Rupee per JPY) are as follows:
JPY 1
July 2022 Rs. 1.9365
September 2022 Rs. 1.9421
January 2023 Rs. 1.9490
The contract can mature at the end of the above months only.
Currency Options
Options have a contract size of JPY 250,000. The premium (paisa per Rupee) payable on various
options and the corresponding strike prices are shown below:
Strike Calls Puts
Price 31 July 30 September 31 July 30 September
2022 2022 2022 2022
Rs. -------------------------------------------------Paisas--------------------------------
-----------------
1.90 2.88 3.55 0.15 0.28
1.91 1.59 2.32 1.00 1.85
1.92 0.96 1.15 2.05 2.95
Options are exercisable at the end of relevant month only.
Required:
Illustrate four methods by which STL might hedge its currency exposure.
Recommend which method should be selected.

Q.27
Engro Limited wish to borrow $ 5 Million in six months time for a three month period. It can
normally borrow from its bank at KIBOR + 0.50%.
The current three month KIBOR rate is 5.25%, but the company is worried about the risk of sharp
rise in interest rates in the near future.
A bank quotes FRA rates of:
3 v 9: 5.45% – 5.40%
9 v 12: 5.20% -- 5.15%
6 v 9: 5.30% – 5.25%
Required:
What will be effective borrowing rate for the company? Suppose that the KIBOR reference rate is
fixed at 6.5% at settlement date for the FRA.
Q.28
Uniliver need to borrow $6 million in three months for a twelve-month period.
It can borrow funds at KIBOR + 50 basis points. KIBOR rates today are at 5% but the company’s
treasurer expects rates to go up to about 6% over the next few weeks. So the treasurer is concerned
that the company will be forced to borrow at higher rates unless some sort of hedge is transacted to
protect the borrowing requirement.
The treasurer decided to buy a 3 v 15 (three-fifteens) FRA to cover the twelve-month period
beginning three months from now. A bank quotes 5.50% for the FRA which the company buys for a
notional Rs. 10 million. Three months from now rates indeed have gone up to 5%, so the treasurer
must borrow funds at 6.50% (the KIBOR rate plus spread). However, the company will receive a
settlement amount which will be.
Required:
Calculate result of FRA and effective rate of financing.
Q.29
Parco expect to borrow $10 million for three months, starting in two months time in early June, and
expect to pay interest at three-month dollar KIBOR plus 0.50%.
It wishes to use Futures to hedge the exposure to rising interest rates.
It therefore sells 10 June Short Currency Contracts ($10 million ÷ 1000,000 per contract) at a price of
93.4. Each subsequently closes the position in early June at a price of 92.70, when it also borrows $10
million at 7.80% which is the current three-month KIBOR rate of 7.30% plus 0.50%.
Required
Calculate effective rate of interest and interest payoffs.

Q.30
Ford Motors expect to invest $10 million for three-months at KIBOR minus 0.50%, starting next
month in early November, and wishes to use futures to hedge against a fall in interest rates before
then.
It therefore buys six December three-month sterling futures at a price of 89.40 (ten contracts x
$1,000,000 per contract = $10 million), in early November when it makes the investment.
Ford Motors closes the futures position by selling six December contracts at 89.35, and invest $10
million at 10.15% which is the three-month KIOBR rate of 10.65% minus 0.50%.
Required: Calculate effective rate of interest for Ford Motors and interest payoffs.
Q.31
Rise Ltd need to borrow Rs. 10 Million in six months’ time for a period of three months. The three-
month KIBOR rate is currently 3.0%, but might go up or down in the next six months.
The borrower’s option is available at a premium of 0.2% per annum with an exercise price of 3.35%
with expiry date is six months’ time.
Assume that the company is able to borrow at the Rs. KIBOR rate.
Required:
Computer interest cost and effective interest rate for Rise Ltd, if
(a) The 3-month KIBOR rate is 3.9% at the expiry date
(b) The 3-month KIBOR rate is 2.9% at the expiry date.
Q.32
Kelloge a wheat trader estimates demand from her customers in next three months as 12.72 tons of
wheat. The following are relevant information
Spot price = Rs. 35,000 per ton.
Futures contract on one ton of wheat with three months to expiry is Rs. 38,000
Required:
Compute the outcome at the end of three months period if Kelloge uses futures contracts to hedge the
market rate risk and price goes to Rs. 41,000 per ton at the end of three months.
Q.33 (ICAP Model Paper)

b) On 1 May 202X, a Pakistani company plans to hedge the foreign exchange risk of a export receipt
amounting to USD 1,600,000 expected to receive on 31 July 202X.
The current spot price is Rs. 174.0/USD.
A futures contract is for USD 125,000 and is available at Rs. 175.50/ USD. The value of a tick is Rs.
12.50. Required:
Compute the outcome of hedge with future contracts if:
(i) spot rate of dollar on 31 July 202X is USD 174.155
(ii) spot rate of dollar on 31 July 202X is USD 176.225 (05)

Q.34 (ICAP Spring 2022)

Shaheen Limited (SL) is engaged in manufacturing and selling textile products. SL procures the
material locally which is then manufactured and exported to customers. The management of SL is
concerned over high volatility in foreign exchange rates. The receipt of USD 50,000 from a customer
is expected in three months’ time and management is considering to hedge the foreign exchange risk.
SL’s bank has quoted the following exchange rates and annual interest rates:
USD 1
Buy Sell
Spot 178.650 179.800
1 month forward 177.745 178.795
3 months forward 177.555 178.555
Deposit % Borrowing
%
USD 1.25 2.75
PKR 6.75 9.75
Required:
Determine which of the following options would be more beneficial for SL:
(a) Hedging through forward contract
(b) Hedging through money market
(c) No hedging. Assume that on the date of settlement of transaction, spot rate is
USD 1 = PKR 178.15. (09)
Q.35 (ICAP Autumn 2022 – Q.8)

Assume today is 1 September 2022.
On 1 September 2022, Karachi Kites Limited (KK) plans to hedge the market rate risk of an export
receipt amounting to USD 2,000,000 which is expected to be received on 30 November 2022.
The current spot price per USD is Rs. 208.
KK intends to hedge the currency risk through futures. A future contract is for USD 120,000 and is
available in standard lot size of 1 with a tick value of Rs. 12. Following future rates are available:
Future Rate Maturity Date

October future Rs. 31 October 2022
210.5/USDNovember futureRs. 30 November 2022
213.5/USD 31 December 2022
December future Rs. 215.5/USD
The spot rate on 30 November 2022 is expected to be Rs. 218.5.

Required:
(a) Set up the hedge for USD receipt. (02)
(b) Compute the gain/loss in term of ticks. (02)
(c) Compute the effective exchange rate for KK. (02)

Q.36 (ICAP Spring 2023 – Q.9)

(a) Apart from market risk, identify other broader categories of financial risks that a business is
subjected to. Also identify two strategies to manage each of the identified financial risks. (03)
(b) Fifa Sports Limited (FSL) imports raw material from China. FSL has to pay CNY
1,000,000 in six months’ time. FSL plans to hedge this exposure to currency risk using a money
market hedge. Following information is available in this regard:
Deposit Borrowin
Interest rates gs
--- Rate per annum ---
In CNY (3 months) 11.35% 15.12%
In CNY (6 months) 11.71% 15.81%
In PKR (3 months) 12.12% 17.01%
In PKR (6 months) 12.90% 17.16%
PKR/C
NY
Current spot exchange rate PKR 34.5
Estimated exchange rate in 3 months PKR 36.8
Estimated exchange rate in 6 months PKR 37.6
Required:
Construct money market hedge and determine the effective exchange rate. Recommend whether the hedge
would be beneficial for FSL. (06)
Q.37 (ICAP Autumn 2023 – Q.9)

Assume that the date today is 1 September 2023.
Unity Rice Traders (URT) estimates that it will have 25.59 metric tons (MT) of rice available for sale on 29
February 2024. In view of the recent volatility in food prices, URT is consideringhedging its market risk.
The following information is available:
(i) The current spot price stands at PKR 90,000/MT.
(ii) The futures contract for one MT, set to expire in six months, is priced atPKR
93,500/MT.
(iii) The term of the forward contract for one MT, with six-months expiry, is as follows:
Buy Sell
PKR 93,600 PKR 94,500
Required:
(a) Determine the outcome using the futures and forward contract hedging strategies, assuming
the spot rate on 29 February 2024 is expected to be PKR 87,500/MT. (05)
(b) Suggest the optimal strategy for URT, along with appropriate justifications, in the event that
the spot price is forecasted to rise to PKR 102,000/MT within the next six months.What
could be the reason(s) that might prevent the execution of the optimal strategy?
(Note: Calculations are not required for this part) (03)

Q.38 (ICAP Spring 2024 – Q.8)
(a) Imran Trading Company (ITC) intends to borrow Rs. 30 million in one month’s time
for a period of 6 months. Being concerned about the volatility in the KIBOR rate, ITC
has taken out a borrower’s option with a strike rate of 21% for a notional 6-month loan of
Rs. 30 million. The option will expire in one month’s time. The option premium is the
equivalent of 0.5% per annum of the notional principal.
The current and the expected KIBOR rates are as under:
Current Expected
KIBOR KIBOR in
1 month’s time
1-month KIBOR 19.5% 22.0%
6-month KIBOR 20.5% 23.5%
Required:
Determine whether the option would be exercised. Also calculate the net effective
interest rate. (04)
(b) It is now 1 March 2024. Medical Hub (MH) signed an agreement with an American
Welfare Organization to build a world class medical school in Pakistan, offering free
medical education. In lieu of this agreement, MH anticipates to receive a grant of
USD 50 million in June 2024. To hedge this potential receipt, MH wishes to use a
currency option. Each currency option is for USD 5 million.
The current spot exchange rate is USD 1 = PKR 279. June options are available with a
strike price of PKR 280 and a premium of PKR 500,000 per option. MH expects that
spot rate in June will move to USD 1 = PKR 276.
Required:
Determine whether the option should be purchased. (Show all necessary computations) (04)

CHAPTER 14
Budgeting
BASIS OF BUDGET
Introduction of Budget
A budget could be defined as a quantified plan of action relating to a given period of time.
The quantification of the budgets has provided:
a) A definite target for planning purposes; and
b) A yardstick for planning purposes.
Forecasting Vs Budgeting
Forecasting Budgeting
1) Forecasts are statements of probable events. Budgets relate to planned events.
2) Forecast is only a tentative estimate. Budget is a target fixed for a
period.
3) Forecasting results in planning. Planning results in budgeting.
4) Forecasting does not act as a tool to control. Budgets cannot be a sense of
control.
Purposes of budgeting
 Planning
 Control
 Decision making
 Resource allocation
 Coordination and communication
Stages in budgeting process

 Communicating details of budget policy: First step is to communicate policies and manual to those
responsible for preparation of budgets. Objectives and long term goals must be communicated to them.
They must know the basis on which goals have been set.
 Identify principal budget factor: Principal budget factor refers to the resource that is restricted in
supply, therefore before planning for the entire organization, budgeting is required for the Principal
Budget Factor.
 Preparation of budgets: If all resources are in full supply, sales budget will be prepared first and the on
basis of sales remaining budgets will be prepared including production, labour, and overheads budgets.
 Final acceptance: After all negotiation and documentation, budgets will be presented in front of budget
committee for final approval. If there are any objections raised, necessary amendments will be made
accordingly. Once budget has been improved, responsibilities are assigned to departmental managers to
achieve targets mentioned in budgets.
 Ongoing review of budgets: The process is not ended up here. Periodic review is necessary so that
managers must be focused and do not take budgets for granted. Performance should be compared with
actual results on periodic basis.

Chapter 14: Budgeting
TYPES OF BUDGETS
 Sales budget
Sales budget is the first and basic component of master budget and it shows the expected number
of sales units of a period and the expected price per unit. If there is no restriction of resources,
sales budget is the foundation of all other budgets, since all expenditure is ultimately dependent
upon volume of sales.
Production budget
Production budget is a schedule showing planned production in units which must be made by a
manufacturer during a specific period to meet the expected demand for sales and the planned
finished goods inventory.
Direct materials budget

Direct material purchases budget shows budgeted beginning and ending direct material
inventory, the quantity of direct material that will be used in production, the amount of direct
material that must be purchased and its cost during a specific period.
Direct labour budget

Direct labour budget shows the total direct labour cost and number of direct labour hours needed
for production. It helps the management to plan its labour force requirements.
Manufacturing overhead budget

The factory overhead budget shows all the planned manufacturing costs which are needed to
produce the budgeted production level of a period, other than direct costs which are already
covered under direct material budget and direct labor budget.
Ending finished goods inventory budget

The ending finished goods inventory budget calculates the cost of the finished goods inventory at the end
of every budget period.
The ending finished goods inventory budget contains an itemization of three major costs that are
required to be included in the inventory asset in the balance sheet. These costs are:
Direct materials: The cost of materials per unit (as listed in the direct materials budget), multiplied by
the number of ending units in inventory (as listed in the production budget).
Direct labour: The direct labour cost per unit (as listed in the direct labour budget), multiplied by the
number of ending units in inventory (as listed in the production budget).
Overheads: The amount of overhead cost per unit (as listed in the manufacturing overhead budget),
multiplied by the number of ending units in inventory (as listed in the production budget).
Cost of goods manufactured budget

Cost of goods manufactured is the cost incurred to manufacture the finished goods and includes elements
of all the costs including material, purchases and manufacturing overheads.
Cost of goods sold budget

Cost of goods sold is the accumulated total of all costs used to create a product or service, which has been
sold.
Selling and administrative expenses budgets

Selling and administrative expense budget provides details of budgeted costs for the sales of the products
and for managing affairs of the business.
Selling and administrative expenses can be both either fixed or variable.

Capital expenditure budgets

This is the budget that provides for the acquisition of assets necessitated by the following factors:
 Replacement of existing assets
 Purchase of additional assets to meet increased production
 Installation of improved type of machinery to reduce costs
Capital expenditure budgeting is the process of establishing a financial plan for purchases of long-term
business assets.
Cash budget
Cash budget is a summary statement of the firm’s expected cash inflows and outflows over a projected
time period. It helps in determining the future cash needs of the firm and also assists in planning for
financing of those needs.
It acts as a tool to exercise control over cash and liquidity of the firm. The overall objective is to enable
the firm to meet all its commitments in time and preventing accumulation of unnecessary large balances
with it as well.
Master budget
Budgeting is a collective process in which various departments / divisions of the organization prepare
their plans for the upcoming periods, which in turn are aggregated into a corporate budget. Corporate
Budget is also termed as Master Budget.
Master Budgets are in the form of Projected Financial Statements and they help an organization
plan in advance about its targets for the upcoming periods.

SALES BUDGET
EXAMPLE-1
A company makes two products PS and TG. Sales for next year are budgeted to be 5,000 units of PS
and 1,000 units of TG. Planned selling prices are Rs. 95 and Rs. 130 per unit respectively.
Required:
Prepare the sales budget for the next year.
SOLUTION:
PS TG Total
Sales units 5,000 1,000 6,000
Sales value Rs. 475,000 Rs. 130,000 Rs. 605,000
Workings:
Sales – PS = 5,000 × Rs. 95 = Rs. 475,000
Sales – TG = 1,000 × Rs. 130 = Rs. 130,000
EXAMPLE-2
A company makes two products A and B. The products are sold in the ratio 1:1. Planned selling prices
are Rs. 100 and Rs. 200 per unit respectively. The company needs to earn Rs. 900,000 revenue in the
coming year.
Required:
Prepare the sales budget for the coming year.
SOLUTION:
Sales budget
A B Total
Sales units (see working) 3,000 3,000 6,000
Selling price per unit Rs. 100 Rs. 200
Sales value Rs. 300,000 Rs. 600,000
Rs. 900,000
Workings:
Total sales revenue = Rs. 900,000
Rs. 300 revenue is earned every time a mix of one unit of Product A and one unit of Product B is sold
(Rs. 100 + Rs. 200).
Number of ‘mixes’ to be sold to earn Rs. 900,000 = Rs. 900,000 = 3,000 ‘Mixes’
Rs. 300
3,000 ‘mixes’ = 3,000 units of Product A and 3,000 units of Product B.
Production budgets
Budgeted production levels can be calculated as follows:
Forecast sales xx
Opening inventory of finished goods (xx)
Closing inventory of finished goods xx
Budgeted production xx
EXAMPLE-3
Production budgets
A company makes two products, PS and TG. Forecast sales for the coming year are 5,000 and 1,000
units respectively.
The company has the following opening and required closing inventory levels.
PS TG
units units

Opening inventory 100 50

Required closing inventory 1,100 50
Required:
Prepare the production budget for the coming year.
SOLUTION:
Production budget PS TG
Units Units
Sales budget 5,000 1,000
– Opening inventory (100) (50)
+ Closing inventory 1,100 50
Budgeted production in units 6,000 1,000
Material budgets
There are two types of material budget that you need to be able to calculate, the usage budget and
the purchases budget.
 The material usage budget is simply the budgeted production for each product
multiplied by the quantity (e.g. kg) required to produce one unit of the product.
 The material purchases budget is made up of the following elements.
Material usage budget x

Opening inventory (x)
Closing inventory x
Material purchases budget x
EXAMPLE-4
Material budgets
A company produces Products PS and TG and has budgeted to produce 6,000 units of Product PS
and 1,000 units of Product TG in the coming year.
The data about the materials required to produce Products PS and TG is given as follows.
PS TG
Finished products: per unit per unit
Kg of raw material X 12 12
Kg of raw material Y 6 8
Direct materials:
Raw material
X Y
kg kg
Desired closing inventory 6,000 1,000
Opening inventory 5,000 5,000
Standard rates and prices:
Rs 0.72 per
Raw material X kg
Rs 1.56 per
Raw material Y kg
Required:
Prepare the following:
(a) The material usage budget.
(b) The material purchase budget.

SOLUTION:
Material budgets
Material X Material Y
kg kg
For production of PS (W1) 72,000 36,000
For production of TG (W2) 12,000 8,000
Material usage budget 84,000 44,000
– Opening inventory (5,000) (5,000)
+ Closing inventory 6,000 1,000
Material purchases budget (units) 85,000 40,000
Material Cost / kg Rs. 0.72 Rs. 1.56
Material Purchase Budget (Rs.) Rs. 61,200 62,400
Workings:
(W1) Budgeted production of Product PS 6,000 units
6,000 × 12 kg per unit = 72,000 kg
6,000 × 6 kg per unit = 36,000 kg
(W2) Budgeted production of Product TG 1,000 units
1,000 × 12 kg per unit = 12,000 kg
1,000 × 8 kg per unit = 8,000 kg
Labour budgets
Labour budgets are simply the number of hours multiplied by the labour rate per hour as the following
illustration show.
EXAMPLE-5 – Labour budgets

A company produces Products PS and TG and has budgeted to produce 6,000 units of Product PS and
1,000 units of Product TG in the coming year.
The data about the labour hours required to produce Products PS and TG is given as follows.
Finished products:
PS per unit TG per unit
Direct labour hours 8 12
Standard rate for direct labour = Rs 5.20 per hour
Required:
Prepare the labour budget for the coming year.
SOLUTION:
Hours Rs
For Product PS 6,000 × 8 hrs 48,000 Rs. 5.2 249,600
For Product TG 1,000 × 12 hrs 12,000 Rs. 5.2 62,400
60,000 312,000
EXAMPLE-6
Manufacturing overheads budget
A company produces the product A. The company has budgeted the production units of Product A for
next month at 47,000 units. The variable overhead rate per unit is Rs. 2 per unit. The allocated fixed
overheads are Rs. 65,000.
Required:
Prepare manufacturing overhead budget for the next month.

SOLUTION:
Budgeted Production Var. OH/Unit
Units Rs. Rs.
Product A 47,000 2 94,000
Allocated fixed overheads 65,000
Budgeted manufacturing overheads 159,000
EXAMPLE-7
Ending finished goods inventory budget
XYZ Company sells a product “S” and has derived it main cost components. The direct materials cost
per unit is Rs. 12.50, direct labor cost per unit is Rs. 4 and manufacturing overhead cost is Rs. 6.50. The
company is expected to have finished goods inventory of 8,000 units at the end of next quarter.
Required:
Prepare ending finished goods inventory budget for the next quarter.
SOLUTION:
Rs.
Direct material cost 12.50
Direct labor cost 4.00
Manufacturing overhead cost 6.50
Total cost per unit 23.00
Ending finished goods inventory 8,000
Ending finished goods inventory (Rs.) 184,000
EXAMPLE-8
Cost of goods manufactured budget
The company B is engaged in the manufacturing of its product “Beta”. The company is preparing the
budgeted cost of goods manufactured for next year. The budgeted direct material purchases for next
year are Rs. 371,250, budgeted direct labor cost of Rs. 564,000 and manufacturing overheads to be
Rs.159,000. The opening and closing stock of direct materials is Rs. 11,250 and Rs. 30,000 respectively.
Required:
Prepare the budget for cost of goods manufactured for next year.
SOLUTION:
Rs.
Direct material purchases 371,250
Opening direct material 11,250
Closing direct material (30,000)
Direct material cost 352,500
Direct labor cost 564,000
Manufacturing overheads 159,000
Budgeted cost of goods manufactured 1,075,500
EXAMPLE-9
Cost of goods sold budget
Assume the data of Example 8, the company is expected to have opening finished goods inventory of
Rs.90,000 and closing finished goods inventory of Rs. 130,000.

Required:
Prepare cost of goods sold budget.
SOLUTION:
Rs.
Budgeted cost of goods manufactured 1,075,500
Opening finished goods inventory 90,000
Total cost of goods available for sale 1,165,500
Closing finished goods inventory (130,000)
Budgeted cost of goods sold 1,035,500
Cash budgets and cash flow forecasts

A cash forecast is an estimate of cash receipts and payments for a future period under existing
conditions.
A cash budget is a commitment to a plan for cash receipts and payments for a future period after taking
any action necessary to bring the forecast into line with the overall business plan.
Cash budgets are used to:
 assess and integrate operating budgets
 plan for cash shortages and surpluses
 compare with actual spending.
Cash forecasts can be prepared based on:
 Receipts and payments forecast. This is a forecast of cash receipts and payments based on
predictions of sales and cost of sales and the timings of the cash flows relating to these items.
 Statement of financial position forecast. This is a forecast derived from predictions of future
statements of financial position. Predictions are made of all items except cash, which is then
derived as a balancing figure.
In the exam it is most likely to be part of a receipts and payments forecast i.e. calculating the receipts
from receivables or the payments to payables.
Preparing a cash flow forecast
Every type of cash inflow and outflow, along with their timings, must be forecast. Note that cash receipts
and payments differ from sales and cost of sales in the statement of profit and loss because:
 not all cash receipts or payments affect the statement of profit and loss, e.g. the issue of new
shares or the purchase of a non-current asset
 some statement of profit and loss items are derived from accounting conventions and are not
cash flows, e.g. depreciation or the profit/loss on the sale of a non-current asset
 the timing of cash receipts and payments does not coincide with the statement of profit and loss
accounting period, e.g. a sale is recognised in the statement of profit or loss when the invoice is
raised, yet the cash payment from the receivable may not be received until the following period
or later.
Receipts from receivables
If a business offers credit sales these will be recorded in the statement of profit or loss at the point when
the sale is made. This does not reflect the actual cash received by the business.
To calculate the cash receipts from the credit sales there are two things to consider:
 The value of the receipts – how much cash will be received from the credit sales
 The timing of the receipts – when will the cash be received from the credit sales.

EXAMPLE-10
Forecast cash receipts
The forecast sales for an organisation are as follows:
January February March April
Rs Rs Rs Rs
Sales 6,000 8,000 4,000 5,000
All sales are on credit and receivables tend to pay in the following pattern:
%
In month of sale 10
In month after sale 40
Two months after sale 45
The organisation expects the rate of irrecoverable debts to be 5%.
Required:
Calculate the forecast cash receipts from receivables in first Quarters.
SOLUTION:
Credit Receipts
Sales January February March April
January 6,000 600 2,400 2,700 -
February 8,000 - 800 3,200 3,600
March 4,000 - - 400 1,600
April 5,000 - - - 500
600 3,200 6,300 5,700
Payments to payables
If a business makes credit purchases these will be recorded in the statement of profit or loss at the point
when the purchase is made. This does not reflect the actual cash paid by the business.
To calculate the cash payments for the credit purchases there are two things to consider:
 The value of the payment – how much cash will be paid to the payable
 The timing of the payment – when will the cash be paid to the payable.
It may be necessary to calculate the amount due to be paid based on quantities purchased.
EXAMPLE-11
Forecast cash payments
A manufacturing business makes and sells chairs. Each chair requires two units of raw materials, which
cost Rs. 3 each. Production and sales quantities of chairs each month are as follows:
Month Sales and production
units
December (actual) 50,000
January (budget) 55,000
February (budget) 60,000
March (budget) 65,000
In the past, the business has maintained its inventories of raw materials at 100,000 units. However, it
plans to increase raw material inventories to 110,000 units at the end of January and 120,000 units at
the end of February. The business takes one month’s credit from its suppliers.
Required: Calculate the forecast payments to suppliers each month, for raw material purchases.

SOLUTION:
Quantity of raw material purchased in units:
December January February March
Production 50,000 55,000 60,000 65,000
Raw Material Usage (× 2) 100,000 110,000 120,000 130,000
– opening inventory (100,000) (100,000) (110,000) (120,000)
+ closing inventory 100,000 110,000 120,000 120,000
Purchases (units) 100,000 120,000 130,000 130,000
Cost Rs. 3 per unit Rs. 300,000 Rs. 360,000 Rs. 390,000 Rs. 390,000
Payments (Rs.) - Rs. 300,000 Rs. 360,000 Rs. 390,000
EXAMPLE-12
The following budgeted statement of profit or loss has been prepared for Quest Company for the four
months January to April Year 5:
Rs000 Rs000 Rs000 Rs000
Sales 60.0 50.0 70.0 60.0
Cost of production 50.0 55.0 32.5 50.0
(Increase)/decrease in inventory (5.0) (17.5) 20.0 (5.0)
Cost of sales (45.0) (37.5) (52.5) (45.0)
Gross profit 15.0 12.5 17.5 15.0
Administration and selling overhead (8.0) (7.5) (8.5) (8.0)
Net profit before interest 7.0 5.0 9.0 7.0
 40% of the production cost relates to direct materials. Materials are bought in the month prior
to the month in which they are used. Purchases are paid for one month after purchase.
 30% of the production cost relates to direct labour which is paid for when it is used.
 The remainder of the production cost is production overhead.
 Rs. 5,000 per month is a fixed cost which includes Rs. 3,000 depreciation. Fixed production
overhead costs are paid for when incurred.
 The remaining overhead is variable. The variable production overhead is paid 40% in the month
of usage and the balance one month later. Unpaid variable production overhead at the beginning
of January is Rs. 9,000.
 The administration and selling costs are paid quarterly in advance on 1 January, 1 April, 1 July
and 1 October. The amount payable is Rs. 15,000 per quarter.
 All sales are on credit. 20% of receivables are expected to be paid in the month of sale and 80%
in the following month. Unpaid trade receivables at the beginning of January were Rs. 44,000.
 The company intends to purchase capital equipment costing Rs. 30,000 in February which will
be payable in March.
 The bank balance on 1 January Year 5 is expected to be Rs. 5,000 overdrawn.
Required:Complete the cash budget for each of the months January to March Year 5 for Quest
Company.

SOLUTION:
January February March
Rs Rs Rs
Opening balance (5,000) (14,000) (7,100)
Receipts
Sales (W-1) 56,000 58,000 54,000
Payments
Capital expenditure – – 30,000
Direct materials (W-2) 20,000 22,000 13,000
Direct labour (30 % of production cost) 15,000 16,500 9,750
Fixed production overheads (W-3) 2,000 2,000 2,000
Variable production overheads (W-4) 13,000 10,600 8,800
Admin/selling overhead 15,000 – –
Total outflow (65,000) (51,100) (63,550)
Closing balance (14,000) (7,100) (16,650)
W-1
Cash receipts
Cash from sales Total sales January February March
Rs Rs Rs Rs
Opening 44,000 – –
Receivables
January 60,000 12,000 48,000 –
February 50,000 – 10,000 40,000
March 70,000 – – 14,000
56,000 58,000 54,000
W-2
Payments for materials purchases
December January February March April
Rs Rs Rs Rs Rs
Total cost of production – 50,000 55,000 32,500 50,000
Material cost of production (40%) – 20,000 22,000 13,000 20,000
Purchases made in the month prior to usage 20,000 22,000 13,000 20,000 –
Payments are made in the month following purchase. – 20,000 22,000 13,000 20,000
W-3
Payments for overheads
January February March
Rs Rs Rs
Total cost of production 50,000 55,000 32,500
Overhead cost of production (30%) 15,000 16,500 9,750
Fixed costs (5,000) (5,000) (5,000)
Variable overhead costs 10,000 11,500 4,750
Of the monthly fixed overhead costs of Rs. 5,000, Rs. 3,000 is depreciation which is not a cash
expenditure.
Monthly fixed cost cash expenditure is therefore Rs. 2,000.
The opening balance of unpaid variable production overhead cost at the beginning of January is
Rs.9,000. This cost should be paid for in January. Variable overheads are paid 40% in the month of
expenditure and 60% the following month.
W-4
Variable overheads
Cost January February March

Rs Rs Rs Rs
Opening payables for variable overheads 9,000
January 10,000 4,000 6,000 –
February 11,500 – 4,600 6,900
March 4,750 – – 1,900
Total payments 13,000 10,600 8,800
Preparing master budgets
Having prepared budgets for sales and costs, the master budget can be summarised as a statement of
profit or loss, a cash budget (as seen in the previous section) and a statement of financial position as at
the end of the budget period.
EXAMPLE-13
Hash makes one product the Brown. Sales for next year are budgeted at 5,000 units of Brown. Planned
selling price is Rs. 230.
Hash expects to have the following opening inventory and required closing inventory levels of finished
products:
Units
Opening inventory 100
Required closing inventory 1,100
Budgeted production data for the product is as follows:
Finished products
Raw material X: Kg per unit 12
Direct labour hours per unit 8
Raw material inventories
Opening inventory (kg) 5,000
Planned closing inventory (kg) 6,000
Standard rates and prices:
Direct labour rate per hour Rs. 7
Material X purchase price per kg Rs. 2
Production overhead absorption rates
Variable Rs. 1 per direct labour hour
Fixed Rs. 8 per direct labour hour
Budgeted administration and marketing overheads are Rs. 225,000.
The opening Statement of financial position is expected to be as follows:
Rs Rs
Non current assets 950,000
Current Assets
Inventory 66,000
Trade receivables 260,000
Cash 25,000 351,000
Current Liabilities
Trade payables 86,000
Other short-term liabilities 24,000 (110,000)
Net assets
1,191,000
Non-current assets in the statement of financial position are expected to increase by Rs. 40,000, but no
change is expected in trade receivables, trade payables and other short-term liabilities.
There are no plans at this stage to raise extra capital by issuing new shares or obtaining new loans. The
company currently has an overdraft facility of Rs. 300,000 with its bank.
Required:
Complete the following:

(i) The production budget
(ii) The raw material purchases Budget
(iii) The direct labour budget
(iv) The overhead budget
(v) The cost per unit of Brown
(vi) Budgeted Statement of Profit or loss.
(vii) Budgeted Statement of financial position
SOLUTION:
(i)
Production budget
Sales 5,000
Opening inventory (100)
Closing inventory 1,100
Production units 6,000
(ii)
Raw material budget
Production 6,000
kg per unit × 12
Material Usage (kg) 72,000
Opening inventory (5,000)
Closing inventory 6,000
Purchases(kg) 73,000
Cost per kg × Rs. 2
Purchases (Rs ) 146,000
(iii)
Direct Labour budget
Production 6,000
Hours per unit ×8
Labour hours 48,000
Rate per hour × Rs. 7
Labour cost (Rs ) 336,000
(iv)
Overhead budget
Labour hours 48,000
Cost per hour (Rs 1 + Rs 8) × Rs. 9
432,000
(v)
Cost of one unit of Brown
Direct material (12 kg × Rs. 2) Rs. 24
Direct labour (8 hr × Rs7) Rs. 56
Overheads (8 hr × (Rs1 + Rs8)) Rs. 72
Cost per unit Rs. 152
(vi)
Budgeted Statement of profit or loss
Rs Rs
Sales revenue 5,000 × Rs. 230 1,150,000
Cost of sales
Opening inventory 100 × Rs. 152 15,200
Production cost 6,000 × Rs. 152 912,000

Closing inventory 1,100 × Rs. 152 (167,200)
(760,000)
Gross profit 390,000
Administration and Marketing (225,000)
Profit 165,000
(vii)
Budgeted Statement of financial position
Rs Rs
Non current assets Rs. 950,000 + Rs. 40,000 990,000
Inventory (W-1) 179,200
Trade receivables 260,000
Cash (W-2) 36,800
476,000
Other short term liabilities 24,000
(110,000)
Net current assets 366,000
Net assets Rs. 1,191,000 + Rs. 165,000 1,356,000
W-1
Inventory
Raw materials (6,000 × Rs. 2) Rs. 12,000
Finished goods (1,100 × Rs. 152) Rs.167,200
Inventory valuation Rs. 179,200
W-2
Cash
Opening balance Rs. 25,000
Profit for the period Rs. 165,000
Cash spent on NCA (Rs. 40,000)
Change in inventory (Rs. 113,200)
Closing cash Balance Rs. 36,800

APPROACHES TO BUDGETING
Fixed & Flexible Budget
Budgets show the planned costs and revenues which an organization expects in a future period. They
can be divided into two categories.
Fixed budgets are set before the start of an accounting period, are not susceptible to change, and are
used as a plan for the future their use is most appropriate where resources have to be tightly controlled,
as in cash control.
Flexible budgets may be set before or after the actual performance is known. If they are set after the
event, they are set on the basis of the level of activity which was actually undertaken. This allows valid
comparison to be made against the costs and revenues which were actually recorded, facilitation
operational control.
Incremental Budgeting
It is a simple approach towards budgeting which starts by taking the budgets from previous budget period and
then adds (or subtracts) any incremental amount for the next budget period. Incremental amounts will be added
for:
 Inflation in costs next year
 Any other changes like tax rates
 Possibly, the cost of additional activities that will be carried out next year
Advantages of incremental budgeting

 It is a simple, quick and easy approach towards budgeting.
 Suitable in a stable environment where historic figures are reliable and are not expected to change.
 Information does not need to be searched, it is readily available.
Disadvantages of incremental budgeting

 The deficiencies or say ‘budgetary slack’ which were incorporated in previous period is highly likely to
be carried forward for the next budget period.
 Uneconomic activities may continue for the next period, for example a company may continue to make
parts in-house when it might be cheaper to outsource.
 Amount of increment (inflation or growth) may be difficult to estimate.
Zero base budgets

A simple idea of preparing a budget from a zero base each time i.e. as though there is no expectation of current
activities to continue from one period to the next. Zero base budget is normally found in service industries where
costs are more likely to be discretionary. A form of zero base budget is used in local government.
There are four basic steps to follow:
 Prepare decision packages: Identify all possible services (and levels of service) that may be
provided and then cost each service or level of service, these are known individually as decision
packages.
 Rank: Rank the decision packages in order of importance, starting with the mandatory requirements of a
department. This forces the management to consider carefully what their aims are for the coming year.
 Funding: Identify the level of funding that will be allocated to the department.
 Utilise: Use up the funds in order of the ranking until exhausted
Advantages (as opposed to incremental budgeting)

 Emphasis on future need not past actions.
 Eliminates past errors that may be perpetuated in an incremental analysis.
 A positive disincentive for management to introduce slack into their budget.
 A considered allocation of resources.
 Encourages cost reduction.

Disadvantages
 Can be costly and time consuming.
 May lead to increased stress for management.
 Only really applicable to a service environment.
 May “re-invent” the wheel each year.
 May lead to lost continuity of action and short term planning.
Rolling Budgets:
In a periodic budgeting system the budget is normally prepared for one year, a totally separate budget will then
be prepared for the following year. In continuous budgeting the budget from one period is rolled on from one
year to the next.
This means that the budget will again be prepared for 12 months in advance. This process is repeated each quarter
(or month or half year).
Advantages (as opposed to periodic budgeting)
 The budgeting process should be more accurate.
 Much better information upon which to appraise the performance of management.
Disadvantages
 More costly and time consuming.
 An increase in budgeting work may lead to less control of the actual results.
Performance Budgeting:
Performance budgeting is a system of planning, budgeting and evaluation that emphasizes the relationship
between money budgeted and results expected. Performance budgeting focuses on results as departments are held
accountable to certain performance standards.
BUDGETING IN NON-PROFIT ORGANIZATION

In a non-profit organization the budgeting process is initiated with an exercise by the managers where they
calculate the expected costs of the activities being supervised by them. Any desirable changes are also
accommodated if needed. The available resources to fund the budgeted level of public services should be enough
to cover the overall costs of such services.
Traditional Format: Line Item Budgets

A line item budget is considered as the traditional format of budgeting in non-profit organizations. In such budgets
the expenditures are presented in detail, but the activities undertaken are given less attention. It shows the nature
of the expenses but not the purpose. Any anticipated or expected changes in costs and activity levels are reflected
in the budget.
These budgeted figures when compared with the actual expenditure show if the authorized budgeted expenditure
has been exceeded or under-spending was witnessed. Moreover the spending pattern too can be analysed by
comparing the data of the current year and for the previous year.
Line item budgets though fail to recognize the cost of activities and the programs to be executed. Moreover, line
item budgets do not guarantee the efficient and effective use of the resources.

HUMAN AND MOTIVATIONAL ASPECT OF BUDGETING

Budgetary slack
Success of budgets is heavily dependent upon how motivated employees are to meet budget targets.
Dysfunctionalbehaviour
Budgets may also lead to dysfunctional behavior. Dysfunctional behaviour is when individual managers seek to
achieve their own objectives at the expense of the objectives of the organisation.
Budgetary styles
Level of participation and budgetary style also affects human behavior. Two common budgetary styles are:
 Imposed style of budgeting: A budget that is set without allowing the ultimate budget holder to have the
opportunity to participate in the budgeting process. Also called “top-down” budgeting.
 Participative style of budgeting: A system in which budget holders have the opportunity to
participate in setting their own targets. Also called “bottom up” budgeting.
Motivation
Budgets represent a target and aiming for target is itself a strong motivator. Managers and employees
know in advance what level of performance is expected from them.
FLEXIBLE BUDGET
Fixed budget Actual
Sale Unit 1,000 1,200
Production Unit 1,300 1,250 Variance
Rs Rs Rs
Sales revenue 10,000 11,500 1,500 F
Labour costs 2,600 2,125 475 F
Material costs 1,300 1,040 260 F
Overheads 1,950 2,200 250 A
Profit 4,150 6,135 1,985 F
 The fixed budget shown above is not particularly useful because we are not really comparing
like with like. For example, the budgeted sales were 1,000 units but the actual sales volume was
1,200 units.
 The overall sales variance is favourable, but from the report shown we don’t know how much
of this variance is due to the fact that actual sales were 200 units higher than budgeted sales (or
whether there was an increase in the sales price).
 Similarly, actual production volume was 50 units less than the budgeted production volume, so
we are not really making a very useful comparison. It is more useful to compare actual results
with a budget that reflects the actual activity level – a flexed budget.
If this control process is to be valid and effective, it is important that the variances are calculated in a
meaningful way. One of the major concerns here is to ensure that the budgeted and actual figures reflect
the same activity level. As activity levels (output, for example) change, total variable costs will change,
but fixed costs stay the same. In order to compare like with like we need to prepare a flexed (or flexible)
budget which reflects the actual level of output achieved.
It would be unreasonable to criticise a manager for incurring higher costs if these were a result of a
higher than planned volume of activity. Conversely, if the level of activity is low, costs can be expected
to fall and the original budget must be amended to reflect this. A variance report based on a flexible
budget therefore compares actual costs with the costs budgeted for the level of activity actually
achieved. It does not explain any change in budgeted volume, which should be reported on separately.
The key points to note are:
 A fixed budget is set at the beginning of the period, based on estimated production. This is the
original budget. At the same time a flexible budget may be produced at a range of activity levels.
 Actual results are compared with the relevant section of the flexible budget, that which
corresponds to the actual level of activity. This is usually referred to as the flexed budget.

EXAMPLE-14
Wye Ltd manufactures one product and when operating at 100% capacity can produce 5,000 units per
period, but for the last few periods has been operating below capacity.
Below is the flexible budget prepared at the start of last period, for three levels of activity at below
capacity:
Level of activity (units) 3,500 4,000 4,500
Rs Rs Rs
Direct materials 7,000 8,000 9,000
Direct labour 28,000 32,000 36,000
Production overheads 34,000 36,000 38,000
Administration, selling and
distribution overheads 15,000 15,000 15,000
Total cost 84,000 91,000 98,000
In the event, the last period turned out to be even worse than expected, with production of only 2,500
units. The following costs were incurred:
Rs
Direct materials 4,500
Direct labour 22,000
Production overheads 28,000
Administration, selling and distribution overheads 16,500
Total cost 71,000
Required:
Use the information given above to prepare the following.
(a) A flexed budget for 2,500 units.
(b) A budgetary control statement.

SOLUTION:
(a) Flexed budget for 2,500 units
Rs
Direct materials (W1) (2,500 × Rs. 2) 5,000
Direct labour (W2) (2,500 × Rs. 8) 20,000
Production overheads (W3) 30,000
Administration, selling and distribution overheads (W4) 15,000
Total cost 70,000
Workings:
W-1
Material is a variable cost – Rs. 2 per unit
Rs. 7,000
Variable material cost = = Rs. 2 per unit
Rs. 3,500
W-2
Labour is a variable cost – Rs8 per unit.
Rs. 28,000
Variable labour cost = = Rs. 8 per unit
Rs. 3,500
W-3
Production overheads are semi-variable. Using the high/low method, the variable cost is Rs. 4 per unit,
the fixed cost is Rs. 20,000.
The cost for 2,500 units therefore
= Rs. 20,000 + (2,500 × Rs. 4) = Rs. 30,000.
Units Total Overheads V.FOH Fixed FOH
3,500 34,000 14,000 20,000
4,500 38,000 18,000 20,000
1,000 4,000
Rs. (38,000 – 34,000)
Variable labour cost = = Rs. 4 per unit
Rs. 4,500−3,500
(b) Budgetary control statement
Flexed Budget Actual Variance

Production Units 2,500 units 2,500 units
Rs Rs Rs
Direct materials 5,000 4,500 500 (F)
Direct labour 20,000 22,000 2,000 (A)
Production overheads 30,000 28,000 2,000 (F)
Administration, selling and distribution overheads 15,000 16,500 1,500 (A)
Total cost 70,000 71,000 1,000 (A)

PRACTICE QUESTIONS
QUESTION-1
Plagued engineering produces two products, Niks and Args. The budget for the forthcoming year to
31 March 20X8 is to be prepared. Expectations for the forthcoming year include the following.
(a)
PLAGUED ENGINEERING
STATEMENT OF FINANCIAL POSITION AS AT 1 APRIL 20X7
ASSETS Rs. Rs.
Non-Current Assets
Land and building 45,000
Plant and Equipment 187,000
Less: Accumulated Depreciation (75,000)
112,000
Current Assets
Raw Materials 7,650
Finished goods 23,600
Receivables 19,500
Cash 4,300
55,050
212,050
EQUITY AND LIABILITIES
Capital and Reserves
Share Capital 150,000
Accumulated profits 55,250
205,250
Current liabilities
Payables 6,800
212,050
(b) Finished products
The sales director has estimated the following.
Niks Args
i. Demand for the company's products 4500 units 4000 units
ii. Selling price per unit Rs. 32 Rs. 44
iii. Closing inventory of finished products at 31 March 2008 400 units 1200 units
iv. Opening inventory of finished products at 1 April 2007 900 units 200 units
v. Unit cost of this opening inventory Rs. 20 Rs. 28
vi. Amount of plant capacity required for each unit of product:
Machining 15 min 24 min
Assembling 12 min 18 min
vii. Raw material content per unit of each product:
Material A 1.5 kilos 0.5 kilos
Material B 2.0 kilos 4.0 kilos
viii. Direct labour hours per unit 6 hours 9 hours
Finished goods are valued on a FIFO basis at full production cost.
(c) Raw materials
Material A Material B
Closing inventory requirement in kilos at 31 March 2008 6,00 1,000
Opening inventory at 1 April 2007 1,100 6,000
Budgeted cost of raw materials per kilo Rs.1.5 Rs.1.00
Actual costs per kilo of opening inventories are as budgeted cost for the coming year.
Direct labor: The standard wage rate of direct labor is Rs.1.60 per hour.
Production overhead
Production overhead is absorbed on the basis of machining hours, with separate absorption rates for
each department. The following overheads are anticipated in the production cost center budgets.
Machining Assembly
Department Department
Rs. Rs.
Supervisor’s Salaries 10,000 9,150
Power 4,400 2,000
Maintenance and running costs 2,100 2,000
Consumables 3,400 5,00
General expenses 19,600 5,000
39,500 18,650
Depreciation is taken at 5% straight line on plant and equipment. A machine costing the company
Rs.20000 is due to be installed on 1 October 2007 in the machining department, which already has
machinery installed to the value of Rs.100000 (at cost). Land worth Rs.180000 is to be acquired in
December 20X7.
Selling and administration expenses
Rs.
Sales commissions and salaries 14,300
Travelling and distribution 3,500
Office salaries 10,100
General administration expenses 2,500
30,400
There is no opening or closing work in progress and inflation should be ignored.
Budgeted Cash flows are as follows:
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Receipts from customer 70,000 100,000 100,000 40,000
Payments:
Materials 7,000 9,000 10,000 5,000
Wages 33,000 20,000 11,000 15,000
Other costs and expenses 10,000 100,000 205,000 5,000
Required:
Prepare the following for the year ended 31 March 20X8 for Plagued Engineering Ltd.
(a) Sales budget (h) Computation of the factory cost per unit
(b) Production Budget for each product
(c) Direct materials usage budget (i) Cost of goods sold budget
(d) Direct materials purchase budget (j) Budgeted income statement
(e) Direct labor budget (k) Cash Budget
(f) Plant utilization budget (l) Budgeted Balance Sheet
(g) Factory overhead budget
QUESTION-2
XYZ Company manufactures two products STAR and BRIGHT. There are two manufacturing
departments in a company Dept. 1 and Dept. 2. All material has been added in dept. 1
The standard material and labour usage for each product is as follows:
STAR BRIGHT
Details of Dept. 1
Material X (Rs. 20/kg) 3 kgs 5 kgs
Material Y (Rs. 15/kg) 5 kgs 4 kgs
Direct Labour (Rs. 10/hr.) 5 hrs. 2.5 hrs.
Details of Dept. 2

Material Nil Nil

Direct Labour (Rs. 12/hr.) 4 hrs. 6 hrs.
Inventory details
Finished Product STAR BRIGHT
Forecast Sales (Units) 8000 2000
Selling Price / Unit (Rs.) 500 450
Ending Inventory (Units) 1800 200
Beginning Inventory (Units) 2000 500
RAW MATERIAL MATERIAL MATERIAL
X Y
Beginning Inventory 5000 Kgs 6000 Kgs
Ending Inventory 4000 Kgs 7000 Kgs
Details of overheads
Budgeted variable overhead rates per labor hour DEPT 1 DEPT 2
Indirect labour Rs. 4 Rs. 3
Electricity (variable) Rs. 3 Rs. 5
Maintenance ( variable) Rs. 2 Rs. 4
Budgeted fixed overheads DEPT 1 DEPT 2
Rent Rs.50,000 Rs.45,000
Supervision Rs. 20,000 Rs. 10,000
Electricity (fixed) Rs. 6,500 Rs. 5,000
Maintenance (fixed) Rs. 10,000 Rs. 2,100
Non-manufacturing overheads
- Salaries Rs. 30,000
- Depreciation Rs. 20,000
- Advertising Rs. 25,000
- Miscellaneous Rs. 10,000
Budgeted cash flows are as follows:
Q1 Q2 Q3 Q4
Rs. Rs. Rs. Rs.
Receipts 800,000 1,000,000 800,000 900,000
Payments:
Material 400,000 200,000 300,000 100,000
Wages 200,000 500,000 100,000 129,300
Other 300,000 200,000 400,000 100,000
Balance Sheet as on 200X
Rs. 000 Rs. 000 Rs. 000
Land 2,000
Building and equipment 3,000
Acc. Depreciation: (480) 2,520 4,520
Current Assets
Inventory – Finished goods 1,300
– Raw materials 800
Debtors 800
Cash 1,000 3,900
TOTAL ASSETS 8,420
Equity and Liabilities
Ordinary share capital 3,000
Reserves 2,000 5,000
Non-current liabilities 2,000
Current liabilities 1,420 3,420
Total Equity And Liabilities 8,420
Required:
Prepare Master budget for 200Y and the following budgets:

a. Sales budget
b. Production budget
c. Material usage budget
d. Purchase budget
e. Direct labor budget
f. Factory overheads budget
g. Selling and admin
h. Cash budgets
QUESTION-3
Star Ltd. manufactures two products A and B. The summarized Balance Sheet of the company as at 31st
March 2012 is as under:
Equity and Liabilities Rs.
Shareholder ‘s funds
Share capital 1,200,000
Reserve and Surplus 96,000
Current liabilities
Short-Term Provisions
Provision for income tax 60,000
1,404,000
Assets (Rs.)
Non- Current Assets
Fixed Assets(Net) 9,00,000
Current Assets
Inventories 3,54,000
Trade Receivables 90,000
Cash and Cash Equivalents 60,000
1,404,000
The following information has been furnished to you for the preparation of the budget for the year
ending 31 March, 2013:-
(i) Sales forecast:-
Product A 24,000 units at Rs. 30 per unit.
Product B 15, 000 units at Rs. 40 per unit.
(ii) Raw materials:-
Products
A B
Material X@ 3 per kg. 2kgs. 4kgs.
Material Y@ 1 per kg. 1 kg 2kgs.
(iii) Direct Labour:-
Dep. P: 2 Hrs. @ Rs. 1 per hour for A.
1 Hrs. @ Rs. 2 per hour for B.
Dep. Q: 1 Hrs. @ Rs. 3 per hour for A.
1 Hrs. @ Rs. 3 per hour for B.
(iv) Overheads:-
DEPT .P DEPT.Q
Rs. Rs.
Fixed overheads per annum:-
Depreciation 48,000 12,000
Others 96,000 30,000

Variable overheads per hour 0.50 1.50

(v) Inventories:-
(a) Raw materials:
X Y
Kgs. Kgs.
Opening Stock* 36,000 6,000
Closing Stock 48,000 12,000
* Value of opening Raw Material is Rs. 114,000
(b) Finished goods:
A B
Units. Units.
Opening Stock* 600 6,000
Closing Stock 6,600 3,000
* Value of opening stock of finished goods is Rs. 240,000.
(i) Selling, Distribution and administration expenses are estimated at Rs.180,900 per annum.
(ii) The cost of raw material purchases, direct wages, factory overheads, selling, distribution and
administration overheads of the year will be met in full in cash during the year. The estimated
position of debtors and creditors as on 31st March, 2013 is Rs.150,000 and Rs.48,000
respectively. Income tax provision standing at the beginning of the year will be paid during the
year. Rate of income tax is 30%.An equipment purchased at Rs.120,000 will be paid during the
year.
Required:
You are required to prepare for the year ending 31st March, 2013:
a) Cost of Goods Sold Budget
b) Cash Budget
c) Projected Balance Sheet as at 31st March, 2013 in the same format as given in the question.
The detailed working for each of the above should be shown.
QUESTION-4
S Ltd manufactures three products - A, C and E - in two production departments - F and G - each of
which employs two grades of labour. The cost accountant is preparing the annual budgets for Year 2 and
he has asked you as his assistant to prepare, using the data given below:
(a) The production budget in units for Products A, C and E
(b) The direct wages budget for Department F and G with the labour costs of Products A, C and
E and totals shown separately.
Produc
t
A C E
Data: Rs.'000 Rs.'000 Rs.'000
Finished stocks:
Budgeted stocks are:
1 January, year 2 720 540 1,800
31 December, year 2 600 570 1,000
All stocks are valued at expected cost per unit Rs. 24 Rs. 15 Rs. 20
Expected profit: 20% 25% 16 2 %

3
Rs.'000 Rs.'000 Rs.'000 Rs.'00
0
Budgeted sales:
South 6,600 1,200 1,800 3,600

Midlands 5,100 1,500 1,200

2,400
North 6,380 1,500 800
4,080
18,080 4,200 3,800
10,08
0
Normal loss in production 10% 20% 5%
Hours Hours Hours
Expected labour times per unit and expected rates per
Rate per Unit per per unit
hour
Unit
Department F: Rs.
Grade 1 1.80 1.00 1.50 0.50
Grade 2 1.60 0.75 1.00 0.75
Department G:
Grade 1 2.00 1.50 0.50 0.50
Grade 2 1.80 1.00 0.75 1.25
QUESTION-5
JK Ltd has recently completed its sales forecasts for the year to 31 December 20X4. It expects to sell
two products - J and K at prices of Rs. 135 and Rs. 145 each respectively.
Sales demand is expected to be:
J 10,000 units
K 6,000 units
Both products use the same raw materials and skilled labour but in different quantities per unit:
J K
Material X 10 kgs 6 kgs
Material Y 4 kgs 8 kgs
Skilled labour 6 hrs 4 hrs
The prices expected during 20X4 for the raw materials are:
Material X Rs. 1.50 per kg
Material Y Rs. 4.00 per kg
The skilled labour rate is expected to be Rs. 6.00 per hour.
Stocks of raw materials and finished goods on 1 January 20X4 are expected to be:
Material X 400 kgs @ Rs. 1.20 per kg
Material Y 200 kgs @ Rs. 3.00 per kg
J 600 units @ Rs. 70.00 each
K 800 units @ Rs. 60.00 each
All stocks are to be reduced by 15% from their opening levels by the end of 20X4 and are valued using
the FIFO method.
The company uses absorption costing, and production overhead costs are expected to be:
Variable Rs. 2.00 per skilled labour hour
Fixed Rs. 315,800 per annum
Required:
Prepare for the year to 31 December 20X4 JK Limited's:
(a) Production budget (in units)
(b) Raw material purchases budget (in units and Rs.)
(c) Production cost budget
QUESTION-6
X plc manufactures Product X using three different raw materials. The product details are as follows:
Selling price per unit Rs. 250
Material A 3- kgs material price Rs. 3.50 per kg
Material B 2- kgs material price Rs. 5.00 per kg
Material C 4- kgs material price Rs. 4.50 per kg

Direct labour 8 hours labour rate Rs. 8.00 per hour

The company is considering its budgets for next year and has made the following estimates of sales
demand for Product X for July to October 1999:
July August September October
400 units 300 units 600 units 450 units
It is company policy to hold stocks of finished goods at the end of each month equal to 50% of the
following month's sales demand, and it is expected that the stock at the start of the budget period will
meet this policy.
At the end of the production process the products are tested: it is usual for 10% of those tested to be
faulty. It is not possible to rectify these faulty units.
Paw material stocks are expected to be as follows on 1 July 1999:
Material A 1,000 kgs
Material B 400 kgs
Material C 600 kgs
Stocks are to be increased by 20% in July 1999 and then remain at their new level for the foreseeable
future.
Labour is paid on an hourly rate based on attendance, in addition to the unit direct labour hours shown
above, 20% of attendance time is spent on tasks which support 'production activity.
Required:
Prepare the following budgets for the quarter from July 1999 to September 1999 inclusive:
a) Sales budget in quantity and value
b) Production budget in units
c) Raw material usage budget in kgs
d) Raw material purchases budget in kgs and value
e) Labour requirements budget in hours and value
QUESTION-7
Qavi & Qamar, a partnership firm, produces a single chemical product. Current operations are at 50%
capacity utilization with a production of 5,000 tons. Cost per ton is Rs.1,800 which sells for
Rs.2,000/ton.
The firm is considering options to increase the level of operations. Investigations by the firm reveals
following changes in cost structure in the event of a change in the capacity operations:
At 60% capacity utilization
a. Material cost per unit increases by 2% over present material cost.
b. Selling price per unit falls by 2% over present selling price.
At 80% capacity utilization
a. Material cost increases by 5% over present material cost.
b. Selling price per unit falls by 5% over present selling price.
Current cost per unit are reported as follows:
Rs.
Material 1,000
Labor 300
Fixed Manufacturing Overheads 120
Variable Manufacturing Overheads 180
Administration Overheads - Fixed 40
Variable 60
Marketing Overheads - Fixed 60
Variable 40
Required:
a) Statement showing profit projections at 60% and 80% capacity utilization.
b) Comments on the profit projections at 60% and 80% capacity operations.

QUESTION-8
McDreamy is in an industry sector which is recovering from the recent recession. The directors of the
company hope next year to be operating at 85% of capacity, although currently the company is operating
at only 65% of capacity. 65% of capacity represents output of 10,000 units of the single product which
is produced and sold. One hundred direct workers are employed on production for 200,000 hours in the
current year.
The flexed budgets for the current year are as follows.
Capacity level 55% 65% 75%
Rs. Rs. Rs.
Direct materials 846,200 1,000,000 1,153,800
Direct wages 1,480,850 1,750,000 2,019,150
Production overhead 596,170 650,000 703,830
Selling and distribution overhead 192,310 200,000 207,690
Administration overhead 120,000 120,000 120,000
Total costs 3,235,530 3,720,000 4,204,470
Profit in any year is budgeted to be 162/3% of sales.
The following percentage increases in costs are expected for next year.
%
Direct materials 6.0
Direct wages 3.0
Variable production overhead 7.0
Variable selling and distribution overhead 7.0
Fixed production overhead 10.0
Fixed selling and distribution overhead 7.5
Administration overhead 10.0
Required:
Prepare for next year a flexible budget statement on the assumption that the company operates at 85%
of capacity; your statement should show both contribution and profit.
QUESTION-9
The following information relates to budget period 1 for Ejaz & Co:
Budget Budget Actual for period
(60,000 units) (90,000 units)
Rs. Rs. Rs.
Sales 900,000 1,350,000 1,240,000
Raw materials 450,000 675,000 632,400
Labour 155,000 207,500 165,200
Production overheads 190,000 235,000 238,000
Actual production and sales in budget period 1 were 80,000 units. Actual labour costs for the period
included Rs. 50,000 of fixed labour costs. Actual production overheads for the period included
Rs.110,000 of fixed production overheads.
Required:
(a) Using a marginal costing approach, prepare a flexed budget for the period and calculate
variances in as much detail as allowed by the information provided above.
(b) Explain how budgeting can help organizations to achieve their objectives.

QUESTION-10
Noble is a restaurant that is only open in the evenings, on SIX days of the week. It has eight restaurant
and kitchen staff, each paid a wage of Rs. 8 per hour on the basis of hours actually worked. It also has
a restaurant manager and a head chef, each of whom is paid a monthly salary of Rs. 4,300. Noble’s
budget and actual figures for the month of May was as follows:
Budget Actual
Number of meals 1,200 1,560
Rs. Rs. Rs. Rs.
Revenue: Food 48,000 60,840
Drinks 12,000 11,700
60,000 72,540
Variable costs:
Staff wages (9,216) (13,248)
Food costs (6,000) (7,180)
Drink costs (2,400) (5,280)
Energy costs (3,387) (3,500)
(21,003) (29,208)
Contribution 38,997 43,332
Fixed costs:
Manager’s and chef’s pay (8,600) (8,600)
Rent, rates and depreciation (4,500) (13,100) (4,500) (13,100)
Operating profit 25,897 30,232
The budget above is based on the following assumptions:
(1) The restaurant is only open six days a week and there are four weeks in a month. The average
number of orders each day is 50 and demand is evenly spread across all the days in the month.
(2) The restaurant offers two meals: Meal A, which costs Rs. 35 per meal and Meal B, which costs Rs. 45 per
meal In addition to this, irrespective of which meal the customer orders, the average customer consumes four
drinks each at Rs.2.50 per drink. Therefore, the average spend per customer is either Rs. 45 or Rs. 55 including
drinks, depending on the type of meal selected. The May budget is based on 50% of customers ordering Meal
A and 50% of customers ordering Meal B.
(3) Food costs represent 12.5% of revenue from food sales.
(4) Drink costs represent 20% of revenue from drinks sales.
(5) When the number of orders per day does not exceed 50, each member of hourly paid staff is
required to work exactly six hours per day. For every incremental increase of five in the average
number of orders per day, each member of staff has to work 0.5 hours of overtime for which
they are paid at the increased rate of Rs. 12 per hour. You should assume that all costs for hourly
paid staff are treated wholly as variable costs.
(6) Energy costs are deemed to be related to the total number of hours worked by each of the hourly
paid staff, and are absorbed at the rate of Rs. 2.94 per hour worked by each of the eight staff.
Required:
Prepare a flexed budget for the month of May, assuming that the standard mix of customers remains the
same as budgeted.
QUESTION-11
You have been provided with the following operating statement which represents an attempt to compare
the actual performance for the quarter which has just ended with the budget.
Budget Actual Variance
Number of units sold ('000s) 640 720 80
Rs.'000 Rs.'000 Rs.'000
Sales 1,024 1,071 47
Cost of sales: (all variable)
Materials 168 144
Labour 240 288
Overheads 32 36
(440) (468) (28)

Fixed labour cost 100 94 6
Selling and distribution costs:
Fixed 72 83 (11)
Variable 144 153 (9)
Administration costs:
Fixed 184 176 8
Variable 48 54 (6)
(548) (560) (12)
Net profit 36 43 7
Required:
Using a flexible budgeting approach, re-draft the operating statement so as to provide a more realistic
indication of the variances.
QUESTION-12
A company has recorded the following output levels and associated costs in the past six months:
Month Output (000 Total cost
of units) (Rs m)
January 5.8 40.3
February 7.7 47.1
March 8.2 48.7
April 6.1 40.6
May 6.5 44.5
June 7.5 47.1
Required:
Construct the equation of a line of best fit for this data.
QUESTION-13
Week Units produced Total Cost (Rs.000)
1 5 20
2 9 27
3 4 17
4 5 19
5 6 23
Required:
a) Use linear regression analysis to obtain an estimate of fixed costs per week and the variable cost of
production per unit.
b) Use your results to estimate total costs in a week when 8 units are produced.
c) Estimate a value of fixed costs and variable costs from same data using the high/low analysis and use the
values that you obtain to estimate total costs in a week when 8 units are produced.

Question-14 (Q1, Autumn 2020)

Smart Fit (SF) is engaged in manufacturing and selling of product X75. It offers twovariants of X75 that
are ‘Standard’ and ‘Premium’.
The management is in the process of preparing its budgeted profit or loss statement for theyear ending 31
August 2021. Following information are available in this respect:
Information for the year ended 31 August 2020

(i) Extracts from profit or loss statement:
Rs. in million
Sales 5,250
Cost of goods sold:
Material (1,584)
Labour (540)
Manufacturing overheads (440)
Gross profit 2,686
Selling and administration expenses (426)
Profit before tax 2,260
(ii) During the year, SF operated at 75% of capacity. It manufactured and sold 900,000and
600,000 standard and premium units respectively.
(iii) The retail price of premium unit is set at two times of retail price of standard unit.
(iv) 1.6 kg of material is required for each standard unit whereas 2 kg of material isrequired
for each premium unit.
(v) Labour manufactures three standard units per hour. Each premium unit takes 50%more
labour time than standard unit.
(vi) 25% of total manufacturing overheads are fixed. Variable manufacturing overheadsper
premium unit are 1.25 times of a standard unit.
(vii) All selling and administration expenses are fixed.
(viii) There are no closing stocks of raw material and finished goods.
Information and projections for the budget year ending 31 August 2021
(i) Retail price of standard and premium units would be increased by 10% and 15% respectively.
It is expected that existing demand for standard and premium units would not be affected by
price increase. In addition, SF has entered into a contract with a new foreign customer for
supply of 450,000 premium units at a discount of 20% of new retail price.
(ii) Any constraint due to production capacity would be met by reducing the existing production
of standard units. However, any shortfall in production of standardunits would be met by
purchasing it from the market at a price of Rs. 2,400 per unit.
(iii) Material price would increase by 5% with effect from 1 January 2021. The material would
be purchased evenly during the year.
(iv) Labour, manufacturing overheads and selling and administration expenses would be subject
to inflation of 10% per annum.
Required:
Prepare a budgeted profit or loss statement for the year ending 31 August 2021. (19)

QUESTION-15 (Q2 Spring 2020)

Neo Hardware (Private) Limited (NHPL) is engaged in the manufacturing and marketing of a single
product ‘locks’. NHPL is in the process of preparing its budgeted profit or loss statement for the year
ending 28 February 2021. Following information pertains to the year ended 29 February 2020:
(i) Extracts from prof: or loss statement:
Rs. in million
Sales 6.930
Cost of goods sold:
Material (3,140)
Labour (645)
Gross profit 2,185
Selling expenses (55% variable) (468)
Administration expenses (276)
Net profit before tax 1,441
(ii) The production plant at NHPL factory has an annual production capacity of 6 million locks.
During the year, it operated at 77% of capacity and all locks produced during the year were sold
out.
(iii) During the year, NHPL had received a quotation from a Chinese company at Rs.1,400 per lock,
similar to NHPL’s locks. Since the production target for the year had already been met, the
management decided to keep this option open for any future shortfall in production.
(iv) NHPL has divided the sales team in three regions i.e. East, West and Central with 20, 24 and 46
sales personnel in each region respectively. During the year, the ratio of each region’s sales to
total sales was 20%. 30% and 50% respectively.
(v) Manufacturing overheads include fixed overheads of Rs.625 million which include depreciation
of Rs.415 million.
(vi) Administration expenses comprised of fixed costs including depreciation of Rs.23 million.
Information and projections for the budget year ending 28 February 2021
(i) Selling price would be increased by Rs.150 per lock.
(ii) It is anticipated that sales volume will increase by 25% and in order to achieve this target, sales
commission would be introduced to motivate the sales personnel. However, the commission
would be paid on regional teams’ performances and the rate of commission would be determined
on the basis of average number of units sold by each team member as follows:
Average number of locks Commission % on
sold by a sales person regional sale revenue
0 - 50,000 1.00%
50,001 – 70,000 1.25%
70,001 – 90,000 1.50%
> 90,000 1.75%
(iii) It is expected that East, West and Central will contribute to the increase in sales volume by 10%,
30% and 60% respectively.
(iv) The price of locks from the Chinese company is expected to increase to Rs.1,500 per lock.
(v) Labour is short in supply and already working overtime. The increase in production can only be
achieved by increasing efficiency of the existing labour. The management has approved 20%
bonus for labour which would increase the efficiency by 15%.
(vi) At the beginning of the year, a major overhaul amounting to Rs. 55 million will be carried out
on one of the machines in a manufacturing department which was originally purchased in 2018

for Rs. 100 million. The overhauling would increase the original useful life of machine from 4
years to 8 years and salvage value would increase from Rs.12 million to Rs.15 million. The
company uses straight line method for depreciating its machines.
(vii) All variable costs would increase by 8% and all fixed costs other than depreciation would
increase by 5%.
Required:
Prepare budgeted profit and loss statement for the year ending 28 February 2021. (18)
QUESTION-16 (Q5 Autumn 2019)

Americano Limited (AL) is engaged in the assembling and marketing of three products, Alpha, Beta
and Gamma. AL is in the process of preparation of product-wise projected statement of contribution
margin for the next financial year commencing from 1 January 2020. Following information in this
regard is available:
(i) Total sales of AL for the year ending 31 December 2019 are estimated to be Rs. 28 million. The
current sales price and ratio of sales for each of three products are given below:
Alpha Beta Gamma
Sale price per unit (Rs.) 8,000 12,000 10,000
Ratio of quantities sold 4 1 2
With effect from 1 January 2020, AL is intending to increase the selling prices by 10%. The
demand would decline by 2% due to increase in sale prices.
(ii) The details of components that are used in each product are as follows:
Components
Description
A B C
--------------Units--------------
Alpha 4 2 5
Beta 5 4 6
Gamma 4 3 4
--------------Rs.--------------
Purchase price per component 45 60 30
The suppliers have informed AL that prices of components would increase by 15% with effect
from 1 April 2020.
(iii) All products pass through assembling and finishing departments. Details of labour costs at each
department are as follows:
Assembling Finishing
Description
Direct labour (Hours)`
Alpha 10 15
Beta 12 20
Gamma 10 18
----------Rs.----------
Rate per hour 50 40
(iv) Factory overheads are estimated at 60% of direct labour cost. 40% of factory overheads
are fixed.
Required:
Prepare a product-wise statement showing projected contribution margin for the year ending 31
December 2020.

QUESTION-17 (Q.6 Spring 2019)

Rose Industries Limited (RIL) is in process of preparation of its budget for the year ending 31 March
2020. In this respect, following information has been extracted from RIL's projected financial
statements for the year ending 31 March 2019:
Rs. in million
Sales (100% credit sales) 360,000 units 2,800
Cost of sales
 Raw material 1,120
 Variable conversion cost 280
 Fixed conversion cost (including depreciation of Rs. 24 million) 160
Operating cost
 Variable (varies with sales volume) 190
 Fixed (including depreciation of Rs. 16 million) 45
Closing inventory
 Raw material 70
 Finished goods 40,000 units 110
Information and projections for the budget year ending 31 March 2020:
(i) The management estimates that profitability can be increased by employing the following
measures:
(b) Introduction of cash sales at 5% less than the credit sales price. This would increase the
total sales volume by 30% whereas credit sales volume would reduce by 20% as some
of the existing customers would shift to cash sales.
(c) Installation of a software that would automatically generate follow-up emails to the
customers and relevant reports for the management. The software having useful life of
10 years would be operational from 1 April 2019. The software would cost Rs. 2.5
million and its maintenance cost is estimated at Rs. 0.15 million per quarter. It is
expected that as a result of the use of this software, RIL would be able to reduce its fixed
operating costs by 15%.
(d) As the purchases increase, RIL would negotiate with the suppliers and receive 2% trade
discount.
(e) Cost reduction measures would be taken which would save 5% of the variable
conversion and variable operating costs.
(ii) The increase in working capital requirements would be met by arranging a running finance
facility of Rs. 100 million at a mark-up of 10% per annum. It is estimated that on an average,
90% of the facility would remain utilised during the budget year.
(iii) Effect of inflation on price of raw material and all other costs (excluding depreciation) would
be 10%.
(iv) Closing raw material and finished goods inventories would increase by 8%.
RIL uses marginal costing and follows FIFO method for valuation of inventory.
Required:
Prepare budgeted profit or loss statement for the year ending 31 March 2020. Assume that except stated
otherwise. all transactions are evenly distributed over the year t36t) days). (16)

QUESTION-18 (Q.7 Autumn 2018)

Tennis Trading Limited (TTL) was incorporated on 1 September 2018 and would start trading from the
month of October 2018. As part of planning and budgeting process, the management has developed the
following estimates:
(i) During the month of September 2018, TTL would pay Rs. 5 million, Rs. 2 million and Rs. 1.2
million for purchase of a property, equipment and a motor vehicle respectively.
(ii) Projected sales for October is Rs. 12 million. The sales would increase by Rs. 2.5 million per
month till January 2019. From February 2019 and onwards, sales would be Rs. 25 million per
month.
(iii) Cash sales is estimated at 30% of the total sales.
(iv) Credit customers are expected to pay within one month of the sales.
(v) 80% of the credit sales would be generated by salesmen who would receive 5% commission on
sales. The commission is payable in the following month after sales.
(vi) Gross profit margin would be 30%.
(vii) TTL would maintain inventory at 80% of the projected sale of the following month, up to
December 2018 and thereafter, 85% of the projected sale of the following month. All purchases
of inventories would be on two months’ credit.
(viii) Salaries would be Rs. 1.5 million in September and Rs. 2 million per month, thereafter. Other
administrative expenses would be Rs. 1 million per month from September till January 2019
and Rs. 1.3 million per month thereafter. Both types of expenses would be paid in the same
month in which they are incurred.
(ix) An aggressive marketing scheme would be launched in September 2018. The related expenses
are estimated at Rs. 7 million. 50% of the amount would be payable in September and 50% in
October 2018.
(x) Marketing expenses from October 2018 would consist of 65% variable and 35% fixed expenses.
Total expenses in October 2018 would be Rs. 2 million. All expenses would be paid in the month
in which they occur.
(xi) Bank balance as of 1 September 2018 is Rs. 12 million. TTL has arranged a running finance
facility from a local bank at a mark-up of 10% per annum. The mark-up is payable at the end of
each month on the closing balance.
Required:
Prepare a cash forecast (month-wise) from September 2018 to February 2019. (18)


Sadiq Limited (SL) is in the process of preparation of budget for the year ending 31 December 2018.
Following are the extracts from the statement of profit or loss for the year ended 31 December 2017:
Rs. in million
Sales (30% cash sales) 7,500
Cost of goods sold (4,000)
Gross profit 3,500
Operating expenses (1,250)
Raw material inventory as on 1 January 2017 amounted to Rs. 152 million. There were no opening and
closing inventories of work in process and finished goods.
SL follows FIFO method for valuation of inventories.
Following are the projections to be used in the preparation of the budget:
(i) Selling price would be reduced by 5%. Further, credit period offered to customers would be
reduced from 45 days to 30 days. As a result, volumes of cash and credit sales are expected to
increase by 10% and 5% respectively.
(ii) Ratio of manufacturing cost was 5:3:2 for raw material, direct labour and factory overheads
respectively.
(iii) All operating expenses and 20% of factory overheads are fixed. Total depreciation for the year
2017 amounted to Rs. 100 million and was apportioned between manufacturing cost and
operating expenses in the ratio of 7:3. Depreciation for the next year would remain the same.
(iv) Raw material inventory would be maintained at 30 days of consumption. Up to 31 December
2017, it was maintained at 45 days of consumption.
(v) Raw material prices and direct labour rate would increase by 10% and 6% respectively.
(vi) Impact of inflation on all other costs would be 5%.
(ii) The existing policy of payment to raw material suppliers in 30 days is to be changed to 15 days.
Other costs are to be paid in the month of incurrence.
Required:
Compute the budgeted net cash inflows/(outflows) for the year ending 31 December 2018. (Assume
there are 360 days in a year)
(16)


Falcon (Private) Limited (FPL) is in the process of preparing its annual budget for the next year. The
available information is as follows:
(i) Budgeted and actual production and sales for the current year:
Budgeted Actual
--------Units--------
Production 25,000 23,760
Sales 24,000 22,800
(ii) Current year’s actual production cost per unit:
Rupees
Raw material input (49 kg) 980
Direct labour 800
Variable production overheads 500
Fixed production overheads 400
2,680
(iii) Inventory balances:

FPL maintains the following inventory levels:
Raw material Average two months’ consumption based on
budgeted production
Finished goods Average one month’s budgeted sales
Work in process (opening as well as 1,500 units (100% complete as to material and
closing) 60% as to conversion cost)
FPL follows absorption costing and uses FIFO method for valuation of inventory.
(iv) Impact of inflation:

Inflation %
Raw material and variable overheads 8
Direct labour 10
Fixed overheads (excluding depreciation) 5
(v) Sales volume would increase by 10%.
(vi) Balancing and Modernization of plant would be carried out at a cost of Rs. 20 million which
would:
 increase depreciation from Rs. 5,800,000 to Rs. 7,016,800;
 reduce raw material wastages from 5% to 2% of input; and
 increase labour efficiency by 7%.
Required:
Prepare budgeted statement of cost of sales for the next year.
(16)


Double Crown Limited (DCL) is engaged in manufacturing of a product Zee. Sales projections
according to DCL’s business plan for the year ending 31 December, 2017 are as follows:
May June July August
-------------Rs. in million-------------
Sales 60 55 70 68
(i) Goods are sold at a gross margin of 40% on sales.
(ii) Ratio of direct material, direct wages and overheads is 6:3:1 respectively.
(iii) Normal loss is 5% of the units completed.
(iv) Inventory levels maintained by DCL are as under:
Direct materials Next month’s budgeted consumption
Finished goods 50% of next month’s budgeted sales
(v) 10% of all purchases are in cash. Remaining purchases are paid in the following month.
(vi) Direct wages include DCL's contribution at 5% of the direct wages, towards canteen expenses.
An equal amount is deducted from the employees’ wages. Direct wages are paid on the last
day of each month. Both contributions are paid to the canteen contractor in the following
month.
(vii) Overheads for each month include depreciation on plant and machinery and factory building
rent, amounting to Rs. 0.2 million and Rs. 0.1 million respectively. The rent is paid on half
yearly basis in advance on 30 June and 31 December each year.
Required:
(a) Prepare budget for material purchases, direct wages and overheads, for the month of June
2017.(10)
(b) Prepare cash payment budget for the month of June 2017. (03)


The following information has been extracted from the projected financial statements of Lotus
Enterprises (LE) for the year ending 30 September 2016:
Rs. in million
Sales (100% credit sales) 3,000
Raw material consumption 900
Raw material inventory (including imports of Rs. 98 million) 158
Conversion cost: Variable 570
Fixed (including depreciation of Rs. 16 million) 40
Operating cost: Variable 730
Fixed (including depreciation of Rs. 27 million) 120
Trade creditors (local purchases) 95
Advance to suppliers for import of raw material 30
LE is in the process of preparing its budget for the next year. The relevant information is as under
(i) Sale volume is projected to increase by 30%. In order to finance the additional working capital, the
management has decided to adopt the following measures:
 Introduce cash sales at a discount of 2%. It is estimated that 20% of the customers would
avail the discount.
 The present average collection period is 45 days. LE has decided to improve follow-ups
which would ensure collection within 40 days.
 40% of the raw material consumed is imported which is paid in advance on placement
of purchase order. The delivery is made within 30 days after the placement of order. LE
has negotiated with the foreign suppliers and agreed that from the next year, payments
would be made on receipt of the goods.
 Local purchases would be paid in 50 days.
(ii) As a result of increased production, economies of scale would reduce variable conversion cost per
unit by 5%.
(iii) Due to price increases, cost of raw material and all other costs (excluding depreciation) would
increase by 10% and 8% respectively.
(iv) Average days for payment of other costs would remain the same i.e. 25 days.
(v) There is no opening and closing finished goods inventory.
(vi) Quantity of closing local and imported raw material as a percentage of raw material consumption
would remain the same.
(vii) LE uses FIFO method of valuation of inventory.
Required:
Prepare cash budget for the next year. (Assume that all transactions occur evenly throughout the year (360
days) unless otherwise specified) (15)


Rainbow Paints Limited (RPL) is in the process of preparing its budget for the year ending 28 February
2017. The following data has been extracted from the profit and loss account for the year ended 29
February 2016:
Rs. in million
Sales (including cash sales of Rs. 19 million) 109.00
Cost of goods sold:
Materials consumed (30.00)
Conversion cost – Variable (18.00)
Conversion cost - Fixed (including depreciation of Rs. 3 million) (12.00)
Opening finished goods inventory (5.00)
Closing finished goods inventory 8.00
Gross profit 52.00
Operating expenses:
Variable (25.00)
Fixed (including depreciation of Rs. 5 million) (10.00)
Operating profit 17.00
For preparation of the budget, Cost Control Manager has prepared the following projections /
information:
(i) Sales volume and sales price are expected to increase by 10% and 5% respectively. The ratio of
cash and credit sales would be 25:75. Cash sales are made at a discount of 5%.
(ii) Average collection and payment time in RPL is as follows:
Collection of trade debtors 35 days
Payment to trade creditors 40 days
Payment of expenses 25 days
(iii) RPL maintains raw material inventory for average 30 days’ consumption. Opening and closing
finished goods inventory quantity would be the same.
(iv) Trade creditors as at 29 February 2016 amounted to Rs. 3 million.
(v) Effect of price increase is estimated as under
 Raw material -10%
 Variable and fixed expenses (excluding depreciation) - 8%
 Depreciation - same as last year
(vi) RPL plans to introduce a new product during the budget period for which it plans to launch an
advertisement campaign during September 2016 to February 2017. In this respect payments of
Rs. 3 million each would be made on 1 September - 2016 and 1 March 2017.
(vii) RPL operates absorption costing system and uses FIFO method for- valuation of inventory.
Required:
(a) Prepare budgeted profit and loss account for- the year ending 28 February 2017.
(08)
(b) Prepare budgeted cash flow statement for- the year ending 28 February 2017.
(08)
(Assume that all the transactions occur evenly throughout the year (360 days) unless otherwise
specified)

QUESTION-24 [Q#6 Autumn 2015]

Queen Jewels (QJ) deals in imitated ornaments and operates its business on-line through a web-portal.
Orders are received through the website and dispatched through a courier.
The mode of payments available to customers are as follows:
Mode of payments % of sales
Cash on delivery which is collected by the courier 60%
Advance payments through credit cards 40%
Cash collected by the courier is settled after every 7 days. The courier company’s charges are Rs. 300
per order which are deducted on a monthly basis from the first payment due in the subsequent month.
Payments through credit cards are credited by the bank in 7 days.
High value items which represent 25% of the sales through credit cards are dispatched after 15 days of
receipt of payment. All other dispatches are made immediately and delivered on the same day.
Following further information is available:
(i) Sales are made at cost plus 30%.
(ii) Sales and sales orders are projected as under:
Sep. 2015 Oct. 2015 Nov. Dec. 2015 Jan. 2016
2015
Sales (Rs.) 4,600,000 5,000,000 4,200,000 5,800,000 6,000,000
Sales orders (Nos.) 400 450 470 490 520
(iii) High value items are purchased on receipt of the order. Stock level of other goods is maintained
at 25% of projected sales of the next month. 40% of all purchases are paid in the same month
whereas balance is paid in the next month.
(iv) Purchases during the month of September 2015 amounted to Rs. 3.2 million.
(v) Selling and administrative expenses are estimated at Rs. 50 million per annum and include
depreciation of tangible and amortization of intangible assets amounting to Rs.8 million and
Rs.2 million respectively.
(vi) Cash and bank balances as at 30 September 2015 amounted to Rs. 5.5 million.
(vii) Purchases/sales occur evenly throughout the quarter.
Required:
Prepare a cash budget of QJ for the quarter ending 31 December 2015, (Month-wise cash budget is not
required). (14)
QUESTION-25 [Q.4 Sept 2013]

Crystal Limited (CL) is engaged in the business of supplying plastic chairs to schools and Hospitals in Karachi.
Following data has been extracted from CL’s business plan:
Actual Forecast
Aug. 2013 Sep. 2013 Oct. 2013 Nov. 2013 Dec. 2013
Purchases (Rs. ‘000) 600 520 680 640 560
(i) All the above amounts are exclusive of sales tax. The company uses Just-in-time inventory
system and therefore has a negligible stock at any point of time.
(ii) Sales tax is charged at the rate of 17% and is payable on the 15th day of the next month along
with the sales tax return. Refunds, if any, are received one month after submission of the sales
tax return.
(iii) 70% of the sales are made to hospitals on two months credit whereas the rest of the sales are
made to schools on credit of one month. All debtors are expected to promptly settle their debts.
CL earns a uniform gross profit of 20 percent on sale.

(iv) 10% of the creditors are paid in the month of purchase, 60% are paid in the first month
subsequent to purchase and the remaining 30% are paid in the second month following the
purchase.
(v) Monthly salaries and wages amount to Rs. 95,000 and are paid in the month in which they are
incurred.
(vi) A monthly rent of Rs. 50,000 is paid in advance on quarterly basis.
(vii) Selling expenses for September are estimated at Rs. 40,000. 35% of selling expenses are fixed
whereas remaining amount varies with the variation in sales. Selling expenses are paid in the
(viii) Other overhead expenses are estimated at 6% of the sales for the previous month.
(ix) Cash and bank balances as at 30 September 2013 are estimated to be Rs. 1,000,000.
Required:
Prepare a month-wise cash budget for the quarter ending 31 December 2013. (16)
QUESTION-26 (Q.6 March 2012)

Zinc Ltd (ZL) is engaged in trading business. Following data has been extracted from ZL's business
plan for the year ended 30.9.2012:
Sales Rs.'000'
Actual:
January 2012 85,000
February 2012 95,000
Forecast:
March 2012 55,000
April 2012 60,000
May 2012 65,000
June 2012 75,000
Following information is also available:
(i) Cash sale is 20% of the total sales. ZL earns a gross profit of 25% of sales and uniformity
maintains stocks at 80% of the projected sale of the following month.
(ii) 60% of the debtors are collected in the first month subsequent to sale whereas the remaining
debtors are collected in the second month following sales.
(iii) 80% of the customers deduct income tax @ 3.5% at the time of payment.
(iv) In January 2012, ZL paid Rs. 2 million as 25% advance against purchase of packing machinery.
The machinery was delivered and installed in February 2012 and was to be operated on test run
for two months. 50% of the purchase price was agreed to be paid in the month following
installation and the remaining amount at the end of test run.
(v) Creditors are paid one month after purchases.
(vi) Administrative and selling expenses are estimated at 16% and 24% of the sales respectively and
are paid in the month in which they are incurred. ZL had cash and bank balances of Rs.100
million as at 29.2.2012.
Required: Prepare a month-wise cash budget for the quarter ending 31.5.2012.
(10)


(a) The management of Opal Limited (OL) is in the process of preparing next year’s budget and
has gathered the following information
(i) Sales 180,000 units per month @ Rs. 110 per unit
(ii) Material “A” 75% of finished product @ Rs. 45 per unit
(iii) Material “B” 25% of finished product @ Rs.30 per unit
(iv) Yield 80%
(v) Labour rate Rs.18,000 per month
(vi) Average working hours in a month 200 hours
(vii) Time required for each unit of product 20 minutes
(viii) Variable overhead Rs.15 per unit of raw material consumed
(ix) Fixed overhead Rs.10,000,000 per annum
Required:
Assuming there is no beginning or ending inventory of the product, calculate OL’s budgeted
gross profit for the next year. (06)
(b) The Board of Directors Opal Limited while reviewing next year’s budgeted margins, as
calculated in (a) above expressed their serious concerns on the projected profits. After careful
analysis of all activities by a cross-functional team of OL, the directors approved a plan of action
to improve the overall performance of the company.
The salient features of their plan are as under:
(i) Import of Material “A” from abroad at a cost of Rs. 48 per unit, this is expected to
improve the overall yield by 12.5%.
(ii) Based on a detailed study, the installation of a new system of production has been
proposed. The expected cost of the system is Rs. 7.5 million with an expected useful life
of 5 years. An incentive scheme for the workers have also been proposed by allowing
them to share 45% of the time saved for making each unit of product. The above
measures are expected to reduce the average time for making each unit of product by
30%.
(iii) Introduction of improved management standards which is expected to reduce the
variable overheads by 20%
(iv) Re-assessment of controllable fixed overhead expenses. This is likely to reduce OL’s
existing fixed overheads by 15%.
Required:
In view of the preceding improvement plan and the data provided in (a) above, calculate OL’s
revised budgeted gross profit for the next year. (13)

QUESTION-28 (Q.4 Sept 2007)

Nooruddin is planning to start a new business. He will invest his saving amounting to Rs. 3,500,000
and intends to make borrowing arrangements with a bank to meet the working capital requirements. His
planning is based on the following estimates:
(i) He has identified a factory cum office premises at a monthly rent of Rs. 80,000 which will be
payable in advance at the beginning of each month. However, he needs to give three months
rent as security deposit to the landlord before occupying the space. Other fixed overheads
excluding depreciation are estimated at Rs. 120,000 per month which will be paid in the same
month.
(ii) He has signed a contract for supply of machinery costing Rs. 1,800,000. The payment will be
made at the time of delivery in January 2008. This machinery has an estimated life of five years
with no residual value.
(iii) Production will start in January 2008 and 60% of the next month's sales will be manufactured
in January 2008. Thereafter, the production will consist of 40% of the current month's sales and
60% of the next month's sales.
(iv) He estimates the following sales for the first five months:
Month Units Rs.
January -- --
February 2,400 3,120,000
March 3,200 4,160,000
April 4,000 5,200,000
May 4,800 6,240,000
(v) Sales will be made on credit basis. 5% cash discount will be allowed for payments in the current
month. It is estimated that 35%of each month's sales will qualify for this discount. Balance 65%
will be recovered in the next month.
(vi) Variable production cost per unit has been estimated as:
Rs.
Direct material 600
Direct labour 200
Variable overhead 100
Total variable cost per unit 900
(vii) Raw materials costing Rs. 1,600,000 will be purchased in January 2008 in cash. Thereafter, he
intends to follow a policy of purchasing 50% of the monthly requirement in the same month and
50% of the next month's requirement. All purchases after January shall be made on 30 days
credit.
(viii) Salaries shall be paid in the first week of subsequent month.
(ix) 70% of the variable overheads shall be paid in the same month and 30% in the next month.
Required:
Prepare a cash budget for the months January 2008 to April 2008 showing the balance of cash/running
finance at the end of each month.
(20)


Tram-way Hardware Store has been owned by Mr. Petrol. He had himself made all investment in the
business and had not obtained any financing. He appointed a junior accountant to maintain the manual
accounting records. During the month of August, he asked his accountant to provide certain information
including estimates as he was planning to withdraw some amount for his personal use.
After the failure of his accountant to provide the required information, he has hired your services for
this purpose. You have gathered the following information from the records:
(i) Sales for August 2006 amounted to Rs. 5,000,000.
(ii) Sales forecast for the next three months was as follows:
Rs.
September 6,000,000
October 5,000,000
November 5,500,000
(iii) Based on past experience, collections are expected to be 56% in the month of sale and 43% in
the month following the sale. 1% remains uncollected
(iv) Gross margin on sales is 20% and cost of goods sold comprises of purchase cost only.
(v) 80% of the goods are purchased in the month prior to the month of sale and 20% are purchased
in the month of sale. Payment for goods is made in the month follow the purchase.
(vi) Other monthly recurring expenses which are paid in cash amount to Rs. 40,700.
(vii) Annual depreciation on fixed assets is Rs. 555,600.
(viii) Annual staff salaries are budgeted at Rs. 600,000.
(ix) Bad debts provision as at 31.8.2006 stands at Rs. 190,400.
(x) Balances of some other accounts as at 31.8.2006 are as follows:
Rs.
Fixed assets 9,940,000
Acc. Depreciation 1,900,500
Owner's capital 2,800,000
Profit and loss 8,380,000
Cash and bank 1,980,940
Required:
(a) Prepare a balance sheet as at 31.8.2006. (6)
(b) Calculate the projected balance in accounts payable as on 30.9.2006. (2)
(c) Prepare a projected income statement for the month of September 2006. (3)


New Vision Trading Company Ltd is planning to arrange for a six monthly overdraft facility with a
bank. However, before finalization of any arrangement it wants to know the estimated requirements of
cash. For this purpose it has hired you as consultant to make an estimate of the foreseeable cash
requirements.
The following is the basic data regarding various business cycles of the company:
Sales forecast for the six months are as under:
Months Rs.
January 800,000
February 950,000
March 600,000
April 900,000
May 1,100,000
June 600,000
Purchases are made as and when required
(i) No closing stock is maintained as the supplier has capability to supply any quantities at any
time.
(ii) Gross profit ratio is maintained@20% of the sales price
(iii) Various expenses for the six months are as under:
Rs.
Salaries and wages 390,000
Repair and maintenance 120,000
Insurance 6,000
Stores and spares 270,000
Duties 360,000
Legal Charges 24,000
(iv) Recoveries from the debtors are made as follows:
50% in the month of sale
30% in the month following the month of sale
20% in the second month after sales
(v) Trade creditors are paid as under:
40% in the month of purchase
40% in the month following the month of purchase
20% in the second month after purchase
(vi) All other business expenses are paid in the month of expense. Expenses are evenly spread
throughout the year.
(vii) The company commenced its business on 1.1.2000 with a cash balance of Rs. 50,000.
Required:
You are required to prepare a cash budget to facilitate the company's management in assessing the
working capital requirement for the next six months. (15)

QUESTION-31
Cinemax Limited has recently constructed a fully equipped theatre and 3 cinema houses at a cost of Rs. 30
million. The theatre has a capacity of 800 seats and each cinema has a capacity of 600 seats. Information and
projections for the first year of operations are as follows:
(i) Fixed administration and maintenance cost of the entire facility is Rs. 4.5 million per year.
(ii) The average cost of master print of a Hollywood film is Rs. 4 million while the cost of master print of a
Bollywood film is Rs. 6.5 million.
(iii) Two cinema houses are dedicated for Hollywood films which show the same film at the same time while
one cinema house will show Bollywood films.
(iv) Each Bollywood film is displayed for 6 weeks and the average occupancy level is 70%. Each Hollywood
film is displayed for 4 weeks and the average occupancy level is 65%. On weekdays, there are 2 shows
while on weekends (Sat and Sun), 3 shows are displayed. Ticket price has been fixed at Rs. 350.
(v) Variable cost per show is Rs. 35,000 and setup cost of each film is Rs. 500,000.
(vi) No films would be shown during 8 weeks of the year.
(vii) Theatre is rented to production houses at Rs. 60,000 per day. Each play requires setup time of 2 days
while rehearsal time needs 1 day. Each play is staged 45 times. One show is staged on weekdays whereas
two shows are staged on weekends.
(viii) There is an interval of 2 days whenever a new play is to be staged. No plays are staged during the month
of Ramadan and first 10 days of Muharram.
(ix) The construction costs of theatre and cinema houses are to be depreciated over a period of 15 years.
(x) Assume 52 weeks in a year and 30 days in a month.
Required:
Prepare budgeted profit and loss account for the first year. (ICAP)
QUESTION-32
Beta (Private) Limited (BPL) deals in manufacturing and marketing of bed sheets. The management of the
company is in the phase of preparation of budget for the year 20X3-X4. BPL has production capacity of 4 million
bed sheets per annum. Currently the factory is operating at 68% of the capacity. The results for the recently
concluded year are as follows:
Rs. in million
Sales 3,400
Cost of goods sold
Material (1,493)
Labour (367)
Gross profit 905
Selling expenses (60% variable) (287)
Administration expenses (100% fixed) (105)
Net profit before tax 513
Other relevant information is as under:
(i) The raw material and labour costs are expected to increase by 5%, while selling and distribution costs
will increase by 4% and 8% respectively. All overheads and fixed expenses except depreciation will
increase by 5%.
(ii) Manufacturing overheads include depreciation of Rs. 285 million and other fixed overheads of Rs. 165
million. During the year 20X3–X4 major overhaul of a machine is planned at a cost of Rs. 35 million
which will increase the remaining life from 5 to 12 years. The current book value of the machine is Rs.
40 million and it has a salvage value of Rs. 5 million. At the end of 12 years, salvage value will increase
on account of general inflation to Rs. 9 million. The company uses straight line method for depreciating
the assets.
(iii) Variable manufacturing overheads are directly proportional to the production volume.
(iv) Selling expenses include distribution expenses of Rs. 85 million, which are all variable
(v) Administration expenses include depreciation of Rs. 18 million. During 20X3– X4, an asset having book
value of Rs. 1.5 million will be sold at Rs. 1.8 million. No replacement will be made during the year.
Depreciation for the year 20X3-X4 would reduce to Rs. 17 million.
The management has planned to take following steps to increase the sale and improve cost efficiency:
 Increase selling price by Rs. 150 per unit.
The sales are to be increased by 25%. To achieve this, commission on sales will be introduced besides
fixed salaries. The commission will be paid on the entire sale and the rate of commission will be as
follows:
No. of units Commission % on total sales
Less than 35,000 1.00%
35,000 – 40,000 1.25%
40,000 – 50,000 1.50%
Above 50,000 1.75%
Currently the sales force is categorized into categories A, B and C. Number of persons in each category is 20, 30
and 40 respectively. Previous data shows that total sales generated by each category are same. Moreover, sales
generated by each person in a particular category are also the same. The trend is expected to continue in future.
 The overall efficiency of the workforce can be increased by 15% if management allows a bonus of 20%.
Further increase in production can be achieved by hiring additional labour at Rs. 180 per unit.
Required:
Prepare profit and loss budget for the year 20X3–X4.
(ICAP)
QUESTION-33
Shahid Limited is engaged in manufacturing and sale of footwear. The company sells its products through
company operated retail outlets as well as through distributors. The management is in the process of preparing
the budget for the year 20X0-X1 on the basis of following information:
i. The marketing director has provided the following annual sales projections:
No. of units Retail price range
Men 1,200,000 Rs. 1,000 – 4,000
Women 500,000 Rs. 800 – 2,500
The previous pattern of sales indicates that 60% of units are sold at the minimum price; 10% units are
sold at the maximum price and remaining 30% at a price of Rs.2,000 and Rs. 1,200 per footwear for men
and women respectively.
ii. It has been estimated that 30% of the units would be sold through distributors who are offered 20%
commission on retail price. The remaining 70% will be sold through company operated retail outlets.
iii. The company operates 22 outlets all over the country. The fixed costs per outlet are Rs. 1.2 million per
month and include rent, electricity, maintenance, salaries etc.
iv. Sales through company outlets include sales of cut size footwears which are sold at 40% below the normal
retail price and represent 5% of the total sales of the retail outlets.
v. The company keeps a profit margin of 120% on variable cost (excluding distributors’ commission)
while calculating the retail price.
vi. Fixed costs of the factory and head office are Rs.45 million and Rs.15 million per month respectively.
Required:
Prepare budgeted profit and loss account for the year 20X0 – 20X1.
(ICAP)

QUESTION-34
During the year ending June 30, 20X1 Abdul Habib Company Limited has planned to launch a new
product which is expected to generate a profit of Rs. 9.3 million as shown below:
Rs. in ‘000’
Sales revenue (24,000 units) 51,600
Less: cost of goods sold 37,500
Gross profit 14,100
Less: operating expenses 4,800
The following additional information is available:
i) 75% of the units would be sold on 30 days credit. Credit prices would be 10% higher than the cash price.
It is estimated that 70% of the customers will settle their account within the credit term while rest of the
customers would pay within 60 days. Bad debts have been estimated @ 2% of credit sales. All cash and
credit receipts are subject to withholding tax @ 6%.
ii) 80% of the expenses forming part of cost of goods sold are variable. These are to be paid one month in
arrears.
iii) The production will require additional machinery which will be purchased on July 1, 20X0 at a cost of Rs.
60 million. The machine is expected to have a useful life of 15 years and salvage value of Rs. 7.5 million.
The company has a policy to charge depreciation on straight line basis. The depreciation on the machinery
is included in the cost of goods sold as shown above.
iv) Variable operating expenses excluding bad debts are Rs. 105 per unit. These are to be paid in the same
month in which the sale is made.
v) 50% of the fixed costs would be paid immediately when incurred while the remaining 50% would be
paid 15 days in arrears.
vi) The management has decided to maintain finished goods stock of 1,000 units.
Required:
Calculate the cash requirements for the first two quarters.
(ICAP)

QUESTION-35
The home appliances division of Umair Enterprises assembles and markets television sets. The company has a
long term agreement with a foreign supplier for the supply of electronic kits for its television sets.
Relevant details extracted from the budget for the next financial year are as follows:
Rupees
C&F value of each electronic kit 9,500
Estimated cost of import related expenses, duties etc. 900
Variable cost of local value addition for each set 3,500
Variable selling and admin expenses per set 900
Annual fixed production expenses 12,000,000
Annual fixed selling and admin expenses 9,000,000
Fixed production overheads are allocated on the basis of budgeted production which is 5,000 units.
The present supply chain is as follows:
i) The company sells to distributors at cost of production plus 25% mark-up.
ii) Distributors sell to wholesalers at 10% margin.
iii) Wholesalers sell to retailers at 4% margin.
iv) Retailers sell to consumers at retail price i.e. at 10% mark-up on their cost.
Performance of the division had not been satisfactory for the last few years. A business consulting firm was hired
to assess the situation and it has recommended the following steps:
(a) Reduce the existing supply chain by eliminating the distributors and wholesalers.
(b) Reduce the retail price by 5%.
(c) Offer sales commission to retailers at 15% of retail price.
(d) Provide after sales services.
(e) Launch advertisement campaign; expected cost of campaign would be around Rs. 5 million.
It is expected that the above steps will increase the demand by 1,500 sets. The average cost of providing after
sales service is estimated at Rs. 450 per set.
Required:
(a) Compute the total budgeted profit:
(i) Under the present situation; and
(ii) If the recommendations of the consultants are accepted and implemented.
(b) Briefly describe what other factors would you consider while implementing the consultants’
recommendations.
(ICAP)

QUESTION-36
RS Enterprises is a family concern headed by Mr. Rameez. It is engaged in manufacturing of a single product but
under two brand names i.e. A and B. Brand B is of high quality and over the past many years, the company has
been charging a 60% higher price as compared to brand A. As the company has progressed, Mr. Rameez has felt
the need for better planning and control. He has compiled the following data pertaining to the year ended
November 30,20X8:
Rupees Rupees
Sales 5,522,400
Production costs:
Raw materials 2,310,000
Direct labour 777,600
Overheads 630,000 3,717,600
Gross profit 1,804,800
Selling and administration expenses 800,000
1,004,800
A B
No. of units sold 5400 3600
Labour hours required per unit 5 6
Other information is as follows:
i) 20% of B was sold to a corporate buyer who was given a discount of 10%. The buyer has agreed to double
the purchases in 20X9 and Mr. Rameez has agreed to increase the discount to 15%.
ii) In view of better margins in B, Mr. Rameez has decided to promote its sale at a cost ofRs.
250,000. As a result, its sales to customers other than the corporate customer, are expected to increaseby
30%. However, the production capacity is limited. He intends to reduce the production/sale of A if
necessary. Mr. Rameez has ascertained that 90% capacity was utilized during the year ended November
30, 20X8 whereas the time required to produce one unit of B is 20% more than the time required to
produce a unit of A.
iii) 2.4 kgs of the same raw material is used for both brands but the process of manufacturing B is slightly complex
and 10% of all raw material is wasted in the process. Wastage in processing A is 4%.
iv) The price of raw material has remained the same for the past many years. However, the supplier has
indicated that the price will be increased by 10% with effect from March 1, 20X9.
v) Direct labour per hour is expected to increase by 15%.
vi) 40% of production overheads are fixed. These are expected to increase by 5%. Variable overheads per
unit of B are twice the variable overheads per unit of A. For 20X9, the effect of inflation on variable
overheads is estimated at 10%.
vii) Selling and administration expenses (excluding the cost of promotional campaign on B) are expected to
increase by 10%.
Required:
Prepare a profit forecast statement for the year ending November 30, 20X9.

QUESTION-37
Smart Ltd has prepared a forecast for the quarter ending 31.12.2009, which is based on the following
projections:
(i) Sales for the period October 2009 to January 2010 has been projected as under:
Rs.
October 2009 7,500,000
November 2009 9,900,000
December 2009 10,890,000
January 2010 10,000,000
Cash sale is 20% of the total sales. The company earns a gross profit at 20% of sales. It intends to
increase sales prices by 10% from 1.11.2009, however since there would be no corresponding increase
in purchase prices the gross profit percentage is projected to increase. Effect of increase in sales price
has been incorporated in the above figures.
(ii) All debtors are allowed 45 days credit and are expected to settle promptly.
(iii) Smart Ltd follows a policy of maintaining stocks equal to projected sale of the next month.
(iv) All creditors are paid in the month following delivery. 10% of all purchases are cash purchases.
(v) Marketing expenses for October are estimated at Rs.300,000. 50% of these expenses are fixed
whereas remaining amount varies in line with the. Value of sales. All expenses are paid in the
(vi) Administration expenses paid for September were Rs.200,000. Due to inflation, these are
expected to increase by 2% each month.
(vii) Depreciation is provided @ 15% per annum on straight line basis. Depreciation is charged from
date of purchase to the date of disposal.
(viii) On 31.10.2009 office equipment having book value of Rs.500,000 (40% of the cost) on
1.10.2009 would be replaced at a cost of Rs.2,000,000. After adjustment of trade-in allowance
of Rs.300,000 the balance would have to be paid in cash.
The opening balances on 1.10.2009 are projected as under:
Rupees
Cash and bank 2,500,000
Trade debts – related to September 5,600,000
Trade debts – related to August 3,000,000
Fixed assets at cost (20% are fully depreciated) 8,000,000
Required:
(a) Prepare a month-wise cash budget for the quarter ending December 31, 20X9.
(b) Prepare a budgeted profit and loss statement for the quarter ending December 31, 20X9.
Question-38
The records of direct labour hours and total factory overheads of IMI Limited over first six months of its
operations are given below:
Direct labour Hours Total factory Overheads
in 000 Rs. in 000
September 20X9 50 14,800
October 20X9 80 17,000
November 20X9 120 23,800
December 20X9 40 11,900
January 20X0 100 22,100
February 20X0 60 16,150
The management is interested in distinguishing between the fixed and variable portion of the overheads.
Required: Using the least square regression method, estimate the variable cost per direct labour hour and the
total fixed cost per month.

Question-39 (Autumn 2022 – Q7)

Multan Star (MS) is engaged in manufacturing and selling of a single product K-100.
The management is in the process of preparing its budgeted profit or loss statement for theyear ending 31
August 2023. Following information is available in this respect:
Information for the year ended 31 August 2022

(i) Extracts from profit or loss statement:
Rs. in '000
Sales 90,000
Cost of goods sold:
Material (36,000)
Labour (25,000)
Manufacturing overheads (9,000)
Gross profit 20,000
Selling and administration expenses (2,500)
(ii) During the year, MS operated at 80% of its machine production capacity. It manufactured and
sold 72,000 units of K-100. Each unit of K-100 requires 3 hours of machine time.
(iii) 2.5 kg of material is required for manufacturing of each unit of K-100.

(iv) Each unit of K-100 requires three labour hours. Labour is hired under a third partycontract
according to which MS has to pay for a minimum of 250,000 labour hours.However, each hour
exceeding 250,000 hours would be paid at two times of standard labour rate per hour.
(v) 20% of total manufacturing overheads are fixed. Variable manufacturing overheads areabsorbed on the
basis of machine hours.
(vi) All selling and administration expenses are fixed.
(vii) There are no opening or closing stocks of raw material and finished goods .
Information and projections for the budget for the year ending 31 August 202 3
(i) MS would introduce the mini version of K-100 under the name of K-50. The demand for K-50 is
expected to be 25,000 units. The selling price of K-50 would beRs. 750 each.
(ii) The introduction of K-50 would not affect the existing demand for K-100. In addition, MS has entered
into a contract with a new customer for supply of 10,000 units of K-100 at the last year’s
prevailing price.
(iii) Any constraint due to production capacity would be met by reducing the production of K-100.
However, any shortfall in production of K-100 would be met by purchasing itfrom the market at a
price of Rs. 1,200 per unit.
(iv) The selling price of K-100 (other than already contracted to supply) would increase by12%.
(v) Each unit of K-50 would require 1 kg of material, 1.5 hours of machine and 1.5 hoursof labour. The
production of K-50 would result in increase in selling and administrationexpenses by 20% other than
the inflation.
(vi) All expenses unless otherwise specified are subject to inflation of 5%.
Required:
Prepare a budgeted profit or loss statement for the year ending 31 August 2023. (12)

Question-40 (Autumn 2023 – Q7)

Armaan Khan recently registered a small spice exporting business and will begin exporting Biryani Masala
to customers in the USA starting from October 2023. He managed to securea cash injection of Rs. 0.5
million from his friends. He has promised to repay this loan by the end of 2023. Additionally, he has
brought his personal car, valued at Rs. 1.5 million, into the business.
While formulating the planning and budgeting strategy, he developed the following estimates:
(i) An immediate investment of Rs. 1 million will be required to purchase the
packagingmachinery.
(ii) The month-wise projected sales (in rupee equivalence) from October
2023 toJanuary 2024 are as follows:
Month October 23 November 23 December 23 January 24

Amount in 7,500,000 10,500,000 13,500,000 15,000,000
Rs.
(iii) 20% of sale receipts from customers are received in the month before sale, 60% during
the month of sale, and the remaining in the following month.
(iv) The bank deducts a 1.5% tax at source from all customer receipts.
(v) To timely process the spices for export, Armaan must purchase the spices a month
before the expected sales. Packing materials are readily available and can be purchased
in the month of sales.
(vi) Further details regarding sales and purchase are as follows:
Rupees
Sales price per carton 1,500
Spices required per carton (Rs. 400 per kg) 1,000
Packing material required per carton (Rs. 40 per foot) 60
(vii) 60% of the spice purchases are paid in the month of purchase, with the remaining
amount settled in the following month. Packing material suppliers are paid in the
month of purchase.
(viii) A 2% agency commission is payable to the agents in the month of sale.
(ix) Projected administrative expenses amount to Rs. 300,000 per month for the quarter
ending 31 December 2023. The related payment is made in the month of its incurrence.
(x) Armaan has arranged a running finance facility of Rs. 3 million with a local bank at a
mark-up of 25% per annum. The mark-up is payable at each month-end on the
outstanding closing balance.
Required:
Prepare a month-wise cash budget for the quarter ending 31 December 2023. (13)

Question-41 (Spring 2024 – Q6)
Majestic Alliance (MA) is engaged in producing and selling a single product, AZ08. MA
is currently preparing its budget for the year ending 31 March 2025. The budgeted production
volume is set at 300,000 units. The budgeted production costs per unit are as follows:
Material A 30 kg per unit @ Rs. 200 per kg
Material B 18 kg per unit @ Rs. 150 per kg
Skilled labour 4.5 hours per unit @ Rs. 500 per hour
Semi-skilled labour 3.5 hours per unit @ Rs. 300 per hour
Other variable overheads Rs. 567 per unit
Additional information relating to budgeted production

(i) The budgeted selling price of AZ08 will be cost of manufacturing plus 25%.
(ii) The normal defective units during production are 5% of budgeted production, which
can be sold at Rs. 10,000 per unit.
(iii) Fixed production overheads are budgeted at Rs. 129.9 million per annum, whereas
total selling and administration expenses are budgeted at Rs. 3 million per annum.
(iv) There will be no opening or closing inventories of AZ08.
Suggestions of financial controller

The newly appointed financial controller has suggested following revisions to the current
policies, believing they would improve MA’s profitability:
(i) Currently, 40% of AZ08 sales comprises credit sales. He proposed offering a 3%
discount for upfront cash payment that would increase the total sales volume by5%.
He is of the view that this would also reduce the volume of credit sales to 20% oftotal
sales.
(ii) Implementing strict quality controls is recommended to improve quality of procured
materials, which would reduce the number of defective units to 3% of total production.
However, these controls would increase fixed production overheads by Rs. 2 million per
annum.
(iii) MA has faced challenges regarding packaging of AZ08. To overcome these challenges,
negotiations with a packaging company have been concluded. This deal would result in
outsourcing of the packaging process for a lump sum cost of Rs. 200 per good unit. This
would also lead to:
a reduction of semi-skilled labour costs by 25% and skilled labour costs by 5%.
a reduction of variable overheads by 15%.
Sales price would remain the same despite the implementation of the above measures. All
other information relating to the budgeted production will remain the same.
Required:
Prepare a budgeted profit or loss statement under the present situation and after the
implementation of the suggestions made by the financial controller. (13)

Chapter 15: Working Capital Management
CHAPTER 15
Working Capital Management
The nature and elements of working capital
Working capital is the capital (finance) that an entity needs to support its everyday operations.
Working capital can therefore be defined as the net current assets (or net current operating assets)
of abusiness.).
The objectives of working capital management

The management of working capital is an aspect of financial management, and is concerned with:
• Ensuring that the investment in working capital is not excessive;
• Ensuring the level of working capital is not low (aggressive strategy)
• Ensuring that enough working capital is available to support operating activities.
Avoiding excessive working capital

An aim of working capital management should be to avoid excessive investment in working capital.
Avoiding liquidity problems

On the other hand, a shortage of working capital might result in liquidity problems due to having
insufficient operational cash flows to pay liabilities when payment is due. Operational cash flows come
into a business from the sale of inventories and payment by customers: inventory and trade receivables
are therefore a source of future cash income. These must be sufficient for the payment of liabilities.
The conflict of objectives with working capital management

A conflict of objectives therefore exists with working capital management. Over- investment should
be avoided, because it reduces profits or returns to shareholders. Under-investment should be
avoided because it creates a liquidity risk.
Benefits of investing in working capital

There are significant benefits of investing in working capital:
Holding inventory allows the entity to supply its customers on demand.
Entities are expected by many customers to sell to them on credit otherwise they will buy
fromcompetitors who will offer credit.
It is also useful for an entity to have some cash in the bank to meet demands for immediate
payment.
Disadvantages of excessive investment in working capital

Money tied up in inventories, trade receivables and a current bank account earns nothing.
Investing in working capital therefore involves a cost (financing cost).
The cost of investing in working capital is the reduction in profit that results due to the
opportunity cost.

Management attitude to risk

High levels of working capital are expensive but low levels of working capital are high risk.
• An aggressive working capital policy will seek to keep working capital to a minimum.
o Low finished goods inventory will run the risk that customers will not be
supplied andwill instead buy from competitors.
o Low raw material inventory may lead to stock-outs (or ‘inventory-outs’) and
thereforehigh costs of idle time or expensive replacement suppliers having to be
found.
o Tight credit control may alienate customers and taking long periods of credit
fromsuppliers may run the risk of them refusing to supply on credit at all.
o However low levels of working capital will be cheap to finance and if managed
effectivelycould increase profitability.
• A conservative/Defensive working capital policy aims to keep adequate working capital
for theorganisation’s needs.
o Inventories are held at a level to ensure customers will be supplied and stock-outs
willnot occur.
o Generous terms are given to customers which may attract more customers.
o Suppliers are paid on time.
Permanent and Fluctuating Working Capital

Permanent working capital refers to Fluctuating working capital refers to working
the minimum level of working capital capital which is required at certain times in the
which isrequired all of the time. trade cycle. (Temporary)
It includes minimum levels of inventories, trade E.g. it may be economic for companies to
receivables and trade payables. purchase raw materials in bulk.
Required if companies have seasonal demand.
Minimum Working Capital Difference between Maximum and
MinimumWorking Capital
Medium / Long Term sources of finance are Short Term sources of finance are suitable to
suitable to finance permanent net current assets. finance temporary net current assets.
Financing working capital: short-term or long-term finance

Long-term finance, such as equity and debt, is expensive but low risk.
Short-term finance is less expensive but there is a higher risk of it being withdrawn.
The type of financing used within the business may depend on management attitude to risk.

Conservative funding policy Aggressive funding policy

This is where finance all Permanent and part This is where finance all
ofFluctuating net current assets through Long Fluctuating/Temporary net current assets and
/ Medium term sources of finance part of Permanent net current assets through
short term sources of
finance
This policy is the least risky but also results in the This policy carries the greatest risk of
lowest expected return. illiquidity,as well as the greatest return.
(because short term debt costs are typically
lessthan long-term costs).
Need to manage Risk (Risk Averse) Need more Finance / Return (Risk Seaker)
Focus on long / medium term sources of finance Focus on short term sources of fiance
Moderate funding policy

o Finance all Permanent net current assets through long/medium term sources of finance
o and all Fluctuating / Temporary net current assets through short term sources of finance.
o This policy falls between the two extremes.
o Also called Matching or maturity matching policy
Short term Finance

Short-term finance (trade payables and a bank overdraft) rather than long-term finance
Benefits
• Lower cost. Trade credit is the cheapest form of short-term finance – it costs nothing. The
supplierhas provided goods or services but the entity has not yet had to pay.
• Much more flexible. A bank overdraft is variable in size, and is only used when needed.
Risks
• Short-term finance runs out more quickly and has to be renewed. Suppliers must be asked for
tradecredit every time goods or services are bought from them.
• A bank overdraft facility is risky, because the bank has the right to demand immediate
repayment ofan overdraft at any time.

CASH OPERATING CYCLE / WORKING CAPITAL CYCLE

An important way of assessing the adequacy of working capital and the efficiency of working capital
management is to calculate the length of the cash operating cycle.
This cycle is the average length of time between paying suppliers for goods / services
received toreceiving cash from customers for sales of finished goods or services.
The cash operating cycle is linked to the business operating cycle.

A business operating cycle is the average length of time between obtaining goods and services from
suppliers to selling the finished goods to suppliers.
A cash operating cycle differs significantly for different types of business.

For example, a company in a service industry such as a holiday tour operator does not have much
inventory, and it might collect payments for holidays from customers in advance. The time
betweenpaying suppliers and receiving cash from customers might be very short.
In contrast a manufacturing company might have to hold large inventories of raw materials and
components, work in progress and finished goods, and most of its sales will be on credit so that it has
substantial trade receivables too. The time between paying for raw materials and eventually receiving
payment for finished goods could be lengthy.
Retail companies have differing cash operating cycles.

Major supermarkets have a very short cash operating cycle, because they often sell goods to
customersbefore they have even paid their suppliers for them. This is because supermarkets enjoy
very fast turnover of most items and their sales are for cash.
In contrast a furniture retailer might hold inventory for a much longer time before selling it, and
somecustomers might arrange to pay for their purchases in instalments.
Cash operating cycle and working capital requirements

The cash operating cycle is a key factor in deciding the minimum amount of working capital
required bya company. A longer cash operating cycle means a larger investment in working
capital.
The cash operating cycle, and each of the elements in the cycle, must be managed to ensure that
the investment in working capital is not excessive (i.e. the cash cycle is not too long) nor too
small (i.e. thecash cycle is too short, perhaps because the credit period taken from suppliers is
too long).
Elements in the cash operating cycle

There are three main elements in the cash operating cycle:
• The average length of time that inventory is held before it is used or sold
• The average credit period taken from suppliers
The average length of credit period taken by (or given to) credit customers. A cash cycle oroperating
cycle is measured as follows.

Illustration: Cash operating cycle

Days/weeks
/months
Average inventory holding period X
Average trade receivables collection period X
Average period of credit taken from suppliers (X
)
Operating cycle X
The working capital ratios and the length of the cash cycle should be monitored over time. The
cycle should not be allowed to become unreasonable in length, with a risk of over-investment or
under- investment in working capital.
The length of the working capital cycle

Different industries will have different working capital requirements. The working capital
cycle measures the time taken from the payment made to suppliers of raw materials to the
paymentsreceived from customers. In a manufacturing company this will include the time
that:
• raw materials are held in inventory before they are used in production;
• the product takes in the production process;
• finished goods are held in inventory before being purchased by a customer; and
• time taken by customers to pay the amount owed by them
The working capital cycle is also affected by the terms of trade. This is the amount of credit given
to customers compared to the credit taken from suppliers. In a manufacturing company it may be
normal practise to give customers lengthy periods of credit. This also reflects the relative bargaining
position of the entity vis-a-vis its suppliers and customers.
Analysing the cash operating cycle

The cash operating cycle can be analysed to assess whether the total investment in working capital
istoo large or possibly too small. The analysis can be made by comparing each element of the cash
operating cycle, and the cash operating cycle as a whole, with:
• the cash operating cycle of other companies in the same industry
• the company’s own cash operating cycle in previous years, to establish whether it is
gettinglonger or shorter.
Changes in the cash cycle and implications for operating cash flow
When there are changes in the length of the cash operating cycle, this has implications for cash
flow aswell as working capital investment.
• A longer cash operating cycle, given no change in sales or the cost of sales, increases the
totalinvestment in working capital. An increase in the inventory turnover period means
more inventory, and an increase in the average collection period means more trade
receivables. Areduction in the average payables period means fewer trade payables,

which also increases working capital.

• An increase in working capital reduces operational cash flows in the period.
The reverse is also true. A shorter cash operating cycle results in less working capital investment,
and thefall in working capital increases operating cash flows in the period.
Analysing the liquidity ratios

 If the liquidity ratios are too high, this indicates that there is too much investment in
workingcapital. 
 If the liquidity ratios are low, this indicates that the company might not have enough liquidity,
and might be at risk of being unable to settle its liabilities when they fall due. So how is such
anassessment made?
The liquidity ratios of a company may be compared with:

• the liquidity ratios of other companies in the same industry, to assess whether the
company’sliquidity ratios are higher or lower than the industry average or norm and
• changes in the company’s liquidity ratios over time and whether its current assets are
risingor falling in proportion to its current liabilities.
The ‘normal’ or ‘acceptable’ liquidity ratios vary significantly between different industries. The
idealliquidity ratios depend to a large extent on the ‘ideal’ or ‘normal’ turnover periods for
inventory, collections and payments to suppliers.
A high ratio might be attributable to an unusually large holding of cash. When a company has surplus
cash or short-term investments, this might be temporary and the company might have plans for how
the cash will be used in the near future.
Working Capital Ratios:

Current Ratio = Current Assets
Current Liabilities
Quick Ratio / Acid Test Ratio = Current Assets - Stock
Current Liabilities
Stock Turnover (times) = Cost of Sales
Average FG Stock
Stock Turnover (days) = Average FG Stock x 360
Cost of Sales
Raw Material Holding period (days) = Average Raw material inventory x 360
Material Consumed /purchases
WIP Period (days) = WIP Inventory x 360
Cost of Goods Manufactured
Receivables collection period (days) = Average trade receivables x 360
Credit Sales
Accounts payable payment period (days) = Average trade payables x 360
Credit Purchases

Working Capital Requirement
$m
Debtors Credit Sales x Debtors Period XXX
365
Finished Goods Cost of Goods Sold x Finished Goods Period XXX
365
Work in Progress (WIP) *Cost of Goods Manufactured x WIP Period XXX
365
Raw Materials inventory Raw material consumed x Raw material Period XXX
365
Advance to Supplier Raw material purchases x Advance Period XXX
365
Cash XXX
Total Current Assets XXX
Current Liabilities
Creditors Raw material purchases x Creditors Period (XXX
365 )
Accrued Expenses Expenses for the year x Accrued Expense Period (XXX
365 )
Desired Working Capital / Working Capital Requirement XXX
*WIP inventory (Material 100% complete and WIP 50%)

Raw Material Raw Material consumed x WIP Period XXX
365
Conversion Cost Total Conversion Cost x WIP Period x 50% XXX
365
WIP Inventory XXX

Actions to reduce the length of the cycle
Reduce raw materials inventory Possible disadvantages of reducing inventory levels:

cycle – review the inventory  Risk of stock-outs and production hold-ups
levelsand quantities purchased.  Loss of bulk discounts.
Delay payment to suppliers Possible disadvantages of delaying payments
(increase finance from  Loss of cash discounts
creditors)  A bad business relationship with suppliers
 Possible loss of reliable suppliers of supply
 Suppliers might decide to charge higher prices.
Speed up the production cycle Possible disadvantages of making the production cycle
(reducing production cycle) shorter
 Investment may be required in new technology and
training
 Higher rates of pay may be necessary
 More efficient production should not be allowed to lead
toa build-up of finished goods inventories.
Reduce inventories of Possible disadvantage of reducing finished goods
finishedgoods (Inventory inventories
level  Possible loss of profit due to stock-outs
management).
Reduce the period of credit allowed Possible disadvantage of reducing credit
to customers (receivables (debtors)  Improved credit control will cost more
management)  Cash discounts may be expensive to encourage
promptpayment
 Some loss of sales, because customers might buy
fromcompetitors offering better credit terms.

Practice Questions
Q.1
Nestle Ltd has an installed capacity of 250,000 tones of cement per annum. Its present capacity
utilization is 80 percent. The company produces cement in bags of 100 kgs each. Cost structure per
bagof cement, as estimated by the management is given below:
Rs
.
Limestone 90
Other raw materials 150
Packing material 60
Direct labour 180
Fuel 300
Factory overheads (including depreciation of Rs. 60) 180
Administrative overheads 120
Selling overheads 150
Total cost 1,230
Profit margin 270
Selling price 1,500
Add: Government levies (20 percent of selling price) 300
Invoice price to customers 1,800
Following additional information is also available:

i. Desired holding period of various materials is Limestone: 1 month; other raw materials: 3
months;Fuel: 2.5 months; Packing material: 1.5 months.
ii. Work in process is equal to approximately half month’s production (assume that full
units ofmaterials are required in the beginning; other conversion costs are to be taken at
50 percent).
iii. Finished goods are in stock for a period of 1 month before they are sold.
iv. Debtors are extended credit for a period of 3 months.
v. Average time lag in payment of wages is approximately ½ month and that of overheads
is onemonth.
vi. Average time lag in payment of government levies is 1 month.
vii. The credit period extended by suppliers for fuel, packing materials and other raw
material is 1month, ½ month and 2 months respectively.
viii. Minimum desired cash balance is Rs. 15 million.
Required: From the information given above, determine the net working capital requirement of
thecompany for the current year.

Q.2
Based on the following information, work out length of cash operating cycle for both the years.
Present position for the year Budgeted position for the

2019 year2020
Sales 350,000 403,200
Cost of goods sold 294,000 347,200
Purchases 196,000 238,000
Accounts receivable 43,750 50,400
Creditors 29,400 42,000
Raw materials 49,000 84,000
Work in process 24,500 42,000
Finished goods 56,000 60,200
Assume all sales and purchases are on credit terms and 360 days in a year.
Q.3
The working capital (or cash operating) cycle of a business is the length of time between the payment
forpurchased materials and the receipt of payment from selling the goods made with the materials.
Thetable below gives information extracted from the annual accounts of Entity M for the past three
years. Entity M - Extracts from annual account
Year 1 Year 2 Year 3
Inventory: Rs. Rs. Rs.
Raw materials 108,000 145,800 180,000
Work in progress 75,600 97,200 93,360
Finished goods 86,400 129,600 142,875
Purchases 518,400 702,000 720,000
Cost of goods sold 756,000 972,000 1,098,360
Sales 864,000 1,080,000 1,188,000
Trade receivables 172,800 259,200 297,000
Trade payables 86,400 105,300 126,000
Required
a) Calculate the length of the working capital cycle (assuming 365 days in theyear); and
b) List the actions that the management of Entity M might take to reduce thelength of the cycle.

Q.4
Waseem Limited is engaged in manufacture and sale of consumer products. Its management is in
theprocess of developing the sales plan for the next year.
The sales director is of the view that the main hurdle in increasing the sales is the availability of
finance.The summarized statement of financial position as of November 30, 2016 is shown below:
Rs. in million
ASSETS
Fixed assets 950
Current assets 730
1,680
LIABILITIES AND
EQUITIES
Ordinary share capital 250
700
Long term debts 465
Current liabilities 515
1,680
Following additional information is available:

i. It has been established from the company’s past record that any increase in sales
requirean investment of 140% of the additional sales amount, in inventories and
accounts receivable. Further, the accounts payable of the company also increase by
25% of the additional sales amount.
ii. The current sales of the company are Rs. 1,100 million while the net profit after tax
is10% of sales.
iii. It is the policy of the company to distribute 20% of its profit after tax
among theshareholders of the company.
Required
Assuming that you are the Chief Financial Officer of the company, advise the management on
thefollowing:
a) How much additional finance would be required to achieve 20% increase in sales in the next
year?
b) What would be the maximum growth in sales that the company can achieve if:
• external finances are not available?
• the additional financing is limited to an amount which will maintain the existing debt
equityratio?

Q.5
A company has following details:
Current Sale Rs. 60 Million

Current Credit period 15 Days
Current Bad Debts 0.2 % of Sale
Current CM Ratio 25%
The company is considering to increase credit period to 2 months which will increase sale by 30%
andbad debts to 1.5% of credit sales.
Finance cost is 18% p.a.
Required:
(a) Calculate additional finance cost due to change in credit terms.
(b) Calculate additional profit due to change in credit terms and advice the company.
Q.6
All sales are made by Tesla Ltd are on credit and dealers are given one month’s time to settle bills.
The company is thinking of changing the credit period with a view to increase its overall profits. The
marketingDept has prepared the following estimates for different periods of credit.
Present policy Plan 1 Plan 2 Plan 3
Credit period (in months) 1 1.5 2 3
Sales (Rs. 000) 36,000 39,000 45,000 54,000
Fixed cost (Rs. 000) 9,000 9,000 10,500 12,000
Bad debts (% of sales) 0.5 0.8 1 2
The Company has contribution/ sales ratio of 40% further it requires Pre-tax return on investment at
20%.
Required: Evaluate each of the proposals and recommend the best credit period.
Q.7
Samsung Ltd produces a single product which has a large market. It sells an average of 360,000 units
permonth at a price of Rs. 160 per unit. The variable cost is Rs. 120 pr unit.
All sales are made on credit. Debtors are allowed one month to clear off the dues. The company is
thinking of extending the credit term of two months which will help increase the sales by 25%.
Other information is as follows:
I. Raw material constitutes 60% of the variable cost.

II. The company has a policy of maintaining 60 days stock of finished goods and 30 days

stock ofraw materials. The supplier of raw materials allow a credit of 20 days.
III. The company’s cost of funds is 16%.
Required:
Calculate the effect of the proposed credit policy on the profitability of the company.
Q.8
The Finance Manager of Carrefour Ltd has observed that working capital levels fluctuate quite
substantially from month to month. Based on forecast revenue for next year, the average days and
minimum and maximum working capital levels for next year are likely to be as follows:
Average Days Minimum Maximum

Rs. Rs.
Inventories 105 1,726,000 2,959,000
Accounts Receivable 15 164,000 329,000
Accounts payable 60 740,000 `1,250,000
At present Carrefour Ltd follows an aggressive policy for financing net current assets. All
fluctuating net current assets and 20% of permanent net current assets are funded by overdraft. The
finance manager thinks this is too risky a policy in present economic conditions and is proposing a
more conservative policy where 100% of permanent net current assets and 20% of fluctuating net
current assets are financed by medium or long term finance.
Required: Calculate the short term and long term financing requirements of Carrefour Ltd under the
aggressive policy for financing net current assets that is currently being used and also under the
proposed new conservative policy.

Q.9 (Spring 2022)

Decor Limited (DL) is engaged in selling home decoration items. DL has provided you thefollowing
information based on its latest management accounts:
Rs. in '000
Average inventory 6,000
Average trade debtors 7,500
Average trade creditors 3,800
Sales 50,000
Cost of sales 35,000
The management of DL is concerned over increasing working capital requirement that is

centrally managed through bank overdraft facility. As per arrangement with the bank, DLhas
overdraft limit of Rs. 10 million.
For the next year, it is projected that sales and cost of sales would increase by 25% and 15%
respectively. This would result in:
 average inventory to increase by 30%
 average trade debtors to increase by 20%
 average trade creditors to increase by 10%
The CFO is of the view that DL would not be able to manage its working capital requirement
within the bank overdraft limit for next year. He has suggested that DL should take certain actions
to follow industry average ratios which are given below:
Industry average ratios *Number of

days
Inventory holding period 50
Trade debtors’ collection period 45
Trade creditors’ payment period 30
*Based on 365 days a year
Required:
(a) Determine the cash operating cycle for the next year. (03)
(b) Validate CFO’s view regarding management of working capital requirement if:
 DL does not follow industry average ratios
 DL follows industry average ratios (04)
(c) List down any two actions that management of DL may take to reduce the length ofits
cash operating cycle. Also, mention any two risks associated with those actions of
management (03)

Q.9 (Spring 2023 – Q8)

Faran Limited (FL) manufactures and sells a specialised machine. It is currently in the processof
finalizing its sales plan for 2023. According to the sales director, the main obstacle to
increasing sales is the availability of working capital finance. The finance director informed that
any increase in sales would increase:
 the trade receivables by 80% of the additional sales amount;
 the inventories by 60% of the additional sales amount; and
 the trade payables by 35% of the additional sales amount.
Following is the summary of FL's financial position as at 31 December 2022:

Assets Rs. in million Equity and liabilities Rs. in million
Plant and machinery 950 Long term debt 465
Current liabilities:
Current assets: Trade payables 405
Inventory 500 Other payables 110
Trade receivables 300 Equity:
Cash and bank balances 30 Share capital 350
1,780 1,780
The sales for the year ended 31 December 2022 was Rs. 2,200 million, and the net profit aftertax
was 15% of the sales amount. FL distributes 25% of profit after tax as dividend to its
shareholders. It is expected that profit after tax and dividend distribution for the year 2023 will
be in line with 2022.
All receipts and payments except dividend can be assumed to occur evenly throughout the
year. Dividend is paid on the last day of the financial year.
Required:
(a) Determine the amount of additional working capital finance required to achieve a
25%increase in sales next year. (03)
(b) Estimate the maximum growth in sales that FL can achieve under each of the
followingindependent assumptions:
(i) No external financing is available. (02)
(ii) Only debt financing is available to the extent that existing debt equity ratio is
maintained at the end of 2023. (04)

CHAPTER 16
An Introduction to Project Appraisal
LONG TERM DECISION MAKING
Capital expenditure
Capital expenditure is spending on non-current assets, such as buildings and equipment, or investing
in a new business. As a result of capital expenditure, a new non-current asset appears on the statement
of financial position (balance sheet), possibly as an ‘investment in subsidiary.
Investment appraisal
Before capital expenditure projects are undertaken, they should be assessed and evaluated. As a
general rule, projects should not be undertaken unless:
 they are expected to provide a suitable financial return; and
 the investment risk is acceptable.
Investment appraisal is the evaluation of proposed investment projects involving capital expenditure.
The purpose of investment appraisal is to make a decision about whether the capital expenditure is
worthwhile and whether the investment project should be undertaken.
Features of investment projects

 The project involves the purchase of an asset with an expected life of several years, and involves
the payment of a large sum of money at the beginning of the project. Returns on the investment
consist largely of net income from additional profits over the course of the project’s life.
 The asset might also have a disposal value (residual value) at the end of its useful life.
 A capital project might also need an investment in working capital. Working capital also
involves an investment of cash.
Relevant cost
A relevant cost is any cost that will occur in future and will be paid in cash as a direct consequence
of implementation of a particular decision.
Features of Relevant costs

 Relevant costs are costs that will occur in the future. They cannot include any costs that have
already occurred in the past. (Future costs)
 Relevant costs of a decision are costs that will occur as a direct consequence of making the
decision. Costs that will occur anyway, no matter what decision is taken, cannot be relevant to the
decision. (Incremental Costs)
 Relevant costs are cash flows.
Notional costs, such as depreciation charges, notional interest costs and absorbed fixed costs
cannot be relevant to a decision.
Relevant and irrelevant costs
There are different types of relevant and irrelevant costs. Following are the main categories for those
costs:

Chapter 16: An Introduction to Project Appraisal
A. Relevant costs B. Irrelevant costs

 Incremental costs  Sunk costs
 Avoidable costs  Committed costs
 Differential costs  Unavoidable costs
 Opportunity costs  Notional cost
Relevant costs
Type Description Example
Incremental An incremental cost means A company is planning to launch a new product and
costs an additional cost that will company would appoint a new supervisor for the
be occurred and paid in cash manufacturing of this new product. Salary cost of this
due to implementation of a additional new supervisor will be an incremental
particular decision. cost.
Avoidable An avoidable cost is a cost A company currently pays rent of Rs. 1000 for a
costs that would be saved or special warehouse used for storage of product X. If
avoided or eliminated or company plans to close (shut down) this product then
reduced due to warehouse is left. Rent cost of Rs. 1000 can be saved
implementation of a or avoided due to shut down decision. So this Rs.
particular decision. 1000 cost can be said as avoidable cost for shut down
decision.
Differential Differential cost means any A company currently pays rent for Rs. 1,000 per
costs existing cost that will month, for a photocopy machine and wants to
change in future as a switch to using a larger photocopy machine that will
consequence of cost Rs. 1,800 each month. If it hires the larger
implementation of photocopy machine then it will have to pay extra
particular decision. cost of Rs. 800 per month. So this increase in rental
cost is knows as differential cost.
Opportunity Opportunity cost is a An excess material of 200 Kgs is available in stock
cost possible future cash benefit and it can be sold as scrap for Rs. 50 per kg. If we
of best alternative use this 200 kg material for a special contract then
opportunity forgone due to scrap value foregone is opportunity cost for that
implementation of a special contract.
particular decision.
Irrelevant costs
Type Description Example
Sunk costs Sunk cost means any cost A company must decide whether to launch a new
that has already been product on to the market. It has spent Rs. 500,000 on
incurred or paid in past developing the new product, and a further Rs. 40,000
and that cost cannot be on market research. Both these costs are sunk because
reversed. these costs were paid whether the product is launched
or not.

Committed Committed cost refers to A building was acquired 3 years ago at annual rentals
costs any cost that was agreed of Rs. 20,000 for 10 years. All previous rentals are
(promised) due to sunk cost and remaining future rentals are committed
contractual obligation in costs.
past but cash will be paid
in future whether decision
is implemented or not.
Notional Any cost which is not Depreciation of existing assets, provision for
costs actually paid in cash but doubtful debts and fixed FOH cost absorbed by
accounted for calculation using absorption rate are notional costs.
of accounting profit.
Unavoidable An unavoidable cost is a A company currently pays rent of Rs. 1,000 for a
cost cost that will be incurred warehouse used for all products. If any product is
anyway and cannot be shut down then warehouse will be used for other
saved/ avoided in any products and this rent cannot be saved or avoided.
case.
Application of Relevant costing principles for material cost, labour cost, overheads cost
Relevant cost of Materials
Sr. Situation Relevant items

No.
1 Material is not available in stock Current replacement cost is an incremental cost.
2 Material is available in stock and has Current replacement cost is an incremental cost.
frequent use
3 Material is available in stock and has no regular use:
i. Can be disposed of at a cost.
- Disposal cost’s saving is an avoidable cost and will be
recorded
as relevant benefit.
ii. Can’t be sold as scrap & has no alternative
- Nothing is relevant use.
iii. Can be sold as scrap only
- Scrap value forgone is an opportunity cost.
iv. Can be sold as scrap or it has some alternative use
- (a) Scrap value
- (b) Benefit of alternative use
- Higher of (a) or (b) will be forgone so it will be an opportunity cost.
Relevant cost of Labour

Situation Relevant items
1 Labour is currently has spare hours (i.e., paid hours are more than working hours).
(i) Full wages rate is committed to pay in spare Nothing is relevant because there is no
hours incremental cost.

(ii) Partial wages rate is committed to pay in spare Incremental wages rate is relevant cost.
hours
(iii) Full wages rate is committed to pay in spare Hiring cost of new short worker is an
hours but worker is temporarily posted in incremental cost and relevant cost.
place of other type of short worker.
2 Labour is currently has no spare hours or labour is fully employed.
(a) Hiring cost = Recruitment and training cost of new worker
(b) Overtime cost = Normal wages rate per hour + Overtime premium per hour (c)
Diversion cost = Normal wages rate per hour + Contribution lost per hour
Lower of (a) or (b) or (c) is relevant cost
Relevant cost of Overheads cost

Overheads costs of manufacturing business include both production overheads cost as well as non –
production overheads cost. Both these types of overheads costs are further classified into:
 Variable overheads cost
 Fixed overheads cost – Specific and general
Situation Description Relevant items
1. Variable Variable overheads cost include any Variable overheads costs are
cost cost that will be incurred when each incremental costs that are relevant
extra units of product is produced or cost in all cases.
sold. For example, machine running
cost.
2. Specific Specific Fixed overheads cost include Specific fixed costs are
Fixed any cost that will be incurred specially incremental costs and it will be
cost only when decision proposal is relevant cost. It is also known as:
implemented. If decision proposal is  Directly Attributable Fixed cost
not implemented then fixed cost is not  Incremental Fixed cost
paid.
3. General General fixed overheads cost include General fixed costs are
Fixed any cost will be incurred irrespective of unavoidable costs and it will be
cost decision proposal is undertaken or not. irrelevant cost. It is also known as:
It relates to existing operations of  Fixed overheads absorbed
business.  Fixed overheads apportioned
 Fixed overheads allocated

THE TIME VALUE OF MONEY: INTRODUCTION AND COMPOUNDING

Interest: “It is the extra amount an investor receives after investing a certain sum, at a certain rate for
a certain time.”
Or
“Interest is the additional amount of money paid by the borrower to the lender for the use of money
loaned to him.”
The total interest associated with a loan is the difference between the total repayments and the amount
borrowed.
NET PRESENT VALUE (NPV) METHOD OF INVESTMENT APPRAISAL

Calculating the NPV of an investment project
In NPV analysis, all future cash flows from a project are converted into a present value, so that the value
of all the annual cash outflows and cash inflows can be expressed in terms of ‘today’s value’.
The net present value (NPV) of a project is the net difference between the present value of all the costs
incurred and the present value of all the cash flow benefits (savings or revenues).
Approach
Step 1: List all cash flows expected to arise from the project. This will include the initial investment,
future cash inflows and future cash outflows.
Step 2: Discount these cash flows to their present values using the cost that the company has to pay
for its capital (cost of capital) as a discount rate. All cash flows are now converted and expressed in
terms of ‘today’s value’.
Step 3: The net present value (NPV) of a project is difference between the present value of all the
costs incurred and the present value of all the cash flow benefits (savings or revenues).
• If the present value of benefits exceeds the present value of costs, the NPV is positive.
• If the present value of benefits is less than the present value of costs, the NPV is negative.
Advantages and disadvantages of the NPV method

The advantages of the NPV method of investment appraisal are that:
 NPV takes account of the timing of the cash flows by calculating the present value for each
cash flow at the investor’s cost of capital.
 DCF is based on cash flows.
 It evaluates all cash flows from the project.
 It gives a single figure, the NPV, which can be used to assess the value of the investment
project. The NPV of a project is the amount by which the project should add to the value of
the company, in terms of ‘today’s value’.
 The NPV method provides a decision rule which is consistent with the objective of
maximization of shareholders’ wealth. In theory, a company ought to increase in value by the
NPV of an investment project (assuming that the NPV is positive).
The main disadvantages of the NPV method are:

 The time value of money and present value are concepts that are not easily understood
 There might be some uncertainty about what the appropriate cost of capital or discount rate
should be for applying to any project.
 It does not take into account the risk and uncertainty of estimates and scarcity of resources.
 It fails to relate the return of the project to the size of the cash outlay
The Net Present Value (Npv) Method

Decision Rule:
(a) If the NPV is positive, it means that the present value of the cash inflows from a project is greater
than the present value of the cash outflows. The project should therefore be undertaken.
(b) If the NPV is negative, it means that the present value of cash outflows is greater than the present
value of inflows. The project should therefore not be undertaken.
(c) If the NPV is exactly zero, the present value of cash inflows and cash outflows are equal and
the project will be only just worth undertaking.
INTERNAL RATE OF RETURN (IRR) METHOD

Internal rate of return (IRR)
 The internal rate of return method (IRR method) is another method of investment appraisal using
DCF.
 The internal rate of return of a project is the discounted rate of return on the investment.
 It is the average annual investment return from the project
 The NPV of the project cash flows is zero when those cash flows are discounted at the IRR.
 The internal rate of return is therefore the discount rate that will give a net present value =
Rs.0.
IRR = Lower rate% + 𝐍𝐏𝐕𝐚𝐭 𝐥𝐨𝐰𝐞𝐫 𝐑𝐚𝐭𝐞
x (high-lower)%
𝐍𝐏𝐕𝐚𝐭 𝐥𝐨𝐰𝐞𝐫 −𝐍𝐏𝐕 𝐚𝐭
𝐡𝐢𝐠𝐡𝐞𝐫
Advantages of the IRR method

The main advantages of the IRR method of investment appraisal are:
1. As a DCF appraisal method, it is based on cash flows, not accounting profits.
2. Like the NPV method, it recognizes the time value of money.
3. It is easier to understand an investment return as a percentage return on investment than as a
money value NPV in Rs.
4. For accept/reject decisions on individual projects, the IRR method will reach the same
decision as the NPV method.
Disadvantages of the IRR method

The disadvantages of the IRR method are
 It is a relative measure (% on investment) not absolute measure in Rs. Because it is a relative
measure, it ignores the absolute size of the investment. For example, which is the better
investment if the cost of capital is 10%
 an investment with an IRR of 15% or
 an investment with an IRR of 20%?
 If the investments are mutually exclusive, and only one of them can be undertaken the correct
answer is that it depends on the size of each of the investments. This means that the IRR method
of appraisal can give an incorrect decision if it is used to make a choice between mutually
exclusive projects.
 Unlike the NPV method, the IRR method does not indicate by how much an investment project
should add to the value of the company.
Decision Rule:
If IRR of the project is greater than the cost of capital than accept the project and if IRR of the project
is less than the cost of capital than reject the project.

DCF AND INFLATION

Real cash flows and money (nominal) cash flows
Real cash flows are cash flows expressed in today’s price terms. (They ignore the expectation of
inflation).
Money (nominal) cash flows are cash flows that include expected inflation. They are the actual amount
of cash received at a point in time.
Real cost of capital and money (nominal) cost of capital
Real cost of capital is the return required by investors measured in terms of a constant price level. It
excludes the expectation of inflation.
Money (nominal) cost of capital the return required by investors measured in terms of a changing price
level. It includes the expectation of inflation. The real cost of capital and the money cost of capital is
linked together by the following equation.
Relationship between Money Cost of Capital and Real Cost Of Capital
The Fisher equation
1+m = (1 + r) × (1 + i)
Where: m = money rate
r = real rate
I = General rate of inflation
m = [(1 + r) × (1 + i)] -1
1+m
r =( ) -1
1+i
ANNUITIES AND PERPETUITIES

Annuity
Constant cash flows for a specified period of time. Cash Flows mean both inflows and outflows.
Annuities Deferred / Delayed

Annuity
OR
Normal Annuity
OR Advance Annuity
Simple Annuity OR
Immediate Annuity
Annuity Factor: −n
Sum of discounting factors. Formula for annuity factor is: Annuity factor =1−(1+r)
r
This formula brings cash flows to T1.
1. Normal Annuity:
Cash flows relating to (T1, T2, T3,.............. TN)
−𝐧
Annuity factor =𝟏−(𝟏+𝐫)
𝐫

2. Advance Annuity:
(1 + annuity factor)
3. Deferred Annuity:
−n
Annuity factor = 1------N = 1−(1+r) =X
r −3
Annuity factor = 1------3 = 1−(1+r)
=(X)
r
X
Perpetuity
Constant cash flows for limitless period of time.
OR
An annuity for limitless period of time
Formula:
Perpetuity Factor = 𝟏
𝒓
This formula brings cash flows to T1 by default.
Perpetuity
Normal Deferred
Perpetuity OR Advance Perpetuity Perpetuity
Simple Perpetuity OR OR
Immediate Perpetuity
1. Normal Perpetuity:
Cash flows relating to (T1, T2, T3,.............. ∞)
2. Advance Perpetuity:
3. Deferred Perpetuity:

Examples
Example 1
The directors of Tesla & Co. propose to buy a machine costing Rs.300 000. At the end of five years
the machine will be sold for Rs.50 000. In each of the five years the machine will increase revenue
by Rs.160 000. Increased annual expenditure of Rs.80 000 will be incurred.
Tesla & Co. will require an increase in working capital of Rs.40 000. Machinery is depreciated on
the straight line method. Tax rate is 30%. Discount factor is 10%.
Required:
(a) Calculate the Net Present Value (NPV) of the machine.
(b) Calculate the Internal Rate of Return (IRR) of the machine.
Example 2
Required:
(a) Calculate the Net Present Value (NPV) of both machines.
(b) Calculate the Internal Rate of Return (IRR) of both machines.

Example 3
Nestle Ltd can invest in any of the 4 projects below. The Company intends to make decision on the
basis of payback period. Calculate Payback period in each of the following case and suggest suitable
project on its basis:
Project A Project B Project C Project D
Initial Outlay (Rs m) 240 300 400 500

Years (Rs m) (Rs m) (Rs m) (Rs m)
1 80 120 150 100
2 80 120 150 200
3 80 120 120 90
4 80 20 280 165
Pay Back Period
Example 4
Mango Limited Company requires all investment projects to pay back their initial investment within
three years. It is considering a new project requiring a capital outlay of Rs. 140,000 on plant and
equipment and an investment of Rs. 20,000 in working capital. The project is expected to earn the
following net cash receipts:
Years Rs.
1 40,000
2 50,000
3 90,000
4 20,000
Advice should the investment be undertaken?
Example 5
Life of the Assets 3 Years
Rs. Scrap value at end Rs. 40,000
Initial Investment Interest rate on loan 10% (initial
400,000 investment is obtained
Annual Sales from bank)
450,000 Tax rate 30%
Annual Cash Costs:
Material
70,000
Labour
80,000
Factory OH
66,000
Admin OH
20,000
Selling OH
10,000
Required: Calculate payback period.

Example 6
Dinzee Ltd must choose between two investments, Project A and Project B. It cannot undertake both
investments. The expected cash flows for each project are as follows:
Year Project A Project B
Rs. Rs.
0 (80,000) (80,000)
1 20,000 60,000
2 36,000 24,000
3 36,000 2,000
4 17,000 --
The company has a policy that the maximum permissible payback period for an investment is three
years and if a choice has to be made between two projects, the project with the earlier payback will
be chosen.
Example 7
Required:
(a) Calculate net cashflows generated by the new player, Brad Driscol (8)
(b) Calculate the net present value for Brad (5)
The current cost of capital for the club is 12%
(c) Calculate the discounted payback period for Brad. (4)

Example 8
Rise Ltd. has estimated that its cost of capital is 11%. It is deciding whether to invest in a project
that would cost Rs.900,000.
Required
a) Calculate the NPV if the net cash flows of the project after Year 0 are: Years 1 – 6:
Rs.225,000 per year.
b) Calculate the NPV if the net cash flows of the project in Years 1 – 10: Rs.150,000 per year.
c) Calculate the NPV if the net cash flows of the project are: Years 0 – 4: Rs.240,000 per year .
d) Calculate the NPV if the net cash flows of the project after Year 0 are:
Years Rs.
1 200,000
2—6 300,000
7—10 50,000
e) Calculate the NPV if the net cash flows of the project after Year 0 are Rs. 100,000 every year
in perpetuity.
f) Calculate the NPV if the net cashflows of the project after Year 0 are:
Years Rs.
0—4 80,000
5—7 300,000
8—13 50,000
11 onwards 40,000

PRACTICE QUESTIONS
QUESTION-1
A company is investing Rs. 200,000 to earn annual return of 6% over three years. How much company
will receive at the end of year 3?
QUESTION-2
A person borrows Rs. 100,000 for 10 years at an interest rate of 8% compounding annually. What must
he pay to clear the loan at the end of this period?
QUESTION-3
A company will have to pay Rs. 5,000,000 to replace a machine in 5 years. The company wishes to save
up to fund the new machine by making a series of equal payments in to an account which pays interest of
8%.
The payments are to be made at the end of the year and then at each year end thereafter.
Required:
What fixed annual amount must be set aside so that the company saves Rs. 5,000,000?
QUESTION-4
A man wants to save to meet the expense of this son going to university. He intends to puts Rs. 50,000
into as savings account at the end of each of the next 10 years. The account pays interest of 7%.
Required:
What will be the balance on the account at the end of the 10 year period?
QUESTION-5
A business wishes to start a sinking fund to meet a future debt repayment of Rs. 100,000,000 due in 10
years. What fixed amount must be invested every 6 months if the annual interest rate is 10%
compounding semi- annually if the first payments is to be made in 6 months?
QUESTION-6
A person expects to receive Rs. 13,310 in 3 years. If the person faces an interest rate of 10%, what is
the present value of this amount?
QUESTION-7
How much would an investor need to invest now in order to have Rs. 1,000 after 12 months, if the
compound interest on the investment is 0.5% each month?
QUESTION-8
A borrower is due to repay a loan of Rs. 120,000 in 3 years. He has offered to pay an extra Rs. 20,000 as
long as he can repay after 5 years.
The lender faces interest rates of 7%.
Required:
Is the offer acceptable?

QUESTION-9
A company is considering whether to invest in a new item of equipment costing Rs. 45,000 to make a
new product. The product would have a four-year life, and the estimated cash profits over the four-year
period are as follows.
Year Rs.
1 17,000
2 25,000
3 16,000
4 4,000
The project would also need an investment in working capital of Rs. 8,000, from the beginning of Year1.
The company uses a discount rate of 11% to evaluate its investments
Required
A Calculate the NPV of the project at the discount rate of 11%.
B Using the NPV you have calculated at 11%, and the NPV at a discount rate of 15%, estimate
the internal rate of return (IRR) of the project.
QUESTION-10
A company is considering an investment in an item of equipment costing Rs. 150,000. The equipment
would be used to make a product. The selling price of the product at today’s prices would be Rs. 10 per
unit, and the variable cost per unit (all cash costs) would be Rs. 6.
The project would have a four-year life, and sales are expected to be:
Year Units of sale
1 20,000
2 40,000
3 60,000
4 20,000
At today’s prices, it is expected that the equipment will be sold at the end of Year 4 for Rs. 10,000. There
will be additional fixed cash overheads of Rs. 50,000 each year as a result of the project, at today’s price
levels.
The company expects prices and costs to increase due to inflation at the following annual rates:
Item Annual inflation rate
Sales 5%
Variable costs 8%
Fixed costs 8%
Equipment disposal value 6%
The company’s money cost of capital is 12%.
Required:
Calculate the NPV of the project.
QUESTION-11
Initial Investment is Rs. 2000. Project life is 4 years. Cash Inflows per year is Rs. 3000. Cost of
Capital is 10%. Calculate NPV of the project?
QUESTION-12
Initial Investment is Rs. 6000. Project life is 4 years. Cash Inflows per year is Rs. 5000 starting
immediately (project will give 4 equal cash flows starting immediately). Cost of Capital is 10%.
Calculate NPV of the project?

QUESTION-13
Initial Investment is Rs. 10,000. Cash Inflows per year is Rs. 19,000 from T 4 to T11. Cost of Capital is
10%. Calculate NPV of the project?
QUESTION-14
Initial Investment is Rs. 10,000. Cash Inflows per year is Rs. 14,000 for limitless period. Cost of Capital
is 10%. Calculate NPV of the project?
QUESTION-15
Initial Investment is Rs. 200,000. Cash Inflows per year is Rs. 11,000 starting immediately. Cost of
Capital is 10%. Calculate NPV of the project?
QUESTION-16
Initial Investment is Rs. 40,000. Cash Inflows per year is Rs. 16,000 starting from T 4 to onwards. Cost
of Capital is 10%. Calculate NPV of the project?
QUESTION-17
The following draft appraisal of a proposed investment project has been prepared for the finance director
of OKM Co by a trainee accountant. The project is consistent with the current business operations of
OKM Co.
Year 1 2 3 4 5
Sales (units/year) 250,000 400,000 500,000 250,000
Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000
Contribution 1,330 2,128 2,660 1,330
Fixed costs (530) (562) (596) (631)
Depreciation 1438) (438) (437) (437)
Interest payments (200) (200) (200) (200)
Taxable profit 162 928 1,427 62
Taxation (49) (278) (428) (19)
Profit after tax 162 879 1,149 (366) (19)
Scrap value 250
After-tax cash flows 162 879 1,149 (116) (19)
Discount at 10% 0.909 0.826 0.751 0.683 0.621
Present values 147 726 863 (79) (12)
Net present value = 1,645,000 - 2,000,000 = (Rs. 355,000) so reject the project.
The following information was included with the draft investment appraisal:
The initial investment is Rs2 million
Selling price: Rs. 12/unit (current price terms), selling price inflation is 5% per year
Variable cost: Rs. 7/unit (current price terms), Variable cost inflation rate is 4% per year.
4. Rs. 200,000/year of the fixed costs are development costs that have already been incurred and
are being recovered by an annual charge to the project
5. Investment financing is by a Rs. 2 million loan at a fixed interest rate of 10% per year
6. OKM Co can claim 25% reducing balance capital allowances on this investment and pays
taxation one year in arrears at a rate of 30% per year
7. The scrap value of machinery at the end of the four year project is Rs. 250,000
8. The real weighted average cost of capital of OKM Co is 7% per year
9. The specific rate of inflation is expected to be 4.7% per year
Required:
(a) Identify and comment on any errors in the investment appraisal prepared by the trainee
accountant.

(b) Prepare a revised calculation of the net present value of the proposed investment project and
comment on the project’s acceptability.
QUESTION-18
BQK Co, a house-building company, plans to build 100 houses on a development site over the next four
years. The purchase cost of the development site is Rs. 4,000,000, payable at the start of the first year
of construction. Two typos of house will be built, with annual sales of each house expected to be as
follows:
Year 1 2 3 4
Number of small houses Sold: 15 20 15 5
Number of large houses sold: 7 8 15 15
Houses are built in the year of sale. Each customer finances the purchase of a home by taking out a
long-term personal loan from their bank. Financial information relating to each type of house is as
follows:
Small house Large house
Selling price: Rs. 200,000 Rs. 350,000
Variable cost of construction: Rs. 100,000 Rs. 200,000
Selling prices and variable cost of construction are in current price terms, before allowing for selling
price inflation of 3% per year and variable cost of construction inflation of 4.5% per year.
Fixed infrastructure costs of Rs. 1,500,000 per year in current price terms would be incurred. These
would not relate to any specific house, but would be for the provision of new roads, gardens, drainage
and utilities. Infrastructure cost inflation is expected to be 2% per year.
BQK Co pays profit tax one year in arrears at an annual rate of 30%. The company can claim capital
allowances on the purchase cost of the development site on a straight-line basis over the four years of
construction.
BQK Co has a real after-tax cost of capital of 9% per year and a nominal after-tax cost of capital of
12% per year.
Required:
Calculate the net present value of the proposed investment and comment on its financial acceptability.
Work to the nearest Rs. 1,000.
QUESTION-19
HDW Co is a listed company which plans to meet increased demand for its products by buying new
machinery costing Rs5 million. The machinery would last for four years, at the end of which it would
be replaced. The scrap value of the machinery is expected to be 5% of the initial cost. Capital allowances
would be available on the cost of the machinery on a 25% reducing balance basis, with a balancing
allowance or charge claimed in the final year of operation.
This investment will increase production capacity by 9,000 units per year and all of these units are
expected to be sold as they are produced. Relevant financial information in current price terms is as
follows:
Forecast inflation
Selling price Rs. 650 per unit 4.0% per year
Variable cost Rs. 250 per unit 5.5% per year
Incremental fixed costs Rs. 250,000 per year 5.0% per year
In addition to the initial cost of the new machinery, initial investment in working capital of Rs. 500,000
will be required. Investment in working capital will be subject to the general rate of inflation, which is
expected to be 4.7% per year.

HDW Co pays tax on profits at the rate of 20% per year, one year in arrears. The company has a nominal
(money terms) after-tax cost of capital of 12% per year.
Required:
Calculate the net present value of the planned purchase of the new machinery using a nominal (money
terms) approach and comment on its financial acceptability.
QUESTION-20
Uftin Co is a large company which is listed on a major stock market. The company has been evaluating
an investment proposal to manufacture Product K3J. The initial investment of Rs. 1,800,000 will be
payable at the start of the first year of operation. The following draft evaluation has been prepared by a
junior employee.
Year 1 2 3 4
Sales (units/year) 95,000 100,000 150,000 150,000
Selling price (Rs/unit) 25 25 26 27
Variable costs (Rs/unit) 11 12 12 13
(Note: The above selling prices and variable costs per unit have not been inflated.)
Rs. 000 Rs. 000 Rs. 000 Rs. 000
Sales revenue 2,475 2,605 4,064 4,220
Variable costs (1,097) (1,260) (1,890) (2,048)
Fixed costs (155) (155) (155) (155)
Interest payments (150) (150) (150) (150)
Cash flow before tax 1,073 1,040 1,869 1,867
Tax allowable depreciation (450) (450) (450) (450)
Taxable profit 623 590 1,419 1,417
Taxation (137) (130) (312)
Net cash flow 623 453 1,289 1,105
Discount at 12% 0.893 0.797 0.712 0.636
Present values 556 361 918 703
Rs. 000
Present value of cash inflows 2,538
Cost of machine (1,800)
NPV 738
The junior employee also provided the following information:
(1) Relevant fixed costs are forecast to be Rs. 150,000 per year.
(2) Sales and production volumes are the same and no finished goods inventory is held.
(3) The corporation tax rate is 22% per year and tax liabilities are payable one year in arrears.
(4) Uftin Co can claim tax allowable depreciation of 25% per year on a reducing balance basis on
the initial investment.
(5) A balancing charge or allowance can be claimed at the end of the fourth year.
(6) It is expected that selling price inflation will be 4.2% per year, variable cost inflation will be 5%
per year and fixed cost inflation will be 3% per year.
(7) The investment has no scrap value.
(8) The investment will be partly financed by a Rs. 1,500,000 loan at 10% per year.
(9) Uftin Co has a weighted average cost of capital of 12% per year.
Required:
i. Prepare a revised draft evaluation of the investment proposal and comment on its financial
acceptability.
ii. Explain any TWO revisions you have made to the draft evaluation in part (a) above.

QUESTION-21
Hulme Ltd is considering the production of a new product, the Champ, to add to its existing range.
Manufacture would commence on 1 January 2009, and 100,000 Champs would be produced and sold
each year for three years. The directors of Hulme Ltd expect to be able to charge a price of Rs. 6 per
Champ during 2009 and to Increase the price during 2010 and 2011 in line with increases in the retail
prices index. The index is expected to increase in the future at an annual compound rate of 10%.
The following costs are involved in producing Champs:
Labour: Each Champ requires 15 minutes of skilled labour and 30 minutes of unskilled labour. Current
(1 January 2009) wage rates are Rs. 3 per hour for skilled labour and Rs. 2 per hour for unskilled labour.
For 2009 only, Hulme Ltd expects to have 100,000 surplus hours of unskilled labour. Whether or not
Champs are manufactured the employees concerned will be retained and paid by the company. All
labour costs are expected to increase at an annual compound rate of 20%.
Materials: Each Champ requires 2 kg of Alpha and 1 kg of Beta. Hulme currently holds in stock 200,000
kg of Alpha and 100,000 kg of Beta. The stock of Alpha originally cost Rs. 40 per kg and has a current
realizable value of Rs. 30 per kg. The current buying price is 0.50 per kg. The stock of Beta originally
cost 0.80 per kg and has a current realizable value of 0.90 per kg. The current buying price is Rs. 1.10
per kg. Alpha is used regularly by the company on, many products. Beta is used rarely and the only use
for the existing stock, if it is not used the manufacture of Champs, will sell it immediately.
Materials required to manufacture Champs must be purchased and paid for annually in advance.
Replacement costs and realizable values of Alpha and Beta are expected to increase at an annual
compound rate of 10%.
Overheads: It is the policy of the company to allocate all overhead costs to its various products. The
calculated overhead cost per unit for Champs at current prices is:
Rs.
Allocated head office fixed costs (rent. Rates, administration, etc.) 0.70
Depreciation (Rs. 30,000 + 100,000) 0.30
Variable overheads 0.50
1.50
Head office costs and variable overheads are expected to increase in line with retail prices index. The
machine required to manufacture Champs was bought some years ago. Its current book value is Rs.
90,000 and the above depreciation charge is based on a remaining life of three years at the end of which
the machine will have no scrap or resale value. If it is not used to produce Champs the machine will be
sold immediately for Rs. 150,000.
Hulme Ltd has a cost of capital of 20% per annum in money terms.
Assume that all receipts and payments (except costs of materials and machine sale proceeds) will arise
on the last day of the year to which they relate. Assume also that input prices will change annually on
31 December.
Required:
(a) Prepare calculations showing whether Hulme Ltd should: undertake production, of the Champ.
(b) Provide brief explanations of the figures you have used.

QUESTION-22
Bailey Ltd is developing a new product, the Oakman, to replace an established product, the Shepard,
which the company has marketed successfully for a number of years. Production of the Shepard will
cease in one year whether or not the Oakman is manufactured. Bailey Ltd has recently spent Rs. 75,000
on research and development relating to the Oakman. Production of the Oakman can start in one year's
time.
Demand for the Oakman is expected to be 5,000 units per annum for the first three years of production
and 2,500 units per annum for the subsequent two years. The product’s total life is expected to be five
years.
Estimated unit revenues and costs for the Oakman, at current prices, are as follows;
Rs. Rs.
Selling price per unit 35.00
Less: Costs per unit
Materials and other consumables 8.00
Labour (see 1) below) 6.00
Machine depreciation and overhaul (see (2) below) 12.50
Other overheads (see (3) below) 9.00
35.50
Loss per unit 0.50
(1) Each Oakman requires two hours of labour, paid Rs. 3 per hour at current prices. The labour
force required to produce Oakmans comprises six employees, who are at present employed to produce
Shepards, if the Oakman is not produced, these employees will be made redundant when production of
the Shepard ceases. If the Oakman is produced, three of the employees will be made redundant at the
end of the third year of its life, when demand halves, but the company expects they be able to find work
for the remaining three employees at the end of the Oakman’s five year life. Any employee who is made
redundant will receive a redundancy payment equivalent to 1,000 hours wages, based on the most recent
wage rate at the time of the redundancy.
(2) A special machine will be required to produce the Oakman. It will be purchased in one year’s
time, (just before production begins). The current price of the machine is Rs. 190,000. It is expected to
last for five years and to have no scrap or resale value at the end of that lime. A major overhaul of the
machine will be necessary at the end of the second year of its life. At current prices, the overhaul will
cost Rs. 60,000. As the machine will not produce the same quantity of Oakmans each year the directors
of Bailey Ltd have decided to spread its original cost and the cost of the overhaul equally between all
Oakmans expected to be produced (i.e. 20,000 units). Hence the combined charge per unit for
depreciation and overhaul is Rs. 12.50 ([Rs. 190,000 + Rs. 60,000] + 20,000 units).
(3) Other overheads at current prices comprise variable overheads of Rs. 4.00 per unit and head
office fixed costs of Rs. 5.00 per unit, allotted on the basis of labour time.
All wage rates are expected to increase at an annual compound rate of 15%. Selling price per unit and
all costs other than labour are expected to increase in line with the retail prices index. The retail prices
index is expected to increase in the future at an annual compound rate of 10%.
Assume that all receipts and payments will arise on the last day of the year to which they relate. Assume also
that alt current prices given above have been operative for one year and are due to change shortly.
Subsequently all prices will change annually.
Required:
You are required to prepare calculations, showing whether Baily Ltd should undertake production of
the Oakman.


Aluminium Limited (AL) is engaged in the manufacture of product GH which requires one unit of a single
raw material PQR. The manufacturing of PQR is currently outsourcedunder a contract which is expiring
shortly.
The management of AL has decided to setup an in-house manufacturing facility for production of PQR
instead of renewing the existing contract of supply on its expiry. Inthis respect, following two proposals at
current prices have been forwarded for evaluation:
Proposal 1 Proposal 2
Purchase cost (including setup cost) Rs. 3,500,000 Rs. 5,000,000
Useful life (Note) 3 years 5 years
Residual value (Note) Nil Rs. 1,000,000
Annual production capacity 10,000 units 9,000 units
Plant operation cost Rs. 90,000 per month Rs. 70,000 per month
Annual maintenance cost Rs. 1,380,000 Rs. 1,200,000
Note: Under proposal 1, on carrying out a major overhaul at a cost of Rs. 1,300,000(at current price)at
the end of year 2, useful life and residual value of the plant would increase to 5 years and Rs. 500,000(at
current price) respectively.
Other information:
(i) Existing demand of GH is 7,500 units which is expected to increase by 5% everyyear.
(ii) In case of any shortage of PQR, it would be purchased from the market at a price of
Rs. 550 per unit at current price.
(iii) Variable cost of production at current price under proposal 1 and proposal 2 areRs. 400 per
unit and Rs. 380 per unit respectively.
(iv) Depreciation would be charged on a straight line basis. Accounting depreciation isassumed to
be the same as tax depreciation.
(v) Inflation rate is estimated to be 6% per annum which is applicable from year 1.
(vi) Applicable tax rate is 30% and is payable in the year in which liability arises.
(vii) AL’s cost of capital is 14%.
Assume that except stated otherwise, all cash flows arise at year-end.
Required:
By using net present value (NPV) method, recommend the best course of action to themanagement
of AL. (20)

Ayyan Group (AG) opened a pizza outlet under the brand name ‘Say Cheese’ (SC) two years ago. The
initial assessment of the investment in SC had high financial prospects. AG entered into a five year rent
agreement for pizza outlet. The rent for the first year was agreed at Rs.600,000 subject to an annual
increment of 10%. For pizza preparation, AG imported equipment amounting Rs.5,000,000 having
useful life of five years with a residual value of Rs.1,000,000.
After two years of operations, SC has failed to achieve desirable results and the management of AG is
skeptical whether to continue to operate SC for further three years or not. You have been provided the
following information in this regard:
(i) Sales for the first two years were amounted to Rs.7,500,000 and Rs. 9,000,000 respectively.
(ii) Variable costs for the first two years were amounted to Rs.6,000,000 and Rs.7,080,000
respectively.
(iii) The fixed costs other than rent and depreciation for the first two years were amounted to
Rs.500,000 and Rs.525,000 respectively.
(iv) The trend in sales, variable costs and fixed costs other than rent and depreciation from year 1 to
year 2 is expected to continue in future.
(v) If management of AG decides to discontinue the investment in SC now. Equipment could be
sold for Rs.4,000,000. Further termination of rent agreement would require three months’ notice
period.
(vi) Applicable tax rate is 30% and tax is payable in the year in which liability arises. Tax
depreciation on equipment is allowed at the rate of 25% under reducing balance method.
(vii) The cost of capital of AG is 16%.
Assume that except stated otherwise, all cash flows arise at the end of the year.
Required: By using net present value method, recommend whether management of AG should
continue to operate SC for a further period of three years or discontinue it now. (16)

Latte Limited (LL) is considering to accept a five-year proposal from Mocha Limited (ML) for supply
of a product namely K44. ML would use K44 as a raw material for its main product. Details of the
proposal and related matters are summarized as follows:
(i) Initial investment in the specialized machinery is estimated at Rs. 60 million. At the beginning
of year 4, LL would require a major overhauling on this machinery amounting to Rs. 10 million.
The machinery can be disposed of at 80% of written down value at the end of project.
(ii) In year 1, LL would supply 18,000 units of K44 to ML at Rs. 5,000 per unit. The supply would
increase by 5% per annum from year 2 onward.
(iii) Variable cost is estimated at Rs. 4,000 per unit for year 1. Fixed cost associated with the proposal
(other than depreciation) is expected to be Rs. 250,000 per month, out of which Rs. 50,000
would be allocated overheads.
(iv) Impact of inflation on revenues as well as all costs would be 7%.
(v) Tax rate would be applicable at 30% and tax would be payable in the year in which liability
would arise. Tax depreciation on machinery would be allowed at the rate of 25% under reducing
balance method.
(vi) The cost of capital of LL is 15%.
Assume that except stated otherwise, all cash flows would arise at the end of year.
Required:
(a) Using net present value method, advise whether LL should accept the proposal. (11)
(b) Determine the minimum discount rate at which the proposal would be acceptable to LL. (03)


Lotus Enterprises (LE) is engaged in trading of various locally manufactured products. Hope Limited
(HL), a company incorporated outside Pakistan has offered to assist LE in establishing a manufacturing
facility in Pakistan for producing its products. LE has gathered the following information in respect of
HL’s offer:
(i) The manufacturing facility will be set up on a land which was acquired by LE three years ago
for Rs. 40 million. Market value of the land at the commencement of the project is estimated at
Rs. 60 million. Cost of the manufacturing facility is estimated as under:
Rs. in million
Factory building 30
Plant including its installation 100
Other fixed assets 10
(ii) Sales for the first year of production is estimated at Rs. 500 million. It is expected that sales
demand would increase by 5% in each subsequent year.
(iii) Under the product licensing agreement, HL would be paid a royalty equal to 15% of sales.
(iv) It is expected that cost of production in the first year of production would be 75% of sales
including fixed costs of Rs. 50 million.
(v) Additional working capital of Rs.35 million would be required in the first year of production.
Working capital requirement would increase by Rs.5 million each year.
(vi) Rate of inflation is estimated at 8% per annum with effect from 2nd year onward. It would affect
revenues as well as all the costs (excluding depreciation).
(vii) (Factory building would be depreciated at 5% whereas plant and other fixed assets would be
depreciated at 25% using reducing balance method. It is estimated that at the end of plant’s
useful life of four years:
 market value of the land would be Rs.75 million; and
 residual value of all the assets would be equal to their carrying value.
(viii) Applicable tax rate is 30% and tax is payable in the year in which the liability arises.
(ix) There would be no temporary or permanent timing difference between accounting profit and
taxable income.
(x) LE’s cost of capital is 15%.
Required:
Compute the net present value (NPV) of the project and advise whether it would be feasible to accept
HL’s offer. (Assume that except where stated otherwise, all cash flows would arise at the end of the
year) (15)

Golf Limited (GL) is engaged in the manufacturing and sale of a single product ‘Smart-X’. The existing
manufacturing plant is being operated at full capacity but the production is not sufficient to meet the
growing demand of Smart-X. GL is considering to replace it with a new Japanese plant. The production
capacity of new plant would be 50% more than the existing capacity.
To assess the viability of this decision, the following information has been gathered:
(i) The purchase and installation cost of new plant would be Rs. 500 million and Rs. 25 million
respectively. The supplier would send a team of engineers to Pakistan for final inspection of the
plant before it is commissioned. 50% of the total cost of Rs. 12 million to be incurred on the
visit, would be borne by GL.
(ii) As a result of installation of the new plant, fixed costs other than depreciation would increase
by Rs. 30 million.

(iii) The existing plant has an estimated life of 10 years and is in use for the last 6 years. Plant’s tax
carrying value is Rs. 50 million. A machine supplier has offered to purchase the existing plant
immediately at Rs. 45 million.
(iv) During the latest year, 6 million units were sold at an average selling price ofRs.
550 per unit. Variable manufacturing cost was Rs. 450 per unit. GL expects that it can increase
the sales volume by 25% in the first year after the plant’s installation. Thereafter, the sales
volume would increase by 4% per annum.
(v) The new plant would be depreciated under the straight line method. Tax depreciation is
calculated on the same basis. The residual value of the plant at the end of its useful life of 4
years is estimated at Rs. 60 million.
(vi) Applicable tax rate is 30% and tax is paid in the year in which the liability arises.
(vii) Rate of inflation is estimated at 5% per annum and would affect the revenues as well as expenses.
(viii) GL’s cost of capital is 12%.
(ix) All receipts and payments would arise at the end of the year except cost of setting up the plant
which would arise at the beginning of the year. It may be assumed that the new plant would
commence operations at the start of year 1.
Required:
On the basis of internal rate of return (IRR), advise whether GL should acquire the new plant. (17)
QUESTION-28 (Spring 18,Q # 02)

(a) Briefly describe any three differences between investment and speculation. (03)
(b) Valika Limited (VL) plans to introduce a new product AX which would be used in hybrid
cars.
Following information is available in this regard:
Initial investment in the new plant including installation and commissioning is estimated
at Rs.50 million. The plant is expected to have a useful life of four years and would have
annual capacity of 200,000 units.
The demand of AX for the first year is expected to be 180,000 units which would
increase by 10% per annum in year 2 and 3. However, in year 4 the demand is expected
to decline by 10%.
The contribution margin for the first year is estimated at Rs. 100 per unit which is
expected to increase by 5% each year.
The new plant would be installed at VL’s premises which are presently rented out at Rs.
1.8 million per annum. As per the terms of rent agreement, the rent is received in advance
and is subject to 7% increase per annum.
Working capital of Rs. 10 million would be required at the commencement of the
project. Working capital is expected to increase by 10% each year.
The new plant would be depreciated at the rate of 25% under the reducing balance
method. Tax depreciation is to be calculated on the same basis. The residual value of the
plant at the end of useful life is expected to be equal to its carrying value.
VL’s cost of capital is 10%.
Tax rate is 30% and is paid in the year in which the tax liability arises.
Required:
On the basis of net present value, advise whether VL should invest in the above project. (Assume that
except stated otherwise, all cash flows would arise at the end of year) (17)

QUESTION-29 (Autumn 17,Q # 04)

Cloudy Company Limited (CCL) manufactures and sells specialized machine X85. A newer version of
the machine is gaining popularity in the market and CCL is therefore considering to introduce a similar
version i.e. D44. Detailed research in this respect has been carried out during the last six months at a
cost of Rs. 3.25 million.
The related information is as under:
(i) Initial investment in the new plant for manufacturing D44 would be Rs. 450 million including
installation and commissioning of the plant.
(ii) Projected production and sales of D44 are as follows:
Year 1 Year 2 Year 3 Year 4
No. of units
20,000 25,000 27,000 29,000
Sales volume of X85 in the latest year was 30,000 units. It is estimated that introduction of D44
would reduce the sale of X85 by 2,000 units every year.
(iii) Estimated selling price and variable cost per unit of D44 in year 1 is estimated at Rs.
40,000 and Rs. 32,000 respectively. The contribution margin on X85 in year 1 is estimated at
Rs. 5,500 per unit.
(iv) Fixed costs in year 1 are estimated at Rs. 45 million. However, if the new plant is installed these
costs would increase to Rs. 75 million.
(v) Impact of inflation on selling price, variable cost and fixed cost would be 10% for both the
machines/plants.
(vi) The new plant would be depreciated at the rate of 25% under the reducing balance method. Tax
depreciation is to be calculated on the same basis. The residual value of the plant at the end of
its useful life of four years is expected to be equal to its carrying value.
(vii) Applicable tax rate is 30% and tax is paid in the year in which the liability arises.
(viii) CCL’s cost of capital is 12%.
Required:
Compute internal rate of return (IRR) of the new plant and advise whether CCL should introduce D44.
(Assume that all cash flows would arise at the end of the year unless stated otherwise)
(15)
QUESTION-30 (Spring 2017, Q#8)

Modern Transport Limited (MTL) is considering an investment proposal from Burraq Cab Services
(BCS). As per the proposal, MTL would provide branded cars to BCS under the following terms and
conditions:
(i) BCS would pay rent of Rs. 1.8 million per annum per car to MTL. The cars would operate on a
24-hour basis. The payment would be made at the end of year.
(ii) Cost of the drivers and maintenance cost of the car would initially be paid by BCS but would be
adjusted against car rentals payable to MTL at the end of each year.
(iii) MTL would provide a smart mobile to each driver.
MTL has estimated the following costs for deployment of a car with BCS:
Description Rupees Remarks
Car purchase price 2,000,00 Estimated useful life and residual value of the car is 4
0 years and Rs. 0.75 million respectively
Car registration fee 35,000 One-time payment on registration of the car.
Mobile phone price per set 15,000 To be charged-off in the year of purchase.

Insurance premium 50,000 To be paid at the beginning of each year. It would

reduce by Rs. 5,000 each year due to decrease in WDV
of the car.
Annual salaries per driver 300,000 Would work in 8-hour shifts.
Annual maintenance cost 60,000 Due to ageing of cars, cost would increase by 10% each
year.
 The car would be depreciated at the rate of 25% under the reducing balance method.
Tax depreciation is to be calculated on the same basis.
 Applicable tax rate is 30% and tax is payable in the year in which the liability arises.
 Inflation is estimated at 5% per annum.
 MTL's cost of capital is 12% per annum.
Required:
Advise whether MTL should accept BCS’s proposal.
(16)
QUESTION-31(Autumn 2016, Q#2)

Tropical Juices (TJ) is planning to expand its production capacity by installing a plant in a building
which is owned by TJ but has been rented out at Rs. 6 million per annum. The relevant details are as
under:
(i) The cost of the building is Rs. 40 million and it is depreciated at 5% per annum.
(ii) The rent is expected to increase by 5% per annum.
(iii) Cost of the plant and its installation is estimated at Rs. 60 million. TJ depreciates plant and
machinery at 25% per annum on a straight line basis. Residual value of the plant after four years is
estimated at 10% of cost.
(iv) Additional working capital of Rs. 25 million would be required on commencement of production.
(v) Selling price of the juices would be Rs. 350 per litre. Sales quantity is projected as under:
Litres 250,000 300,000 320,000 290,000
(vi) Variable cost would be Rs. 180 per litre. Fixed cost is estimated at Rs. 100 per litre based on normal
capacity of 280,000 litres. Fixed cost includes yearly depreciation amounting to Rs. 16 million.
(vii) Rate of inflation is estimated at 5% per annum and would affect the revenues as well as expenses.
(viii) TJ's cost of capital is 15%.
Required:
Compute net present value (NPV) of the project and advise whether it would be feasible to expand the
production capacity. (Assume that all cash flows other than acquisition of plant and additional working
capital would arise at the end of the year) (11)

QUESTION-32 (Spring 2016, Q#4)

Digital Electronics (DE) acquired a plant on 1 January 2016 under a lease arrangement on the following
terms:
Lease period (commencing from 1 January 2016) 3 years
Down payment on commencement of lease Rs. 2.00 million
Lease installments payable annually in arrears Rs. 3.90 million
Amount payable on expiry of the lease term Rs. 0.89 million
-
On the date of acquisition, fair value of the plant was Rs. 10 million. DE depreciates its property, plant
and equipment over their - useful life. The disposal price of the plant at the end of the useful life of four
years is estimated at Rs. 0.50 million.
Net cash inflows from the use of the plant are estimated as under:
Year 2016 2017 2018 2019
Amount (Rs. in million) 5.90 5.20 2.45 1.00
It may be assumed that all cash inflows arise at the end of the year.
Required:
Compute internal rate of return (IRR) and advise whether- it is feasible to acquire the plant assuming
that DE’s cost of capital is 15%.
(08)
QUESTION-33 (Autumn 2015, Q#2)

Sona Limited (SL) is considering investment in a joint venture. The entire cash outlay of the project is
Rs.175 million which would require to be invested by SL immediately. The joint venture partner,
Chandi
Limited (CL) would provide all the necessary technical support.
The other details of the project are estimated as follows:
a. The project would extend over a period of four years.
b. Sales are estimated at Rs. 155 million per annum for the first two years and Rs. 65 million per
annum during the last two years.
c. Cost of sales and operating expenses excluding depreciation would be 50% and 10% of sales
respectively.
d. CL would be entitled to share equal to 5% of sales and the remaining profit would belong to SL.
e. At the end of the project, SL would be able to recover Rs. 100 million of the invested amount.
f. Assume that all cash flows other than the initial cash outlay arise annually in arrears.
Required:
Calculate the project’s internal rate of return.
(09)
QUESTION-34 (Spring 15,Q # 02)

Diamond Investment Limited (DIL) is considering to set-up a plant for the production of a single
product X-49.The details relating to the investment are as under:
(a) The cost of plant amounting to Rs. 160 million would be payable in advance. It includes
installation and commissioning of the plant.
(b) Working capital of Rs. 20 million would be required at the commencement of the commercial
operations.
(c) DIL intends to sell X-49 at cost plus 25% (cost does not include depreciation on plant).
Sales for the first year are estimated at Rs. 300 million. The sales quantity would increase
at 6% per annum.

(d) The plant would be depreciated at the rate of 20% under the reducing balance method. Tax
depreciation is to be calculated on the same basis. Estimated residual value of the plant at the
end of its useful life of four years would be equal to its carrying value.
(e) Tax rate is 34% and tax is payable in the year the liability arises.
(f) DIL’s cost of capital is 18%. All costs and prices are expected to increase at the rate of 5%
per annum.
Required:
Compute the following:
(a) Net present value of the project (12)
(b) Internal rate of return of the project (05)
(Assume that unless otherwise specified, all cash flows would arise at the end of the year.)
QUESTION-35 (Autumn 14,Q # 03)

Omega Limited (OL) is the sole distributor of goods produced by ABC Limited which is a leading brand in the
international market. This now planning to establish a factory in collaboration with ABC Limited. The factory
would be established on a land which was purchased at a cost of Rs. 20 million in 2005. The existing market value
of the land is Rs. 40 million. The cost of factory building and plant is estimated at Rs. 30 million and Rs. 100 million
respectively.
The factory will produce goods which are presently supplied by ABC Limited. The sale for the first year of
production is estimated at Rs. 300million. The existing profit margin is 20% on sales. As are result of own
production, cost per unit would decrease by 10%. The sale price and cost of production per unit (excluding
depreciation) are expected to increase by 10% and 8% respectively, each year.
Following further information is available:
(a) ABC Limited would assist in setting up of the factory for which it would be paid an amount of Rs. 10
million at the time of signing the agreement. In addition, ABC Limited would be paid a royalty equal to
3% of sales.
(b) The factory building and installation of plant would be completed and commercial production would
start one year after signing the agreement.
(c) 50% of the cost of plant would be financed through a five year loan with interest payable annually at
10% per annum. Principal would be repaid at the end of 5th year.
(d) A working capital injection of Rs. 15 million would be required at the commencement of commercial
production.
(e) OL charges depreciation on factory building and plant under the straight line method.
(f) OL uses a five year project appraisal period. The residual value of the factory building and plant after five
years is estimated at 50% and 10%ofcost respectively.
(g) The market value of the land after five years is estimated at Rs. 70 million.
(h) OL’s cost of capital is 12%.
Required:
Calculate the net present value of the project assuming that unless otherwise specified, all
cash inflows/outflows would arise at the end of year. Ignore taxation. (15)

QUESTION-36
Consolidated Oil wants to explore for oil near the coast of Ruritania. The Ruritanian government is prepared to
grant an exploration licence for a five-year period for a fee of Rs.300,000 per annum. The licence fee is payable
at the start of each year. The option to buy the licence must be taken immediately or another oil company will
be granted the licence.
However, if it does take the licence now, Consolidated Oil will not start its explorations until the beginning of
the second year.
To carry out the exploration work, the company will have to buy equipment now. This would cost Rs.10,400,000,
with 50% payable immediately and the other 50% payable one year later. The company hired a specialist firm
to carry out a geological survey of the area. The survey cost Rs.250,000 and is now due for payment.
The company’s financial accountant has prepared the following projected income statements. The forecast
covers years 2-5 when the oilfield would be operational.
Projected income statements
Year
2 3 4 5
Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000
Sales 7400 8300 9800 5800
Minus expenses
Wages and salaries 550 580 620 520
Material and 340 360 410 370
consumables
License fee 600 300 300 300
Overheads 220 220 220 220
Depreciation 2100 2100 2100 2100
Survey cost written off 250 - - -
Interest charges 650 650 650 650
4710 4210 4300 4160
Profit 2690 4090 5500 1640
Notes
(i) The licence fee charge in Year 2 includes the payment that would be made at the beginning of year 1 as
well as the payment at the beginning of Year 2. The licence fee is paid to the Ruritanian government at
the beginning of each year.
(ii) The overheads include an annual charge of Rs. 120,000 which represents an apportionment of head
office costs. The remainder of the overheads are directly attributable to the project.
(iii) The survey cost is for the survey that has been carried out by the firm of specialists.
(iv) The new equipment costing Rs. 10,400,000 will be sold at the end of Year 5 for Rs. 2,000,000.
(v) A specialised item of equipment will be needed for the project for brief period at the end of year
2. This equipment is currently used by the company in another long-term project. The manager of the
other project has estimated that he will have to hire machinery at a cost of Rs. 150,000 for the period
the cutting tool is on loan.
(vi) The project will require an investment of Rs. 650,000 working capital from the end of the first year to
the end of the license period.
The company has a cost of capital of 10%. Ignore taxation.
Required: Calculate the NPV of the project. (15)

QUESTION-37
A company has estimated that its cost of capital is 8.8%. It is deciding whether to invest in a project that would
cost Rs. 325,000.
Required:
(a) Calculate the NPV if the net cash flows of the project after Year 0 are: Years 1 - 6: Rs. 75,000 per year.
(b) Calculate the NPV if the net cash flows of the project after Year 0 are:
Year Rs.
1 50,000
2–6 75,000
(c) Calculate the NPV if the net cash flows of the project after Year 0 are Rs. 50,000 every year in perpetuity.
QUESTION-38
ASD, a manufacturing company, is considering a proposal to invest in machinery that it will use to
increase its output and sales by 10,000 units in each of the next five years. The full purchase cost of the
machinery would be Rs. 225,000. This price includes a payment of Rs. 20,000 made 12 months ago to
the machinery supplier for a non-refundable down-payment for purchase of the machinery.
The company currently makes and sells a single product. This has a selling price of Rs. 15 per unit and at present-
day prices the direct costs per unit are Rs. 3.75 for material and Rs. 2.50 for labour. Incremental production
overheads (all cash expenses) would be Rs. 37,500 in each year, at current price levels.
Assume that all cash flows occur at the end of the year to which they relate. ASD’s cost of capital is 10%.
Required:
(a) Calculate the NPV of the project, ignoring inflation.
(b) Calculate the NPV of the project, at a cost of capital of 10%, taking the following inflationary increases
in revenues and costs into consideration:
Because of inflation, selling prices will rise by 7% in each year.
Material costs will rise by 5% each year, labour costs by 6% each year and overheads by 2% each year.
Comment on the differences in your results, compared with the NPV you calculated in part (a).
QUESTION-39
(a) Calculate the NPV of an investment with the following estimated cash flows, assuming a cost of capital
of 8%:
Years Annual cash flow
Rs.
0 (3,000,000)
1–4 500,000
5–8 400,000
9 – 10 300,000
11 onwards in perpetuity (per year) 100,000
(b) The cash flows for an investment project have been estimated at current prices, as follows:
Year Equipment Revenue Running costs
Rs. Rs. Rs.
0 (900,000)
1 800,000 (400,000)
2 800,000 (400,000)
3 600,000 (350,000)
4 200,000 400,000 (300,000)
It is expected that the cash flows will differ because of inflation. The annual rates of inflation are
expected to be:
 Equipment value: 5% per year

 Revenue: 3% per year

 Running costs: 5% per year. The cost of capital is 12%
Required:
(i) Calculate the NPV of the project ignoring inflation.
(ii) Calculate the NPV of the project allowing for inflation.
(ICAP)
QUESTION-40
Conto Company is considering an investment in a new machine that would be used to manufacture a new
product at its existing production centre. The product and the machine are both expected to have an economic
life of four years. The following estimates of revenues and costs have been made.
Year 1 2 3 4
Selling price per unit Rs. 8 Rs. 9 Rs. 10 Rs. 10
Variable cost per unit Rs. 4 Rs. 4.50 Rs. 5 Rs. 5.50
Sales volume (units) 30,000 40,000 50,000 20,000
It has been estimated that there would be no increase at all in fixed costs, except for depreciation of the new
machine. The machine would cost Rs. 440,000 and at the end of its four-year life it would have no residual
value.
The company has a cost of capital of 9%.
Required:
Calculate the net present value of the proposed project
(08)
QUESTION-41
Bay pack Company is considering whether to invest in a project whose details are as follows.
The project will involve the purchase of equipment costing Rs. 2,000,000. The equipment will be used
to produce a range of products for which the following estimates have been made.
Year 1 2 3 4
Average unit sales price Rs. 73.55 Rs. 76.03 Rs. 76.68 Rs. 81.86
Average unit variable cost Rs. 50 Rs. 50 Rs. 45 Rs. 45
Incremental annual fixed costs Rs. 1,200,000 Rs. 1,200,000 Rs. 1,200,000 Rs. 1,200,000
Sales volume (units) 65,000 100,000 125,000 80,000
The sales prices allow for expected price increases over the period. However, cost estimates are based on
current costs, and do not allow for expected inflation in costs. Inflation is expected to be 3% per year for variable
costs and 4% per year for fixed costs. The incremental fixed costs are all cash expenditure items. Tax on profits
is at the rate of 30%, and tax is payable in the same year in which the liability arises.
Bay pack Company uses a four-year project appraisal period, but it is expected that the equipment will continue
to be operational and in use for several years after the end of the first four-year period.
The company’s cost of capital for investment appraisal purposes is 10%.
Required:
Calculate the net present value of the project. (15)

QUESTION-42
Larkana Fabrication Limited is considering an investment in a new machine, with a maximum output of
200,000 units per annum, in order to manufacture a new toy.
Market research undertaken for the company indicated a link between selling price and demand, and the
research agency involved has suggested two sales strategies that could be implemented, as follows:
Strategy 1 Strategy 2
Selling price (in current price terms) Rs. 8.00 per unit Rs. 7.00 per Unit
Sales volume in first year 100,000 units 110,000 units
Annual increase in sales volume after first year 5% 15%
The services of the market research agency have cost Rs. 75,000 and this amount has yet to be paid.
Larkana Fabrication Limited expects economies of scale to reduce the variable cost per unit as the level of
production increases. When 100,000 units are produced in a year, the variable cost per unit is expected to be
Rs. 3.00 (in current price terms). For each additional 10,000 units produced in excess of 100,000 units, a
reduction in average variable cost per unit of Rs. 0.05 is expected to occur. The average variable cost per unit
when production is between 110,000 units and 119,999 units, for example, is expected to be Rs. 2.95 (in current
price terms); and the average variable cost per unit when production is between 120,000 units and 129,999
units is expected to be Rs. 2.90 (in current price terms), and so on.
The new machine would cost Rs. 1,600,000 and would not be expected to have any resale value at the end of
its life.
Operation of the new machine will cause fixed costs to increase by Rs. 110,000 (in current price terms).
Inflation is expected to increase these costs by 4% per year. Annual inflation on the selling price and unit
variable costs is expected to be 3% per year.
The company has an average cost of capital of 10% in money (nominal) terms
Required:
(a) Determine the sales strategy which maximizes the present value of total contribution. Ignore
taxation in this part of the question. (9)
(b) Evaluate the investment in the new machine using internal rate of return. (12)
QUESTION-43
Badger plc. a manufacturer of car accessories is considering a new product line. This project would commence
at the start of Badger plc.’s next financial year and run for four years. Badger plc.’s next year end is 31st
December 2012.
The following information relates to the project:
A feasibility study costing Rs. 8 million was completed earlier this year but will not be paid for until March 2013.
The study indicated that the project was technically viable.
Capital expenditure
If Badger plc. Proceeds with the project it would need to buy new plant and machinery costing Rs. 180 million
to be paid for at the start of the project. It is estimated that the new plant and machinery would be sold for Rs.
25 million at the end of the project.
If Badger plc. Undertakes the project it will sell an existing machine for cash at the start of the project for Rs. 2
million. This machine had been scheduled for disposal at the end of 2016 for Rs. 1 million.
Market research
Industry consultants have supplied the following information:
Market size for the product is Rs. 1,100 million in 2012. The market is expected to grow by 2% per annum.
Market share projections should Badger plc. Proceed with the project are as follows:
2013 2014 2015 2016

Market share 7% 9% 15% 15%

Cost data:
Rupees in Million
Purchases 40 50 58 62
Payables (at the year-end) 8 10 11 12
Payments to sub-contractors, 6 9 8 8
Fixed overheads (total for Badger plc)
With new line 133 110 99 90
Without new line 120 100 90 80
Labour costs
At the start of the project, employees currently working in another department would be transferred to
work on the new product line. These employees currently earn Rs. 3.6 million. An employee currently
earning Rs. 2 million would be promoted to work on the new line at a salary of Rs.3 million per annum.
A new employee would be recruited to fill the vacated position.
As a direct result of introducing the new product line, employees in another department currently earning Rs.
4 million would have to be made redundant at the end of 2013 resulting in a redundancy payment of Rs. 6
million at the end of 2014
Material costs
The company holds a stock of Material X which cost Rs. 6.4 million last year. There is no other use for this
material. If it is not used the company would have to dispose of it at a cost to the company of Rs. 2 million in
2013. This would occur early in 2013.
Material Z is also in stock and will be used on the new line. It cost the company Rs. 3.5 million some years ago.
The company has no other use for it, but could sell it on the open market for Rs. 3 million early in 2013.
Further information
The year-end payables are paid in the following year.
The company’s cost of capital is a constant 10% per annum.
It can be assumed that operating cash flows occur at the year end. Time 0 is 1st January 2013 (t1 is 31st December
2013 etc.)
Required:
Calculate the net present value of the proposed new product line (work to the nearest million).
(20)

Question-44 (CAF 06 Spring 2022)

Comfort Wear Limited (CWL) is engaged in selling men activewear (units) through its retail outlets. The
extracts from CWL’s last year management accounts have been provided as follows:
Rs. in '000
Sales [5,000 units @ Rs. 2,500] 12,500
Cost of goods sold 6,875
Gross profit 5,625
The management is considering setting up kiosks in four major shopping malls. The financemanager has
gathered following data in this regard:
(i) Kiosks will set-up at the cost of Rs. 250,000 each. Kiosks would have estimated usefullife
of three years, subject to a depreciation of 40% on reducing balance method. At
the end of three years, kiosks would have no residual value.
(ii) 4,000 units would be sold through all kiosks in the first year. It is estimated that 20%
customers of retail outlets would shift to kiosks.
(iii) The past trend of retail outlets sales has revealed an average 5% increase in units’ saleeach
year. It is expected to continue for both retail outlets and kiosks.
(iv) In the first year of kiosks’ sales, a discount of 15% would be offered on retail price.
However, discount would be reduced to 10% for subsequent years’ sales.
(v) The rent for each kiosk’s space would be Rs. 150,000 per annum.
(vi) The marketing campaign for kiosks would be carried out at Rs. 50,000 for the first
year. However, it would be reduced to 50% for subsequent years.
(vii) One sales person would be hired for each kiosk. He would be paid Rs. 20,000 per
month in addition to 1% commission on retail price of each unit sold through kiosk.
(viii) CWL’s cost of capital is 18%.
(ix) Applicable tax rate is 30% and tax is paid in the year in which the liability arises.
(x) All revenues and costs are quoted on today’s rate that is expected to remain same inthe
first year. Thereafter, the estimated annual inflation of 10% would be applicablefor all
future revenues and costs.
Required:
By using net present value method, recommend whether CWL should set-up kiosks. (15)
(All cash flows occur at the end of year except for cost of setting-up kiosks)

Question-45 (CAF 06 Autumn 2022)

Islamabad Universe (IU) is engaged in production and sales of various consumer products. The
management is in the process of launching a new product ‘Gladiator’. You have beenprovided the
following information in this regard:
(i) IU has outsourced the due diligence of Gladiator at the cost of Rs. 250,000 which ispayable
shortly.
(ii) A specialized machine costing Rs. 25 million would be needed for the production ofGladiator.
The machinery would be financed by a bank loan that would carry interest rate of 12% per
annum.
(iii) The machine would be expected to produce 10,000 units in the first year of its operation.
However, the production would reduce by 10% and 15% in the second and third years
respectively. At the end of third year, an overhauling would be carried out at the cost of Rs. 2.5
million. This would result in continuation of third year’s production in the fourth and fifth
years.
(iv) The selling price and cost of goods sold (other than depreciation) of Gladiator wouldbe Rs.
1,600 and Rs. 750 per unit respectively.
(v) The fixed operating cost of producing Gladiator would be Rs. 1 million per annum,whereas
variable operating cost would be Rs. 100 per unit.
(vi) The machine would have an estimated useful life of five years, after which it could be scrapped
for Rs. 5 million. The machine and overhauling costs would be subject to tax depreciation of
25% on reducing balance method.
(vii) The applicable tax rate would be 30% and tax would be payable/refundable in the yearin which
the liability/asset would occur.
(viii) All revenues and costs are quoted on today’s rate. The estimated annual inflation of8% would
be applicable for all revenues and costs that arise from first year and onwards.
(ix) There are no opening or closing inventories of Gladiator in any of the five years.
Required:
By using net present value method, determine the discount rate at which launching of Gladiator would
be financially feasible. (All cash flows occur at the end of year unless otherwise specified) (12)

Question-46 (CAF 06 Spring 2023 – Q7)

Cherat Mobiles (CM) produces and sells smart mobile accessories. It is planning to introducea low-
priced smart watch for the local market. Following information has been gathered in this respect:
(i) Research and development team incurred an amount of Rs. 0.5 million on market
and product research. However, only Rs. 0.2 million was paid as an advance
and the remaining amount is due for payment in two months' time.
(ii) Initial investment in the new plant for manufacturing the smart watch would
be Rs. 250 million including installation and commissioning of the plant. The
plant wouldbe partly financed through a loan of Rs. 100 million at an interest
rate of 18% per annum. The interest would be payable annually and the
principal amountwould have to be repaid at the end of 5th year.
(iii) The plant would be installed in a building owned by CM which has been
currently rented out at Rs. 0.5 million per month.
(iv) CM expects to produce 3,000 watches per month. Sales volume is expected to
increaseby 5% per annum. Contribution margin is estimated to be Rs. 4,000 per
watch, whereasthe annual fixed cost is estimated to be Rs. 58 million.
(v) Additional working capital requirements are estimated to be Rs. 15 million which
would be realized at 80% of its value at the end of 5th year. No further investment in
working capital is expected during the course of the project.
(vi) The plant would be depreciated at the rate of 15% under the reducing balance method.
The plant supplier has offered to repurchase the plant for Rs. 80 million (at current
prices) at the end of 5th year. CM would have to incur dismantling costs of
Rs. 1.2 million (at current prices) at the end of 5th year.
(vii) All revenues and costs are quoted on today's rate and are expected to remain the same in
the first year. Thereafter, the estimated annual inflation of 9% would be applicable on
all future revenues and costs.
(viii) Applicable tax rate is 30% and tax would be payable / refundable in the year in which
it arises. Dismantling costs are allowed as an expense by the tax authorities when they
are incurred.
(ix) CM's cost of capital is 20%.
Required:
By using the net present value method, recommend whether CM should launch the new smart
watch. (Assume that all cash flows arise at the end of each year unless otherwise specified) (15)

Question-47 (ICAP Autumn 2023-Q9)

Sania Cosmetics (SC) is considering the launch of a beauty product called Zinco. Following
information has been gathered in this regard:
(i) SC will need to spend Rs. 250 million on purchasing and installing the plant for the
manufacturing of Zinco. At the end of year 4, the plant’s resale value is expected to be Rs.
65 million. The plant will be subjected to accounting/tax depreciation at 25% using the
reducing balance method.
(ii) SC estimates immediate working capital requirement to be Rs. 75 million. A 15%
increase, inclusive of inflation, in the working capital requirement (based on the
previous balance) is anticipated at the start of years 2, 3, and 4. However, only 60% of the
working capital is expected to be realised at the project’s end. The remaining balance
would be written off as unsaleable inventory at the end of year 4.
(iii) Sales of Zinco are expected to be 30,000 units per annum, remaining constant over a 4-year
period. The selling price is estimated to be Rs. 4,000 per unit.
(iv) Raw material requirements for the year, along with current inventory details, are as follows:
Raw Material
B S
W B
Annual requirement for Zinco (kg) 3,000 1,200
Current inventory (kg) 1,500 1,200
Cost per kg Rs. 550 Rs. 4,200
Contribution margin if used on other products (per kg) Rs. 200 Rs. 1,500
(v) SB will not be available in the market until the end of the first year. Further, it is alsoused
in another product, requiring 600 kg for the year. However, that product will be discontinued
at the end of the year. SB is not used in any other product and can be soldin the market at
50% of its cost.
(vi) SC estimates an annual labour requirement of 30,000 semi-skilled labour hours at Rs.150
per hour and 10,000 skilled labour hours at Rs. 250 per hour.
(vii) The annual fixed cost (excluding depreciation) is estimated to be Rs. 1.8 million.
(viii) The applicable tax rate would be 30%. Taxes will be payable or refundable in the year in
which the tax liability or asset arises.
(ix) All revenues and costs are quoted in today’s rate. Annual inflation is estimated to be11%
and will apply to all revenues and costs (except where specified) from the first yearonwards.
(x) SC’s cost of capital is 22%.
Required:
Compute internal rate of return (IRR) of Zinco and advise whether SC should introduce it.
(Assume that all cash flows arise at the end of each year unless specified otherwise.) (17)

Question-48 (CAF 06 Spring 2024-Q.9)

Zaid Limited (ZL) launched a product called ‘Zing’ two years ago and prepared a five-year projection for
it. In the first year, Zing performed well and achieved all milestones. However, in the second year, the
machine used for production of Zing developed certain operationalissues. While ZL was able to maintain
the production of the originally estimated quantity, the quality of Zing was significantly affected, resulting in
lost sales. ZL is now considering either replacing the machine and continuing with Zing’s production or
discontinuing Zing’s production.
Following information is available in this respect:

Original estimates:
(i) ZL purchased an old machine costing Rs. 120 million for production of Zing and had to incur an
overhaul cost amounting to Rs. 25 million immediately and another overhaul of the same amount
would have to be incurred at the end of third year.
(ii) As per ZL’s policy, the machine was depreciated at a rate of 25% using the reducing
balance method. It was anticipated that the residual value of machine would be equalto its written
down value at the end of the project i.e. the fifth year.
(iii) Initial investment in working capital was assessed at Rs. 20 million, with no further additions
required in subsequent years. ZL anticipated that only 25% of this investment would be realized at the
end of the fifth year.
(iv) A warehouse was rented for a 5-year period at an annual rent of Rs. 5 million, subject to an annual
increase of 10%. Early termination of the agreement would incur a penalty equivalent to 6 months’
rent.
(v) Production and sales were estimated at 40,000 units per annum for all the years. However, in the
second year, only 15,000 units were sold due to quality issues.
(vi) The sales price for the first year was Rs. 1,500 per unit, with an annual increase of 10%.
(vii) Variable costs were estimated at Rs. 650 per unit, with fixed costs (other than rent) associated with
Zing at Rs. 1.5 million per annum. Both costs were subject to a 7% annual increase.
(viii) The weighted average cost of capital is 18%.

(ix) ZL operates in a tax-free environment.
(x) All cash flows would arise at the end of the year, except where stated otherwise.
Option 1: Replace the machine and continue with the production of Zing
(i) A Chinese supplier has offered ZL the opportunity to trade-in the old machine for Rs. 60 million
and upgrade to the latest machine for an additional investment ofRs. 100 million. This would help
ZL in maintaining the production of Zing at standard quality for the remaining period of project. At the
end of the project, ZL expects selling
this upgraded machine with a 15% profit above its written down value.
(ii) ZL can negotiate a contract with an existing customer to sell the existing stock of Zing at 85% of the
price based on the original estimates.
(iii) The new machine is expected to reduce variable cost by 8% compared to the original estimates.
(iv) All other information would remain consistent with the original estimates.
Option 2: Discontinue production of Zing
(i) Under this option, the existing stock of Zing would be sold at 80% of the price based on
the original estimates.
(ii) Machine would be sold for Rs. 50 million on an ‘as is where is’ basis.
(iii) 35% of the working capital would be realized.
(iv) All other information would remain consistent with the original estimates.

Required:
Evaluate both options by using net present value method. Recommend the best course ofaction for ZL to
follow. (Net present value based on original estimates is not required)

ANSWERS TO QUESTIONS
Chapter 1
Answer 1
(i) Financial Incentive Strategy

Businesses may gain a position where they can pursue a financial incentive strategyto use their economic
leverage to influence public policymakers.
Example
WMB can offer financial support to government in support of the pressing issues faced by the country e.g., if
reducing pollution is a government priority, then WMB can initiate projects and offer financial support in
reducing carbon emission and managing its adverse impact to the environment.
(ii) Stakeholder Coalitions

WMB may try to influence politics by mobilizing various organizational stakeholders - employees,
stockholders, customers, and the local community - to support their political agenda.
Example
WMB can organize programs to get organizational stakeholders, acting as lobbyists or voters, to influence
government officials to vote or act in a way that would notput a complete ban on imports of automobiles
and parts.
(iii) Advocacy Advertising
WMB can influence constituents by using advocacy advertising. Advocacy ads focus not on a particular
product or service, like most ads, but rather on an organization’s or company’s views on controversial
political issues.
Example
WMB can run adverts that would advocate its value addition to the country andsociety. It can run ads on
supporting taxes or generating employment or fostering innovation/growth to advocate import of necessary and
relevant goods.
(iv) Trade Associations
WMB can work with trade associations to influence government policy. As tradeassociations represent
numerous businesses, government tend to give greater weightto the views of trade associations than they do to
individual businesses.
Example
WMB can work with trade associations to publish content on widely circulatedmagazines and
newsletters to broadcast and educate how imports help better the
automobile industry.

Answers to Questions (Chapter 2)
Chapter 2
Answer 1
Factors Affecting the Balance of Trade:
A number of factors influence a country's balance of trade.
Factors Influences
Availability, price
If local producers are able to supply the home market with high –quality,
and quality of goods
competitively priced goods, it will be difficult for overseas producers to export to
produced by local
that market.
producers
If a nation inflation rate is higher than its competitor, producers in that country will
Inflation
face higher cost which will cause the price of product to rise.
If a nation’s currency weakens against those which export to it, then the good it
Exchange rates
imports become more expensive. We will look at exchange rate again later on.
Trade agreements affect the volume of import and exports between nations. Nations
Trade agreements are more likely to be able to export competitively to nations they are on an ‘even
playing field’ with.
Taxes and tariffs increases price of imports, making them less attractive to buy.
Taxes , tariffs and
Government manifesto attempts to help home producers with subsidises, although
trade measures
free trade agreements means this may be difficult (or lead to tit-for –tat relation)
Nations looking for export –led growth require sufficient demand in overseas
The business cycle
markets for their products.
If producers in one country are able to produce something cheaper than producers in other countries, it likely
they will export it. This improves the balance of trade in the country in which the producers are based.
On the other hand if overseas suppliers are able to supply something cheaper than domestic producers demand
for imports will increase.
Most countries expect to import some goods and services and export others. For example New Zealand produces
lamb for export, far more is produced than the home market could consume. Many countries import oil as they
lack their own supply.
The volume of imports and exports, and the price levels of the products and services imported and exported,
affect the balance of trade.
Answer 2
The president probably had two related issues in mind.
(1) Expenditure on cars manufactured in the UK in British pounds and cars are sold in Europe for euros. If the
value of the pound is high relative to the euro, Honda must charge higher prices in euros to cover its costs and
make a profit. The relatively low market share of Honda in Europe is probably due partly or largely to the
relatively high prices that have to be charged.
(2) Honda is probably also concerned that the pound might increase still further in value against the euro. This
would make selling cars in Europe even less profitable, or prices would have to be increased even more, and
market share would be lost.
In view of the fact that the UK market for cars is small in comparison with the market in the rest of Europe,
Honda would probably prefer to have a factory in a country in the Eurozone rather than in the UK.
Answer 3
The manufacturer might be affected directly in three ways.
(1) If it has borrowed money at a variable rate of interest, for example a medium term bank loan, its borrowing
costs (interest charges) will rise and its profits will be affected.
(2) If the company has been planning new investments, it might reconsider the decision to invest if it is
intended to finance the investments by borrowing.
(3) The increase in interest rates might result in a stronger currency, with the country’s currency rising in value
against other currencies. This would make any exports more expensive to foreign buyers.
The manufacturer might therefore suffer a fall in export orders. The manufacturer might also be affected
eventually by the effect of a higher interest rate on the economy generally, through the transmission

mechanism. Higher interest rates might eventually result in a fall in consumer spending. If this happens,
demand in the domestic market for computer games is likely to fall.
Answer 4
Control over a market by a monopoly firm can be undesirable because of the effects of monopoly on
customers.
(a) When a monopoly firm controls a market, the prices charged are likely to be higher than they would be in a
competitive market.
(b) Because prices are higher than in a competitive market, demand to buy the product is likely to be lower.
Monopoly has the effect of both raising prices and reducing output to the market.
(c) When there is a monopoly, there will be less variety and choice for customers.
A government might act against monopolies in the following ways.

(1) It might set up a committee or department to investigate companies that are suspected of being a monopoly
(as defined by law or regulations), and recommend actions that the company should be forced to make in order
to reduce its monopoly power. (For example, the monopoly company might be required to sell off some of its
assets to rival firms.)
(2) It might prohibit takeovers or mergers between companies that would create a monopoly, or allow a
takeover to go ahead only under certain conditions.
(3) It might appoint a commission to regulate the prices charged to consumers by the monopoly (for example
prices of energy and water supply).

Chapter 3
Answer 1
(a) The principal aims of government legislation are: (4 only required):
(i) To protect business entities, e.g. by enacting laws putting limits on market dominance by acting against
monopolies and restrictive practices and by providing financial assistance to selected ailing industries
and companies.
(ii) To protect consumers through consumer protection regulations covering packaging, labelling, food
hygiene and advertising.
(iii) To protect employees with laws governing the recruitment of staff and health and safety legislation that
regulates conditions of work.
(iv) To protect third parties such as shareholders, suppliers and creditors through Companies Act regulation
on capital maintenance and insolvency.
(v) To protect the interests of society at large against excessive business behaviour, e.g. by acting to protect
the environment.
(b) Organisations are affected by legislation and regulation in the following areas (four only required).
(i) Health and safety at work
(ii) Intellectual property and copyright
(iii) Data protection
(iv) Discrimination and equal opportunities
(v) Preparation of account
Health and safety at work. Organisations are required to have health and safety procedures including
emergency procedures, evacuation procedures and accident reporting procedures. Employers are required to
look after the health and safety of their employees by ensuring that plant and equipment are safe and that
articles and substances are handled and stored safely. There is also a requirement to provide appropriate
information, instruction, training and supervision. A safe working environment and adequate welfare facilities
must be provided.
Intellectual property and copyright. This refers to the reproduction and use of other people's work, including
photocopying and recording. Copyright law covers books of all kinds, sound recordings, film and broadcasts,
computer programs, dramatic and musical works. Modern technology enables the spying and distribution of
software packages or DVDs to be done relatively easily and cheaply compared with the cost of developing and
producing the original. Manufacturers are increasingly bringing prosecutions to try and reduce the number of
pirate copies of their material.
Data protection. The underlying principles behind the legislation in this area are openness, good practise in
obtaining, using and securing data and an opportunity for redress when an individual has causes for complaint.
The requirements will cover obtaining, storing, disclosing and using any personal data about individuals. The
need for privacy is recognised by the requirement that all data should be held for clearly designated purposes.
Accuracy and integrity must be maintained and data must be open to inspection. Only legitimate parties can
access data, and information must be secured against alteration, accidental loss and deliberate damage. Data
must be obtained fairly, to precise specification and must not be kept for longer than is required.
Discrimination and equal opportunities. Equal opportunities is the term describing the belief there should be
an equal chance for all workers to apply to be selected for a job, to be trained and promoted in employment and
have that employment terminated fairly. Organisation are effected in a number of areas including (but not to
limited) to following areas, which are included here are as examples.
Preparation of accounts:
This includes keeping appropriate accounting records. It also includes preparing and circulating annual reports
and accounts and the preparation of auditing and financial statements. Accounts of companies prepared under
company Act are affected in a number of areas including the following which are including here as examples.
Limited companies are required to publish account annually for distribution to shareholders. Financial statement
of companies must show a ‘true and fair view’. Prescribe formats for income statements and the balance sheet
must be used. Detail disclosures of information are required. A company is limited in the amount of profit it can
distribute to shareholders.

Chapter 4
Answer 1
Passwords:
Alpha should follow strong password policy. The policy may include having a password with a
combination of letters, numbers and symbols, that is not easily guessed, periodically changing
passwords, etc.
Encryption:
The data confidentiality can be maintained at Alpha by asking the clients to encrypt data before
sending it through network. When Alpha has received the encrypted data it can decrypt it with a
decryption key to access the data.
Firewall:
Alpha should use firewall to protect its computer that stores the client data to protect it from
unauthorized access from within and outside the company. It can also be used to obtain reports on
blocked messages for further analysis and action.
Install anti-virus software
Alpha should install anti-virus software to protect it from viruses that can harm the system and
compromise data confidentiality.
Answer 2
Examples of data validation checks that would assist the management of AZ to ensure that data
input in e-procurement system is correct are given below:
 To input a transaction for purchase of goods, the system would require a code number for the
supplier (range check). If all supplier codes are in the range of 2000-3999, input of supplier code
outside this range would be reported as an error.
 Key code numbers can be designed to include a ‘check digit’ (digit check). This is an additional
digit in the code that enables the program to check the code against an input error.
Answer 3
The advantages of Business Process Outsourcing are:
 Outsourcing would enable the managers and the staff to concentrate in activities whichare of
critical importance for the achievement of the corporate mission, thus improving their core
competencies and the overall productivity.
 Outsourcing may help to reduce the operating costs of SEL.
 Outsourcing would enable SEL to reduce the amount of capital investment that it wouldotherwise
have to incur in the facilities which would be provided by the outsourced agency. Also enable
SEL to improve core activities performance.
 Careful selection of outsourcing companies would help to acquire new know-how and expertise
from the outsource agencies as they would be providing similar services to their several
customers.
The disadvantages of Business Process Outsourcing are:
(i) Outsourcing involves loss of some control and places excessive reliance on outsiders.
(ii) Outsourcing can result in loss of valuable in-house skills.
(iii) Outsourcing may result in creation of competition in future.
(iv) Outsourcing may result in disclosure of critical confidential information to outsiders.
(v) If the level of the performance is not the same then it might result in brand dilution andshift ibrand
loyalty

Answers to Questions (Chapter
283)
Answer 4
(i) Transaction processing system
It is used for processing routine transactions.
(ii) Management information system

It provides management with the information, typically routine in nature, neededfor planning
and controlling operations.
(iii) Expert system
It provides information, advice and recommendations on matters related to aspecific area
of expertise.
(iv) Decision support system
It helps managers to make decisions of a more complex or unstructured nature.
(v) Enterprise resource planning

It integrates all departments and manages the collective knowledge contained in anorganization,
using data warehouses and other technology tools.
Answer 5
(a) Public-private key encryption involves a pair of keys: a public key, shared openly, and a private key, kept
secret.
When a sender wants to send confidential data, they use the recipient's public key to encrypt it. This encrypted
data is transmitted over a communication channel to the receiver.
The recipient then uses their private key to decrypt the data, reversing the encryption process and revealing the
original content.
This process ensures only the intended recipient, with the private key, can access the decrypted information.
(b) Following are the issues with Shehzad’s actions and recommended corrective measures:
(i) Issue no. 1: Shehzad used his own public key to encrypt the file instead of the recipient’s public key.
Recommended Corrective Measure: Shehzad should have used the public key of the recipient to
encrypt the file/data. He can then send the encrypted data to the recipient through the secure channel. The
recipient will then use his own private key to decode the message. The system can also be updated to
prompt the user that he is using his own public key.
(ii) Issue no. 2: Sending the private key through a chat channel, even if it's a secure channel, exposes the
private key to potential eavesdropping or interception by unauthorized individuals.
Recommended Corrective Measure: Shehzad should not share his password or private key with
anyone. Sending the private key through a chat channel defeats the purpose of public-private encryption.
However, the recipient’s public key could be shared through the secure chat channel, if not already
available.
(iii) Issue no. 3: Shehzad may not be adequately trained on the proper procedures for handling sensitive
information and encryption.
Recommended Corrective Measure: The organization should provide comprehensive training to all
employees on data security best practices, including proper encryption methods, encryption key
management, secure communication channels, and the risks associated with insecure practices, such as
using weak passwords.
(iv) Issue no. 4: There is lack of encryption keys management
Recommended Corrective Measure: PH should have a secure and well-managed space where
encryption keys can be stored and securely accessed. The proprietary
software can be enhanced to manage the keys.

Chapter 5
Answer 1
(a) FabTabz
Outsourcing means arranging for other business organisations to perform some administrative tasks, or
management tasks, instead of having to employ individuals to do the task internally, as part of the
organisation’s own activities.
When a business performs all these non-core activities itself, this diverts management attention away from the
core competences. The management should focus on its strengths, not the routine and ordinary. It should
therefore outsource ‘noncore’ activities and concentrate on its core activities, to make sure that it maintains or
improves its competitive advantage over rivals.
Therefore, FabTabz should outsource its non-core activities i.e. product assembly, packaging and distribution
to specialized vendors to meet the demand.
(b) Disruptive technology is an innovation that significantly alters the way consumers, industries, or
businesses operate.
The examples are: 3D printing, Blockchain Technology and Biotechnology.

Chapter 6
Answer. 1
Relevant environmental factors for the purpose of PEST analysis:
(i) Political factors:
Foreign investment is encouraged by government by offering tax holidays.
Strong opposition of existing tax incentives may pressurize government to reconsider the policy.
Government is considering to raise minimum wage rate which would increase costs and may affect
the profitability of businesses.
(ii) Economic factors:
Demand for fast food is growing and fast food chains are enjoying substantial profits.
There is a widening gap in terms of wealth distribution and demand for fast food items is mainly
from middle and lower class which might be affected as the gap further widens.
Xanata is facing high rate of inflation which may have adverse impact on economy of the country
and customers’ ability to buy.
(iii) Social factors:
There is an increased trend on habits of eating fast food among middle and lower classes that may
comprise of major proportion of population of Xanata.
There is a pressure on health ministry to revise health policy which may adversely impact the
business prospects of fast food chains.
Social contributions are appreciated by consumers.
(iv) Technological factors:
There is a trend of using advanced technologies among fast food chains as reflected in the success
of Burger Buddy.
Use of social media and mobile application for promotional activities is also on rise.
Answer 2
(a) PESTEL analysis of the pharmaceutical industry in Malan is as follows:
(i) Political
Business-friendly policies of government.
Tax holidays as incentive for new investments.
Subsidized interest rate loans to encourage research and development activities.
(ii) Economic
Increasing rate of inflation.
Declining consumer disposable income.
Increasing demand for pharmaceutical products.
(iii) Social
Overall health environment is not conducive.
Over 25% population of country comprises of children and old age people who are more
prone to health issues.
Interest in healthy life style is getting popularity among youth.
(iv) Technological
Trend of e-commerce is emerging in the country.
More and more people are using mobile apps and social media for making online orders.
The key players in pharmaceutical industry have been using social media to market their
products and CSR activities.
(v) Environmental / Ecological
Use of renewable energy.
Conducting free public health awareness sessions.
Sponsoring treatment of needy patients.
(vi) Legal
Pharma industry is regulated by Drug Regulatory Framework.
(b) CL may capitalize on following opportunities:

Business friendly practices of a government particularly for pharmaceutical industry would

mean that CL can enjoy certain privileges such as tax holidays and subsidized interest rate
loans.
Demand for pharmaceutical products has been increasing which would mean that CL can
generate high revenue or find easy entry to the existing and new markets.
The following threats may impact CL:
Increasing rate of inflation and declining consumer disposable income may result in price
pressure or low profit margins.
Incentives of government may result in more competition as new entrants would find it easy
to enter and compete in the market.
Answer 3
Political Factors
 NS is based in a stable, prosperous country, where successive governments have valued and
encouraged technology will help the company to adopt long term strategies and achieve its
objective
 Tax incentives and grants are given to companies that invest in technology and in research and
development will help in cost savings.
 Tax credits are also provided to companies that invest in research and development will assist in
innovation.
 The government has also promoted the use of technology through a well-publicized awards
scheme. NS is a recent beneficiary of such an award – for “technological innovation in data
communications” can be uses as marketing to attract customers.
Economic Factors
The case study suggests that 20X4 saw a downturn in the domestic economy which resulted in a
reduction of customer commitment to long-term investment. Customers may postpone their buying
decisions.
Socio-cultural Factors
It appears that electronic communication and information exchange will continue to increase with
implications for companies supplying products and systems to meet these growing needs. All
evidence suggests that the social use of services on such networks will increase.
Technological Factors
Technology is a significant factor in shaping the life cycles of existing products and the introduction
of new ones. The technology sector is extremely innovative, with new and improved technologies
constantly emerging. NS must scan the external environment for such technologies and identify how
they might affect the future of their current products.
Legal Factors
NS operates in a country where there are laws defining employer responsibilities and employee rights.
It is likely that such regulation will continue and NS, like all companies working in Redland, have to
evaluate the benefits and costs of working within such constraints.
Answer 4
POLITICAL FACTORS
Ryde has been an innovative service that is becoming popular. The governments in Pakistan are
facing the challenges of unemployment and bad civic services. Chances are that this business would
be supported by Governments of any ideology.
ECONOMIC FACTORS

The industry that Ryde operates in is the sharing economy. It means that this industry is based on
sharing physical or intellectual resources. In this case, Ryde users register themselves to respond to
customer needs and drive them to a location. It’s often deemed cheaper than taxis and easier to
schedule a ride since it’s in the same vicinity.
Ryde has grown at a rapid pace since its initial launch and its reach is increasing. But the countries
may debate restricting its services due to Ryde having an unfair competition against regular taxis or
public transportation. The increasing competition can also cause a drop in pay despite the new
opportunities.
People may consider whether this type of services bring new avenues to earn an income or takes
away livelihood from existing services (Ryde vs. traditional public transport). This gives rise to large
part of the workforce that is pushed out of business and adds to the unemployed population.
SOCIAL FACTORS
Customers of Ryde enjoy its easy-to-access platform. The main target market of the company is the
young generation from upper middle class that wants convenient and fast service which is available
on their smart phones with a tap of the finger. These are tech-savvy people who are drawn towards
fast and reliable digital services and products.
Another large part of the customers are women. Today more women are integrating in society as
they become more independent. The number of girls has increased in universities as well as
workplaces. An app like Ryde provides these women an easy and safe option to find their own
commute.
The cheaper price due to the use of technology and collaboration is also attractive to many.
Ryde has leveraged the power of social media in today’s age of technology and connectivity. Buyers
are searching for cheaper transportation options and Ryde fulfills this need using technology as an
enabler.
Consumers make schedule commutes through the app. An estimate for the ride cost can appear in the
app depending on many factors like drop off location, traffic density and weather. They can pay for
the ride up front, through a debit/credit card or through a digital wallet on the app. And drivers who
are registered and available in the area respond and pick up the passengers to take them to their
destination.
Technology also brings its inherent risks. The app is pivotal to Ryde. It can’t function if the app goes
down or suffers difficulties. The company must ensure everything is updated, reliable and ready to
go. The company must also maintain back up infrastructure such as data servers and networking.
Many drivers use 4G networks to connect to the app — it’s deemed critical to do their jobs.
LEGAL FACTORS
Additionally, how the company is dealing with competition laws in the taxi industry as being the
only such service and taking the largest market share, and whether Ryde was abiding by these rules.
Some government officials also think that drivers require commercial licenses as well, since they are
driving as Ryde drivers they should have the additional documentation.
Some major laws that the company must follow include labor and employee safety laws, competition
and monopoly laws and other laws related to road traffic (e.g. driver’s license and vehicle
documentation) and ownership of vehicles, etc.
The company must also ensure that the vehicle being used are tested for road-worthiness and the users
have regularly filed vehicle taxes, etc.

Answer 5
POLITICAL FACTORS
FROOT is a multinational and exports to multiple countries including the United States, Canada,
UAE and Europe, etc. Hence, the varied political factors like government policies and legislations
etc. in different countries could influence its operating business accordingly.
The taxes and duties related to import and export also play a huge role. Even the production and
distribution policies can impact the strategies and its business model significantly. As FROOT is a
juice concentrate, the governments with pro-growers’ ideology would be more interested in
protecting the interest of growers. Similarly, governments with strong environmental commitments
may make policies on waste management and packaging.
As the government is keen on increasing exports and wants to encourage such industries that produce
high quality products for the international market, FROOT can leverage on this factor to increase its
sales and profitability.
ECONOMIC FACTORS
During the recent COVID-19 pandemic lockdown, the sale of longer shelf-life food products like that
of FROOT got impacted tremendously.
As consumer spending got decreased and consumption worsened across the country as well as
globally, the brand might have a suffered a lot. With supply chains getting hampered and many
distribution channels like retail stores and markets, restaurants being shut down, the consumption
and sale would have decreased. But with the situation getting better now and restaurants, commercial
places getting opened once again, the consumers are again focusing on more consumption. This is an
opportunity for FROOT having high consumer appeal to position and market itself accordingly. It
can increase its share over different segments like carbonated drinks with its high fruit juice content.
SOCIAL FACTORS
There are a lot of social factors which play a huge role in consumers eating and drinking choices.
Factors such as lifestyle, employment, education level, status, culture and the community impact the
consumer choices and decision making process. Even the demographic factors such as age, gender,
location and income status have a major role in consumer buying decisions.
Youngsters and children have an inclination towards beverages at home as well as restaurants.
Pakistan being a population with large young demography is a good market for FROOT.
With the rising culture of dining out and urbanization, this brand has a huge potential to focus on its
competitive strategies.
With rising technological innovations in product design, packaging, promotional channels, the
beverage industry is evolving in itself.
As sales and distribution channels are increasing and making a shift to E-commerce platforms the
company should focus on increasing its distribution through unconventional channels as well besides
the regular stores.
Apart from this, a lot of technological innovations are happening in terms of manufacturing and
operations. FROOT may need to invest in latest equipment and upgrade its assembly lines to become
more efficient.
With the rising internet penetration among consumers, this brand can leverage the online digital
marketing for boosting its sales and other operations.
LEGAL FACTORS
The beverage industry is regulated and controlled by several laws as any other industry. The company
has to deal with authorities which regulate many aspects like licensing, packaging, labeling and other
necessary permits.
All legal factors which include health and safety laws, environment laws, consumer protection laws etc.
must be taken into consideration while formulating strategies.

Answer 6
POLITICAL FACTOR
The political environment of Pakistan will have a huge impact on Hike’s business strategy as it is a
multinational company which would have to adapt to local environment.
Moreover, the government wants to encourage tourism in Gilgit Baltistan and has taken measures to
attract foreigners as well as locals to explore the unique locations and opportunities for
entertainment. There has also been a lot of focus on hiking and mountaineering as Pakistan boasts
some of highest peaks and mountain ranges in the world.
Similar to any other developing country in the region Pakistan has faced political instability in past.
However, in recent past the country has seen political stability. All political parties are reasonably
expected to support tourism, which is encouraging for planned venture.
ECONOMIC FACTOR
According to the economic surveys, GDP of Pakistan has been growing at slow but steady pace. The
affordability of hiking equipment by good size of population is a critical question. Due to this
uncertainty, a large investment in hiking business in Pakistan would be a high risk venture.
SOCIAL FACTOR
The population has a huge youth entering the workforce through which a stronger middle class is
steadily emerging.
The country also has the advantage of an affordable and abundant workforce with fairly good English
speaking skills. Hike could tap on this potential to its advantage.
Moreover, for last few years, with the improved tourism site in Pakistan, locals are visiting northern
areas. This could be an attractive segment for Hike, though hiking would be a new sporting activity
for Pakistanis.
A very critical analysis of law and order situation, current and in near future, would be important to
take decision.
TECHNOLOGICAL FACTOR
Hike would have to make provisions for the technology it needs to sell and distribute its products.
Since it is not going to manufacture in Pakistan, the advanced equipment and assembly lines would
not be a concern for now.
Top social networking sites in Pakistan are Facebook, Twitter, Pinterest, Instagram, YouTube, and
LinkedIn have a substantial following that is good tool for Hike to use for promotional campaigns and
advertisements.
The success of other global tech platforms like Careem and Uber have paved the way for brands like
Hike to utilize a market that is willing to accept technological change.
LEGAL FACTOR
In terms of legal environment, Hike should keep an eye on the copyright of designs of its apparel and
equipment plans to sell in Pakistan.
Other laws that Hike may want to study closely are laws relating to corporate taxes, employment,
minimum wages and incorporation of business and the ease of doing business in Pakistan.
Answer 7
Political factors
InfoTech would have to carefully consider how the politics of a country affects a foreign company
entering into the market. Most countries with a communist ideology want businesses that are closely
controlled by the government. A lot of government invention, in such countries, could affect smooth
operations of the company. Some countries encourage joint ventures with the local companies rather
than independent investments to have greater control over the business sector.
The government may have higher taxes to curb certain business activity and businesses would not be
allowed to own assets independently.
Economic factors

While considering Economic factors, InfoTech should monitor key economic indicators of Highland
in the recent years. These indicators may include;
• The Gross Domestic Product and its growth
• The levels of foreign direct investment
• International Trade and balance of payments
• Interest rate levels and monetary policy
• Cost of Products and services available in the country (Inflation)
• Unemployment levels and the availability of reasonable human resource
Social factors
Considering the social environment of Highland, it can be noted that the situation of Highland seems
favorable for companies like InfoTech. People in Highland are adopting technology at faster rate as
compared to other countries in Asia. They are open and willing to experience innovative products
and services.
InfoTech should also consider education levels in Highland and especially the languages that are
commonly spoken as that will affect the products they manufacture. Literacy would affect the
acceptance of advanced technology amongst industrial and consumer markets.
Youth is a primary target market for technology products. The larger the market, the more beneficial
it will be for InfoTech. It is important for InfoTech to study the demographics of Highland’s
population in terms of age, gender and social classes. This would give useful insight into the size of
the market for related technology related products.
Technological factors
Although Highland has an advanced technological base, but InfoTech should study whether the
technologies it is working on have a market in Highland. It should also consider the ease of
technology transfer when entering a new country.
Legal factors
As any other country Highland would have laws and regulations that foreign companies would be
expected to follow. Some specific laws that would need attention would be:
• Laws of incorporating a business
• Labour and Employment laws
• Copyright, patents and licenses
• Insurance and Regulatory costs
• International Trade regulations
• International payments regulations, etc.
Answer 8
Star Business School
A PESTEL analysis for Star Business School (SBS) would consider the following factors:
Political:
SBS is facing political instability in the country and a decline in grants from the government, which could
impact its future plans and activities.
Economic:
The overall deteriorating economic conditions of the country are affecting the education sector and causing a
decrease in grants. However, SBS is trying to stay competitive by offering scholarships and launching online
programs for international students.
Social:
SBS is working on student and faculty exchange programs to collaborate with world-class universities, which
could help improve its reputation and attract international students.
Technological:

SBS has invested in the latest software and technology to ensure smooth online and face-to-face lectures, which
will ensure smooth delivery of lectures both online and in-person.
Environmental/Ecological:
The impact of the school's activities on the environment is not addressed in the given situation.
Legal:
A bill has recently been placed in the National Assembly to issue grant to a university only on the
recommendation of Higher Education Commission. If the bill is passed it could impact SBS’s ability to achieve
its goals.

Chapter 7
Answer 1
The competitive forces that may have shaped the airline industry as per Porter’s Five Forces Model
are explained below:
(i) Threat of new entrants
The threat of new entrants in an airline industry is low because of the following probable reasons:
The new entrants in an airline industry would have to make large capital investment (acquisition of
airplanes, extensive marketing campaigns, acquisition of license, etc.).
The airline service would require particular set of skills, knowledge and experience that could be
time consuming and cost bound.
The new entrant might find difficult to develop customer base as customers usually have high
concerns of safety and trust in an airline industry.
Airline industry is highly regulated (stringent aviation and other regulations) in terms of entry,
operations and exit.
(ii) Threat of substitutes
The threat of substitute services in an airline industry is low to moderate because of the following
probable reasons:
The threat may be considered as moderate for domestic travelling because of the presence of
number of substitutes such as trains, cars, boats, etc.
The threat may be considered as low for international travelling as air travel usually remains the
first choice of customers.
(iii) Bargaining power of suppliers
The bargaining power of suppliers in an airline industry is high because of the following probable
reasons:
The airline industry mainly relies on aircraft and related parts manufacturers and fuel suppliers.
Given the small number of suppliers, they can exert high bargaining powers.
There are no or may be very few substitutes to aircrafts and fuel, therefore, airline industry has to
heavily rely on suppliers.
(iv) Bargaining power of customers
The bargaining power of customers in an airline industry is high because of the following probable
reasons:
The costs of switching from one airline to another are low thereby empowering buyers to exert
high bargaining power.
In a developing country, the customer groups are likely to comprise of people who may be price
sensitive than brand sensitive.
Customers have easy access to pricing information offered by other airlines to make comparison.
(v) Competitive rivalry
The competitive rivalry in an airline industry is high because of the following probable reasons:
The airline industry involves high fixed costs that might be identical for each airline company;
thereby the companies compete by means of differentiation or costs leadership by attempting to attain
economies of scale.
The demand for airline services often remains constant or has low growth rate, thereby, airline
companies compete for a fairly fixed amount of sales and customers.
The costs of entry and exit are high in an airline industry thereby companies may be reluctant to
leave the industry and attempt to survive by means of competing with each other.
Answer 2
(i) Rivalry among Existing Firms/ Competitive Rivalry
Since companies of equal size and strength are involved in competition in a market which is not
expected to show any growth. The strategies pursued by any one company can be successful to the
extent that it has competitive advantage over the strategies of its rivals.

Price competition, campaigns for creation of perceptions of quality differentiation, more convenient
and attractive packaging features and aggressive promotion would be observed among the
competing firms.
(ii) Potential Threat of New Entrants

Since the market has significant growth prospects and present firms are earning lucrative profits,
there would be a strong attraction for other resourceful companies to enter this market. Although a
new entrant would have to incur huge research and development costs to develop the specialized
products, yet threats from successful and experienced companies would always be present.
(iii) Bargaining Power of the Supplier

Lucky Coal Mines is in a strong bargaining position. It can sell its coal to many other buyers
whereas the cement plant would have to incur high transportation costs - switching costs – if it were
to procure coal from other mines which are located at a considerable distance. Furthermore, the
quality of coal from other sources may not be as suitable for the cement plant. Lucky Coal Mines
can therefore dictate its terms e.g. price, advance payments on placement of orders and recovery of
transportation costs from the cement plant.
Answer 3
InstaB
It is a ‘Dog’ as it has a low market share in a low growth market. Its market share has
continuously been declining from the year its patent expired. Its market share in the current year
is about 27%, which is much less than the share of the market leader (45%). Further, it is
forecasted to continue to decline to 20% by 2022.
Recommended Strategies
If it is no more generating positive cash flows, then the appropriate strategy would be to
withdraw it and invest the resources in other products which have potential in the existing
market.
If it is generating positive cash flows, then SP may continue to enjoy the cash flows as long as
these are positive before eventually withdrawing from the market.
If SP decides to continue it, then it is recommended to not to invest heavily as gaining market
share in a low-growth market is highly unlikely to achieve.
Azkaard
It is a ‘Cash cow’ as it has a high market share in a low growth market. It is a patent product and
enjoying 100% market share which would continue at least till the patent expires. It is more
likely earning substantial net cash inflows due to the benefit of having a patent in place.
Recommended Strategies
If SP decides to continue Azkaard when patent expires:
Defend and maintain market share which might be possible by achieving economies of scale
and/or become efficient through experience.
Try to extend the patent validity as long as possible.
Do nothing and keep reaping the profits as long as it enjoys positive cash flows and then
eventually withdraw from the market.
Use the cash from the sales of Azkaard for R&D or to further develop other drugs which are in
‘Question mark’ and or ‘Star’ quadrants.
If SP decides to discontinue Azkaard when patent expires:
Use the sale proceeds of Azkaard for R&D or to further develop drugs that are in ‘Question
mark’ and or ‘Star’ quadrants.

For the last year before the patent expires, raise the prices further, if feasible, to gain
maximum benefit before competition kicks in that would reduce revenue and market share.
Answer 4
(a)
Salon:
According to the BCG matrix, this division is a ‘Cash Cow’. It has relatively high market share in an
otherwise low growing market. This division might have attained high economies of scale and/or have
become efficient through experience. New entrants would be reluctant to enter as they may perceive
that market is old and near decline. This division would be cash rich having high return on investment.
Cosmetics:
According to the BCG matrix, this division is a ‘Question Mark’. This division has relatively low
market share in an otherwise high growing market. Since the market is growing quickly, there is an
opportunity to increase market share but initially it would require substantial investments to increase
or even maintain the existing market share.
(b)
Salon:
 It may adopt any of the following strategies:
 Since the market is maturing with low prospects of growth, spending on innovation (R&D)
should belimited. Reinvestment should be restricted to the extent of maintaining the existing
level of market share.
 The ROI of this division is high and it might be earning substantial net cash inflows. The
excess cash may be used to develop cosmetics division which is in ‘question mark’ quadrant or
in any other viableinvestment opportunity.
Cosmetics:
 It may adopt any of the following strategies:
 The market is emerging with probable opportunity of increasing market share. Fashionista
may opt to invest substantially (like marketing activities) to increase its market share to
become a Star and finally a Cash Cow, if the growth prospects are good.
 Fashionista may opt to disinvest/abandon the division and formulate an exit strategy if:
 It cannot last long with a small market share and competitors are in a position to apply cost
and / or price pressures; or
 There is a considerable doubt as regards the prospects of increasing market share.
Answer 5
Product 1: Analysis of Information
 It is a product in a market with low growth.
 Its market share is consistently very high and is forecasted to remain high.
 Its market share in the current year, 2019, is 56% (55.6%), which makes it the market leader.
 It is a long-standing product in the existing market.
 It displays the characteristics of a mature product with dominant position.
 This is a Cash Cow product.
Future Strategies:
 It should be dealt with consistently to keep reaping profits.
 The cash generated by product 1 can be used to invest in other products.

 Market penetration, although difficult to implement in a low growth market, should be used when
expansion is required as it is the least risky approach. For example, this can be obtained through
costleadership and acquisition of competitors, etc.

 It is a product in a market with declining growth.
 Its market share is consistently very low and is forecasted to dip lower.
 Its market share in the current year is about 3% (2.9%) which is much less than the 44% market
shareof the market leader.
 It is an existing product in the existing market.
 It has weak position and seems to be in the decline phase.
 This is a Dog product.
Future Strategies:
 If the product is generating required ROIs or positive NPV, EM can choose to keep the product till
it is feasible.
 Divest the product as it is projected to decline and may incur losses.
 If EM decides to keep this product for any reason (e.g. profit, brand value, product synergy, etc),
market penetration strategy may be used for expansion, however, EM should avoid risky
investments on this product.

 It is a product in a market that is showing high growth.
 It has low market share.
 Its market share in the current year is about 11% (11.4%) which is less than the 37% market share
ofthe market leader.
 It is considered a new product in the new market.
 It resembles an entrepreneurial venture in a high growth market.
 This is a Question Mark product.
Future Strategies:
 The market is growing quickly, there is an opportunity to increase market share, but initially it
will require a substantial investment of cash to increase or even maintain market share. EM should
keep investing in the growth of this product.
 EM can invest cash generated from product 1 into Product 3.
 Differentiation or focus strategy may be used to gain a larger market share.

Answer 6
Differentiation strategy can affect Porter's five forces in the following ways:
(i) Threat from potential entrants
Offering the services in line of COS would require significant capital investment which might create
entry barriers for potential entrants.
(ii) Threat from substitute products
The uniqueness of services being offered by COS i.e. one of a kind shoppingexperience in a cruise
ship may reduce the threat of substitute products significantly.
With differentiated features COS can yield higher margins with which it can offset suppliers' power.
Customers of BOS are likely to be less price sensitive as cruise ship is offering luxury, thereby, they
are less likely to exert bargaining power.
BOS is offering one of a kind 3-storey full-length shopping mall in a state of the artcruise ship with
a customer base unlikely to be affected by pricing war, thereby, competitive rivalry is likely to be
low.
Answer 7
(a) MG may enjoy the following benefits by adopting life cycle costing:
 The potential profitability of Glory Ultimate would be assessed before major
development is carried out and further costs are committed. It may assist
management in deciding whether to introduce new series at all or not.
 It may assist in identifying various types of costs over the life of Ultimate Glory.
Strategies may then be devised to reduce / control these costs.
 It may assist in developing a pricing strategy that would cover the costs and
achieve desired level of profits.
(b) MG might have to incur following costs in each phase of the life cycle of Glory Ultimate:
(i) Introductory phase
 Manufacturing costs (costs of operations)
 Marketing and advertising costs to raise product awareness
 Costs of setting up and expansion of distribution channels
(ii) Growth phase
 Increased costs of working capital
 Costs of increasing capacity
 Marketing and advertising costs to raise customer base
(iii) Maturity phase
 Costs to maintain manufacturing capacity
 Marketing and product enhancement costs to extend maturity
(iv) Decline phase
 Costs of withdrawals (costs of remaining warranties)
 Discounts to attract customers
(c) MG may adopt any or combination of the following strategies to extend the maturityphase of
Glory Ultimate:
 Differentiate by modifying design, features, packaging, etc. to extend product life.
 Sell to untapped markets in terms of geographical area, gender, type of customer,
life style etc.
 Revisit pricing strategy by offering discounts or promotional schemes to attract
customers who are happy to purchase 'old models' for a lower price and avoid
paying the premium required for the new models.

Answer 8
(i) Bargaining Power of Buyers
Ocean Ship Breaking Company enjoys an exceptionally strong bargaining position vis- à-vis the ship-
owners. OSBC can purchase ships at very low prices. Besides, OSBC has the significant advantages
of low ship dismantling costs, favourable tax policies and a ready market for sale of steel scrap
material combined with limited number of interested entrepreneurs in this line of business which
would strengthen its position vis-à-vis the ship owners
(ii) Potential Threat of Entry of New Competitors

Since the market for genetically modified rice seeds is expected to offer significant growth
prospects resulting in increase in revenues and lucrative profits by the two companies, there would
be a strong attraction for other resourceful research-orientedcompanies to enter this market.
Although the new entrants would have to incur huge R&D costs to develop the specialized
products, and make substantial investments in creation of production facilities yetthreats from
potential competitors cannot be ruled out.
(iii) Rivalry among Existing Firms
Since six companies of equal size and strength are involved in competition in the market for cement
which is not expected to show any growth, the strategies pursued by only those companies would be
successful to the extent that they have competitiveadvantages over the strategies of their rivals. Price
competition, campaigns for creation of perceptions of better quality of cement, free onsite delivery to
bulk buyers and aggressive promotional strategies would be common features among the competing
firms.
Answer 9
The impact of internet on each of the Porter’s five competitive forces for a retail industry is
discussed hereunder:
Threat from potential entrants:
The internet has strengthened the threat of new entrants by reducing the barriers to entry. Start-up
cost in a retail industry has significantly been reduced as new entrants do not necessarily have to
make substantial capital investments such as establishing retail outlets, forming sales force,
distribution channels, insurance premiums, etc.
Threat of substitute products:
The internet has no direct impact on the threat of substitute products in a retail industry. Although
customers may have an ease of access to alternative products, retailers may diversify product
portfolios which could lessen the threat of substitute products considerably.
Bargaining power of suppliers:
The internet has weakened the bargaining power of suppliers. Buyers’ ease of access togreater number
of suppliers means that bargaining power of suppliers has reduced significantly.
The internet has strengthened the bargaining power of suppliers as they have access towider spectrum
of customers at relatively lower cost per customer
Bargaining power of customers:
The internet has strengthened the bargaining power of customers. Buyers have greater access to
information (product, supplier, price, market reality) that has empowered them to make informed
buying decisions.
Competitive rivalry:
The internet has strengthened the rivalry among competitors. The availability of detailed information
about the retailers and their products (price, products, etc.) has made it difficult for the firms to
differentiate (as competitors can easily imitate) resulting in focus being shifted towards the price
competition thereby rivalry has intensified.

Answer 10
A star is a product in a market that is growing quickly, where the company’s product has a large
market share or where the market share is increasing. Product 3 appears to be a star. The total market
is expected to double in size between Year – 2 and Year + 2. The expected market share in two years’
time is 15%, compared with 7.5% in Year – 2. Its market share in the current year is over 13%, which
makes it the current market leader.
A cash cow is a product in a market that has little or no growth. The market share, however, is
normally quite high, and the product is therefore able to contribute substantially to operational cash
flows. Product 2 appears to be a cash cow. In the current year its market share was over 53%, and it
is the market leader.
A dog is a product in a market with no growth, and where the product has a low share of the market.
Dogs are likely to be loss-making and its cash flows are probably negative. Product 4 appears to be a
dog. The total market size is not changing, and the market share for Product 4is only about 3%. This
is much less than the 29% market share of the market leader.
A question mark is a product with a fairly low market share in a market that is growing fairlyquickly.
Product 1 appears to be a question mark. The total market is growing quite quickly, but the market
share of Product 1 is about 4% and this is not expected to change. Product 5 also appears to be a
question mark, for the same reason.
The company should decide on its strategy for the products it will sell.
 It should benefit from the cash flows generated by its only cash cow, Product 2.
 It should invest in its star, Product 3, with the objective that this will eventually
become a cash cow.
 It should give serious consideration to abandoning its dog, Product 4, and
withdrawing from the market.
 It has to make a decision about its two question marks, Product 1 and Product 5.
The main question is whether either of these products can become a star and cash
cow. Additional investment and a change of strategy for these products might be
necessary, in order to increase market share.
For all the products (with the exception of Product 4, if this is abandoned) the company should also
consider ways of making the products more profitable. Techniques such as valuechain analysis might
help to identify cost savings.
Answer 11
Horizon Limited may pursue Promotion Strategies in the marketing of its consumer durable
products in their different stages of Product Life Cycles as follows:
Introduction Stage
 inform and educate the potential customers of the existence of the product
 encourage trial of product and create awareness of the benefits that would accrue
to the customers by using the product and how it should be used
 secure distribution in leading retail outlets
 place heavy emphasis on personal selling and promotion in trade shows and
exhibitions.
Growth Stage
 stimulate demand in selected market segments and promote the particular brand
as competition increases
 increase emphasis on advertising to capture a large share of the growing market.
 enter new markets and expand coverage

 identify new distribution channels

 shift emphasis from product awareness to the individual firm’s brand preference
through aggressive advertising
 promote differentiation
Maturity Stage
 focus on promotion and advertising to persuade the customers to purchase the
particular brand rather than to provide information about the product
 selective promotion only as intense competition and increase in promotion
expenditures would result in lower profits
 increase R&D budgets to improve product quality vis-à-vis competitors
 extend product lines to meet niche customer demand
Declining Stage
 reduce promotion expenses as the size of the market is shrinking
 focus of promotion towards reminding remaining customers
 rejuvenate old products to make them look new
Answer 12
Possible methods of market segmentation.
 Passenger facilities: first class and second class travel
 Time: peak time travel, off-peak travel, week-end travel
 Freight transport and passenger transport
 Commuter travel, business travel, holiday travel
 Long-distance travel, short journeys, international journeys
Answer 13
Possible methods of market segmentation.
 By professional accountancy body
 By level or stage in the examinations
 By examination paper
 Full time student, revision course student, evening class student, weekend course
student
 Learning method: face-to-face courses, distance learning, other home study
methods
Answer 14
(a)
Product 1 and Product 2 both fall under the quadrant of ‘Dog’ as neither of theproduct is market
leader nor the market is growing above cut-off of 10%.
For ‘Dog’ products, BCG matrix recommends the following strategies:
Immediate withdrawal from the market as it is unlikely that the products will gain a larger market
share because the market leader will defend the positionof its cash cow.
Keep selling the products till they generate profit / positive cash flows before eventually
withdrawing it from the market. However, a dog product may generate positive cash flows
only temporarily and would ultimately be a loss
making product.
Do not invest more capital in ‘dog’, in the hope of increasing market share and improving cash
flows, because gaining market share in a low-growth market is very difficult to achieve.
(b)

Product 1:
BCG matrix focuses on market share and market size only. There may be other factors that can also
influence the overall performance of a business. For example,strength of competition, cost base, brand
strength, etc.
Although Product 1 is a Dog product according to BCG Matrix, it has strong brandvalue and repute for
AUM. Immediate withdrawal or withdrawal after some time of this product may have adverse impact
on other business activities of AUM. The recommended strategies could be as follows:
Continue this product until the costs of this product (even if the cash flows are negative or
temporarily positive) exceed the benefits (influence on other business activities of AUM).
If possible, make further investment in this product to defend its brand value,repute and its
positive influence on other business activities of AUM.
Product 2:
According to BCG matrix, if an organization is not a market leader then it is considered as having
low market share. These might practically not hold true particularly if difference of market share
between market leader and next to market leader is minimal. Therefore, it may not be wise to shut
down or stop making investments in this product altogether.
Product 2’s market share is merely 1.5% less than the only competitor in the market.The recommended
strategies could be as follows:
This product is enjoying high profits and it could possibly be considered as (or be
converted into) a cash cow for AUM. This means it can generate necessarycash to sustain
the other products, or new products. Therefore, AUM shouldnot change strategy or stop
investments in the product as recommended by
BCG model.
It would be wise to defend and maintain its position in the market. Since, there is only one
competitor in market, it may be fruitful to invest in efforts to increase the market share
of the company to get the leading position.
Answer 15
The impact of Saldia allowing import of automobiles on each of the Porter’s fivecompetitive forces is discussed
hereunder:
(i) Threat from potential entrants
It will be strengthened as it will give access to foreign automakers to enter theSaldia’s automobile
market.
(ii) Threat of substitute products
It will be weakened as influx of foreign automobiles in the market would increasethe competition which
is likely going to reduce prices of automobiles. This meansmore people will be able to afford automobiles
and might move from substitute products (such as motor bike, public transport, etc.).
It will be strengthened at least initially as new automakers will enter the market and their demand for
components of automobile would likely increase thereby suppliers of those components would be in a better
position to bargain.
It will be strengthened as availability of more automobile suppliers would allow customers to have greater
options to choose from and customers would likely easily switch from one supplier to another.
It will be strengthened as ease of entry would allow foreign automakers to enter themarket and compete with
local automakers to gain the Saldia’s automobile market
share.
Answer 16
ShoalFish
PESTEL analysis indicates that fish stocks are rapidly declining (environmental) and the government
has imposed fishing restrictions (political) with which ShoalFish have to comply.
Using the BCG matrix, ShoalFish has the characteristics of a dog. It has a small (12%) market share
and the market itself is declining (5% over two years). Profits are also declining, although the 20X9
gross profit margin (4.9%) is higher than in 20X8 (4.7%) possibly indicating that the company has
managed to reduce operating costs in line with the turnover.
However, despite being an apparent dog, disposing of the company may not be in Shoal plc's interest
as it perceives there are synergies between ShoalFish and the other companies in the Shoal plc
portfolio; it provides 40% of the fish used by ShoalPro, and it will directly supply the Captain
Haddock restaurants post- acquisition therefore keeping the cost of raw materials down.
Shoal Plc must determine whether it can tolerate the declining performance of ShoalFish for the sake
of the supply chain to the other companies in the group. If this is not feasible, a possible alternative
may be to lease or sell their boats to individual owners with the guarantee of sales to Shoal plc
companies. The scenario indicates that owner-skippers account for almost half of the boats in the
western oceans so this could be a viable alternative.
ShoalPro
ShoalPro is a mature organisation that is still expanding (market growth of +2% from 20X7 to 20X9).
It holds 40% of market share and so is likely to be the market leader. Although a significant
percentage of its fish is provided by ShoalFish it is increasingly processing fish for other companies.
It is a profitable company, and gross profit margins have increased from 10% in 20X7 to 10.6% in
20X9. This suggests that revenues are increasing faster than costs.
These characteristics (high relative market share; slow growth) in the BCG matrix suggest ShoalPro is
a cash cow.
PESTEL analysis indicates that ShoalPro operates in an area of high unemployment which attracts
national grants (political and economic), and ShoalPro has access to a skilled local workforce (socio-
cultural). The high unemployment rates suggest that Shoal Pro is likely to be able to recruit skilled
workers relatively cheaply.
ShoalPro is a key part of Shoal plc and should be retained and maintained.
ShoalFarm
ShoalFarm is a fairly recent addition to the Shoal plc group and has a low market share (10%) of a
growing market. ShoalFarm is growing at a slower rate (+12% from 20X7 to 20X9) than the market
as a whole (+20% over same period).
PESTEL analysis shows that there is a favourable ethical perception of this market (socio-cultural)
but the company faces difficulty in finding acceptable sites (environmental).
In 20X7 ShoalFarm had the highest gross profit (14%) of these three companies. This declined to
12.7% in 20X8 before recovering slightly to 13.3% in 20X9.
ShoalFarm has the potential to be a significant provider to both ShoalPro and the Captain Haddock
restaurants, and could replace fish supplies from ShoalFish if the latter continues to decline.
ShoalFarm could be classified as a question mark (problem child) in the BCG matrix as it requires
further investment to allow it to become a key player in a significant market place. If Shoal plc is
happy to provide this investment, then ShoalFarm should be expanded and developed. If it does not
wish to take this risk, then it may be better to divest itself of this company.
The three companies are closely linked in the value chain, however there are conflicting
environmental forces that both reduce the dependency between the companies and encourage the
synergies of a vertically integrated group. The proposed acquisition of Captain Haddock could lead to
additional synergies, but only if the correct relationships are set up between the companies.

Answer 17
(a)
Product A - Introduction phase
During this stage of a product life cycle, there is some sales demand but total salesare low and the
product is not yet profitable.
BL needs to make and sell the product which would incur high investment costs,start-up costs,
running costs, setting up and expansion of distribution channels, etc.
Product B - Decline phase
At this stage, total annual sales starts to fall and so do profits.
It will lead BL to leave the market for the product, and incur cost of withdrawals.This continues until
it is no longer possible for any company in the market to turna profit from the product. When the last
supplier exits the market, the product lifecycle is complete.
Product C - Maturity phase
During the maturity phase, total annual sales remain fairly stable. Prices and profitsstabilize.
Although the opportunity for more growth no longer exists, BL can extend the life of the product
through product enhancement and marketing. BL and other companies might seek to improve profits by
differentiating their products more from those of competitors, and selling to a ‘niche’ market segment.
Product D - Growth phase
During the growth phase, total sales demand in the market grows at a faster rateand new entrants are
attracted into the market at this stage by the prospect of high sales and profits.
Hence, the requirement of working capital grows as is the case of BL.
(b) (i) Product A - Introduction phase

Manufacturing costs (costs of operations)
Discounts to attract customers

 Costs to maintain manufacturing capacity
 Costs of increasing capacity
(ii)
Product A - Introduction phase

(i) Inform and educate the potential customers of the existence and benefitsof the
product.
(ii) Secure distribution in leading retail outlets.
(iii) Place heavy emphasis on personal selling and promotion in trade showsand
exhibitions.
(i) As the size of the market is shrinking reduce overall promotion expensesand focus
efforts towards reminding remaining customers.
(ii) Rejuvenate old products to make them look new.


(i) Focus on promotion and advertising to persuade the customers to purchase the
particular brand rather than to provide information about the product
(ii) Selective promotion only as intense competition and increase in promotion
expenditures would result in lower profits
(i) Stimulate demand in selected market segments and promote theparticular brand
as competition increases
(ii) Enter new markets and expand coverage
(iii) Identify new distribution channels
(iv) Shift emphasis from product awareness to the individual firm’s brandpreference
through aggressive advertising.
(v) Promote differentiation
Answer 18
Porter's five forces analysis of Urbana's micro-mobility industry:

(i) Threat of New Entrants:
 Strength: Low
 Substantial initial investments act as a significant barrier, making it difficult for new players to enter the
market and compete with established players.
 Strict government regulations further deter new entrants from entering the micro- mobility industry, as
compliance with these regulations requires additional resources and expertise.
 Existing companies have already built customer trust and loyalty through their services and enticing loyalty
programs, making it challenging for new entrants to attract and retain customers.
(ii) Bargaining Power of Suppliers:
 The micro-mobility industry in Urbana relies on numerous suppliers, primarily small to medium-sized firms,
offering innovative products. The abundance of suppliers may limit their individual bargaining power.
(iii) Bargaining Power of Buyers (Customers):
 Strength: High
 Customers in Urbana enjoy a diverse range of micro-mobility options from existing players, providing
them with multiple choices and fostering easy switching between providers. This high level of choice
empowers customers and increases their bargaining power.
(iv) Threat of Substitutes:
 Micro-mobility options are highly convenient for short-distance commutes in Urbana. This is due to the
well-planned infrastructure with dedicated bike lanes and convenient parking. This convenience and
infrastructure support create a low threat of substitutes for these short trips.
(v) Competitive Rivalry:
 Strength: High
 The micro-mobility industry in Urbana is fiercely competitive among key players. As there are various micro-
mobility options available to the customers, which makes it easy to switch between them.
 Speculations of mergers and acquisitions indicate the high stakes and desire for market dominance, further
supporting the high strength of competitive rivalry in the micro-mobility industry.

Answer 19
(a) Senior Executives (Aged 45 to 60):
This option is not suitable for the brand because senior executives, who are aged 45 to 60, fall outside Suave's
traditional target age range of 18 to 40.
Savvy Entrepreneurs (Aged 30 to 40):

This option is not suitable for the brand because the primary characteristic of this group being cost-conscious may not
align well with Suave's premium brand image. The emphasis on affordability might contradict the premium image
Suave aims to maintain.
College Fashionistas (Aged 18 to 25):

This option is not suitable for the brand because college students often have limited disposable income, which
may pose challenges in terms of pricing and overall revenue generation.
(b) Any option that caters to customer segment that can afford premium clothing brand who likes to wear stylish
clothes and is between the age of 18 to 40. Examples of such options include:
 Urban Professionals: This segment is an ideal fit for Suave as it falls within the brand's target age group and
aligns with its premium image. Urban professionals have the financial capacity to afford Suave's stylish
offerings and often seek high-
quality, fashionable clothing for work and social engagements.
 Luxury Enthusiasts: This segment comprises individuals aged 30 to 40 who have a strong affinity for luxury
brands and are willing to invest in high-end, stylish clothing. Suave's premium image would resonate with
this group, offering them
a unique alternative to established luxury labels.
 Style-Conscious Professionals: This segment consists of working professionals aged 25 to 40 who
prioritize style in their daily lives. They appreciate well- tailored, fashionable clothing suitable for both
work and social events.

Chapter 8
Answer 1
(a) SWOT analysis:
Strengths
Eat Smart (ES) has following strengths:
It is being managed and operated by qualified persons with a team of qualified staff.
It is enjoying high profit margins with strong client base.
Weaknesses
ES has following weaknesses to overcome:
High reliance on family members for management of business.
No dine-in service is being offered even though other restaurants are offering similar services.
Opportunities
ES has following opportunities to take:
Partnership with ‘Be Fit’ to expand the business.
Start offering dine-in service as client-base is already strong.
Threats
ES is subject to following threats:
New online businesses are entering into the market because of low set-up costs.
Existing competitors have also started to offer diet food on their menus.
(b) Activities forming part of primary value chain with two examples:
Inbound logistics
Procurement of ingredients.
Safe storage of ingredients.
Operations
Preparation of diet food, energy drinks and low-carb salads.
Packaging of food for delivery.
Outbound logistics
Direct sale by means of take-away.
Delivery of food to clients.
Marketing and sales
Marketing by means of word of mouth.
Marketing through social media pages.
Services
Responding to customer complaints.
Encouraging feedback from customers.
Answer 2
(a)
Strengths:
Operates in all major cities within the country
Operates in 16 international destinations
Excellent customer services
Spacious passenger seats
Fleet of 12 new aircrafts
Weakness:
4 aging aircrafts
Threats:
Worsening global aviation industry due to pandemic / heavy losses due to international travel
restrictions
Uncertainty in local air business due to the strict travel SOPs to be followed
Waiver on taxes is temporary
Opportunity:
Tax waiver from government for the time being

(b)
Threat of new entrants
The threat of new entrants is likely to decline as new investors would not enter the
airline industry during this time.
Threat of substitutes
The threat of substitutes is likely to rise as people would want to find more secluded
way to travel.
Bargaining power of suppliers
The bargaining power of suppliers is likely to decline as there would be less demand for
supplies.
Bargaining power of customers
The bargaining power of customers is likely to decline as due to international travel
restrictions, lesser number of flights might be operating, thereby, reducing the bargaining
power of customers.
Competitive rivalry
The competitive rivalry is likely to rise due to increased competition among airlines for
the limited number of travelers.
(c) FA should:
i. Concentrate on local air travel business
Reasons:
- there are restrictions on international air travel
- government is supporting local air travel
- FA operates in all major cities within the country
ii. Offer discounted rates/promotions to attract the buyers

Reasons:
- the threat of substitutes and competitive rivalry are high
- airport tax waiver from the government gives room to offer discounts
iii. Leverage on and market good reputation for customer services to pandemic related issues
Reason:
- FA enjoys good reputation for customer service. SOPs need to be enforced for which good customer
services should help
iv. Leverage on and market good reputation for spacious seats to tackle SOP issues
Reason:
- FA enjoys good reputation for spacious seats. SOPs need to be enforced for which spacious seats
should help
v. Capitalize on low international traffic by diverting younger planes for local travel
Reasons:
- International air travel is restricted
- This would attract more customers
vi. Postpone the existing plan of replacing the aging aircrafts with the new ones
Reasons:
- FA is incurring heavy losses and replacing the aging aircrafts would require high cash flows
- Due to high uncertainty, new investments should be avoided for a time being

Answer 3
Strengths
Extensive research knowledge of employees
Highly-skilled scientists in the workforce
High investment in advanced equipment
Patents on six products
High profit margins
Weaknesses
Slow progress with existing research projects
Poor record of converting research projects into new product development
Recent increase in employee turnover
Opportunities
Strong growth potential of the industry
New scientific discoveries have not yet been fully exploited
Threats
Recent merger of two major competitors
Stricter regulation of new products
Answer 4
(a) SWOT analysis is a technique (or ‘model’)
 For analysing strategic position.
 Identifying key factors that might affect
business strategy.
 Understanding competitive position.
 Development of competitive advantage.
(b)
Strengths: Weaknesses:
-Profitability growth in future -No weaknesses found in this company
-Reputation for low prices due to quality
-Strong reputation of good services
-Sales growth
Opportunities: Threats:
-Growth market -Attractive industry will attract new entrants
-Expansion of business will create competitive -Merger of two competitors
advantage -Pressure of Govt. action against monopoly
-Increase in market share-Competitive -Weakness in National economy
Advantage
Answer 5
(i) Value chain analysis
(ii) PESTEL analysis
(iii) Five forces model
(iv) SWOT analysis
Answer 6
SWOT ANALYSIS
Strengths
• Strong brand and reputation
• Worldwide facilities for manufacture and distribution
• Managers with ideas for improving the business
• Successful experience with EDI

• Successful experience with website and e-commerce.
Weaknesses
• Poor communications between divisions within the company
• Little or no access to information about competitors
• Possibly the decentralisation of IS/IT systems is a weakness.
Opportunities
• Possible use of intranet to improve internal communications and interchange of ideas
• Possible use of extranets to improve communications with customers
• Possible use of an executive information system to provide more information about
competitors and the market.
Threats
• Strong competition in the market. Competitors have made some successful initiatives
• Significant fall in number of ‘hits’ on the website
Answer 7
Main factors in the external environment The environment of an organisation is everything outside the
boundaries of the organisation. Organisations are by definition open to the environment: it is the
source of their inputs; it is the destination of their outputs; and it sets constraints over what the
organisation can do. Some argue that the environment is increasingly a source of uncertainty for
organisations, and that it is becoming harder to read. The degree of uncertainty it causes results from
its complexity and the rate of change.
As far as the general environment is concerned, we can analyse PEST and competitive factors.
Political and legal factors

Firebridge Tyres Ltd (FTL) operates in a stable political environment. Agreements between
governments have opened up international markets, not only to FTL but to its competitors: however
GTC does not want FTL to increase its exports outside Europe. There is no shortage of car service
stations, a fragmented industry, so political interference is unlikely. Local government might
determine the siting of certain activities. FTL is indirectly affected by government transport policy, if
this affects the demand for and use of cars.
Economic factors
In the UK, tyres must be checked annually, as part of the MOT testing process. The overall level of
economic activity determines transport use, which influences wear and tear of tyres. However, in
times of hardship, people will be less likely to buy the premium brand range preferring to go for the
lower cost Freeway range, cheaper overseas tyres, or even retreads. The general level of prosperity
also influences
the number of people in the population who use cars; rising incomes and wealth mean rising numbers
of cars purchased, hence greater demand for tyres. People will also move to lower cost service options
in hard times: FTL does not want a service business lumbered with heavy overheads. The UK market
is much smaller than the US: GTC might be unrealistic in assuming that the same formula, which
might depend on economies of scale, would work over in the UK.
Social factors
Social factors influence demand indirectly, via political pressure for legislation or changing patterns
of demand. For example, governments are more concerned with ecological issues. There are disposal
problems with used tyres. This might affect what they are made of. Some can be burnt as fuel, but

with landfill taxes increasing, recyclable tyres may be preferred. The proposed service business
depends on patterns of car use. It may be that many drivers and will prefer a garage.
Technological factors
Tyres are a fairly mature technology, although there are improvements to be made to increase their
grip, their longevity, and their recyclability. Any changes in the plastics and materials industry might
be relevant. Also, if cars become lighter, lighter tyres will be needed.
The main factor in the environment is competition, which is impinging directly on FTL.
A number of service chains already exist in the UK, but otherwise the industry is fairly fragmented.
Competition on price is important, but also on quality. However, FTL needs to assess how the
competition will respond.
The competitive environment can be described using Porter's five forces model (barriers to entry – see
below, substitute products, customer bargaining power, supplier bargaining power, competitive
rivalry). There are few substitute products, but competitive rivalry is intense. Suppliers have low
bargaining power probably.
Part (b)
Barriers to entry discourage new competitors to an industry. If they are low, it is easy to set up shop,
but hard to discourage other people from doing so too. The main barriers to entry are described below.
Economies of scale
For some firms, a barrier to entry is the size of the operation needed to be profitable. Tyres are high
volume, low margin products on the whole, and for most cases, the best way to make money is to
manufacture in large quantities. A large plant implies high fixed costs and a high breakeven point.
There is little evidence that significant economies of scale can be achieved in servicing. There are
some service chains, but the industry seems fragmented.
Product differentiation
FTL already pursues this strategy by producing different tyres, directed at different segments. In
service, differentiation might be achieved on the basis of FTL's brand name, and a promise of service
quality. Advertising costs might be considerable, however, to build the brand.
Capital requirements
No new factories need to be built, of course, but FTL will have to acquire leases or freeholds of a
number of properties in which to set up its service stations. Many of the prime spots might be taken
over by petrol stations. Ideally FTL will be positioned near residential areas or near roads, to make
them easy to find. The cost of this depends on the size of the operation that GTC is proposing.
Switching costs
Switching costs are minimal; new customers are easy to find, but hard to keep, unless service quality
is better
Distribution
The chain is basically a distribution outlet for FTL's tyres. The importance of choosing the right sites
for distributing the service was identified above. Existing service providers know the market, but
otherwise they have no special advantages.
Conclusion
Barriers to entry are fairly low. This will make it easy to set up business, but hard to make a profit
perhaps, unless some unique lessons can be transferred from GTC, operating in a very different
transport infrastructure.

Answer 8
Primary activities
Inbound logistics
SC gets cherries from Guatemala to ensure it has the best quality of cherries, to make the perfect cup
of coffee.
SC pays growers to book premium shipping agents to ensure quality and timely delivery of cherries.
SC performs quality check on the cherries received to ensure only the best are selected for coffee.
SC carefully stores the cherries at the warehouse and sends them to the cafes per demand to ensure
that the quality of the cherries is maintained to standard.
Cherries are carefully delivered to the cafes to ensure their quality is maintained.
Operations
SC cafes roast the cherries themselves so they can roast the cherries into coffee beans per SC’s
specific requirements for quality.
SC cafes grind the coffee beans right when the cup of coffee needs to be made so the customer
receives the very fresh coffee every time.
Outbound logistics
The cafes act as a delivery point where the customers can come and enjoy their coffee.
Marketing and sales
By keeping the cafes in the commercial areas, it can easily reach out to their target customers.
SC does not spend much on marketing activities (e.g. tv adverts, social media, etc.). It only spends on
in-store posters and imprints on cups. This saves them money.
Service (after sales)
All the facilities at cafes (free use of Wi-fi, newspapers, magazines, etc.) and after sales services
(loyalty programs) are to ensure the customers have a pleasant experience.
Answer 9
SWOT Analysis:
Strengths
Large continuing investment in R&D
Weaknesses
Operations are based in Western Europe and North America: high labour costs compared to
competitor companies?
Clinical failure of new drug
Opportunities
Opportunities for growth in the market for pharmaceutical products outside North America and
Western Europe?
Establish operations in other countries: lower labour costs, but are the skills available?
Threats
Public concerns about the safety of new drugs
Concerns about the regulation of drugs and about regulatory decisions by national authorities
Answer 10
SWOT analysis for CE is as follows:
(i) Strengths
Exclusive road permits.
Large fleet of state-of-the-art buses.
Wide area coverage.
(ii) Weaknesses
Restriction on fixation of fare rates.
Reliance on GoS for subsidies, tax exemptions and promotion of business.
Buses often depart late and schedules are cancelled frequently.

Unprofitable routes.
(iii) Opportunities
Operate in unexplored markets of other provinces / Start operating intra- city bus services.
Abandon non-profitable routes.
Negotiate with GoS to revise the fares / subsidies.
(iv) Threats
Introduction of new inter-city train services by GoS.
Non-preferential treatment from GoS in future.
Answer 11
The value chain of the primary activities of Perfect Shopper comprises:
Inbound logistics. Handling the bulk orders delivered by suppliers and storing them in bulk in purpose-built regional warehouses.
Operations. Splitting the bulk orders intosmaller units; re-packaging, sealingandstoring these smaller units.
Outbound logistics. Deliver the smaller units to neighbourhoodstores every two weeks using specialist local haulage
contractors.
Marketing and sales. Provide specially commissioned signs for the shops and personalised sales literature. Undertake the
ordering process based on standing order agreed by sales representative.
Service. Provide specialist in-store display units for certain goods. Manage distribution of promotional material and leaflets for
all shops.
Answer 12
(a)
Inbound logistics
These are the activities concerned with receiving and handling purchased materialsand components (inputs),
and storing them until needed. Complus is carrying out the following activity under inbound logistics:
The supplier packages the products and sends them directly to each Complusstore according to the
requirements received from Rauf.
Operations
These are the activities concerned with converting the purchased materials into an item that a business sells
to customers (outputs). Complus is carrying out the following activity under operations:
When the products reach the store, the staff places a price tag, stacks andorganises the products in
a standard fashion.
Outbound logistics
These are the activities concerned with the storage before sale of finished goods (outputs), and its
distribution and delivery to the customers. The following activities can be classified under outbound
logistics:
Customers visit Complus stores to buy products
The products are stored in Complus stores
Marketing and sales
These are the activities associated with advertising and brand building which seek to increase visibility and
communicate why a product or service should be purchased. These activities are usually associated
with the ‘4Ps’ of marketing, namely; product, place, price, and promotion. Complus is carrying out the
following activity under marketing and sales:
Complus frequently runs social media campaigns, SMS messages and TVadverts to inform
customers about the products and discounts

Complus has an aftersales customer helpline that assists customers withcommon queries
and collects their feedback.
(b) Product quality check can be done to reduce customer complaints. Quality checkcan be
performed at any of the following positions in Porter’s primary value chain:
(i) Quality check of products should be done before they are delivered to the stores. This will
ensure only products in working condition are present at the store, which will reduce customer
complaints of faulty products at first use.
This activity is to be placed in Inbound logistics of Porter’s primary value chain.
Answer 13
24Seven
Step 1 - Identify the critical success factors that are essential for profitability.
Short/minimal call handling time is one of their critical success factors (CSF).
Step 2 - Identify what is necessary (the ‘critical competence’) in order to achieve a superior performance in
the critical success factors.
The critical competence in this case is adequate number of staff and their proper training.
Step 3 - The entity should develop the level of critical competence so that it acquires the ability to gain a
competitive advantage in the CSF.
The staff, new and existing, should be trained to reduce the call handling time.
Step 4 - Identify appropriate key performance indicators for each critical competence.
The target KPI is to reduce the call handling time from 45 seconds to the desired level of 30 seconds or less.
Step 5 - Give emphasis to developing critical competencies for each aspect of performance, so that
competitors will find it difficult to achieve a matching level of competence.
Given the importance of the issue, the management has hired 3 additional staff and emphasized on setting an
ambitious training target to resolve the matter within the next three months.
Step 6 - Monitor the firm’s achievement of its target KPIs and also monitor the competitors’ comparative
performance.
The management closely followed the progress in implementing the plan and has recorded a decrease in call
handling time to 35 seconds for the first month. Getting the call handling time reduced to 28 seconds as
planned shall solidify their position as a leader in the market for call handling times.
Answer 14
SWOT Analysis for IQRA is presented below:

(a)
Strengths:
(i) Unique Features: IQRA has unique features that set it apart from competitors, providing a competitive
advantage in the market.
(ii) User-Friendly Interface: The app's ease of use enhances the overall user experience, which can lead
to higher retention rates and word-of-mouth referrals.
(iii) Cultural Relevance: Catering to the Indo-Pak region's cultural nuances and language learning perceptions
helps establish a strong connection with the target audience.
Weaknesses:
(i) Limited Brand Recognition: The lack of brand awareness makes it challenging to attract new users and
compete effectively with established competitors.

(ii) Limited Budget: The constrained marketing budget may restrict the reach and impact of promotional
efforts.
(iii) Localization Challenges: Adapting the app to suit various dialects and linguistic variations within the
region can be complex and resource-intensive.
Opportunities:
(i) Growing Smartphone Penetration: With an increasing number of people owning smartphones in the Indo-Pak
region, there is a vast potential user base to tap into.
(ii) Increasing Interest in Arabic Learning: A rising interest in Arabic language learning, possibly due to
educational, cultural, or economic reasons, presents a
significant opportunity for IQRA.
(iii) Social Media and Influencer Marketing: Leveraging social media platforms and
collaborating with influential figures can help reach a broader audience effectively.
(iv) Building partnerships: Building partnerships with educational institutions will help reach target audience
effectively.
Threats:
Fierce Competition: The market for language learning apps is highly competitive, with established players and new
entrants vying for market share.
Varying Language Learning Perceptions: Different learning preferences and expectations from users in the region
may require diverse approaches to cater to
their needs effectively.
Negative Reviews and Feedback: Any negative feedback or reviews left unaddressed can harm IQRA's
reputation and deter potential users.
Legal and Regulatory Compliance: Failure to comply with regional laws and regulations can lead to legal issues
and a loss of user trust.
Threat: Fierce Competition
Tackled using strength: Unique Features
IQRA can leverage its unique features to stand out from competitors and attract users seeking a more engaging language
learning experience. By highlighting these features in its marketing campaigns, IQRA can position itself as a distinct
and valuable choice in a crowded market.
Threat: Varying Language Learning Perceptions
Tackled using strength: Cultural Relevance
IQRA's understanding of the Indo-Pak region's cultural nuances can help address varying language learning perceptions.
The app can offer content and learning approaches that align with the preferences and expectations of different user
segments, ensuring a more personalized and effective learning experience.
Threat: Negative Reviews and Feedback
Tackled using strength: User-Friendly Interface
IQRA's user-friendly interface can be instrumental in addressing negative reviews and feedback. By actively listening to
user concerns and feedback, the app can make continuous improvements to enhance the user experience. Responding
to negative reviews with helpful solutions and thanking users for positive feedback can show a commitment to user
satisfaction.
Threat: Legal and Regulatory Compliance
Tackled using strength: Cultural Relevance
IQRA's understanding of the Indo-Pak region's cultural nuances and language learning perceptions can be
instrumental in addressing legal and regulatory compliance. By aligning its content and practices with the cultural
norms and values of the region, IQRA can navigate potential compliance issues more effectively and gain user
trust through responsible and relevant offerings.

Chapter 9
Answer-1:
(a) What are the facts of the case?
The facts are that the civil servants have made what is an apparently legitimate request for
information.
However the circumstances suggest that if the board supplies this information, it may be used by the
governing party to support its bid for re-election.
What are the ethical issues in the case?

Independence. The main ethical issue is independence. The corporation exists to serve the interests
of the country as a whole and should not be seen to be supporting one political party, even if the
board believes that party's policies are best for EPC. The fact that the request has come via the civil
servants will not be a defence, since the civil servants also have a (possibly stronger) duty of
independence.
Obedience. The board also however owes a duty of obedience to the Ministry of Energy, which is its
employer, and has a right to make legitimate business requests. Confidentiality may also be an issue,
that the board may be instructed to treat the request and its response as confidential.
What are the norms, principles and values related to the case?
Objectives. The board must act in accordance with the corporation's objectives, which will be to
supply electricity as economically and efficiently as possible. The board is entitled to consider
whether major cost-cutting may increase the risk of the electricity supply failing.
Governance. As EPC is a nationalised entity, the directors are expected to act in accordance with
the wishes of the properly elected government, since the democratic process confers legitimacy
upon the government's wishes. This means accepting major changes such as privatisation if they
wish to remain on the board, also accepting other obligations such as keeping certain information
confidential if necessary.
Independence. The duty of independence means that the board cannot actively intervene in the
political process, an issue of most relevance during a general election campaign.
Transparency. Ultimately also the board owes a duty of transparency about its policies to the public
and consumers, as they are primary stakeholders. However the duty of transparency is not normally
regarded as absolute; strategic business discussions may legitimately be kept confidential in the short-
term for various reasons.
What are the alternative courses of actions for the board?

Supply the information on the grounds that the board is not empowered to refuse a legitimate
request from the Ministry of Energy.
Supply the information provided that the board receives prior assurance, certainly from the civil
servants and preferably from the Minister of Energy, that the information will not be used for political
purposes during the election campaign.
Refuse to supply the information on the grounds that the board must be seen to be neutral when its
future is a significant issue in the election campaign.
Refuse to supply the information on the grounds that it cannot be expected to make a major
commitment to cost reduction instantly; review and discussion of possible options will be required
and this will take time.
What is the best course of action that is consistent with the norms, principles and values?
The board seems to have legitimate business reasons for asking for more time to consider cost
reductions. It is also entitled to be sensitive to independence issues and seek assurances before it
supplies any information that could help the governing party.

What are the consequences of each course of action?

If the information is supplied and then kept confidential, the board's independence is unlikely to
be questioned, although a hastily drawn up plan may later be criticised for business reasons. If
detailed information is not supplied until the board has had the chance to consider its plans carefully,
the decisions are more likely to be in accordance with the corporation's objectives If the board
supplies the information and it is used for political purposes, then the board's independence will
be questioned. If the opposition party then wins the election, some or all of the board may well be
replaced and EPC may suffer disruption to board decision-making and monitoring. Similarly if the
board refuses, the current government takes offence and wins the election, the board may also be
replaced.
What is the decision?

The board may feel able to supply some indications of how it might cut costs. It should refuse to
supply detailed information until it has had time to consider future planning carefully, even if this
means the information is not available until after polling day. Before it supplies any information it
should seek guarantees from the governing party that it will not use the information to forward its
political platform. It should not reveal the request has been made unless the information is used for
political purposes and the board therefore needs to demonstrate that it has acted independently.
(b) The stages of Tucker's five question model are in the decision:
Profitable
Although the nationalised corporation will be a non-profit making body, it has the duty to control its
costs.
The costs of combating the protestors will include:
The costs of security
The costs of taking action to counter the bad publicity that may be a consequence of the treatment
of the protestors
The costs of legal action brought by the protestors as a result of the actions of the security guards
The other issue however is whether there is any alternative to incurring these costs. If the protestors
are determined to protest, the alternative may be disruption to the country's power supply, which is
likely to be regarded as being much more important.
Legal
The legality of the security guards' action depends upon local legislation, in particular the rights to
protest, to protect property and use reasonable force. There is also the issue of how far EPC will
be held responsible for the actions of its agent, the security firm. Because of the issues of poor
publicity and also the costs described above, EPC's board should be wary if it appears that excessive
force may be being used, since this is likely to be a legally grey area.
Fair
The pressure groups may claim that they have a legitimate right to protest. Their case may be
weakened by the fact that they can currently take political action in the general election campaign,
although perhaps they might argue that none of the major parties fairly represents their views.
However even if the board was to accept that the pressure groups are legitimate stakeholders, it also
has a duty to consumers, who are undoubtedly also legitimate stakeholders, to preserve the
continuity of electricity supplies. These include consumers whose livelihoods and indeed lives may
be threatened by power cuts (hospital patients for example).
Right
The main ethical issues are whether it is right for the pressure group to take potentially life-
threatening action in order to advance a cause that has fundamental long-term consequences (action
against global warming). From EPC's point of view the ethical issue is whether force should be used
against the pressure group if its actions are life-threatening; if it can be, how much force would be
right; ultimately would it be legitimate to take action that might jeopardise the lives of the protestors.
Sustainable
Because of the general election campaign and a possible change of government, the board cannot be
expected at present to make long-term decisions about switching to a more environmentally friendly
method of electricity generation. However if the managing director's attitude is typical of the board,
then the viewpoint is not sustainable; continued use of coal will mean supplies are eventually
exhausted and there is strong scientific evidence that the emissions are having adverse climatic
effects. Many countries are investigating alternative sources of power. Whatever the result of the
general election, EPC's board has a duty to ask the new government to review energy policies.
Answer 2:
Application of AAA Model
Step 1- Establishing the facts of the case.
 Environmental Protection Agency discovers that Opulent Furniture is clearcutting trees
 AIA’s reservation on control on classification of sustainable wood sourcing
 AIA discovers that the Company has minimal involvement in forest management
 AIA is offered an undue favour
Step 2- Identify the ethical issues in the case
 Opulent Furniture is clearcutting forests causing environmental concerns
 Senior management offers an undue favour to AIA
 Senior management wants the AIA to ignore the results of her assignment
Step 3- The major principles, rules and values include,
 AIA is bound to show objectivity in such situations
 CFO of the Company is bound to show integrity and professional behaviour 
 Senior management is required to present a true and fair view of wood sourcing in financial
statements
Step 4- Each alternative course of action is identified.
 AIA can accept the undue favour, and take no action on the findings
 AIA can accept the undue favour, and disclose the findings in his/her report
 AIA can refuse the undue favour, and take no action on the findings.
 AIA can refuse the undue favour, and disclose the findings in his/her report
Step 5- Matching norms, principles, and values to options
 Accepting the undue favour, is accepting inducement that is with an intent to influence. Taking no
action on the findings is compromising integrity and objectivity. 
 Accepting the undue favour, is accepting inducement that is with an intent to influence. Reporting
the findings is in line with the principles of integrity and objectivity. 
 Refusing the undue favour, is refusing inducement that is with an intent to influence. But taking no
action on the findings is compromising integrity and objectivity. 
 Refusing the undue favour, is refusing inducement that is with an intent to influence. Reporting the
findings is in line with the principles of integrity and objectivity. 

Step 6- Analysis of consequences:

 Accepting the undue favour may damage the reputation of AIA. Taking no action on the findings
may support environmental damage that the company is causing, but may save AIA from any career
threat. It will also maintain the claim of the Company as being responsible organization.
 Accepting the undue favour may damage the reputation of AIA. Reporting the findings may be a
step towards fair and true presentation of the matter. But it may harm AIA’s career in the Company.
It may also damage the reputation of the Company.
 Refusing the undue favour may build good reputation of AIA. Taking no action on the findings may
support environmental damage that the company is causing, but may save AIA from any career
threat. It will also maintain the claim of the Company as being responsible organization.
 Refusing the undue favour may build good reputation of AIA. Reporting the findings may be a step
towards fair and true presentation of the matter. But it may harm AIA’s career in the Company. It
may also damage the reputation of the Company. 
Step 7- Taking decision
 From the above analysis AIA will be able to balance the consequences against primary principles
and values by selecting the best fit alternative.
Answer-3:
Application of Tucker Model

Use Tucker’s five-question to analyze lawyer’s advice for recommendation to the CEO.
Is following the lawyer’s advice profitable?
 It is profitable for the company if it could delay demolition for six months.
 It is profitable for the villagers as they will have six months to preserve their produce in the storage
and subsequently use the planned new facility
 It will delay the possibility of expansion in school, which is in the interest of the society.
Is following the lawyer’s advice legal?
 Trying to gain time for shifting may not be illegal, though the storage facility is constructed over
illegal property. 
 Presenting false documentation to the court for delaying hearing is illegal
 Exaggeration of estimated costs may not be clearly illegal
Is following the lawyer’s advice fair?
 Trying to gain time for shifting is fair for tenant, as early demolition will be a disproportionate
burden on tenant.
 Struggling for extension in notice period is fair with villagers, as early demolition will cause
disproportionate loss to them when they will have no facility during the construction period of new
facility. 
 An extension of six months in notice period will be unfair with the youth of the city who can now
go to a bigger school if built over that property
Is following the lawyer’s advice right?
 It is not right for you, being responsible to promote the legitimate objectives of your employer, to
recommend the unethical strategy given by the lawyer.
Is following the lawyer’s advice sustainable?

 The extension in notice period will prove sustainable for the fruit farms in nearby villages and will
encourage farming, which is good for environment.
Answer-4:
Application of Tucker Model

Are the decisions of CEO profitable?
 Decision (b) is not profitable in the short run, but profitable for the business in the long run, as it
will build customer loyalty from those who were refunded. It will be profitable for the guests who
were yet to check out.
 Decision (c) is profitable for the business since it will save the amount that otherwise is refundable
for 70 nights, but will not be profitable for the guests who left the property.
Are the decisions of CEO legal?
 Decision (b) is legally a gratuitous act of the Hotel, as it does not follow the fundamental principles
of offer and acceptance under contract law.
 Decision (c) is legal, as it follows the fundamental principles of offer and acceptance in contract
law.
Are the decisions of CEO fair?
 Decision (b) is fair to all the guests who booked during the three nights and are yet to check out.
 Decision (c) is not fair to the guests who already checked out, as the discrimination applied by the
Hotel has no grounds except that these guests have left the property before the error could be
detected by them. 
 Decision (b) is fair to the business as it is refunding the amount collected erroneously
Are the decisions of CEO right?
 The guests who have checked out have a moral right to a refund for the excess price they paid
compared to what was offered. 
Are the decisions of CEO sustainable?
 The case has no environmental issue
Answer 5
Is wage policy profitable?
• It is profitable for Maham as she would earn huge profits
• It is profitable for the female workers as it will provide them with proper employment
Is wage policy legal?
• It will be a legal contract, as women will be hired with their free will The daily wages
conform to the minimum wage law.
Is wage policy fair?
• It is unfair because Maham is getting undue advantage of workers’ weak bargaining position
and lack of knowledge of actual worth of their work.
Is wage policy right?
• Wage policy is right in essence.

Is wage policy sustainable?

• It is sustainable for the environment because the fabrics and embroidery are hand-woven.
Answer 6
Applying the AAA model:
The facts of the case are:
• Internal audit uncovered that a key pre-qualification criterion was not applied in SSL’s case
• The Board approved the Procurement Committee’s suggestion of a special waiver for SSL
• SSL had an excellent contract performance history
The ethical issues in the case are:
• By allowing the waiver, the Board might be unfair with other supplier who fulfil all conditions
or those who were rejected due to that particular short coming.
• Objectivity of Board members and management might be threatened by familiarity threat due
to frequent client relationship techniques used by SSL.
The norms, principles and values related to the case are:
• The Board had to make decisions free from bias and should ignore any favours offered by the
SSL.
• SSL was given reasonable favour due to its good performance record.
• Other suppliers were not given fair chance.
Each alternative course of action were:
• The board allows the waiver.
• The board does not allow the waiver and go for rebidding process.
Matching norms, principles, and values to options as follows:
• Allowing waiver could be compromising the fairness in dealing
• Not allowing waiver is not acting with due care.
The analysis of consequences of each possible course of action are:
• Allowing the waiver sets a tone that the Company is flexible towards its policies. This decision
may create a domino effect on future decisions that further dilute the Company’s policies.
• Rejecting the waiver would mean the Board will not compromise on the Company’s policies.
However, it may not be in the interest of the company.
Taking decision
From the above analysis, it appears that the board balanced the consequences against primary
principles and values by selecting the best fit alternative.
Answer 7
Is hiring of consultant profitable?
Yes, for the company because work will not be delayed further Is hiring of consultant legal?
Yes, it is legal to hire a consultant
• There is a budget available for such appointment.
Is hiring of consultant fair?
• It is not fair with the company to pay such a disproportionate consultant fee.

Is hiring of consultant right?

• It is not right, as such a high fee of consultant indicates that the consultant would use unfair
means to get the approval.
Is hiring of consultant sustainable?
This situation does not include any information about the environmental impact of
manufacturing facility.
Answer 8
Is the decision
Profitable
Route A is a profitable choice. Projections demonstrate that its Net Present Value is positive $5
million, $1 million more than if Route B was chosen. However both routes have additional, uncertain
costs which complicate the analysis. With Route A RDC may be faced with costs arising from direct
action by the protest group. With Route B, RDC could have been faced with the costs of defending a
legal action.
Legal
The local government authority has given planning permission for Route A, so RDC seems to have
fulfilled its requirements. RDC does not appear to face the threat of legal action with Route A that it
could have faced if it had chosen Route B.
Fair
RDC has had to decide between the conflicting claims of different stakeholders, the birds versus
Eddie Krul and his workers. Choosing Route A ignores the birds' rights to access their feeding
grounds and may threaten their existence. Choosing Route B means depriving Eddie Krul of a farm
that he wants to keep and causing his workers to lose their jobs. Arguably it has taken the decision not
out of an objective assessment of the strength of each claim, but because Route A is more profitable
and it has been influenced by Eddie Krul's threat of legal action.
Right
If a pristine capitalist view is taken that RDC's duty is to choose options that maximise shareholder
value, then the choice of Route A appears to be correct. However, from the viewpoint of a deep
ecologist, the decision is wrong because RDC should not disrupt the existence of other species in any
circumstances. From a social and economic viewpoint however, the decision appears to be right as the
line will improve transport and boost economic activity and the construction work will provide
employment opportunities. Route A does not have the adverse consequences of closing the farm that
Route B would have had, including loss of employment and loss of a source of local food.
Sustainable
The decision to choose Route A appears to be the less environmentally-sustainable decision. It could
threaten the existence of an endangered species and disrupt the local ecosystems, with possible
unforeseen consequences. Choice of Route B would though have had implications for social
sustainability, with loss of jobs at the farm and adverse impacts on the local community. Arguably the
investment in rail is an investment in a relatively sustainable form of transport that should reduce the
number of cars on the roads.
Summary
Whichever decision RDC chose would have had negative implications for some stakeholders. It chose
to prioritise profitability and minimising the impact on the local community over the effect on the
birds and the associated ecosystems.

Answer 9
What are the facts of the case?
The facts are that the company has been offered some designs that appear to have been stolen.
What are the ethical issues in the case?

The ethical issue is whether to gain a business advantage by using designs that belong to someone
else.
What are the norms, principles and values related to the case?
Accepting the offer is likely to be illegal in Cadge's home country or illegal under international
design protection laws. Even if the action could be justified as legal, it would demonstrate a lack of
honesty and integrity if Cadge used designs that belonged to someone else whom it had not paid.
What are the alternative courses of action?

1 Reject Mr Sim's offer. 2 Accept Mr Sim's offer, pay Mr Sim money and use the designs.
What is the best course of action that is consistent with the norms, principles and values?
The best course of action is Option 1, as accepting the designs would be dishonest. The directors
would need to decide whether to have no further dealings with Mr Sim, or to whistleblow on him to
the competitors.
What are the consequences of each possible course of action?

1 Cadge will not be able to gain a competitive advantage. 2 Cadge may be able to gain a temporary
advantage, but the consequences if the transaction is discovered could be severe. Cadge's customers
are likely to view this activity unfavourably and this could jeopardise existing contracts. The board
may come under pressure from other shareholders who find this behaviour unacceptable.
What is the decision?

The ethical decision in Option 1, to refuse Mr Sim's offer.
Answer 10
Is it profitable?
Yes, it is profitable as NHL will make a superior return from this investment due to lower operating
costs.
Yes, it is profitable for the locals as it will bring tourism in the area and will creategreater earning
opportunities.
Is it legal?
Yes, it is legal as all the government approvals have been taken and there seems tobe no-legal
issues.
Is it fair?
No, the land is obtained at a significantly lower market price. It seems that the local community did
not get a fair price for this deal.
NHL is expecting to obtain cheap labor for its resort. It needs to be determinedwhether it
would be exploitation of the local community.
Is it right?
Yes, construction of the resort will help the valley with tourism development andalso provide
employment opportunities to the local community.
Is it sustainable or environmentally sound?
Yes, it is sustainable as construction of the road infrastructure will bring a lot of development
and would make the valley further sustainable.

It needs to be considered that in the absence of any sewerage system, how the resortwould dispose
of the waste without harming the environment.
Answer 11
Tucker's Five Question Model is applied to the scenarios above as such:
(i) Is it profitable? No
While taking action against the client might result in financial losses in the short term, it is essential to consider the
long-term impact on the firm's reputation and client trust. Upholding ethical standards and maintaining the firm's
integrity can lead to stronger client relationships and increased trust from other clients, ultimately benefiting the firm's
profitability in the long run.
(ii) Is it legal? (Legal values) Yes
Taking action against the client is aligned with legal values, as it involves addressing fraudulent practices and
adhering to the laws and regulations governing financial reporting. Ignoring the fraud could lead to legal
consequences and potential damage to the firm's reputation.
(iii) Is it fair? (Social values) Yes
Addressing the financial irregularities is fair to all stakeholders involved. It ensures that all clients are treated with
integrity and that the firm's reputation remains untarnished. Failing to take action would be unfair to other clients
who rely on the firm's ethical conduct.
(iv) Is it right? (Personal values) Yes
From a personal values perspective, Asif Ahmed, as the managing partner, has a responsibility to ensure the firm
operates ethically and maintains its integrity. Doing the right thing involves confronting the fraudulent practices and
taking necessary actions to uphold the firm's ethical standards.
(v) Is it sustainable development? (Environmental values) N/A
No environmental information is provided in the scenario.
Advice for Asif Ahmed:

Considering Tucker's Five Question Model, it is advisable for Asif Ahmed to take action against the client and address
the financial irregularities promptly. Despite potential short-term financial losses, the long-term benefits of upholding ethical
conduct, maintaining the firm's reputation, and building trust among clients far outweigh the immediate financial concerns.
Asif Ahmed should collaborate with Nawaz Ali and the relevant legal teams to handle the situation diligently and
transparently, ensuring that the firm's commitment to ethical values remains unwavering. By taking a principled stand, the
firm can reinforce its commitment to integrity, potentially attracting more ethical clients and strengthening its position
in the
industry.

Chapter 11
SOLUTION NO 1
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒+𝐷𝑒𝑏𝑡 × 𝑘𝑑 100,000×15%+40,000×08%

𝑊𝐴𝐶𝐶 = = = 13%
𝐸𝑞𝑢𝑖𝑡𝑦+𝐷𝑒𝑏𝑡 100,000+40,000
SOLUTION NO 2
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒+𝐷𝑒𝑏𝑡 × 𝑘𝑑 145,000×16%+58,000×10%
a) 𝑊𝐴𝐶𝐶 = = = 14.29%
𝐸𝑞𝑢𝑖𝑡𝑦+𝐷𝑒𝑏𝑡 145,000+58,000
b)
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 𝑓𝑟𝑜𝑚 𝐶𝑜. 𝐴 = 30% × 16% + 40% × 18% + 20% × 30% = 18%
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 𝑓𝑟𝑜𝑚 𝐶𝑜. 𝐵 = 30% × 12% + 40% × 10% + 15% × 30% = 12.10%
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 𝑓𝑟𝑜𝑚 𝐶𝑜. 𝐶 = 30% × 16% + 40% × 18% + 12% × 30% = 15.60%
c) Ansari ltd. should invest in Co. A & C as it has higher return than WACC. But Ansari ltd. should
not invest in Co. B as it has lower return as compared to Required return of Ansari ltd.(i.e.
WACC)
SOLUTION NO 3
⇒ 𝑘 = 10.75%
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒+𝐷𝑒𝑏𝑡 × 𝑘𝑑 165,000 × 22%+60,000 × 𝑘𝑑
𝑊𝐴𝐶𝐶 = ⇒ 19% =
𝐸𝑞𝑢𝑖𝑡𝑦+𝐷𝑒𝑏𝑡 165,000+60,000 𝑑
SOLUTION NO 4
a) 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 𝐵𝑉 × 𝑃𝑟𝑖𝑐𝑒 𝑡𝑜 𝐵𝑉 𝑟𝑎𝑡𝑖𝑜 = 3,308,000∗ × 2.78 = 𝑅𝑠. 9,196,240
∴ BV= Book value, *(4,658,000 − 1,350,000).
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 9,196,240
b) 𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = = 𝑅𝑠. 183.92
𝑁𝑜.𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 50,000
SOLUTION NO 5
Masoom ltd.
1400,000
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 × 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 60 × = 𝑅𝑠. 8,400,000
10
Harani ltd.
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 𝐵𝑉 × 𝑃𝑟𝑖𝑐𝑒 𝑡𝑜 𝐵𝑉 𝑟𝑎𝑡𝑖𝑜 = 2,280,000 × 3.89 = 𝑅𝑠. 9,196,240
SOLUTION NO 6
CFs 1 𝑃𝑉 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 = 100 (1 + .125)−1−5= 88.89
1−(1+.125)
CFs 2 𝑃𝑉 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 = 150 × [ ] = 534.09
.125
120
CFs 3 𝑃𝑉 𝑜𝑓 𝐶𝑎𝑠ℎ 𝑓𝑙𝑜𝑤𝑠 = = 960
.125
SOLUTION NO 7
𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 150
Co. A 𝑀𝑉 = 𝑘𝑒
= .12 = 1,250
Co. B 𝑀𝑉 = 𝑘𝑒
= .1
= 2,500
Co. C 𝑀𝑉 = 𝑘𝑒
= .22 = 1,272.73

SOLUTION NO 8
Assumption: All profits are distributable (i.e. Dividend = Profit) and Constant.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 460,000
Co. A 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = = = 3,680,000
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 .125
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 3,680,000
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = = 147.20
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
Co. B 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = ⇒ 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
3,000,000
=16%
18,750,000
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑
Co. C 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = ⇒ 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
250,000
=22.5%
1,111,111
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 1,800,000
Co. D 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = = = 22,500,000
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 .08
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 22,500,000
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = = 375
SOLUTION NO 9
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 𝐵𝑉 × 𝑃𝑟𝑖𝑐𝑒 𝑡𝑜 𝐵𝑉 𝑟𝑎𝑡𝑖𝑜 = 9,000,000(𝑊 − 1) × 1.3 = 𝑅𝑠. 11,700,000
𝑃𝑟𝑜𝑓𝑖𝑡 𝑃𝑟𝑜𝑓𝑖𝑡(𝑊 − 1.2) 1,404,000
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = ⇒ 𝑘𝑒 = = = 12%
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 11,700,000
(W-1) 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

14,000,000 (𝑊 − 1.1) = 𝐸𝑞𝑢𝑖𝑡𝑦 + 5,000,000 ⇒ 𝐸𝑞𝑢𝑖𝑡𝑦 = 9,000,000
(W-1.1) 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 𝑇𝑜𝑡𝑎𝑙 𝑁𝑜𝑛 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 + 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 8,000,000 + 6,000,000 = 14,000,000
(W-1.2) Profit Rs. In ‘000’
Sales 4,000
Cost of Sales (1,800)
Operating Expenses (300)
Interest (496)
Profit 1,404
SOLUTION NO 10
𝑫(𝟏 + 𝒈) 725,518(1 + 10.28%(W − 1))
𝑴𝑽 = = = 5,089,702
𝑲𝒆 − 𝒈 26% − 10.28%
(W-1) 490,500 (1 + 𝑔)4 = 725,518 ⇒ 𝑔 = 10.28%
SOLUTION NO 11
Trendy ltd.
𝐷(1 + 𝑔) 𝐷(1 + 𝑔) 6,158(1 + 20%)

𝑀𝑉 = 𝐾𝑒 ⇒ 𝐾𝑒 = + 𝑔 = 150,000 × 3.42 + 20% = 21.44%

−𝑔 𝑀𝑉
(W-1) 2,473 (1 + 𝑔)5 = 6,158 ⇒ 𝑔 = 20%

Jumbo ltd.
𝐷(1 + 𝑔) 𝐷(1 + 𝑔) 48,130(1 + 5.06%)
𝑀𝑉 = ⇒ 𝐾𝑒 = +𝑔 = + 5.06% = 20.62%
𝐾𝑒 − 𝑔 𝑀𝑉 500,000 × .65
(W-1) 37,600 (1 + 𝑔)5 = 48,130 ⇒ 𝑔 = 5.06%
SOLUTION NO 12
389,247 987,500
𝑔=𝑏×𝑟= × = 10.27%
987,500 3,788,753(𝑊 − 1)
(W-1) Opening RE = 1,428,000 + 2,750,000 − 389,247 = 3,788,753

SOLUTION NO 13
𝐷(1 + 𝑔) 180(1 + 6%(W − 1))
𝑀𝑉(𝐶𝑢 𝑖𝑛 ′000′) = = = 1,362.860
𝐾𝑒 − 𝑔 20% − 6%
(W-1) 𝑔 = 𝑏 × 𝑟 = 0.4 × 0.15 = 6%
SOLUTION NO 14
𝐷(1 + 𝑔) 𝐷(1 + 𝑔) 68𝑚(1 + 10.79%)
𝑀𝑉 = ⇒ 𝐾𝑒 = +𝑔= + 10.79% = 19.16%

𝐾𝑒 − 𝑔 𝑀𝑉 200𝑚 × 4.5
(W-1) 50m (1 + 𝑔)5 = 68m ⇒ 𝑔 = 10.79%
SOLUTION NO 15
𝐷(1 + 𝑔) 3(1 + 𝑔)
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = ⇒ 40 = ⇒ 𝑔 = 2.34%

𝐾𝑒 − 𝑔 10% − 𝑔
SOLUTION NO 16
20m 60𝑚
𝑔 =𝑏×𝑟 = × = 3.60%
60𝑚 556𝑚
SOLUTION NO 17
Description Y1 Y2 Y3
Interest 10 10 10
Tax savings@30% (3) (3) (3)
Redemption Value 100
Net Cash flows 7 7 107
1 − (1 + .06)−3
𝑀𝑉 = 𝑃𝑉 𝑎𝑡 6% = 7 [ ] + 100(1 + .06)−3 = 102.67
0.06
SOLUTION NO 18
Description Y1 Y2 Y3 Y4
Interest 12 12 12 12
Tax savings@30% (3.6) (3.6) (3.6) (3.6)
Net Cash flows 8.4 8.4 8.4 113.4
1 − (1 + .08)−4
𝑀𝑉 = 𝑃𝑉 𝑎𝑡 8% = 8.4 [ ] + 105(1 + .08)−4 = 105
0.08
SOLUTION NO 19 SOLUTION 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 =

NO 20
𝑀
𝑉

𝐷𝑖𝑣 𝐷𝑖𝑣 0.70

⇒ 𝐾𝑒 = =
𝐾𝑒 𝑀𝑉 8.20
= 8.54%
𝐷(1 + 𝑔) 3(1 + 5%)
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = = 𝑅𝑠. 45
𝐾𝑒 − 𝑔 12% − 5%
SOLUTION NO 21
𝐷(1 + 𝑔) 𝐷(1 + 𝑔) 0.7(1 + 3.5%)

𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = ⇒ 𝐾𝑒 = +𝑔 = + 3.5% = 12.34%
𝐾𝑒 − 𝑔 𝑀𝑉 8.20

SOLUTION NO 22
𝐷(1 + 𝑔) 12(1 + 𝑔)
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = ⇒ 80 = ⇒ 𝑔 = 0%
𝐾𝑒 − 𝑔 15% − 𝑔
Note: It indicates dividend will remain constant in foreseeable future.
SOLUTION NO 23
40m 120𝑚
𝑔 =𝑏×𝑟 = × = 3.57%
120𝑚 1120𝑚
SOLUTION NO 24
𝐷(1 + 𝑔) 𝐷(1 + 𝑔) (125 × 80%)(1 + 3%(𝑊 − 1))
𝑀𝑉 = ⇒ 𝐾𝑒 = +𝑔= + 3% = 9.87%
𝐾𝑒 − 𝑔 𝑀𝑉 1500
(W-1) 𝑔 = 𝑏 × 𝑟 = 20% × 15% = 3%
SOLUTION NO 25
𝐷(1 + 𝑔) 39.25(1 + 6.95%(𝑊 − 1))
𝐾𝑒 = +𝑔 = + 6.95% = 12%
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 831
(W-1) 30 (1 + 𝑔)4 = 39.25 ⇒ 𝑔 = 6.95%
SOLUTION NO 26
𝐷(1 + 𝑔) 80(1 + 6%(W − 1))
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = = 605.714286
𝐾𝑒 − 𝑔 20% − 6%
15,000,000
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 605.714286 × = 605,714,286
15
(W-1) 𝑔 = 𝑏 × 𝑟 = 0.4 × 0.15 = 6%
SOLUTION NO 27
𝐷(1 + 𝑔) 0.96𝑚(1 + 12%(𝑊 − 1))
𝐾𝑒 = +𝑔 = + 12% = 20.96%
𝑀𝑉 4𝑚 × 3
(W-1) 0.61m (1 + 𝑔)4 = 0.96m ⇒ 𝑔 = 12%
SOLUTION NO 28
100,000 400,000
𝑔=𝑏×𝑟= × = 2.22%
400,000 4,500,000
SOLUTION NO 29
𝐷(1 + 𝑔) 1.2(1 + 10.83%(𝑊 − 1))

𝐾𝑒 = +𝑔 = + 10.83% = 27.45%
𝑀𝑉 8
1.3 1.25∗
(W-1) 𝑔 = 𝑏 × 𝑟 = × = 10.83%
2.5 6∗∗

𝑃𝐴𝑇
*𝐸𝑃𝑆 = ⇒ 𝑃𝐴𝑇 = 𝐸𝑃𝑆 × 𝑆ℎ𝑎𝑟𝑒𝑠 = 2.5 × 0.5𝑚 = 1.25𝑚
𝑆ℎ𝑎𝑟𝑒𝑠
**𝑢𝑠𝑖𝑛𝑔 𝐴𝑠𝑠𝑒𝑡𝑠 𝑖𝑛𝑠𝑡𝑒𝑎𝑑 𝑜𝑓 𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑡𝑜 𝑑𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦
SOLUTION NO 30
Appropriate Dividend growth rate = 10%

SOLUTION NO 31
Description Yo Y1 Y2 Y3 Y4
MV at issue date (103.64)
Tax savings@30% (3.9) (3.9) (3.9) (3.9)
Net Cash flows (103.64) 9.1 9.1 9.1 109.1
1 − (1 + .1)−4
𝑁𝑃𝑉 𝑎𝑡 10% = −103.64 + 9.1 [ ] + 100(1 + .1)−4 = −6.49
0.1
1 − (1 + .05)−4
𝑁𝑃𝑉 𝑎𝑡 5% = −103.64 + 9.1 [ ] + 100(1 + .05)−4 = 10.9
0.05
10.9
𝑲𝒅 = 𝐼𝑅𝑅 = 5% + × (10% − 5%) = 8.13%
10.9 + 6.49
SOLUTION NO 32
Interest 9 9 9 9
Tax savings@40% (3.6) (3.6) (3.6) (3.6)
Net Cash flows (101.88) 5.4 5.4 5.4 110.4
1 − (1 + .1)−4
𝑁𝑃𝑉 𝑎𝑡 10% = −101.88 + 5.4 [ ] + 105(1 + .1)−4 = −13.05
0.1
1 − (1 + .05)−4
𝑁𝑃𝑉 𝑎𝑡 5% = −101.88 + 5.4 [ ] + 105(1 + .05)−4 = 3.65
0.05
13.05
𝑲𝒅 = 𝐼𝑅𝑅 = 5% + × (10% − 5%) = 6.09%

3.65 + 13.05
SOLUTION NO 33
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑
𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡
21,264 × 24% + 1,025 × 9.26%
= = 23.32%
21,264 + 1,025
Workings
Equity:
𝐷(1 + 𝑔) 16(1 + 7.78%(W − 1))
𝐾𝑒 − 𝑔 24% − 6%
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 106.32 × 200,000 = 21,264,000

(W-1) 11 (1 + 𝑔)5 = 16 ⇒ 𝑔 = 7.78%
𝒌𝒆 = 24%
Debt: (Rs. In ‘000’)
Net Cash flows (102.5) 10 10 10 110

1 − (1 + .1)−4
𝑁𝑃𝑉 𝑎𝑡 10% = −102.5 + 10 [ ] + 100(1 + .1)−4 = −2.5
0.1
1 − (1 + .07)−4
𝑁𝑃𝑉 𝑎𝑡 7% = −102.5 + 10 [ ] + 100(1 + .07)−4 = 7.66

0.07
7.66
𝑲𝒅 = 𝐼𝑅𝑅 = 7% + × (10% − 7%) = 9.26%

7.66 + 2.5
MV of Debt
𝐷𝑒𝑏𝑡 = 10,000 × 102.5 = 1,025,000
SOLUTION NO 34
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡𝑟𝑒𝑑 × 𝑘𝑑𝑟𝑒𝑑 + 𝐷𝑒𝑏𝑡𝑖𝑟𝑟 × 𝑘𝑑𝑖𝑟𝑟
𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡𝑟𝑒𝑑 + 𝐷𝑒𝑏𝑡𝑖𝑟𝑟
906,818 × 16% + 24,356 × 8% + 18,667 × 9%

= = 15.66%
906,818 + 24,356 + 18,667
Workings
Equity:
𝐷(1 + 𝑔) 9.5(1 + 5%)
𝐾𝑒 − 𝑔 16% − 5%
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 90.682 × 10,000 = 906,818

Redeemable Debt: (Assuming face value =100)
MV at issue date
Interest 10 10 10
Tax savings@30% (3) (3) (3)
Net Cash flows 7 7 107
1 − (1 + .08)−3
𝑁𝑃𝑉 𝑎𝑡 8% = 7 [ ] + 100(1 + .08)−3 = 97.42
0.08
25,000
𝑀𝑉 𝑜𝑓 𝑅𝑒𝑑𝑒𝑒𝑚𝑎𝑏𝑙𝑒 𝐷𝑒𝑏𝑡 = 97.42 × = 24,356
100
Irredeemable Debt :( Assuming face value =100)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡(1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒) 12(1 − 30%)
𝑀𝑉 = = = 93.33
𝐾𝑑 9%
20,000
𝑀𝑉 𝑜𝑓 𝐼𝑟𝑟𝑒𝑑𝑒𝑒𝑚𝑎𝑏𝑙𝑒 𝐷𝑒𝑏𝑡 = 93.33 × = 18,667
100
SOLUTION NO 35
Equity: 𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑

𝑊𝐴𝐶𝐶 = =
𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡
Workings
4,711,111 × 24% + = 22.8%

418,880 × 10% 4,711,111 + 418,880
𝑀𝑉 = 94.2 × 50,000 = 4,711,111
𝑘𝑒 = 24%

MV at issue date

Interest 17 17 17
Tax savings@30% (5.1) (5.1) (5.1)
Net Cash flows 11.9 11.9 111.9
1 − (1 + .1)−3
𝑃𝑉 𝑎𝑡 10% = 11.9 [ ] + 100(1 + .1)−3 = 104.72
0.1
400,000
100
𝑘𝑑 = 10%
SOLUTION NO 36
(a)
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑 812,667 × 24% + 166,700 × 8%
𝑊𝐴𝐶𝐶 = = = 21.27%
𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡 812,667 + 166,700
Workings
Equity:
𝐷(1 + 𝑔) 9.20(1 + 6%)
𝐾𝑒 − 𝑔 24% − 6%
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 54.17 × 15,000 = 812,667

𝑘𝑒 = 24%

MV at issue date
Interest 12 12 12
Tax savings@30% (3.6) (3.6) (3.6)
Net Cash flows 8.4 8.4 108.4
1 − (1 + .08)−3
𝑃𝑉 𝑎𝑡 8% = 8.4 [ ] + 100(1 + .08)−3 = 101.03
0.08
165,000
100
𝑘𝑑 = 8%
(b)
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑁𝑒𝑤 𝑊𝐴𝐶𝐶 − 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑊𝐴𝐶𝐶

𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑊𝐴𝐶𝑐 =
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝐷𝑒𝑏𝑡
237,692 − 208,376
= = 29.316%
100,000
(c)
𝑁𝑃𝑉@ 29.32%
= −100,000 + 50,000(1 + .2932)−1 + 55,000(1 + .2932)−2 + 90,000(1 + .2932)−3
= 13,166
(d)

𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡𝑜𝑙𝑑 × 𝑘𝑑 + 𝐷𝑒𝑏𝑡𝑎𝑑𝑑 × 𝑘𝑑𝑎𝑑𝑑

𝑁𝑒𝑤 𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡𝑜𝑙𝑑 + 𝐷𝑒𝑏𝑡𝑎𝑑𝑑
812,667 × 26.5% + 166,700 × 8% + 100,000 × 9%

= = 22.02%
812,667 + 166,700 + 100,000

 For new WACC we use new rates of debt and equity after obtaining additional debt.
SOLUTION NO 37
𝑙𝑒𝑡 𝑥 = 𝑅𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑒𝑛𝑡𝑢𝑟𝑒
1 − (1 + 𝑟𝑎𝑡𝑒%)−𝑛
𝑃𝑉 = 𝑅 + 𝑥(1 + 𝑟𝑎𝑡𝑒%)−𝑛
𝑟𝑎𝑡𝑒%
(1 − (1 + .1)−10)
100 = 7 × + 𝑥(1 + .1)−10
0.1
𝑥 = 147.81
SOLUTION NO 38
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡(1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒) (95 × 10%)(1 − 30%)
𝐾𝑑 = = = 7.38%
𝑀𝑉 90
SOLUTION NO 39

𝐾𝑑 = = = 8.4%
𝑀𝑉 125
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 15
W-1) 𝑀𝑉 = 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑟′𝑠 𝑟𝑒𝑡𝑢𝑟𝑛 = 12% = 125
SOLUTION NO 40
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑 28 × 12% + 7 × 9.1%
𝑊𝐴𝐶𝐶 = = = 11.42%
𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡 28 + 7
Workings
Equity:
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = 2.8 × 10 = 28𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝐾𝑒 = 12%
Debt:
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡 = 7 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝐾𝑑 = = = 9.1%
𝑀𝑉 100
SOLUTION NO 41
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑 120 × 20% + 80 × 8.4%

𝑊𝐴𝐶𝐶 = = = 15.36%
Workings
Equity:

𝑑𝑖𝑣. . 24
𝐾𝑒 = = = 20%
𝑀𝑉 1.20
Debt:
50
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡 = × 160 = 80 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
100
𝐾𝑑 = 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡(1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒) = 6(1 − 30%)

𝑀𝑉 = 8.4%
50
SOLUTION NO 42
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑 24 × 16% + 6 × 8.4%

𝑊𝐴𝐶𝐶 = = = 14.48%

Workings
Equity:
𝐾𝑒 = 16%
Debt:
𝐾𝑑 = = = 8.4%
𝑀𝑉 100
SOLUTION NO 43
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡 × 𝑘𝑑 14.6 × 12.53% + 7 × 9.1%

𝑊𝐴𝐶𝐶 = = = 11.42%
𝐸𝑞𝑢𝑖𝑡𝑦 + 𝐷𝑒𝑏𝑡 14.6 + 7
Workings
Equity:
𝑇𝑜𝑡𝑎𝑙 𝑀𝑉 = (1.55 − 0.09) × 10 = 14.6𝑚𝑖𝑙𝑙𝑖𝑜𝑛

𝐷(1 + 𝑔) 0.09(1 + 6%)
𝐾𝑒 = +𝑔 = + 6% = 12.53%
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 1.55 − 0.09
Debt:
𝐾𝑑(𝑃𝑜𝑠𝑡 𝑡𝑎𝑥) = 13%(1 − 30%) = 9.1%
SOLUTION NO 44
𝐷𝑖𝑣. 0.25
𝐾𝑒 = = = 25% , (𝐷𝑖𝑣. = .25,

𝑀𝑉 = 1.25 − 0.25 = 1.0)
𝑀𝑉 1
300
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = 0.25 − = 0.19
5,000
𝐷1 0.275(𝑊 − 1)
𝑀𝑉 = = = 1.1 (𝐸𝑥 − 𝑑𝑖𝑣. )
𝐾𝑒 25%
125
W-1) 𝐷1 = 0.25 + = 0.275
5,000
𝑀𝑉(𝐶𝑢𝑚 − 𝑑𝑖𝑣) = 𝑀𝑉(𝐸𝑥 − 𝑑𝑖𝑣) + 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑑𝑖𝑣𝑖𝑑𝑒𝑛 = 1.1 + 0.19 = 1.29 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
SOLUTION NO 45
Description Total MV (Rs.in No. of Shares MV per share
million)
Existing Equity 52.5 (50 × 1.05) 50 -
Share capital issued 10 12.5(10÷0.8) -
NPV of project 2.5 - -
Total 65 62.5 1.04
SOLUTION NO 46
𝐷(1 + 𝑔) 0.25(1 + 4%)
𝐾𝑒 = +𝑔 = + 4% = 19.03%
𝑀𝑉 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 1.98 − 0.25

SOLUTION NO 47
𝐷(1 + 𝑔) 25(1 + 7.1%(𝑊 − 1))
𝐾𝑒 = +𝑔= + 7.1% = 14.94%
𝑀𝑉 0.61 × 560
(W-1) 19 (1 + 𝑔)4 = 25 ⇒ 𝑔 = 7.1%

SOLUTION NO 48
𝐷(1 + 𝑔) 95,880(1 + 5.28%(𝑊 − 1))
𝐾𝑒 = +𝑔 = + 5.28% = 24.24%
𝑀𝑉 426,000 × 1.25(𝑊 − 2)
186,120 282,000
W-1) 𝑔 = 𝑏 × 𝑟 = × = 5.28%
282,000 3,711,120−186,120
95,880
W-2) 𝑀𝑉 = 1.475 − = 1.25
426,000
SOLUTION NO 49
𝐷(1 + 𝑔) 22.7(1 + 3.4%(𝑊 − 1))
𝐾𝑒 = +𝑔= + 3.4% = 10.38%
𝑀𝑉 336
(W-1) 19.2 (1 + 𝑔)5 = 22.7 ⇒ 𝑔 = 3.4%
SOLUTION NO 50
𝐷(1 + 𝑔) 619,300(1 + 4.46%(𝑊 − 1))
𝐾𝑒 = +𝑔 = + 4.46% = 15.3%
𝑀𝑉 6,582,000 − 619,300
(W-1) 520,000 (1 + 𝑔)4 = 619,300 ⇒ 𝑔 = 4.46%
SOLUTION NO 51
𝐷(1 + 𝑔) 1,584(1 + 10%(𝑊 − 1))
𝐾𝑒 = +𝑔 = + 10% = 17.7%
𝑀𝑉 22,630
(W-1) 610,000 (1 + 𝑔)4 = 1,190,000 ⇒ 𝑔 = 10%

𝐷𝑖𝑣. = 1,190(1 + 10%)3 = 1,584
SOLUTION NO 52
𝐾𝑑 = = = 6.58%
𝑀𝑉 85
SOLUTION NO 53
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡(1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒) 7.5(1 − 30%)
𝐾𝑑 = = = 4.2%
𝑀𝑉 125
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 7.5
W-1) 𝑀𝑉 = 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑟′𝑠 𝑟𝑒𝑡𝑢𝑟𝑛 = = 125
6%
𝑶𝑹(𝐴𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑀𝑒𝑡ℎ𝑜𝑑)
𝑘𝑑 = 6% × 70% = 4.2%
SOLUTION NO 54
Description 𝒕𝟏 − 𝒕𝟖 𝒕𝟖
Interest 7 -
Redemption 100
Net Cash flows 7 100
1 − (1 + .1)−8 𝑀𝑉 = 𝑃𝑉 𝑎𝑡 10% = 7
[ ] + 100(1 + .1)−8 = 84
0.1
1 − (1 + .1)−8
𝑃𝑉 𝑎𝑡 10% = −84 + 4.9 [ ] + 100(1 + .1)−8 = −11.21

0.1
1 − (1 + .05)−8
𝑁𝑃𝑉 𝑎𝑡 5% = −84 + 4.9 [ ] + 100(1 + .05)−4 = 15.35
0.05
15.35
𝑲𝒅 = 𝐼𝑅𝑅 = 5% + × (10% − 5%) = 7.89%

15.35 + 11.21

SOLUTION NO 55
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡𝑟𝑒𝑑 × 𝑘𝑑𝑟𝑒𝑑 + 𝑃𝑟𝑒𝑓. 𝑠ℎ𝑎𝑟𝑒𝑠 × 𝑘𝑝
𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡𝑟𝑒𝑑 + 𝑃𝑟𝑒𝑓. 𝑠ℎ𝑎𝑟𝑒𝑠
1250 × 15% + (750 × 10% × 70%) + 500 × 11%

= = 11.8%
1250 + 750 + 500
SOLUTION NO 56
𝐷𝑖𝑣. 35
a) 𝑀𝑉 = = = 178.5
𝐾𝑒 14%
𝐷(1+𝑔) 25(1+4%)
b) 𝑀𝑉 = = = 260
𝐾𝑒−𝑔 14%−4%
SOLUTION NO 57
𝐷(1 + 𝑔) 16(1 + 5%)
𝑀𝑉 = = = 240
𝐾𝑒 − 𝑔 12% − 5%
SOLUTION NO 58
𝐷(1 + 𝑔) 5(1 + 4%)

𝐾𝑒 = +𝑔 = + 4% = 18.85%
𝑀𝑉 40.5
SOLUTION NO 59
𝒀𝟏 𝒀𝟐 𝒀𝟑--------𝖺
Dividend 5.15 5.3045 5.57
[5×1.03] [5.15×1.03] [5.3045×1.03]
𝑑3 5.57
𝑃2 = = = 79.57
𝑘𝑒 − 𝑔 12% − 5%
𝑃𝑉 𝑎𝑡 12% = 5.15(1.12)−1 + 5.3045(1 + .12)−2 + 79.57(1 + .12)−2

= 4.598 + 4.228 + 63.4 = 72.22
SOLUTION NO 60
2019 2020 2021 2022 2023 2024 2025
div 24.96 25.96 26.99 27.53 29.46 31.52 33.41
Cal 24×1.04 LYD×1.0 LYD×1.0 LYD×1.0 LYD×1.0 LYD×1.0 LYD×1.06
c 4 4 2 7 7
∴ LYD = last year dividend

𝑑7 33.41
𝑃6 = = = 238.04
𝑘𝑒 − 𝑔 20% − 6%
𝑃𝑉 𝑎𝑡 20% = 24.96(1.2)−1 + 25.96(1 + .2)−2 + 26.99(1 + .2)−3 + 27.53(1 + .2)−4

+ 29.46(1 + .2)−5 + 31.52(1 + .2)−6 + 238.04(1 + .2)−6
= 𝟕𝟐. 𝟐𝟐
SOLUTION NO 61
2020 2021 2022 2023 2024 2025 2026
div 30.9 31.83 34.05 36.44 38.99 41.72 42.55
Cal 30×1.03 LYD×1.0 LYD×1.0 LYD×1.0 LYD×1.0 LYD×1.0 LYD×1.02
c 3 7 7 7 7
∴ LYD = last year dividend

𝑑7 42.55
𝑃6 = = = 386.82
𝑘𝑒 − 𝑔 13% − 2%
𝑃𝑉 𝑎𝑡 13% = 30.9(1 + .13)−1 + 31.83(1 + .13)−2 + 34.05(1 + .13)−3 + 36.44(1 + .13)−4

+ 38.99(1 + .13)−5 + 41.72(1 + .13)−6 + 386.82(1 + .13)−6
= 𝟑𝟐𝟓
SOLUTION NO 62
Shahi ltd. 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) = 7% + 1.2(11% − 7%) = 11.8%
Delta ltd. 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) = 7% + 1.5(11% − 7%) = 13%
SOLUTION NO 63
𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) = 4% + 0.92(7% − 4%) = 6.76%
SOLUTION NO 64
Abu Dhabi ltd. 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) = 9% + 1.25(8% − 9%) = 7.75%
Dubai ltd. 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) ⇒ 7.75% = 𝑅𝑓 + 1.8(8% − 𝑅𝑓) ⇒ 𝑅𝑓 = 8.31%
SOLUTION NO 65
𝐷 1.5
a) 𝐾𝑒 = = = 11.54%
𝑀𝑉 13
b) 𝐾 = 𝐷(1+𝑔) + 𝑔 = 1.5(1+4%)
+ 4% = 16%
𝑒 𝑀𝑉 13
c) 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) = 5% + 1.2(14% − 5%) = 15.8%
SOLUTION NO 66
i) 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑚 − 𝑅𝑓) = 6% + 1.1(10% − 6%) = 10.4%
𝐷
ii) 𝑀𝑉 = = 0.089 = 0.858 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
10.4%
𝐾𝑒
𝐷1 0.12
iii) 𝑀𝑉 = = = 0.62 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝐾𝑒−𝑔 10.4%−3%
SOLUTION NO 67
𝐷 8
i) 𝐾𝑒 = 𝑀𝑉 = = 20%
40
ii) 𝐾 = 𝐷(1+𝑔) + 𝑔 = 8(1+3%) + 3% = 23.6%

𝑒 𝑀𝑉 40
iii) 𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚) = 5% + 1.15(8%) = 14.2%
SOLUTION NO 68
MV of bonds if bonds are convertible into shares
Description 𝒚𝟏 𝒚𝟐
Interest 4 4
Redemption 106.25
Net Cash flows 4 110.25
1 − (1 + .06)−2
𝑃𝑉 𝑎𝑡 6% = 4 [ ] + 106.25(1 + .06)−2 = 101.89
0.06

𝑅𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 4.25 × 25 = 106.25

MV of bonds if bonds are not convertible into shares
Description 𝒚𝟏 𝒚𝟐 𝒚𝟑 𝒚𝟒
Interest 4 4 4 4
Redemption 100
Net Cash flows 4 4 4 104
1 − (1 + .06)−4
𝑃𝑉 𝑎𝑡 6% = 4 [ ] + 100(1 + .06)−4 = 93.07
0.06
∴ Value of Convertible bond will be equal to Redemption value of shares which is Rs. 106.25
SOLUTION NO 69
Description 𝒚𝟎 𝒚𝟏 𝒚𝟐 𝒚𝟑
Interest (108.70) 7 7 7
Tax savings @30% (2.1) (2.1) (2.1)
Redemption 128*
Net Cash flows (108.70) 4.9 4.9 132.9
*Higher of:
1 − (1 + .1)−3
𝑃𝑉 𝑎𝑡 10% = 4.9 [ ] + 128(1 + .1)−3 = 99.65
0.1
𝑅𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 40 × 3.2 = 128

1 − (1 + .1)−3
𝑃𝑉 𝑎𝑡 10% = −108.70 + 4.9 [ ] + 128(1 + .1)−3 = −0.35
0.1
1 − (1 + .09)−3
𝑃𝑉 𝑎𝑡 9% = −108.70 + 4.9 [ ] + 128(1 + .09)−3 = 2.54
0.09
2.54
𝐼𝑅𝑅 = 9% + × (10% − 9%) = 9.88%
2.54 + 0.35
SOLUTION NO 70
𝐸𝑞𝑢𝑖𝑡𝑦 × 𝑘𝑒 + 𝐷𝑒𝑏𝑡𝑖𝑟𝑟 × 𝑘𝑑𝑖𝑟𝑟 + 𝐷𝑒𝑏𝑡𝐵𝐿 × 𝑘𝑏 + 𝑃𝑟𝑒𝑓. 𝑠ℎ𝑎𝑟𝑒𝑠 × 𝑘𝑝
𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡𝑖𝑟𝑟 + 𝐷𝑒𝑏𝑡𝐵𝐿 + 𝑘𝑝
42𝑚 × 7.5% + 30.3𝑚 × 3.5% + 5𝑚 × 3.2% + 2.66𝑚 × 6%

= = 5.67%
42𝑚 + 30.3𝑚 + 5𝑚 + 2.66𝑚
Workings
Equity:
𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 4.2 × 10𝑚 = 42𝑚
𝑘𝑒 = 7.5%
Debtirr:

DebtBL: 101
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡𝑖𝑟𝑟 = 30𝑚 × = 30.3𝑚
100
𝑘𝑑𝑖𝑟𝑟 = 3.5%
Pref. shares:
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡𝐵𝐿 = 5𝑚
𝑘𝐵𝐿 = 3.2%
𝑀𝑉 𝑜𝑓 𝑃𝑟𝑒𝑓. 𝑠ℎ𝑎𝑟𝑒𝑠 = 1.33 × 2𝑚 = 2.66𝑚

𝑘𝑝 = 6%

SOLUTION NO 71
𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡
138.96𝑚 × 9.72% + 30.44𝑚 × 5.5%
= = 8.96%
138.96𝑚 + 30.44𝑚
Workings
Equity:
𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 1.2𝑚 × (121 − 5.2) = 138.96𝑚

𝐷(1 + 𝑔) 5.2(1 + 5%)
𝐾𝑒 = +𝑔 = + 5% = 9.72%
𝑀𝑉 121 − 5.2
Description Y1 Y2
MV at issue date
Interest 09 09
Tax savings@30% (2.7) (2.7)
Net Cash flows 6.3 106.3
1 − (1 + .055)−2
𝑁𝑃𝑉 𝑎𝑡 5.5% = 6.3 [ ] + 100(1 + .055)−2 = 101.48
0.055
30𝑚
𝑀𝑉 𝑜𝑓 𝑅𝑒𝑑𝑒𝑒𝑚𝑎𝑏𝑙𝑒 𝐷𝑒𝑏𝑡 = 101.48 × = 30.44𝑚
100
𝐾𝑑 = 5.5%
SOLUTION NO 72
(a)
Y1 Y2 Y3 Y4
div 20 20 20 20.4
𝑑4 20.4
𝑃3 = = = 156.92
𝑘𝑒 − 𝑔 15% − 2%
𝑃𝑉 𝑎𝑡 15% = 20(1 + .15)−1 + 20(1 + .15)−2 + 20(1 + .15)−3 + 156.92(1 + .15)−3

= 𝟏𝟒𝟖. 𝟖𝟒
(b)
𝐷(1 + 𝑔) 21
𝑀𝑉 = = = 175 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝐾𝑒 − 𝑔 16% − 4%
(c)
Existing MV of equity = 148.8×15m = 2,232m
New MV of equity = 175×20m = 3,500m
Increase in MV = 3,500-2,232 = 1,268m
Investment through right issue = (500m)
Increase in dividend through new investment = 768m
 New investment is favourable, so Zimba plc. Should go for it.
SOLUTION NO 73
𝑊𝐴𝐶𝐶 =
Burse Co. 𝑦 × 𝑘𝑒 + 𝐶𝑜𝑛𝑣. 𝐷𝑒𝑏𝑡 × 𝑘𝑑 + 𝐷𝑒𝑏𝑡𝐵𝐿 × 𝑘𝑏

𝐸𝑞𝑢𝑖𝑡 𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡𝑖𝑟𝑟 + 𝐷𝑒𝑏𝑡𝐵𝐿
110𝑚 × 12.5% + 31.06𝑚 × 6.02% + 2𝑚 × 5.6%
= = 11%
110𝑚 + 31.06𝑚 + 2𝑚

Workings
Equity:
𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 5.50 × 20𝑚 = 110𝑚
𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚) = 4.7% + 1.2(6.5%) = 12.5%
Debtirr:
107.11
𝑀𝑉 𝑜𝑓 𝐶𝑜𝑛𝑣. 𝐷𝑒𝑏𝑡 = 29𝑚 × = 31.06𝑚
100
𝒌𝒅
Description 𝒚𝟎 𝒚𝟏 𝒚𝟐 𝒚𝟑 𝒚𝟒 𝒚𝟓 𝒚𝟔
Interest (107.11) 7 7 7 7 7 7
Tax savings (2.1) (2.1) (2.1) (2.1) (2.1) (2.1)
@30%
Redemption 117*
Net Cash flows (107.11) 4.9 4.9 4.9 4.9 4.9 121.9
*Higher of:
𝑀𝑉 𝑜𝑓 𝑐𝑜𝑛𝑣𝑒𝑟𝑡𝑖𝑏𝑙𝑒 𝑑𝑒𝑏𝑡 (𝐺𝑖𝑣𝑒𝑛) = 107.11
𝑅𝑒𝑑𝑒𝑚𝑝𝑡𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 5.50(1.06)6 × 15 = 117
1 − (1 + .1)−6
𝑃𝑉 𝑎𝑡 10% = −107.11 + 4.9 [ ] + 117(1 + .1)−6 = −19.73
0.1
1 − (1 + .05)−6
𝑃𝑉 𝑎𝑡 5% = −108.70 + 4.9 [ ] + 128(1 + .05)−6 = 5.07
0.05
5.07
𝐼𝑅𝑅 = 5% + × (10% − 5%) = 6.02%
5.07 + 19.73
DebtBL:
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡𝐵𝐿 = 2𝑚
𝑘𝐵𝐿 = 8% × 70% = 5.6%
SOLUTION NO 74
𝑊𝐴𝐶𝐶 =
𝐸𝑞𝑢𝑖𝑡𝑦 + + 𝐷𝑒𝑏𝑡
19.05𝑚 × 10.5% + 2𝑚 × 5.25%
= = 10%
19.05 + 2
Workings
Equity:
𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 3.81 × 5𝑚 = 138.96𝑚

𝑘𝑒 = 𝑅𝑓 + 𝛽(𝑅𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚) = 4.5% + 1.2(5%) = 10.5%
Debt: 𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡 = 2𝑚
7(1 − .25)
𝑘𝑑 = = 5.25%
100

SOLUTION NO 75
Zaryab Limited
Rs. in '000 Rs. in '000
Market value Cost (rate) MV×Cost
Equity (5,000×25) 125,000 (W-1)0.096 12,000
Bank loan 25,000 0.056 1,400
(0.08×0.7)
150,000 13,400
E×ke+D×kd
Existing WACC =
E+D
Existing WACC = 13,400/150,000
Existing WACC = 8.93%
Issue of preference shares: Rs. in '000
Cost/Market value 150,000
Rate 0.09
MV × Rate 13,500
Revised WACC [13,400+13,500]/[150,000+150,000] 8.97%
Issue of convertible bonds: Rs. in '000

Cost/Market value 150,000
Rate (W-2) 0.0954
MV × Rate 14,310
Revised WACC [13,400+14,310]/[150,000+150,000] 9.24%
W-1: Cost of equity

ke = Rf + (Rm–Rf)×Be
ke = 0.06 +(0.1–0.06)×0.9
ke = 0.096 or 9.6%
W-2: IRR Cashflow D.F. @ 10% PV D.F. @ 5% PV

Issue value [given] 1,000 1.000 1,000 1.000 1,000
Interest (1000×0.09×0.7) (63) 3.170 (200) 3.546 (223)
Redemption value (W-2.1) (1,147) 0.683 (783) 0.823 (944)
17 (167)
NPVA
IRR = A% +[ ]×(B–A)%
NPVA−NPVB
IRR = 0.05+(–167/–167–17)×(0.1–0.05)
IRR = 9.54%
W-2.1: Redemption value

Higher of:
- Bond [1000×1.1] 1,100
- Shares [35×25×(1.07)4] 1,147
1,147
Recommendation:
ZL should issue preference shares as it would result in lower WACC.

SOLUTION NO 76
SOLUTION NO 77
Lahore Quotient
(a) Existing WACC

Ke × E + Kd × D
WACC = E+D
0.132(𝐖−𝟏)×1,177,580,000 (𝐖−𝟐) + 0.077(𝐖−𝟑) × 100,000,000
WACC = = 12.77%
1,177,580,000 + 100,000,000
W-1: Cost of equity

Ke = Rf +(Rm Rf)×Be
Ke = 0.08 + (0.12 0.08) ×1.3 = 13.20%
W-2: Market value (MV) of equity

MV per share = d(1+g) / ke g
MV per share =14(1+0.1187(𝐖 𝟐.𝟏) = Rs. 1,177.58
0.132 0.1187
MV of equity =1,000,000×1,177.58 = Rs. 1,177,580,000
W-2.1: Growth rate

S= P(1+g)n
14=10(1+g)3 ⇒ g = 11.87%
W-3: Cost of debt
Kd=Interest (1 tax) = 11% (1 30%) = 7.70%
(b) Option I: Issuance of new shares

Ke (Using CAPM)= 0.08 + (0.12 0.08) ×1.2 = 12.80%
Revised market value (MV) of equity
14(1+0.1187(𝐖 𝟐.𝟏)
MV per share = = Rs. 1,684.06
0.128 0.1187
MV of equity =1,000,000×1,684.06 = Rs. 1,684,060,000
WACC = [0.128 × (1,684,060,000 + 50,000,000)] + [0.077 × 100,000,000] = 12.52%

1,684,060,000 + 50,000,000 + 100,000,000

 Option II: Issuance of convertible bonds

Cashflow D.F. PV D.F. PV
s @ 10% (Rs.) @ 12% (Rs.
(Rs.) )
Issue value 1,000 1.000 1,000 1.000 1,000
Interest (1000×0.1×0.7) (70) 3.170 (222) 3.037 (213)
Redemption (3×400) (1,200) 0.683 (820) 0.636 (763)
(42) 24
NPVA
IRR = A% + ( ) × (B − A)%
NPVA−NPV B
−42
IRR = 0.1 + ( ) × (0.12 − 0.1) = 11.25%
−42−24
[0.132 × 1,177,580,000] + [(0.077 × 100,000,000)+(0.1125 × 50,000,000)]

WACC = = 12.71%
1,177,580,000 + 50,000,000 + 100,000,000
Recommendation: LQ should issue new shares as it will result in lower WACC.
(c) Before selecting the source of finance, KK should consider the following factors:
Amount required – The company should have a best estimate of the amount of finance
required as after financing, further long-term bank lending may be restrictedor available at a
higher cost.
Cost – The company should consider both the on-going servicing cost and the initial
arrangement cost for its financing. For example, the cost of both raising and servicingequity may be
high as shareholders accept high risk in return for the promise of higher rewards.
Duration – Broadly speaking short-term financing is used to fund short-term assets and long-
term financing used to fund long-term assets.
Flexibility – The Directors should consider balancing risk, cost and flexibility. Forexample,
in a year with low profits (or even a loss) the company could decide not to pay a dividend to
the shareholders. However, most debt financing requires the payment of interest
irrespective of company performance.

SOLUTION NO 78
International Packaging Limited
(a) Cost of equity

Ke = Rf + (Rm ̶ Rf) × Be = 9% + (5% × 1.2) = 15.00%
Dividend growth
Year EPS (Rs.) Year Dividend (Rs.) @ 60%
Dec-17 16 Dec-17 9.6
Dec-22 28 Dec-22 16.8
S = P(1+g)n ⟹ 16.8=9.6(1+g)5 = 11.843%
Market value - Ordinary share capital

MV per share = d(1 + g) ÷ Ke ̶ g ⟹ 16.8(1+0.11843)÷0.15– = Rs. 595.17
0.11843
Cost of 9% redeemable bonds

Years Cash flow Discount Present Discount Present value (Rs.)
(Rs.) factor 10% value (Rs.) factor 8%
0 110.0 1.000 110.00 1.000 110.00
1 (6.3) 0.909 (5.73) 0.935 (5.89)
2 (6.3) 0.826 (5.20) 0.873 (5.50)
3 (121.3) 0.751 (91.10) 0.816 (99.02)
7.97 (0.41)
IRR = L + NPV a × (H – L) = 7.15%

NPVa– NPVb
Cost of irredeemable preference shares

MV = d/ rp ⟹ 20/ 185 = 10.81%
Weighted average cost of capital – Existing

Description Units Per unit MV Total MV Cost % Cost
(in '000) Rs. in '000 Rs. in '0 00
Ordinary shares 10,040 595.17 5,975,507 15.00% 896,331
9% Redeemable 302 110.00 33,220 7.15% 2,375
bonds
Preference shares 204 185.00 37,740 10.81% 4,080
6,046,467 902,786
WACC = 902,786 ÷ 6,046,467 = 14.93%

(b) Revised cost of equity & market value (MV) of ordinary shares
Ke = Rf + (Rm–Rf) × Be = 9% + (5% × 1.3) = 15.50%
MV per share = d(1+g) ÷ Ke– g ⟹16.8(1+0.11843) ÷ 0.155 – = Rs. 513.8

0.11843
Cost of new redeemable preference shares:
Years Cash Flow Discount Present Value Discount Present Value
(Rs.) factor 20% factor 15%
0 100 1.000 100.00 1.000 100.00
1 (15) 0.833 (12.50) 0.870 (13.04)
2 (15) 0.694 (10.42) 0.756 (11.34)
3 (15) 0.579 (8.68) 0.658 (9.86)
4 (135) 0.482 (65.10) 0.572 (77.19)
3.30 (11.43)
IRR = L + NPVa × (H – L) = 18.88%

NPVa–NPVb
Weighted Average Cost of Capital - Revised

Description Units Per unit MV Total MV Cost % Cost
(in '000) Rs. in '000 Rs. in '000
Ordinary shares 10,040 513.80 5,158,552 15.50% 799,576
9% redeemable bonds 302 110.00 33,220 7.15% 2,375
20% preference shares 204 185.00 37,740 10.81% 4,080
15% redeemable 450 100.00 45,000 18.88% 8,496
preference shares
5,274,512 814,527
WACC = 814,527 ÷ 5,274,512 = 15.44%
Conclusion:
As a result of increase in the WACC, the overall market value (equity, preference and debt capital) of the
company will fall.
SOLUTION NO 79
Market value of a share without the new investment
Cost of equity:
Ke = Rf +(Rm–Rf) × b
Ke = 0.12+(0.21–0.12) × 0.8
Ke = 19.20% or 0.192
Terminal value of dividend:
TV = Do(1+g) / (Ke – g)
TV = 25(1+0.03) / (0.192–0.03)
TV = 158.95
2024 2025 2026
Dividend 25.00 25.00 25.00
Terminal value - - 158.95
25.00 25.00 183.95
Discount factor 0.839 0.704 0.590
20.97 17.59 108.61
Market value per share 147.18

Market value of a share with new investment

Cost of equity:
Ke = Rf +(Rm–Rf) × b
Ke = 0.12+(0.21–0.12) × 1.05
Ke = 21.45% or 0.2145
Market value per share

MV = D1/ (Ke – g)
MV = 26/(0.2145–0.05)
MV = 158.05
Whether the investment should be undertaken:

Existing MV of equity Rs. in million
15 million shares × 147.18 2,207.68
New MV of equity
New shares (1 for 3)
15×4÷3 = 20
20 million shares × 158.05 3,161.00
Increase in MV of equity 953.32
Amount raised through rights 600.00
Increase in MV of equity (due to project) 353.32
Conclusion: The project results in increase in MV of the equity, hence should be undertaken.

Chapter 12
Answer 1 (a)
Embedded Risk
Embedding risk management system within the Internal Control System
 A sound system of internal control reduces but cannot eliminate risk.
 An organization should not have a separate system of risk management; they should include the
risk management processes into their system of internal controls
 The risks to business are ever changing because of evolving and expanding operations. An
effective internal control system would be able to identify existing and new threats to business
with similar efficiency.
 Risk manager (or a risk expert) needs to work closely with management while they design the
internal control system
 Risk manager should regularly review reports on monitoring of internal control to identify
whether controls are capable to identify all risks.
Embedding risk management system within the Culture and Values of Organization
Culture is:
 Commonly held and relatively stable set of attitudes, values and norms
 Basic assumptions and beliefs that are shared by members of an organization.
o Risk management needs to be incorporated in the policies and procedures of the organization
o Employees should be aware of the importance of risk management system, otherwise they will
not be able to identify potential threats or monitor risks
o The “tone at the top” gives a significant message of awareness to the staff
o An open culture (open to new ideas) will significantly increase efficiency of risk management
o Risk management function may be included in individual job descriptions, and aligned with
performance indicators expected at time of appraisals
Answer 1 (b)
(b) Senior managers are responsible for the management of business risks/strategic risks. Every
employee needs to be aware of the need to contain operational risks. For example:
• All employees must be aware of health and safety regulations, and should comply with them. A
failure to comply with fire safety regulations could result in serious fire damage. For a
manufacturer of food products, a failure in food hygiene regulations could have serious
consequences for both public health and the company’s reputation.
• In some entities, there could be serious consequences of failure to comply with regulations and
procedures. For example, in banking, there must be a widespread understanding of anti-money
laundering regulations and the rules against mis-selling of banking products. The consequences for
a bank of failures in compliance could be fines by the regulator and damage to the bank’s
reputation.

Answer 2
The main function of a charity is to raise money for spending on the charitable cause. Key objectives
should therefore be (1) to raise a sufficient amount of funds and (2) to spend the funds effectively.
A major risk must be that Labcoats will have difficulty in raising enough funds to invest in the
research projects that it would like to support. There are three other charity organisations that might,
to some extent, be competing for funds from the same sources. One of these other charity
organisations, Medhelp, is much larger and is presumably much more successful at raising funds,
from private and government sources. The management of Labcoats must therefore consider the risk
that funding will possibly be less than expected, due to competition from other sources.
The ability to raise funds for the charity could also be exposed to the risk of a downturn in the general
economy (which might reduce funding from private sources) or in the state of the government’s
finances (which might reduce funding from government sources).
Another major risk is that Labcoats might invest its funds in unsuccessful projects. Each new research
project uses up a large part of its annual funding income. Unsuccessful projects would mean that
Labcoats is not as successful as it would like to be in achieving its objectives. A lack of success could
also damage the perception of Labcoats as a worthwhile charity, and persuade individuals and
organisations to give their money to Medhelp instead.
There will be some key risks affecting the operational effectiveness of Labcoats. An important
requirement will be the need to recruit and retain individuals who have the skills that are necessary to
make Labcoats successful. For example, it will need to attract and retain fund-raisers. It is not clear
whether Labcoats employs scientific or medical experts: if it does, recruiting and retaining these
individuals will also be important. The risks are that Labcoats will fail to attract high-quality
individuals, or having recruited talented individuals, will fail to retain them.
Like any other organisation, Labcoats will face a range of financial risks, operational risks and
compliance risks. The proposal by the new managing director to improve risk management systems is
a very good one.

Chapter 13
Solution.1 (a)
Krone : £ Krone : £
9.434 : 1 9.538 : 1
150,000 : X 150,000:X
X = 15,900 X=15,727
In case of Receipt Receive Less so, £ 15,727

In case of payment pay more so, £ 5,929
Solution.1 (b)
Japan yen : £ Japan yen: £

168.650 : 1 9.538 : 1
1,000,000 : X 1,000,000:X
X = 5,929 X=5,855
Solution.2
One month receipt: = $ 240,000 one month receipt: = $ 240,000
One month payment: = $ 140,000
Net receipt = $ 100,000
One Month Expected Receipt
$ : £
1.7832 : 1
1,000,000 : X
X = 56,079
Three month expected receipt
$ : £
1.7832 : 1
300,000 : X
X = 168,067
Solution.3
(a) Lira From Turkey receipt : 300,000
Lira : PKR Lira : PKR

0.9 : 1 0.87 : 1
300,000 : x 300,000 : x
X = 270,000 X = 261,000
Receive Less So, X = Rs.261, 000

(b) Payment to Saudi Arabia Rs.500,000
PKR : SAR PKR : SAR

1 : 1.45 1 : 1.42
500,000 : X 500,000 : X
X = 725,000 X = 710,000
Pay More SAR.725,000
(c) USA Payment SAR.300,00
SAR : $ SAR : $
2.90 : 1 2.85 : 1
300,000 : X 300,000 : X
X = 10,345 $ X = 10,526 $
Pay More So, 10,526 $
(d) USA Receipt € 500,000
€ : $ € : $
1 : 0.00458 1 : 0.00462
500,000 : X 500,000 : X
X = 22,900 $ X = 23,100 $
Receive less So, 22,900 $
Solution.4
Forward Agreement =$ 850,000
Actual Buy (60%) =$ 510,000
Over Hedge = $ 340,000
Actual Purchase (158 x 850,000) = 134,300,000

Sold (40% x 850,000 x 157.2) = (53,448,000)
Net Transaction Cost = Pkr.80, 852,000
Effective Rate (80,852,000/510,000) = 158.5/$
Solution.5
Currency of A 1+Interest Rate of A
IRP = X 1+Interest Rate of B
Currency of B
5.4670 1+0.14
= X
1 1+0.09

IRP = 5.717

Solution.6
Future Payment : ¥ 3,500,000 in 3 Months
1) Create Foreign Currency
2) Deposits [ 3500000
1+(0.1 X
3
)
] = 3414634
12
3) Transfer from UK
£ : ¥ £ : ¥
1 : 7.5509 1 : 7.5548
x : 3414634 x : 3414634
3414634 3414634
x = x =
7.5509 7.5548
x = 452215 x = 451982
Pay More £ 422215

4) Borrow in £ 452215
Interest (452215 x 6.860 x 3/12) 4723
461938
Effective Ratio = 3500000

= 7.576
461938
Solution.7
Future Payment : Euro 212500

1. Create Foreign Currency
2. Deposits [ 2125000
1+(0.0284X )
3 ] = 2110019
12
3. Transfer from UK
Euro : € Euro : €
1.2230 : 1 1.2270 : 1
2110019 : x 2110019 : x
2110019 2110019
x = x =
1.2230 1.2270
x = 1725281 x = 1719657
1725281
Pay 175281
Interest (1725281 X 0.0572 X 3/12)
Total Cost = 24671
Total Cost = 1749972
Solution.8
Future Payment in Foreign Currency

1. Create Foreign Currency Asset
2. Deposit [ 4000000
1+(0.07X )
3 ] 3931204
12

3. Transaction from Home (Pakistan)

£ : Pak (Rupees) £ : Rs
1 : 84.5 1 : 85
3931204 : x 3931204 : x
x = 3931204 X 84.5 x = 3931204 X 85
x = 332186738 x = 334152340
Pay More 334152340

4. Borrow from UK
Buy 334152340
Interest (334152340 X 14.5% X 3/12) 12113022
Total Cost 346265362
Forward Rate:
£ : Rs £ : Rs
1 : 86.2 1 : 85.6
4000000 : x 4000000 : x
x = 4000000X 86.2 x = 4000000 X 85.6
x = 344800000 x = 342400000
Forward Rate is Better because it is a

Cheaper Low Cost
Solution.9
Future Receipts in Foreign Currency
Create Foreign Currency Liability
Loan amount / Borrow [ 2500000

1+(0.07X )
3 ] 2457002
12
Transfers to Home
Lira : $ Lira : $
1.4498 : 1 1.4510 : 1
2457002 : x 2457002 : x
2457002 2457002
x = x =
1.4498 1.4510
x = 1694718 x = 1693316
Receive Less 1693316
Deposit in Earn Interest 1693316

Interest (1693316 X 0.08 X 3/12) 33866
Total Receipts $ 1727182
Effective Rate = 2500000
1727182
1.4474 / $
Solution.10
Create Foreign Currency Liability
Borrow / Loan amount ( 500000 ) 480769
1+0.08X6/12
Transfer to Home $
Tikka : $
480769 15 : 1
480769 : x
480769
x =
15
x = 32051
Deposit in Earn Interest 32051
Interest (32051 X 0.03 X 6/12) 481
Total Receipt 32532
OR
32051 x [1+0.03 x 6/12 ] = 32532
Solution.11
Create Foreign Currency Asset
Deposit [ 4000000
1+0.07X
3 ] 3931203
12
Transfer from UK
£ : $ £ : $
1 : 1.8625 1 : 1.8635
x : 3931203 x : 3931204
3931203 3931204
x = x =
1.8625 1.8635
x = 2110713 x = 2109580
Pay More 2110713

Borrow in UK
Buy = 2110713
Interest (2110713 X 14.25 X 3/12) = 75194
Total Cost = 2185908
Forward Contract:
400000
= 2168669
1.8625
Lead Time
400000
1.8625
= 2147651
Interest (2147651 X 14.25 % X 3/12) = 76510

Total Cost 2224161

Solution.12
15 - June
Import 223,500
Export (77,000)
Net import € 146,500
15 - March
Export € 98,500
Import £ 22,500,000
Forward Contract
15-June Import € 146,500 in - 6 month
Payment (146,500 x 123.54) = 18,098,610 £
15-March Export € 98,500 in – 6 month
Receipt (98,500 x 123.62) = 12,176,570 £
Payment of 22,500,000 £ is in our home currency So, there is no foreign exchange risk
and therefore, no forward contract is needed.
Money Market Hedge
15-June Import € 146,500 in - 6 month
1. Create foreign currency asset.
2. Deposit in foreign country:
146,500
= 6
(1+3%∗ )
=144,335 €
12
3. Convert into home currency:
144,335 x 124.52 = 17,972,594 £

4. Obtain loan in home currency = 17,972,594
Pay interest (17,972,594 x 11% x 6/12) = (988,493)
Net cost = 18,961,087 £
15-March Export € 98,500 in – 6 month
1. Create foreign currency Liability.
2. Obtain loan in foreign currency:
98,500 x (1+ 5% x3/12)-1 = 97,284 €
97,284 x 124.22 = 12,084,612 £
4. Deposit in home currency: = 12,084,612
And earn interest (12,084,612 x 6.5% x 3/12) = 196,375
Total receipt = 12,280,987 £
Import £ 22,500,000
Payment of 22,500,000 £ is in our home currency So, there is no foreign exchange risk
and therefore, no Money Market Hedge is needed.

Solution.13
1. A
€ : $
1 : 2
1 : 2.4 (2 X 120%)
x : 1000
x = 416.67 €
2. D
𝟏.𝟒𝟒 𝟏+𝟏𝟎%∗𝟑/𝟏𝟐
𝟏
∗ 𝟏+𝟒%∗ 𝟑 = $ 1.4641
𝟏𝟐
3.A
𝟔
𝟏+𝟕%∗
𝟐𝟎
∗ 𝟏𝟐
𝟔 = 𝟐𝟎. 𝟑𝟗
𝟏 𝟏+𝟑%∗
𝟏𝟐
4.B
19.63 1 + 15%
∗ = 20.58
1 1 + 10%

Solution.14
Hedge through Forward Contract
2500000 X 242.77 = 606925000
(b) Hedge through Future

1)
Hedge Date Transaction Date
1) December 31-March
2) Hedge Strategy
Buy Now Sell Later
3) No of Contracts
𝟐𝟓𝟎𝟎𝟎𝟎𝟎 = 5000 Lots OR Contracts

𝟓𝟎𝟎𝟎
4) Gain or Loss on Future
Buy (5000 X 500 X 242.17) = 605425000
Sell (5000 X 500 X W-1 242.32) = 60580000
Gain 375000
5) Gain or Loss on Spot
Actual Buy ( 2500000 X 237 ) 59250000
Could Buy ( 2500000 X 236.85) 59212500
Loss 375000
6) Computation of Net Cost
Actual Buy 59250000
Gain or Future 375000
Margin ( 7000 X 500 X 0.1 X 4/12) 125000
592250000
W-1
Spot 236.85 237
Basis 5.32 5.32
Future 242.17 242.32
At 239 Rate
Gain or Loss on Future
Buy ( 5000 X 500 X 242.17 ) = 605425000
Sell ( 5000 X 500 X W-2 244.32 ) = 610800000
Gain 5375000
Gain or Loss on Spot
Actual Buy ( 2500000 X 239) 597500000
Could Buy ( 2500000 X 236.85 ) 592125000
Loss 5375000
Computation of Net Cost
Actual Buy 597500000
Gain on Future 5375000
Margin ( 7500 X 500 X 0.1 X 4/12 ) 125000

Solution.15
1)
10th November 15-December
2) Hedge Strategy
Sell Now , Buy Later
3) No of Contracts lots
𝟏𝟗𝟕𝟎𝟎
= 19.7 ≈ 20 Contracts
𝟏𝟎𝟎𝟎

Sell ( 1000 X 20 X 33 ) 660000
Buy ( 1000 X 20 X 33 ) 506000
Gain 154000
Actual Sell ( 19700 X 25 ) 492500
Could Sell ( 19700 X 32 ) 630400
Loss 137900
6) Hedge Efficiency
𝟏𝟓𝟒𝟎𝟎𝟎
𝟏𝟑𝟕𝟗𝟎𝟎
= 111.67 %
Effective Hedging (85 % 120%)

7) Computation of Share of Price
Actual Sell 492500
Total Net Proceeds 646500
4) Gain
ShareorPrice
Loss on Future = 32.82/ Share
𝟔𝟒𝟔𝟓𝟎𝟎
Sell ( 1000 X 20 X 33 ) 660000
(b) . Buy ( 1000 X 20 X 37.2) 744000
𝟏𝟗𝟕𝟎𝟎
Loss 84000
2) Hedge Strategy Sell Now Buy Later
5)
3) Gain or Loss
No of Contracts on Spot
Actual Sell ( 19700 X 37 ) 728900
Could
𝟏𝟗𝟕𝟎𝟎 Sell ( 19700 X 32 ) 630400
= 19.7Gain
≈ 20 98500
𝟏𝟎𝟎𝟎
.
6) Hedge Efficiency
𝟖𝟒𝟎𝟎𝟎
𝟗𝟖𝟓𝟎𝟎

𝑿 𝟏𝟎𝟎 = 85.27%

Effective Hedging
7) Computation of share of Price

Actual Sell 728000
Loss on Future 84000
Net Proceeds 644900
Share Price = 𝟔𝟒𝟒𝟗𝟎𝟎 = 32.730 / Share

𝟏𝟗𝟕𝟎𝟎
Solution.16
1)

10th November 15-December
2) Hedge Strategy Buy Now Sell Later
3) No of Contracts
𝟑𝟏𝟔𝟎𝟎
= 31.6 ≈ 32
𝟏𝟎𝟎𝟎

Buy ( 1000 X 32 X 22 ) 704000
Sell ( 1000 X 32 X 29.5 ) 944000
Gain 240000
Actual Buy ( 31600 X 29 ) 916400
Could Buy ( 31600 X 22 ) 632000
Loss 284400
6) Hedge Efficiency
𝟐𝟒𝟎𝟎𝟎𝟎
X 100 = 84.38 %
𝟐𝟖𝟒𝟒𝟎𝟎
7) Computation of Share of Price

Actual Buy 916400
Total Net Proceeds 676400
𝟔𝟕𝟔𝟒𝟎𝟎
Effective Rate = 21.4 / Share
𝟑𝟏𝟔𝟎𝟎

Solution.17

10th Nov 10th January
Hedge Strategy
Sell Now Buy Later
No. of Contracts
Choices of Contract January
𝟗𝟑𝟖𝟎
No. of Contracts =
𝟑𝟎𝟎 = 31.26 ≈ 31
Gain or Loss on Future

Sell ( 300 X 31 X 45.5 ) 423150
Buy ( 300 X 31 X 40.8 ) 379440
Gain 43710
Gain or Loss on Spot

Actual sell ( 9380 X 40 ) 375200
Could Sell ( 9380 X 45 ) 422100
Loss 46900
Computation on Net Receipts

Actual Sell 375200
Future Gain 43710
Total Receipts 418910
Effective Rate = = 44.65 / SAR

𝟒𝟏𝟖𝟗𝟏𝟎
𝟗𝟑𝟖𝟎
X 100 = 93.1987
𝟒𝟑𝟕𝟏𝟎
Hedge Efficiency =
𝟒𝟔𝟗𝟎𝟎
Effective Hedging

Solution.18
Without Hedge:
Export-receipt € 697,500 on 19-may
Import-Payment £ 790,800 on 31-july
Receipt:
$ : €
1.3891 : 1
X : 697,500
X = 968,897
Actual receipt = 968,897
Could receipt = 971,199
Loss 2,301
Payment:
£ 790,800 on 31-july
Actual payment (790,800 x 1.9339) = 1,529,328
Could pay (790,800 x 1.9275) = 1,524,267
Loss = 5,061
With Hedge:
Export-receipt € 697,500 on 19-may
1. Hedge Strategy: Sell Now Buy Later
2. Choice of Contract: 30th June
Size: 697,500/100,000 = 7 Contracts
3.Gain/Loss on Future:
Sell (7 x 100,000 x 1.3875) = 971,250
Buy (7 x 100,000 x 1.3848) = 969,360
Loss = 1,890
4.Gain/Loss on Spot:
Actual sell (697,500 x 1.3891) = 968,897
Could sell (697,500 x 1.3924) = 971,199
Loss = 2302
Computation of Net Cost and Effective Rate:
Actual sell = 968,897
Gain on future = 1,890
Net receipt = 970,787
Effective rate (970,787/697,500) = 1.3918
Payment: £ 790,800 on 31-july
1. Hedge Strategy: buy Now Sell Later
2. Size of contracts 790,800/100,000 = 8 Contracts
3. Gain/loss on future:
Sell (8 x 100,000 x 1.0411) = 1,548,400
Buy (8 x 100,000 x 1.9355) =1,552,880
Gain = 4,480
4.Gain/Loss on spot:
Actual buy (790,800 x 1.9339) = 1,529,328
Could buy (790,800 x 1.9275) = 1,524,267
Loss = 5,061
Computation of net cost and effective rate:
Actual buy = 1,529,328
Gain on future = (4,480)

Net cost 1,524,848

Effective Rate (1,524,848/790,800) = 1.9282
Solution.19
Payment 1st may (Euro) €745,000
Hedge Strategy: Buy now sell later.
Size of contract and Choice of contract:
Number of contracts 745,000/125,000= 5.96 ≈ 6
Choice of contract 1st June
Gain/Loss on Futures:
Buy (6*125,000*0.9245) = 693,375
Sell (6*125,000*0.9373(w-1)) = 702,975
Gain = 9,600
Gain/Loss on Spot:
Actual Buy: (745,000*0.9351) = 696,650
Could Buy: (745,000*0.9212) = 686,294
Loss = (10,356)
Net cost and Effective rate:
Actual buy =696,650
Gain on future = (9,600)
Net cost =687,050
Effective rate (687,050/745,000) =0.9222
st
(w-1) future on 1 may:
01 April 01 May
Spot rate 0.9212 0.9351
Basis (bal) 0.0033 0.0022 (0.0033*2/3)
Future rate 0.9245 0.9373
Solution.20
1st September 15th Nov.(Transaction Date) Maturity Date November
Spot 156 158

Basis 2 2 X 0.5/3 0.333
Future 158 158.333
Basis 2 , 0.333
Future Price 158.333
Solution.21
Pvt. Option
Option 1 Option 2 Option 3

Strike Price 300 300 300
Market Price 180 260 380
Intrinsic Value 120 Yes Exercised 40 Yes Exercised (80) Not Exercised
Premium (60) (60) (60)
Gain / Loss 60 (20) (60)
Solution.22
Solution.23
Solution.24
1. Hedge Strategy: Put option
2. choidce and size of contract:
Choice-December
Size-16,300/1000 =16.3 ≈ 16
Selection of strike price: 86
Strike Premium net amount
80 1.9 (80-1.9) = 78.1
83 2.3 (83-2.3) = 80.7
86 3.0 (86-3) = 83
Note: in put option higher amount will be selected.
Solution.25
Hedge strategy: call option, payment $938,000
1.choice and size of contract:
Choice: January
Size: 938,000/100,000 = 9.38 = 9 contracts
2.Gain on option (if any):
Market price = 161.00
Strike price = (158.50)
Gain = 2.50
3.Computation of net cost and effective rate:
Actual payment (938,000 x 161) = 151,018,000
Gain on option (2.5 x 9 x 100,000) = 2,250,000
Premium (1 x 9 x 100,000) = (900,000)
Net cost = 149,668,000
Effective Rate (149,668,000/938,000) = 159.556
Solution.26
Option-1 Through Forward Contract:
175,000,000 x 1.9493 = 341,127,500
Option-2 Through Money Market Hedge:
1.Create Foreign currency asset.
2.Deposit in foreign Country:
175,000,000 x (1+3% x 3/12) = 173,697,271
173,797,271 x 1.9339 = 335,913,151
4. Obtain loan in home country: = 335,913,151
Interest (335,913,151 x 8% x 3/12) = 6,718,263
Total Payment = 342,631,414
Option-3 Trough Foreign Currency Future:

1.Hedge date 01-July ; Transaction Date 30-september
2.Hedge Strategy: Buy Now Sell Later.
3.Choice and Size of contract:
Choice: September
Contract size: 175,000,000/100,000 = 1,750 Contracts.
4.Computation of total payment:
Actual Buy (1,750 x 100,000 x 1.9421) =339,867,500

Add: Interest on premium = 35,000
(1000 x 1,750 x 8% x 3/12)
Total payment =339,902,500
Option-4 Hedge Through Options:

1. Hedge Strategy: Call Option
2. Choice of Contracts and Size of Contracts:
Choice: September
Size: 175,000,000/250,000 = 700 Contracts
3.Selection of Exercise price = 1.92
Strike Price + Premium = Net Value
1.90 + 3.55/100 = 1.9355
1.91 + 2.32/100 = 1.9322
1.92 + 1.15/100 = 1.9315
4. Computation of Total Payment:
Actual Payment (175,000,000 x 1.92) = 336,000,000
Add: Premium (700 x 250,000 x 0.0115)= 2,012,500
Total Cost 338,012,500
Conclusion:
In case of payment option of lowest cost is considered best so, option-4 is the lowest cot and best
option from all of the above options.
Solution.27
KIBOR rate = 6.5%
FRA rate = 5.3%
Gain = 1.2%
Net cost and Effective Borrowing:
Spot Borrowing = 87,500
FRA Borrowing = (15,000)
Net cost = 72,500
Effective Rate (72,500x12/3) = 290,000
Solution.28
Borrow Amount 6,000,000 3v15 at basic rate + 0.5
Interest (6,000,000 x 6.50% x 1) =390,000
Compensation (6,000,000 x 0.50% x 1) = (30,000)
Net Cost =360,000
Effective Rate (360,000x100/600,000) = 6%
Solution.29
Hedge strategy: Sell Now buy later
Gain/Loss on future:
Sell = 6.0%
Buy = 7.3%
gain = 0.7%
Net Cost:
Actual Borrow (10,000,000 x x7.8% x 3/12) =195,000
Gain on future (10,000,000 x 0.7% x3/12) = (17,500)
Net Interest Cost = 177,500

Solution.30
Invest 10,000,000$ for 3 months @ KIBOR less 0.5%.
Hedge Strategy: Buy Now Sell Later
Gain/Loss on Future:
Buy = 10.60%
Sell = 10.65%
Loss = 0.05%
Net Earnings:
Interest on investment (10m x 10.15% x 3/12) = 253,750
Less: Loss due to future (10m x 0.05% x 3/12) = (1,250)
Net Earning on Investments = 252,500
Solution.31
(a).
KIBOR = 3.9%
OPTIONS = 3.35%
Gain = 0.55%
NET Cost and effective rate:
Spot borrowing (10,000,000 x 3.9% 3/12) = 97,500
Gain on options (10,000,000 x 0.5% x 3/12) = (13,750)
Premium (10,000,000 x 0.2% x 3/12) = 5,000
Net Interest Cost = 88,750
Effective rate (88,750 x 12 x 100 /3 x 10,000,000) = 3.55%
(b)
Net Cost and Effective Rate:
Spot Borrowing (10,000,000 x 2.9% x 3/12) = 72,500
Premium (10,000,000 x 0.2% x 3/12) = 5,000
Net interest Cost 77,500
Effective Rate (77,500 x 12 x 100 /3 x 10,000,000) = 3.1%
Note: in case of loss in options, we don’t exercise the options.
Solution.32
Hedge Strategy: Buy now Sell Later
Number of Contracts 12.72 ≈ 13 tons
Gain/loss on future:
Buy (13 x 38,000) = (494,000)
Sell (13 x 41,000) = 533,000
Gain on future = 39,000
Net Cost and Effective Rate:
Actual Borrow (12.72 x 41,000 = 521,000
Gain on Future = (39,000)
Net Cost = 482,520
Effective Rate (482,520/12.72) = 37,934
Solution.33
Receipt-3 month 1,600,000$
Hedge Strategy: Sell Now Buy later
Contract Size 1,600,000/125,000 = 12.8 ≈ 13
Gain/Loss on Future:
Sell (13 x 125,000 x 175.500) =
Buy (13 x 125,000 x 174.155) =
Gain
Gain/Loss on Spot:
Actual Buy = 278,648,000Gain
on Future = 2,185,625 Net
receipt = 280,833,625
Effective rate (280,833,625/1,600,000) = 175.50
Solution.34
(a) Hedging through forward contract:
SL is expected to receive $50,000 in three months’ time. Therefore, it should enterinto a 3 months’ forward
contract to sell $50,000 as follows:
Amount $50,000
Forward rate PKR 177.555
On the date of settlement:
Payment in PKR (50,000 × 177.555) PKR 8,877,750
(b) Hedging through money market:

SL is expected to receive USD 50,000.
Step 1:
Borrow USD today for three months that would be equivalent to USD 50,000(principle and interest)
in three months’ time.
Annualized borrowing rate 2.75%
One month borrowing rate (2.75% × 3 ÷ 12) 0.006875 or 0.6875%
Amount to borrow (50,000 ÷ 1.006875) USD 49,659
Step 2:
Convert USD to PKR at the spot rate.
Spot rate 178.65
PKR amount (49,659 × 178.650) PKR 8,871,580
Step 3:
Put PKR on PKR deposit account for three months.
Annualized deposit rate 6.75%
Three months’ deposit rate (6.75% × 3 ÷ 12) 0.016875 or 1.6875%
Step 4:
On the date of settlement, principle and interest on PKR deposit account would be:
Amount from deposit account (8,871,580 +
8,871,580 × 1.6875%) PKR 9,021,288
Step 5:
On the settlement date, repay USD loan from USD receive from the customer.
(c) No hedging:
Amount USD 50,000
Spot rate 178.15
PKR [50,000 × 178.15] 8,907,500
Conclusion: The hedging through money market would be more beneficialfor SL as it would
result in the highest amount of receipts.

ANSWER-35
Karachi Kites Limited
(a) Setting up the hedge
Which future contract to choose?

The first future contract to mature after the expected receipt date will be chosen. As the
expected transaction date is 30 November, future contracts which mature on 30
November will be chosen.
Buy/Sell
KK will create a hedge with futures by selling November futures.
How many contracts

US$ 2,000,000 is equivalent to 16.667 contracts (2,000,000/120,000). Since thestandard lot
size is 1, 17 contracts would be used for hedging.
(b) Gain/Loss in terms of ticks Rupees

Open future position: sell at 213.5
Close position: buy at 218.5
Loss (5.0)
No. of ticks
Loss in ticks is (5×120,000/12) (50,000)
(c) Effective exchange rate Rupees

KK sells its receipts (2m×218.5) 437,000,000
Loss (17×120,000×5) (10,200,000)
Net receipts A 426,800,000
Effective exchange rate [A÷2m] (Rupees per USD) 213.40
ANSWER-36
(a)
Apart from market risk, businesses may be subject to the following financial risks:
Credit Risk:
Credit risk is the risk of loss as a result of a borrower's inability to make a payment on a debt obligation.
Some key strategies to manage credit risk are:
 Setting credit limits
 Regular monitoring
 Guarantees
 Credit insurance
Liquidity Risk
Liquidity risk is the risk that a business may not be able to meet its short-term obligations.
Some key strategies to manage liquidity risk are:
 Standing credit lines
 Regular monitoring of working capital ratios
Fifa Sports Limited

Step 1 – Compute required CNY to deposit now for 6 months
FSL will be paying CNY 1,000,000 in six months’ time.

The deposit rate will be 11.71%.

Interest rate for six months will be 11.71% × 6/12 = 5.855% or 0.05855.
Required amount now to make CNY 1,000,000 after 6 months
Final amount/ (1 + interest rate for the period) = 1,000,000 ÷ 1.05855 = CNY 944,689
Step 2 – Funds required in PKR to deposit CNY

Local currency equivalent = CNY 944,689 × PKR 34.5 = PKR 32,591,770
Step 3 - Borrow in PKR and pay in 6 months’ time (Interest & Principal)
The borrowing rate will be 17.16%.
Interest rate for six months will be 17.16% × 6/12 = 8.58%
PKR
Principal 32,591,770
Interest @8.58% 2,796,374
Total 35,388,144
Step 4 – Pay CNY on its due date and calculate effective rate
Convert the borrowed LC loan into FC and deposit. After 6 months the deposit will increase to CNY
1,000,000 which can be used to pay on the due date to the supplier.
Effective exchange rate

Effective Rate (PKR 35,388,144/CNY 1,000,000) = PKR 35.39
Conclusion:
The hedge is likely to be beneficial since the effective exchange rate is lower than the estimated actual spot
rate after 6 months.
ANSWER-37
(a) Hedging through futures and forwards
Hedging through futures

URT would have to sell 26 contracts as the standard contract size is one ton.
Open future position: sell at 93,500

Close position: buy on 29 February 2024 (87,500)
Profit 6,000
Total profit on futures (26 contracts × 6,000) 156,000
URT sells the rice in the spot market (87,500 × 25.59) 2,239,125
Add: Profit on futures 156,000
Net receipts 2,395,125
Hedging through forward contract

URT is expected to have 25.59 metric tons of rice in six months’ time. Therefore, it
will sell 25.59 tons as follows:
Metric tons 25.59
Forward rate 93,600
Receipts 2,395,224

(b) Strategy if spot price expected to be 102,000 / MT

If the expected spot price at 29 February 2024 is PKR 102,000 / MT, then the best
strategy for URT would be to not hedge at all, and instead sell the rice directly at the
spot rate. By doing this, URT can take advantage of higher expected spot price and
maximize its profit.
The strategy may however not be implemented because of the following reasons:
(i) The expected price is just an expectation and may not turn out to be true.
OR
The expected spot price may not be accurate, and the actual price could turn out
to be lower than the price available under the hedging strategies, resulting in
potential losses for URT.
(ii) While no-hedge strategy may result in a better position it is only after assuming
the risk of fall in price of rice.
OR
(iii) URT might have a lower risk tolerance and may prefer the certainty of a hedging
strategy, even if it means potentially lower profit.

Chapter 14
ANSWER-1
(a)
Sales Budget
Niks Args
Sales Units 4,500 4,000
Sale price per unit 32 44
Sales Revenue 144,000 176,000
(b)
Production Budget
Niks Args
Sales Units 4,500 4,000
Closing finished goods 400 1,200
Opening finished goods (900) (200)
Production Units 4,000 5,000
(c)
Raw Material Usage Budget
Material Material
Product A B
Niks – (4,000 x 1.5) 6,000
– (4,000 x 2) 8,000
Args – (5,000 x 0.5) 2,500
– (5,000 x 4) 20,000
Total Material Usage 8,500 28,000
(d)
Raw Material Purchase Budget
Material Material
A B
Raw material usage 8,500 28,000
Closing stock of Raw Material 600 1,000
Opening Stock of Raw Material (1,100) (6,000)
Raw Material Purchased 8,000 23,000
Purchase price Rs. 1.5 1
Cost of Purchase Rs. 12,000 23,000
(e)
Labor cost budget
Material Material
Product A B
Niks – (4,000 x 6) 24,000
Args – (5,000 x 9) 45,000
Wage rate / hour 1.6 1.6
Labour cost 38,400 72,000
Total Labour cost 110,400
(f)
Plant Utilization Budget
Machinin
Product g Assembly
Niks – (4,000 x 0.25) 1,000
– (4,000 x 0.2) 800
Args – (5,000 x 0.4) 2,000
– (5,000 x 0.3) 1,500

3,000 2,300
(g, h)
Factory Overheads Budget
Machining Assembly
FOH 39,500 18,650
Depreciation of Plant
Existing – (100,000 x 5%) 5,000
– (87,000 x 5%) 4,350
New – (20,000 x 5% x 6 ) 500
45,000 23,000
45,000 15 23,000
FOH Absorption Rate 3,000
= Rs.
Machine
hour
2,300
= Rs. 10/Machine hour
(i)
Factory Cost Per Unit
Niks Args
Material Rs. Rs.
A – Niks (1.5 x 1.5) 2.25
A – Args (0.5 x 1.5) 0.75
B – Niks (2 x 1) 2
B – Args (4 x 1) 4
Labor
Niks (6 x 1.6) 9.6
Args (9 x 1.6) 14.4
FOH Applied Rate
Machining
Niks (15 x 15) 3.75
60
Args (15 x 15) 6
60
Assembly
Niks (10 x 12) 2
60
Args (10 x 18)
60 3
Factory Cost Per Unit 19.6 28.15
(j)
Cost of sales budget
Niks Args
Rs. Rs.
Opening Finished Good
Niks (20 x 900) 18,000
Args (28 x 200) 5,600
Production Cost
Niks (19.6 x 4,000) 78,400
Args (28.15 x 5,000) 140,750
Closing Finished Good
Niks (19.6 x 400) (7,840)
Args (28.15 x 1,200) (33,780)
88,560 112,570

(k)
Plagued Engineering
Budgeted Income statement
Niks Args Total
Rs. Rs. Rs.
Sales 144,000 176,000 320,000
Cost of sales (88,560) (112,570) (201,130)
Gross Profit 55,440 63,430 118,870
Selling & Admin expenses (30,400)
Net Profit 88,470
(l)
Plagued Engineering
Cash Budget
Q1 Q2 Q3 Q4
Rs. Rs. Rs. Rs.
Opening balance 4,300 24,300 (4,700) (130,700)
Receipts
Receipts from customer 70,000 100,000 100,000 40,000
Payments
Material (7,000) (9,000) (10,000) (5,000)
Wages (33,000) (20,000) (11,000) (15,000)
Other cost & expense (10,000) (100,000) (205,000) (5,000)
Closing Balance 24,300 (4,700) (130,700) (115,700)
Plagued Engineering
Budgeted balance sheet
For the year ended 31March 2008
Rs Rs
Assets
Non-current
Land & building (180+45) 225,000
Plant & Equipment (187+20) 207,000
Accounting Depreciation (75+9.85) 84,850 122,150
Current
Raw material
Material A (600x1.5) 900
Material B (1000x1) 1,000 1,900
Finished Goods
Niks 7,840
Args 33,780 41,620
Receivables 29,500
73,020
420,170
Equity & Liabilities
Share capital 150,000
Accounting profit (55,250 + 88,470) 143,720 293,720

Liabilities
Payable 10,750
Bank overdraft 115,700 126,450
420,170
Workings:
W-1
Dr. Debtors A/c
Cr.
Rs. Rs.
Op. bal. 19,500 Cash received 310,000
(70 + 100 + 100 + 40)
Sale 320,000 Closing 29,500
(144 + 176)
339,500 339,500
Dr. Creditors A/c
Cr.
Rs. Rs.
Cash 430,000 b/d 6,800
Purchases A 12,000
B 23,000
Labour 110,400
FOH M 39,500
A 18,650
Admin & Selling 30,400
Land 180,000
Bal. c/d 10,750 Plant 20,000
440,750 440,750
ANSWER-2
a. SALES BUDGET
Units SELLING TOTAL
PRICE REVENUE
/UNIT (Rs.) (Rs.)
Star 8,000 500 4,000,000
Bright 2,000 450 900,000
4,900,000
b. PRODUCTION BUDGET
STAR BRIGHT
Sales 8,000 2,000
Closing stock 1,800 200
Units Required 9,800 2,200
Opening stock (2,000) (500)
c. Direct material usage budget
X Y
Star (3 x 7,800) ; (5 x 7,800) 23,400 39,000
Bright (5 x 1,700) ; (4 x 1,700) 8,500 6,800
31,900 45,800
Material Price/kg x 20 x 15

638,000 687,000

d. Material purchase budget

Material X Material Y
(kgs) (kgs)
Material usage 31900 45,800
Ending stock 4,000 7,000
Material required 35,900 52,800
Already in stock (Opening) (5,000) (6,000)
Total purchases (units) 30,900 46,800
Unit Price Rs. 20/kg Rs. 15/kg
Purchases (In Rs.) 618,000 702,000
e. Direct labour budget

STAR BRIGHT TOTAL
Dept Hrs. Rate Total Hrs. Rate Total Hrs. Rate Total
Rs.‘000 Rs.‘000 Rs.‘000
1 *39,000 10 390 ***4,250 10 42.5 43,250 10 432.5
2 **31,200 12 374.4 ****10,200 12 122.4 41,400 12 496.8
764.4 164.9 929.3
* 7800 units x 5hrs/unit = 39,000
** 7800 units x 4hrs/unit = 31,200
*** 1700 units x 2.5hrs/unit = 4,250
**** 1700 units x 6hrs/unit = 10,200
f. Dept1 Factory overhead budget

Dep 1 Dep 2
Rs. Rs.
Variable FOH
Indirect labour
(4x5x7800) 156,000
(3x4x7800) 93,600
(4x2.5x1700) 17,000
(3x6x1700) 30,600
173,000 124,200
Electricity
(3x5x7800) 117,000
(5x4x7800) 156,000
(3x2.5x1700) 12,750
(5x6x1700)
51,000
129,750 207,000
Maintenance
(2x5x7800) 78,000
(4x4x7800) 124,800

(2x2.5x1700) 8,500

(4x6x1700) 40,800
86,500 165,600
Total 389,250 496,800
Fixed FOHs
Rent 50,000 45,000
Supervision 20,000 10,000
Electricity 6,500 5,000
Maintenance 10,000 2,100
86,500 62,100
Labour hours ÷ ÷
(5 x 7,800 + 2.5 x 1,700) 43,250
(4 x 7,800 + 6 x 1,700) 41,400
Rs. 2/L.H Rs. 1.5/L.H
(g) Selling and administration budget
Rs.
Salaries 30,000
Depreciation 20,000
Advertising 25,000
Miscellaneous 10,000
Total 85,000
(h)
XYZ COMPANY
CASH BUDGET
FOR SIX MONTH PERIOD ENDING JUNE, 200Y
-----------------------Rs.000---------------------------
Q1 Q2 Q3 Q4 TOTAL
Opening Balance 1,000 900 1,000 1,000
Receipts
Receipts from customers 800 1,000 800 900 3,500
Payments
Purchase of material (400) (200) (300) (100) (1,000)
Payment of wages (200) (500) (100) (129.3) (929.3)
Other expenses (300) (200) (400) (100) (1,000)
Closing balance 900 1000 1000 1570.7 1570.7

ANSWER-3
(a) Cost of Goods Sold Budget
Particulars (Rs.)
Direct Material (W-2) 378,000
Direct Wages (W-3) 210,000
Overhead (W-6) 285,000
873,000
Add: opening Stock 240,000
Less: Closing Stock (W-12) (200,700)
Cost of Goods sold 912,300
(b) Cash Budget
Particulars (Rs.)
Opening Balance 60,000
Receipts (W-9) 1,260,000
Total Receipts (A) 1,320,000
Payments:
Creditors (W-11) 420,000
Direct Wages (W-3) 210,000
Overheads (W-6) 225,000
Selling, Distribution and Administration Expenses 180,900
Income Tax 60,000
Capital Expenditure 120,000
(1,215,900
Total Payment (B) )
Closing Balance (A) - (B) 104,100
(c) Projected Balance Sheet as at March, 31, 2013
Assets Rs.
Non - Current Assets
Fixed Assets (Net) 960,000
Current Assets
Inventories 356,700
Trade Receivables 150,000
Cash and Cash Equivalents 1,04,100
1,570,800
Equity and liabilities
Shareholder’s Funds
Share Capital 1,200,000
Reserve and Surplus* 254,760
Current liabilities
Trade Payables 48,000
Short- term Provisions
Provision for Income Tax 68,040
1,570,800
*Reserve & Surplus
Particulars (Rs.)
Sales (W 8) 1,320,000
Less: Cost of Goods Sold (912,300)
Gross Profit 407,700
Less: Selling Dist. & Admin Expenses (180,900)

Less: Provision for tax (30%) (68,040)

Profit after tax 158,760
Add: Opening Balance of Reserve & Surplus 96,000
Closing Balance of Reserve Surplus 254,760
W-1
Production Budget (Units)
Particulars A B
Sales 24,000 15,000
Add: Closing Stock 6,600 3,000
Total 30,600 18,000
Less : opening Stock (600) (6,000)
W-2
Direct material Cost
Particulars A B Total
(Rs.) (Rs.) (Rs.)
Material X (2 x 3) : (4 x 3) 6 12
Material Y (1 x 1) : (2 x 1) 1 2
Material Cost (per unit)... (a) 7 14
Production (units)...(b) 30,000 12,000
Direct Material Cost (Rs.)...(a) x (b) 210,000 168,000 378,000
W-3
Direct Labour Cost
Particulars A B Total
(Rs.) (Rs.) (Rs.)
Dept P : 2hr (2 x 1) : (1 x 2) 2 2
Dept Q: 1 hr. (1 x 3) : (1 x 3) 3 3
Direct Labour Cost (per unit ) ... (a) 5 5
Production (units)...(b) 30,000 12,000
Direct Labour Cost (Rs.) ...(a) x(b) 150,000 60,000 210,000
W-4
Direct Labour Hours
Dept. Q
Dept. P Rs.
Particulars Rs.
A: P 30,000 x 2 hrs. Q 30,000 x 1 hr. 60,000 30,000
B: P 12,000 x 1 hrs. Q 12,000 x 1 hr. 12,000 12,000
72,000 42,000
W-5
Overhead Recovery Rate
Particulars Dept. P Dept. Q
Fixed Overheads: (Rs.) (Rs.)
Depreciation 48,000 12,000
Others 96,000 30,000
Total 144,000 42,000
Direct Labour Hours 72,000 42,000
Fixed Overhead (rate per hr.) ...(a) (144,000) (42,000) 2.00 1.00
72,000 42,000
Variable Overhead (rate per hr.)...(b) (0.50) (1.50)
Total Overhead (rate per hr.)...(a) + (b) 2.50 2.50
W-6

Overhead Expenses
Particulars Dept P Dept Q Total
(Rs.) (Rs.) (Rs.)
Fixed (other than Depreciation) 96,000 30,000
Variable [72,000 hr. x Rs.0.50 ; 42,000 hr. x Rs.1.50] 36,000 63,000
Overheads (other than Depreciation (a)) 132,000 93,000 225,000
Depreciation (b) 48,000 12,000 60,000
Total Overhead (a) + (b) 180,000 105,000 285,000
W-7
Cost Sheet
Particulars Products
A B Total
(Rs.) (Rs.) (Rs.)
Direct Material (per unit) 7.00 14.00
Direct Wages (per unit) 5.00 5.00
Overhead (per unit) [Dept. P] (2 x 2.5) : (1 x 2.5) 5.00 2.50
[Dept. Q] (1 x 2.5) : (1 x 2.5) 2.50 2.50
Total Cost (per Unit) (a) 19.50 24.00
Production (b) 30,000 12,000
Total Cost (a) x (b) 585,000 288,000 873,000
W-8
Sales
Particulars Rs.
A 24,000 units x Rs. 30 720,000
B 15,000 units x Rs. 40 600,000
Total 1,320,000
W-9
Trade Receivables
Particulars Rs.
Add: Sales 1,320,000
Total 1,410,000
Less: Closing Balance (150,000)
Cash Receipts 1,260,000
W-10
Raw Material
Particulars Material Total
X Y (Rs.)
(kg.) (Kg.)
Consumption for ‘A’ 60,000 30,000
Consumption for ‘B’ 48,000 24,000
Total Consumption 108,000 54,000
Add: Closing Stock 48,000 12,000
156,000 66,000
Less: Opening Stock (36,000) (6,000)
Material to be Purchase 120,000 60,000
Purchase Price per Kg. Rs. 3 Rs. 1
Purchase Value (Rs.) 360,000 60,000 420,000
W-11
Trade Payables
Particulars (Rs.)


Add: Purchases 420,000
468,000
Less: Closing Balance (48,000)
Paid 420,000
W-12
Inventories as on 31-03-2013
Particulars (Rs.) (Rs.)
Raw Material: ’X’ 48,000 units x Rs. 3 144,000
‘Y’12,000 units x Rs. 1 12,000 156,000
Finished Goods: ‘A’ 6,600 x Rs. 19.50 128,700
‘B’ 3,000 x Rs. 24.00 72,000 200,700
W-13
Fixed Assets as at 31.03.2013
Particulars (Rs.)
Opening Values of Fixed Assets 900,000
Add: Additions 120,000
Less: Depreciation (60,000)
960,000
ANSWER-4
(a) Production budget
-----------------------Units-------------------
----
Product Product Product
A C E
Sales 140 190 420
Closing Stock 25 38 50
Opening Stock (30) (36) (90)
Production required 135 192 380
Add: Excess to cover normal loss 15 48 20
Production budget 150 240 400
Budgeted sales value
(1) Sales units =
EXpected selling price
Expected selling price = Expected unit cost plus expected profit ie,
(2)
Product A Rs.24 x100/80 = Rs. 30
Product B Rs.15 x 100/75 = Rs. 20
Product E Rs.20 x 100/83 = Rs. 24
Budgeted stock values
(3) Stock units = EXpected unit costs
Additional requirements to cover normal loss of production:
(4)
Required production x Loss percentage
Normal production percentage
i.e, Product A 135 x 10/90 = 15 units
Product C 192 x 20/80 = 48 units
Product E 380 x 5/95 = 20 units
(b) Direct wages budget
Product A Product C Product E Total
Hours Rs.’000 Hours Rs.’000 Hours Rs.’000
Department F:
Grade 1 (@ Rs.1.80/hr) 150 270 360 648 200 360 1,278
Grade 2 (@ Rs.1.60/hr) 112.5 180 240 384 300 480 1,044

450 1,032 840 2,322
Department G:
Grade 1 (@ Rs.2.00/hr) 225 450 120 240 200 400 1,090
Grade 2 (@ Rs.1.80/hr) 150 270 180 324 500 900 1,494
720 564 1,300 2,584
Total budget 1,170 1,596 2,140 4,906
Note: hours budgeted represent production budget units at expected labour times.
ANSWER-5
(a) Production budget
J K
Units Units
Opening stock (600) (800)
Closing stock (85%) 510 680
Sales 10,000 6,000
Production for the year 9,910 5,880
(b) Raw materials purchases budget

X Y
Kg Kg
Production (per (i))
J (10 kg : 4 kg) 99,100 39,640
K (6 kg : 8 kg) 35,280 47,040
Opening stock (400) (200)
Closing stock 85% 340 170
134,320 86,650
X Y
Cost per kg Rs. 1.50 Rs. 4.00

Purchase cost Rs. Rs.
201,480 346,600
(c) Production cost budget

Rs. Rs.
Materials
Opening stock (400 kg x Rs. 1.20 + 200 kg x Rs .3) 1,080

Purchase Rs. (201,480 + 346,600) 548,080
549,160
Closing stock (340 kg x Rs. 1.50 + 170 kg x Rs. 4) (1,190)
547,970
Skilled labour (W1) 497,880
Variable overhead (82,980 x 2) 165,960
Fixed overhead 315,900
1,527,710
Workings:
1 Labour hours budget
Units production per (i) 9,910 5,880
Hours per unit 6 4
Total hours 59,460 23,520
Labour Rate/Hour x Rs. 6 x Rs. 6
RISE School of Accountancy 356,760 141,120 Page 374
497,880
ANSWER-6
X plc
(a)
Sales budget in quantity and value
July August September Total
Sales units 400 300 600 1,300
Sale price/unit Rs. 250 Rs. 250 Rs. 250 Rs. 250
Sales value (Rs.) 250/unit 100,000 75,000 150,000 325,000
(b)
Production budget in units Units
Required by sales 1,300

Required closing stock 225
opening stock (200)
Good output required 1,325

Normal loss (1,325 x 1/9) 147
Production required 1,472
(c)
Raw material usage budget Kg
Material A 1,472 x 3 4,416
Material B 1,472 x 2 2,944
Material C 1,472 x 4 5,888
(d)
Raw material purchases budget A B C Total
Kgs Kgs Kgs
Raw Material Usage 4,416 2,944 5,888
Stock increase (20%) 200 80 120
Purchases in kgs 4,616 3,024 6,008
Cost per kg Rs. 3.50 Rs. 5.00 Rs. 4.50
Purchase cost Rs. 16,156 Rs. 15,120 Rs. 27,036 Rs. 58,312
(e)
Labour requirements budget
Production in units 1,472
Labour hours per unit 10
Total hours 14,720
Cost per hour Rs. 8.00
Total cost Rs. 117,760
A B C
kgs kgs Kgs
Raw Material usage 4,416 2,944 5,888
Opening Raw Material (1,000) (400) (600)
Closing Raw Material 1,200 480 720
4,616 3,024 6,008

ANSWER-7
a)
QAVI & QAMAR
PROJECTED PROFIT AND LOSS ACCOUNT
AT 60% AND 80% CAPACITY UTILIZATION
(Figures in Rupees)
60% 80%
Rs. Rs.
Sales (6,000 x 2,000 x 98%) : (8,000 x 2,000 x 95%) 11,760,000 15,200,000
Less: Cost of goods sold:
Materials (6,000 x 1,000 x 1.02) 6,120,000 8,400,000
Labour (600 x 300) : (8,000 x 300) 1,800,000 2,400,000
Variable manufacturing overhead (6,000 x 180) : (8,000 x 180) 1,080,000 1,440,000
Fixed manufacturing overhead (10,000 x 120) : (10,000 x 120) 1,200,000 1,200,000
(10,200,000) (13,440,000)
Gross Profit 1,560,000 1,760,000
Less: Operating expenses:
Administration – Fixed (10,000 x 40) : (10,000 x 40) 400,000 400,000
Administration – Variable (6,000 x 60) : (8,000 x 60) 360,000 480,000
Marketing – Fixed (10,000 x 60) : (10,000 x 60) 600,000 600,000
Marketing – Variable (6,000 x 40) : (8,000 x 40) 240,000 320,000
(1,600,000) (1,800,000)
(40,000) (40,000)
Workings:
W-1
Units
Current operations at 50% Capacity 5,000
Maximum capicity 5,000 x 100% / 50% 10,000
Projected operations at
(10,000 x 60%) 6,000
60%
Projected operations at
80% (10,000) x 80%) 8,000
* As these expenditure are fixed so it should be taken in total on 100% activity level.
b) Above calculations show that the company is indifferent in choosing between the capacity levels,
loss reflected by both is the same. Because fixed costs are constant up to normal capacitylevel are
– decrease in selling price is being off-settled by increase in material cost.
It is advisable that company should tend to work at 60% capacity thereby saving some capacity
which may be used in some other profitable alternatives.

ANSWER-8
a) Flexible budget statement for next year operating at 85% capacity
Workings
Output (W-1) 13,077 units
Rs. Rs.
Sales revenue (W-7) 5,911,484
Variable costs
Direct materials (W-2) 1,386,162
Direct wages (W-3) 2,357,129
Variable production overhead (W-4) 489,734
Variable selling and distribution overhead (W-5) 69,962
4,302,987
Contribution 1,608,497
Fixed costs
Production overhead (W-4) 330,000
Selling and distribution overhead (W-5) 161,250
(W-6) 132,000
623,250
Profit 985,247
Workings:
W-1 65% of capacity = 10,000 units
100% of capacity = 10,000/0.65 = 15,385 units
85% of capacity = (10,000/0.65) x 0.85 = 13,077 units
75% of capacity = 11,538 units
55% of capacity = 8,462 units
W-2 Current direct material cost per unit =Rs.1,000,000/10,000
=Rs.100 per unit
Flexible budget allowance for next year =Rs.100 x 1.06 x 13,077
=Rs.1,386,162
W-3 Current direct wages cost per unit =Rs.1,750,000/10,000
=Rs.175 per unit
Flexible budget allowance for next year =Rs.175 x 1.03 x 13,077
=Rs.2,357,129
W-4
Production Overheads:
Units Total FOH Variable FOH Fixed FOH
11,538 703,830 403,830 300,000
8,462 596,170
3,076 107,660
Variable FOH = 107,660 = Rs. 35/unit

3,076
At 85% Capacity
Variable FOH = 13,077 x 35 x 1.07 = Rs. 489,734
Fixed FOH = 300,000 x 1.1 = Rs. 330,000

W-5
Selling over Heads:
11,538 207,690 57,690 150,000
8,462 192,310
3,076 15,380
Variable sellings Distribution = 15,380 = Rs. 5/unit
3,076
At 85% Capacity
Variable selling & Distribution = 13,077 x 5 x 1.07 = Rs. 69,962
Fixed selling & Distribution = 150,000 x 1.075 = Rs. 161,250
W-6 Administration overhead =Rs. 120,000 x 1.1 =Rs. 132,000
W-7 The cost and selling price structure is as follows.
%
Sales price 100.00
Profit 16.67
Cost 83.33
Profit as a percentage of cost = 16.67 x 100% = 20% of cost
83.33
Total cost (Rs. 4,302,987 +Rs. 623,250) 4,926,237

Profit at 20% of cost 985,247
Sales value 5,911,484
ANSWER-9
Flexed Budget Actual for period Variances
(80,000 units) (80,000 units) for period
Rs.’000’ Rs.’000’ Rs.’000’
Sales 1,200 1,240 40 (F)
Variable costs
Raw materials (600) (632.4) 32.4 (A)
Labour (140) (115. 2) 24.8 (F)
Production overheads (120) (128.0) 8 (A)
(860) (875.6)
Contribution 340 364.4
Less: Fixed Cost
Labour 50 50 Nil
Production overheads 100 110 10.0 (A)
(150) (160.0)
Gross profit 190 204.4 14.4 (F)
Workings:
Sales:
1,350,000
Sale Revenue = x 80,000 = Rs. 1,200,000
90,000
Raw materials:
Variable cost per unit = 675,000 – 450,000 = Rs. 7.50 per unit
90,000 – 60,000
Alternatively, 675,000/90,000 = Rs.7.50 per unit

Raw material cost at 80,000 units = 80,000 x 7.50 = Rs.600,000
Labour:
Units Total cost Fixed cost Variable cost

90,000 207,500 50,000 157,500
60,000 155,000
30,000 52,500
Variable cost per unit = 207,500 – 155,000 = Rs. 1.75 per unit
90,000 – 60,000
Labour cost = 80,000 x 1.75 + 50,000 = Rs. 190,000

Factory Overheads:
90,000 235,000 135,000 100,000
60,000 190,000
30,000 45,000
Variable FOH = 45,000 = Rs. 1.5/unit

30,000
Total Variable FOH at 80,000 units = 80,000 x 1.5 = Rs. 120,000

ANSWER-10
Noble restaurant
Flexed budget
Number of meals 1,560
Rs. Rs.
Food sales (W1) 62,400
Drink sales (W1) 15,600
Total revenue 78,000
Variable costs:
Staff wages (W2) (12,672)
Food costs (62,400 x 12.5%) (7,800)
Drink costs (15,600 x 20%) (3,120)
Energy costs (5) (4,234)
(27,826)
Contribution 50,174
Fixed costs:
Manager’s and chef’s pay (8,600)
Rent, rates and depreciation (4,500)
(13,100)
Operating profit 37,074
Workings:
W-1 Food revenue
Food revenue = 1,560 x Rs. 40 = Rs. 62,400
Drinks revenue = 1,560 x (Rs. 2.50 x 4) = Rs. 15,600
W-2 Staff wages
Average number of orders per day = 1,560/(6 days x 4 weeks) = 65 per day.
Normal orders per day = 50
Therefore extra orders = (65-50) =15 per day.
Overtime Pay
Extra Hour =8 staff x 1.5 hours x 6 days x 4 weeks
= 288 extra hours.
At Rs. 12 per hour = Rs. 3,456 extra wages.
Total flexed wages = Rs. 9,216 (W-2.1) + Rs. 3,456 = Rs. 12,672.
W-2.1 = 4 x 6 x 8 x 6 x 8 = 9,216

W-3 Energy costs

Standard total hours worked = (8 x 6) x 6 days x 4 weeks = 1,152 hours.
Extra hours worked = 288 (working 2).

Total hours = 1,152 + 288 = 1,440.

Energy costs = 1,440 x 2.94 = Rs. 4,233.6
ANSWER-11
Flexible Budgeting
We begin by calculating the budgeted sales revenue and variable costs at a sales level of 720,000 units.
Revenue/cost Revenue/cost per unit Revenue/cost
for for
640,000 720,000
Units Units
Rs. 000 Rs. 000 Rs. 000
Sales 1,024 1.6 1,152
Variable costs
Materials 168 0.2625 189
Labour 240 0.3750 270
Overheads 32 0.0500 36
Selling and distribution costs 144 0.2250 162
Administration costs 48 0.0750 54
Revised quarterly performance reprot (based on sales of 720,000 units)
Flexed Actual Variance
budget
Sales level (units) 720,000 720,000 -
Rs.’000 Rs.’000 Rs.’000
Sales 1,152 1,071 81 (A)
Cost of sales
Materials (189) (144) 45 (F)
Labour
Fixed (100) (94) 6 (F)
Variable (270) (288) 18 (A)
Overheads (36) (36) -
Gross profit 557 509 48 (A)
Other overheads
Selling and distribution costs
Fixed (72) (83) 11 (A)
Variable (162) (153) 9 (F)
Administration costs
Fixed (184) (176) 8 (F)
Variable (54) (54) -
Net profit 85 43 42 (A)
(A) denotes an adverse variance,
(F) a favorable variance.

ANSWER-12
X Y X2 XY
January 5.8 40.3 33.64 233.74
February 7.7 47.1 59.29 362.67
March 8.2 48.7 67.24 399.34
April 6.1 40.6 37.21 247.66
May 6.5 44.5 42.25 289.25
June 7.5 47.1 56.25 353.25
41.8 268.3 295.88 1,885.91
nΣ Xy− ΣX Σy 6(1,885.91)−(41.8)(268.3)
b= =
nΣX 2 −(ΣX)2 6(295.88)−(41.8)2
11,315.46−11,214.94
b= = 100.52 = 3.585
1,775.28−1,747.24 28.04
This is the cost in millions of rupees of making 1,000 units)

Σy bΣX 268.3 3.585(41.8)
a= n
- n
= 6
- 6
a = 44.72 – 24.98 = 19.74
y = a + bx
y = 19.74 + 3.585x
ANSWER-13
Output Total cost
units Rs.000
X Y Σx2 Σxy Σy2
5 20 25 100 400
9 27 81 243 729
4 17 16 68 289
5 19 25 95 361
6 23 36 138 529
Σx = 29 Σy =106 Σx =183
2
Σxy =644 Σy = 2,308
2
There are five pairs of data, so n = 5.

nΣXy − ΣX Σy 5 (644) − (29)(106) 3,220−3,074 146
b= 2
= 2
= =
nΣX2 – (ΣX) 5 (183)−(29) 915−841 74
b (in Rs.000) = 1.97

Σy bΣX 106 1.97(29)
a= – = − =21.2 - 11.4
n n 5 5
a (in Rs.000) = 9.8
(a) The estimate of monthly fixed costs and the variable cost per unit is therefore: y = 9,800+
1.970X.
When output is expected to be 8 units, the expected total costs will be:
Rs.
Fixed 9,800
Variable (8 x Rs.1,970) 15,760
Total costs 25,560

ANSWER-14
Budgeted profit or loss statement
For the year ending August 31, 2020
Rs. in million
Sales (W-1) 7,995.0
Cost of goods sold:
Material (W-3) 2,120.4
Labour (W-4) 792.0
Manufacturing overheads (W-5) 591.3
Purchase from market (W-2) (75,000×2,400) 180.0
(3,683.7)
Gross Profit 4,311.3
Less: Selling & Administration expenses (426×1.1) (468.6)
Profit before tax 3,842.7
W-1: Sales Standard Premium Total

Ratio of sale price 1 2
Actual sale quantity (units) A 900,000 600,000
Weighted quantity (units) 900,000 1,200,000 2,100,000
Sales value (Rs. in million)
[900/2,100×5,250,000,1,200/2,100×5,250,000] B 2,250 3,000 5,250
Sales price (Rs.) C=B/A 2,500 5,000
Revised sale price (Rs.) (C×1.1,1.15) 2,750 5,750
Sales for 2021 (Rs. in million) 2,475 6,037.5 8,512.5
(1,050,000{w-2}
(900,000×2,750) ×5,750)
(450,000×5,750×0.2)
Less: Discount (Rs. in million) (517.5)
Net sales (Rs. in million) 7,995
W-2: Purchase from market Standard Premium

Production at current capacity D 900,000 600,000
Production at full capacity [E=D/0.75] 1,200,000 800,000
Maximum production of premium withexisting

capacity (units) F=[(1,200/1.5)+800] 1,600,000
Demand for Premium (units) G=(600,000+450,000) 1,050,000

Remaining capacity for Standard (units) [(F–G)×1.5] 825,000
To be purchased from market (units) (900,000–825,000) 75,000
W-3: Material
Consumed - 2020 (kg) (900,000×1.6+600,000×2) 2,640,000
Material cost (Rs. in million) 1,584
Price per kg (Rs.) (1,584,000/2,640) 600
Material for 2021

Required (kg) (825×1.6,1050×2) 3,420,000
Average cost per kg (Rs.) (600×4+600×1.05×8)/12 620
Total material cost (Rs. in million) (3,420×620) 2,120.4
W-4: Labour
Total labour hours utilized in 2020 [300,000(900,000÷3)+300,000(600,000÷3×1.5)] 600,000

Labour cost - 2020 (Rs. in million) 540
Labour rate per hour (Rs.) (540,000/600) 900
Labour for 2021

Revised rate (Rs.) (900×1.1) 990
Labour hours required (825÷3)+(1,050÷3×1.5) 800,000

Total labour cost (Rs. in million) (800,000×990) 792
W-5: Manufacturing overheads Standard Premium Total
Variable manufacturing overhead (440×0.75) 330,000,000
Ratio of variable overheads 1.00 1.25
Units produced A 900,000 600,000
Weighted average ratio 900,000 750,000 1,650,00
0
Overheads [900/1,650×330,000,750/1,650×330,000] B 180,000,000 150,000,000 330,000,000
Cost per unit B/A 200 250
Manufacturing overheads for 2021 -------------- Rs. in million -----------------

Fixed manufacturing overheads
(440×0.25×1.1) 121.0
Variable manufacturing overheads 181.5 288.8 470.3
(825×200×1.1) (1,050×250×1.1)
Total manufacturing overheads cost 591.3
ANSWER-15
Rs. in million
Sales [5.775 (W-1)  1,650 (W-2)] 9,529
Less: Sales commission (W-3) (126)
Net sales 9,403
Cost of goods sold:
Material (3,140  1.15  1.08) 3,900
Labour (645  1.15  1.08  1.2) 961
Manufacturing overheads (W-4) 1,046
Imported locks (462,000 (W-1)  1,500) 693
(6,600)
Gross profit 2,803
Selling expenses (W-5) (568)
Administration expenses [(27623)  1.05] + 23 (289)
Net profit 1,946
WORKINGS
W-1: No. of locks
Required production (6,000,000  0.77 = 4,620,000  1.25) 5,775,000
Less: Maximum production due to labour constraints (4,620,000  1.15) 5,313,000
Locks to be imported from chinese company 462,000
W-1.1: No. of locks

Increase in total sales (5,775,000  4,620,000) 1,155,000

W-2:
Selling price per unit [6,930 million  4.62 + 150] Rs. 1,650
W-3: Sales commission
increased
Existing No. of Avg. unit Commission Commission
Categories sales (W- Total sales
sales persons sale / person % (Rs.)
1.1)
Units
(A) (B) (AxB)x1,650
A 924,000 11,500 1,039,500 20 51,975 1.25% 21,439,688
B 1,386,000 346,500 1,832,500 24 72,188 1,50% 42,879,375
C 2,310,000 693,000 3,003,000 46 65,283 1.25% 61,936,875
4,620,000 1,155,000 5,775,000 90 126,255,938
W-4: Manufacturing overheads Rs. in million

Fixed overheads other than depreciation [(625  415)  1.05] 221
Depreciation (W-4.1) 409
Variable overheads [(960  625)  1.15  1.08] 416
1,046
W-4.1: Depreciation Rs. in million

Existing depreciation 415
Less: depreciation on machine before overhaul [(100  12)  4] (22)
Add: depreciation after overhaul [(100  (22 x 2) + 55  15}  (8  2)] 16
409
W-5: Selling expenses Rs. in million

Variable (468  0.55  1.25  1.08) 347
Fixed (468  0.45  1.05) 221
568

ANSWER-16
For the first three months (per unit) Alpha Beta Gamma
Sales (8000, 12000, 10000 x 1.1) 8,800 13,200 11,000
Cost of components used
- A (4, 5, 4 x 45) 180 225 180
- B (2, 4, 3 x 60) 120 240 180
- C (5, 6, 4 x 30) 150 180 120
A 450 645 480
Direct labour
- Assembling (10, 12, 10 x 50) 500 600 500
- Finishing (15, 20, 18 x 40) 600 800 720
B 1,100 1,400 1,220
Variable overheads (DL x 0.6 x 0.6) 396 504 439
Total variable costs 1,946 2,549 2,139
Contribution per unit 6,854 10,651 8,861

Qty (1750, 438, 875 x0.98x3/12) (W-1) 429 107 215
Total contribution 2,940,366 1,139,657 1,905,115
For next nine months (per unit) Alpha Beta Gamma

Sales (8000, 12000, 10000 x1.1) 8,800 13,200 11,000
Cost of components used (Axl.15) 518 742 552
Direct labour 1,100 1,400 1,220
Variable overheads 396 504 439
Total variable costs 2,014 2,646 2,211
Contribution 6,786 10,554 8,789
Qty (1750, 438, 875 x 0.98x9/12) (W-1) 1,286 322 643
Total contribution 8,726,796 3,398,388 5,651,327
Net contribution 11,667,162 4,538,045 7,556,442

W-1: Sales
Alpha Beta Gamma Total
Selling price (given) A 8,000 12,000 10,000
Sales ratio (given) 2 1 2
Weighted average sales ratio 32,000 12,000 20,000 64,000
Sales for the year (given) 28,000,000
Sales (on the basis of sales ratio) B 14,000,000 5,250,00 8,750,000
Number of units to be sold B/A 1,750 438 875

ANSWER-17
Rose Industries Limited
Budgeted profit or loss statement for the year ending 31 March 2020
Rs. in million
Sales - credit 2,800x0.8 2,240.00
Sales – cash [(2,800x1.3)-2,2401x0.95 1,330.00
3,570.00
Variable cost of goods sold:
Raw material consumption (W-1) (1,574.84)
Variable conversion cost [280- 360,000x471,200(W2)1x0.95x1.1 (382.98)
Manufacturing cost (1,957.82)
Opening finished goods (110.00)
Closing finished goods (W-3) 179.99
Variable cost of goods sold (1,887.83)
Gross contribution margin 1,682.17
Variable operating cost (190x1.30)x0.95x1.1 (258.12)
Net contribution margin 1,424.05
Fixed conversion cost (160-24)x1.1+24 (173.60)
Fixed operating cost [(45-16)x0.85x1.1+161+(2.5x10%)+(0.15x4) (43.97)
10% mark-up on running finance
100x90%x10% (9.00)
facility
Net profit 1,197.48
W-1: Budgeted raw material consumption Rs. in million

Consumption at last year's price 1,120—360,000x471,200(W-2) 1,465.96
Use of opening raw material 70.00
Use of current purchases [(1,465.96-70)x1.101x0.98 1,504.84
1,574.84
W-2: Budgeted production quantity Units

Sales 360,000x1.3 468,000
Finished goods inventory - closing 40,000x1.08 43,200
- opening (40,000)
471,200
W-3: Finished goods inventory valuation using marginal costing and FIFO Units
Raw material cost 43,200x(1,120÷360,000)x1.1x0.98 144.88
Variable conversion cost 43,200x(280÷360,000)x1.1x0.95 35.11
179.99

ANSWER-18
Tennis Trading Limited
Cash budget for the period from September 2018 to February, 2019
Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19
------------------------ Rs. in million --------------------
Opening balance 12.00 (2.22) (7.18) (6.82) (7.38) (7.53)

Collections
- From cash sales
(Sales of current month(W-1)×30%) - 3.60 4.35 5.10 5.85 7.50
- From credit customers
W-1 - - 8.40 10.15 11.90 13.65
Total cash inflows A - 3.60 12.75 15.25 17.75 21.15
Payments
Cash paid to suppliers W-2 - - 6.72 9.80 11.55 13.30
Wages and salaries 1.50 2.00 2.00 2.00 2.00 2.00
Other administrative expenses 1.00 1.00 1.00 1.00 1.00 1.30
Commission (Last month sale × 70%
- - 0.34 0.41 0.48 0.55
×80%×5%)
Marketing expenses – Fixed - 0.70 0.70 0.70 0.70 0.70
Marketing expenses – Variable
{(2×65%/12(W-1))×Sales} - 1.30 1.57 1.84 2.11 2.71
Initial promotion and advertisement expenses
3.50 3.50 - - - -
(7×50%)
Property 5.00 - - - - -
Equipment 2.00 - - - - -
Motor vehicle 1.20 - - - - -
(14.20 (20.56
Total cash outflows B (8.5) (12.33) (15.75) (17.84)
) )
Closing balance for mark-up calculation (2.20) (7.12) (6.76) (7.32) (7.47) (6.94)
Mark-up @ 10% p.a (Closing
(0.02) (0.06) (0.06) (0.06) (0.06) (0.06)
balance×10%/12)
Closing balance (2.22) (7.18) (6.82) (7.38) (7.53) (7.00)
W-1
Monthly sales Sales 12.00 14.50 17.00 19.50 25.00
Debtors Receipts(70% of prvious Month) 8.4 10.15 11.90 13.65
W-2
Purchases
Cost of sale (70% of sales) - 8.40 10.15 11.90 13.65
Less: Opening stock - (6.72) (8.12) (9.52)
Add: Closing stock
(80% of cost of sales of next month till Dec.) 6.72 8.12 9.52 10.92
Total purchases 6.72 9.80 11.55 13.30

ANSWER-19
Rs in Million
Receipts
Cash Sales (7,500 x 30% x 0.95 x 1.1) 2351.25
Collection from debtors (W-1) 5,456.72
Payments
Creditors (W-2) (2,343.78)
Direct labour (W-4) (1354.68)
Variable FOH (W-3) (715.68)
Fixed FOH (160-100 x 70%) x 1.05 (94.50)
Operating Expense (1250 – 100 x 30%) x 1.05 (1,281)
Net cash in flow 2,018.33
W-1
Dr. Debtors A/c Cr.
Rs. Million Rs.
Million
Bal. b/d (7,500 x 70% x 45 ) 656.25
360
Credit Sales (7,500 x 0.7 x 0.95 x 1.05) 5,236.88 Cash ( Balancing Figure) 5,456.72
Bal. c/d (5236.88 x 30 ) 436.41
360
5,893.13 5,893.13
W-2: Payments to material suppliers
Consumption of raw material 2018 at 2017 price 2,130.00

(4,000×50%)×{(70%×1.05)+(30%×1.1)}
Opening raw material at 2017 price (4,000×50%)×(45/360) (250.00)
Closing raw material at 2017 price 2,130×30/360 177.50
Purchases of 2018 at 2017 price 2,057.50
Purchases of 2018 – at increased price 2,057.50×1.1 2,263.25
W-2.1
Dr. Creditors A/c Cr.
Rs. Million Rs.
Million
Bal. b/d (2,098 x 30 ) 174.83
360
Cash 2,343.78 Purchases 2,263.25
Bal. c/d (2,263.25 x 15 ) 94.3
360
5,893.13 5,893.13
W-2.2: Purchases 2017
Consumption of raw material 2017 4,000×50% 2,000.00
Opening raw material Given (152.00)
Closing raw material(W-1) 250.00
Purchases 2017 2,098.00
W-3
Total Overheads – 2017 (4,000 x 20%) 800
Fixed overheads – 2017 (20%) (160)
Variable ovherheads 640
For cash sales (640 x 30% x 1.1 x 1.05) 221.76

For credit sales (640 x 70% x 1.05 x 1.05)
493.92
715.68
W-4 Direct Labour Cost
For cash sales (4,000 x 30% x 30% x 1.1 x 1.06) 419.76
For credit sales (4,000 x 30% x 70% x 1.05 x 1.06)
934.92
1354.68
ANSWER20
Cost of goods sold
Rs.
Raw material consumed (W-1) 25,497,753
Add: Direct labour (25,170x800x1.1x0.93) 20,599,128
Add: V. FOH (25,170x500x1.08) 13,591,800
F. FOH (W-3) 10,906,000
Manufacturing cost 70,594,681
Add: WIP opening 3,000,000
Less: WIP closing (3,151,161)
Cost of goods manufactured 70,443,520
Add: Finished good opening 2,000x2,680 5,360,000
Less: Finished good closing 2,090x2818.34 (5,890,330)
Cost of goods sold 69,913,190
W-1 Budgeted production

Units
Sales (22,800x110%) 25,080
Add: Closing (25,080/12) 2,090
Less: opening (24,000/12) (2,000)
Add: Closing WIP 1,500
Less: Opening WIP (1,500)
Production for next year 25,170
W-2
Kg Rs.
Raw material opening 25,000x2/12x49 204,167 x 20 4,083,340
During the year (bal.) 991408 x 20x1.08 21,414,413
Consumed 25,170x49x95/100x100/98 1,195,575 25,497,753
W-3 Fix FOH
Rs.
FOH absorbed = (23,760 x 400) 9,504,000
Less: Dep. Of current year) (5,800,000)
3,704,000
Inflation 5% 185,200
3,889,200
Add: Dep. Of next year 7,016,800
10,906,000
W-4
Product Cost / Unit
Previous Current
100
D. Material 980 (49 x 95 x x 20 x 1.08) 1,026
100 98
D. Labour 800 (800 x 1.1 x 0.93) 818.4
V. FOH 500 (500 x 1.08) 540
F. FOH 400 (10,906,000/25,170) 433.29
2,680
2,818.43
W-5
Budgeted WIP
Opening Closing
D. Material 1,500 x 980 x 100% 1,470,000 1,500 x 1,026 x 100% 1,539,000
D. Labour 1,500 x 800 x 60% 720,000 1,500 x 818 x 60% 736,200
V.FOH 1,500 x 500 x 60% 450,000 1,500 x 540 x 60% 486,000
F.FOH 1,500 x 400 x 60% 360,000 1,500 x 433.29 x 60% 389,961
3,000,000 3,151,161
ANSWER-21
Double Crown Limited
(a) Material Purchase Budget
Rs. in
Million
Raw material consumed (W-1) 22.5
Less: Opening raw material stock (W-1) (22.5)
Add: Closing raw material stock(W-1) 24.84
Raw Material Purchases 24.84
Direct Wages Budget (37.5 x 3 ) 11.25

10
Overhead Budget 1)
(37.5 x 10 3.75
(b) Cash payment budget for the month of June 2017

Rs. in
Million
Material purchases:
10% Cash purchases for current month (24.84×10%) 2.48
Last month's balance of 90% (22.50×90%) 20.25
(A) 22.73
Direct wages:
Payment to employees after deduction of canteen expense 95 10.18

(11.25×105)
Payments to canteen contractor for the month of May 2017 3 5 0.99
[(34.5×10) x 105x2]
(B) 11.17
Overheads:
As computed above in (a) 3.75
Depreciation (0.20)
Factory rent for the month of June 2017 paid in Advance (0.10)
Payment of half yearly rent in advance for Jul-Dec 2017 0.1×6 0.60
(C) 4.05
A+B+C 37.95

W-1

Budget for material purchases, direct wages and overheads for the month June 2017
May Jun Jul Aug
---------------Rs. in million---------------
Sales (A) 60.00 55.00 70.00 68.00
Cost of sales A×60% (B) 36.00 33.00 42.00 40.80
Finished goods: Opening stock (18.00) (16.50) (21.00)
Closing stock 16.50 21.00 20.40

Cost of goods produced 34.50 37.50 41.40
(C)
Raw material Consumed Cx 6 20.70 22.50 24.84
5% Normal loss - no effect, as being normal loss it is already included in cost of goods produced
ANSWER-22
Lotus Enterprises
Cash Budget
Rs . Millions
Opening Balance -
Add: Receipts
Cash Sales (W-1) 764.4
Collection From Debtors (W-2) 3,148
Less: Payments
Import Raw Material (W-3) (514.14)
Local Raw Material (W-4) (777.0)
Variable Conversion (W-5) (747.04)
Fixed Conversion (W-6) (25.79)
Variable Operating Exp (W-7) (1004.435)
Fixed Operating Exp (W-8) (99.92)
Closing Balance 744.075
W-1
Cash Sales = 3,000 x 1.3 x 20 % x 98 %
= 764.4 Rs Million
W-2
Credit Sales = 3,000 x 1.3 x 80%
= 3,120 Rs Million
Debtors A/C
Opening Balance (3000 x 45 ) 375
360
Credit Sales 3,120 Cash (Bal.) 40
3,148
Bal. c/d (3,120 x ) 347
360
3,495 3,495
W-3
Imports/purchases for the next year:
Imports
Rs. in million
Raw material consumption using FIFO:
- From year’s import: at old price 30.00
at revised price [(900x 1.3X40%)-(98+30)] X 1.1 374.00

404.00
Closing raw material inventory (98x1.3x1.1) 140.14
Total imports for the next year 544.14
Payments after adjustment of advance paid = 544.14 – 30 = 514.14
W-4
Local Purchases of R. Material Rs
Purchases for consumption = [( 900 x 60% x 1.3) -60)] x 1.1 706
Purchases for closing stock = 60 x 1.3 x 1.1 85
Total Purchases 792
Creditors A/C
Bal. b/d 95
Cash (Bal.) 777 Purchases 792
Bal. C/d [792 x 50 ] 110
360
887 887
Alternative Working W-4
Consumption 900 x 60 % x 1.3 702
Add : Closing Stock 60 x 1.3 78
Less: Opening Stock (60)
720
= 702 – 60 = 642
= (642 + 78 ) x 1.10 = 792
W-5
Payables - Variable Covn. Exp A/C
Bal. b/d (570 x 25 ) 39.58
360
Cash (Bal. Figure) 747.04 P/L (570x1.3x0.95x1.08) 760.266
Bal. c/d (760.266 x 25 ) 52.80
360
799.84 799.84
W-6
Payables - Fixed Conv. Exp A/C
Bal. b/d [(40-16) x 25 ) 1.67
300
Cash (Bal. Figure) 25.79 P/L (24 x 1.08) 25.92
Bal. c/d (25.92 x 25 ) 1.8
360
27.59 27.59
W-7
Payable Variable Operating Cost
Bal. b/d (730 x 25 ) 50.69
360
Cash (Bal. Figure) 1,004.435 P/L (730 x 1.3 x 1.08) 1,024.92
Bal. c/d (1,024.92 x 25 ) 71.175
360
1,075.61 1,075.61
W-8
Payable - Fixed Operating Exp
Bal. b/d [(120-27) x 25 ] 6.45
360
Cash (Bal.) 99.92 Bal. C/d [100.44 x 25 ] 6.975
360
106.895 P/L [(120-27)x 1.08 100.44

106.895

ANSWER-23
Rainbow Paints Limited
Budgeted profit and loss account for the year ending 28 February 2017
Rs. in Rs. in
million million
Sales (W-1) 125.46
Cost of sales
Raw material consumption (30x1.1x1.1) 36.30
Conversion cost – Variable (18x1.1x1.08) 21.38
Conversion cost – Fixed [(12-
3)x1.08]+3 12.72
Cost of goods manufacture 70.40
Opening finished goods inventory 8.00
Closing finished goods inventory (W-2) (8.69)
(69.71)
Gross profit 55.75
Operating expenses
Variable 25x1.08x1.1 (29.70)
Fixed [(10-5)x1.08+5]+6 (16.40)
Operating profit 9.65
Workings:
W-1 Budgeted sales
Cash Credit Total
--------Rs. in million--------
Existing sales - gross-up of 5% cash disc. 20.00 90.00
110.00
(19/0.95) (109-19)
Gross sales after volume & price increase of 10% & 31.76 95.29 127.05
5% in the ratio of 25:75 for cash and credit sales (127.05x25%) (127.05x75%) (110x1.05x1.1)
respectively
Budgeted sales - net of 5% cash sales discount 30.17 95.29 125.46
(31.76x95%)
W-2 Closing finished goods inventory (same quantity as opening inventory)

Opening Price Closing
inventory increase inventory
Raw material 8
( x 30) 4.0 10% 4.40
60
Conversion cost – variable ( 8 x 18) 2.4 8% 2.59

60
8
( x 9)
Conversion cost - fixed (excl. dep.) 60 1.2 8% 1.30
Depreciation 8
( x 3) 0.4 - 0.40
60
8.0 8.69
(b) Rainbow Paints Limited
Budgeted cash flow statement for the year ending 29 February 2017
Rs. in million Rs. in million
Inflows:
Sale proceeds:
Cash sales 30.17

Collection from debtors 94.78

124.95
Outflows:
Payments for purchases:
Payments to creditors (35.735)
Advertisement (3)
Payments for expenses (65.568)
(104.303)
Net cash inflows 20.647
W-3
Debtor A/c
Rs. Rs.
Bal. b/d 8.75
Cash (bal.) 94.78
Sales 95.29
Bal. c/d 9.26
104.04 104.04
W-3.1
Debtor collection period = Avg.debtors x 360
Credit sales
Opening 35 days = X x 360

90
Avg. debtor = 8.75

Closing
35 = X x 360
95.29
Avg. debtor = 9.26
W-4
Creditor A/c
Rs. Rs.
Bal. b/d 3
Cash (bal.) 35.735
Purchase 36.825
Bal. c/.d 4.09
39.825 39.825
W-4.1
Creditor payment period = Avg.Creditor
x 360
Credit Purchase
40 = X
x 360 = 4.09
36.825
W-4.2
Raw-material purchase Rs.

Consumed 36.3
Add: Closing stock 36.3/360 x 30 3.025
Less: Opening stock 30/360 x 30 (2.5)
Purchase 36.825

W-5
Dr. Expense A/c Cr.
Rs. Rs.
Bal. b/d 3.96
Cash 65.568 P/L 66.204
Bal. c/d 4.596
70.164 70.164
W-5.1
(21.384+9.72+29.7+11.4) - 6 = 66.204
Current
Avg. creditors = 66.204 x 25 = 4.596
360
Previous year
25 Days = X x 360
57(18+12+25+10−3−5)
= 3.96

ANSWER-24
Queen jewels
Cash budget for the quarter ending 31 December 2015
Rs. in ‘000
RECEIPTS:
Collection from sales excluding 10% sales of high valued items:
7 days sale in September received in October (4,600  30  7  90%) 966
Sales for the quarter ending 31 December 2015 (5,000 + 4,200 + 5,000) 90% 13,500
7 days sale in December collected in January 2015 (5,800  30  7  90% (1,218)
13,248
Collection in advance from 10% sales of high valued items:
8 days (15 - 7) sales in October received in September (5,000  30  8 x 10%) (133)
Sales for the quarter ending 31 December 2015 (5,000 + 4,200 + 5,800)  10% 1,500
8 days sale of January 2016 collected in December 2015 (6,000  30  8  10%) 160
1,527
Deduction of courier charges from collection
No of orders recorded in the previous month (400 + 450 + 470) 1,320
No. of high value orders of August delivered in September 2015 -
No of high value orders of November delivered in December 2015 (470  10%  (24)
2)
No of orders delivered previous month 1,296
Courier charges at Rs.300 per order 1,296  300 (389)
Total collection for the quarter 14,386
PAYMENTS:
Cost of sales for the quarter (cost plus 30%) (5,000 + 4,200 + 5,800)  1.3 11,538
Opening stock 1 October 2015 5,000  90%  25%  1.3 (865)
Closing stock 31 December 2015 6,000  90%  25%  1.3 1,038
Purchases 11,712
60% of September purchases paid in October (3,200  60%) 1,920
60% of December purchases to be paid in January 2016 (W-1) 4,496  60% (2,698)
Payments for purchases 10,934
Expenses paid excluding depreciation and amortization (50,000 – 8,000 – 2,000)  4 10,000
Net outflow for the quarter ended 31 December 2015 (6,548)
Cash and bank balances as at 1 October 2015 5,500
Cash and bank balances as at 31 December 2015 – Overdraft (1,048)
(W-1) Purchases for December 2015

Cost of sales for Dec. 2015 (cost plus 30%) 5,800  1.3 4,462
Opening stock 1 December 2015 4,462  90%  25% (1,004)
Closing stock 31 December 2015 6,000  90%  25%  1.3 1,038
Purchases 4,496

ANSWER-25
Month-wise Cash Budget
Rs. in ‘000
OCT NOV DEC
Opening balance 1,000 833.10 708.10
Receipts:
Collection from hospitals (W-1) 614.25 532.35 696.15
Collection from schools (W-2) 228.15 298.35 280.80
Payments:
Purchases (W-3) (655.20) (734.76) (753.48)
Sales tax payable (W-4) (22.10) (28.90) (27.20)
Salaries and wages (95) (95) (95)
Rent (150) - -
Selling expenses: (W-5)
Variable (4% of sales) (34) (32) (28)
Fixed (14) (14) (14)
Overhead expenses (39) (51) (48)
Total payments (1,009.30) (955.66) (965.68)
Closing balance 833.10 708.10 719.41
W-1
Collection from Debtors : (Hospital)
Sales Months Collection Months (Rs. 000)
Oct Nov Dec
Aug 614.25 614.25
Sep 532.35 532.35
Oct 696.15 696.15
Nov 655.20
Dec 573.30
614.25 532.35 696.15
W-2 Collection of Debtors (School)
Oct Nov Dec
Aug
Sept 228.15 228.15
Oct 298.35 298.35
Nov 280.8 280.8
228.15 298.35 280.8
W-3
Payment to Creditors:-
Purchases Months Payment Months (Rs. 000)
Oct Nov Dec
Aug 702 210.6
Sep 608.4 365.04 182.52
Oct 795.6 79.56 477.36 238.68
Nov 748.8 74.88 449.28
Dec 655.2 65.52
655.2 734.76 753.48
W-4
Aug Sep Oct Nov Dec
Tax on Sales(Output Tax) (127.5) (110.5) (144.5) (136) (119)
Tax on purchase (Input Tax) 102 88.4 115.6 108.8 95.2

(25.5) (22.1) (28.9) (27.8) (23.8)

Payment to tax Dept (22.10) (28.9) (27.2)
W-5
Sept Oct Nov Dec
Total Selling Exp 40,000
Less Fixed @35% (14,000) 14,000 14,000 14,000
Variable 26,000
% age of sale 26,000
x 100 = 4 % of Sales
650,000
ANSWER-26
Zinc Ltd
Monthly cash budgets
----------Rs.000 ----------
March April May
Opening balance 100,000 108,002 104,564
Receipts:
Cash sales 20% of current month's sales 11,000 12,000 13,000
Collection from debtors (W-1) 70,252 54,812 44,776
181,252 174,814 162,340
Payments
Purchases (W-2) 47,250 44,250 48,000
Admin expenses 16% of sales 8,800 9,600 10,400
Selling expenses 24% of sales 13,200 14,400 15,600
Pacing machine 4,000 2,000 --
73,250 70,250 74,000
Closing balance 108,002 104,564 88,340
W-1 Collection from customers (Debtors)
Sales Credit Sales March April May
Jan 85,000 68,000 26,248
Feb 95,000 76,000 44,004 29,336
Mar 55,000 44,000 25,476 16,984
Apr 60,000 48,000 27,792
70,252 54,812 44,776
W-2 Payment to Creditors
February March April May
Rs. Rs. Rs. Rs.
Cost of sales: 75% of sales 71,250 41,250 45,000 48,750
Opening stock: 80% of cost of sale (57,000) (33,000) (36,000) (39,000)
Closing stock: 80% of next month's cost of sales 33,000 36,000 39,000 45,000
Purchases 47,250 44,250 48,000 54,750
Payment for purchases in next month 47,250 44,250 48,000

ANSWER-27
(a) The OL’s budgeted gross profit for the rent year is Rs.10,925 million computed as follows:
Rs. Rs.
Sales (180,000  12,110) 237,600,000
Less: Cost of sale 91,125,000
Material A [(180,000  12)  75%  1/.8  45] 20,250,000
Material B [(180,000  12)  25%  1/.8  30] 64,800,000
Labour [(180,000  12)  20/60  18,000/200] 40,500,000
Variable FOH [(180,000  12)  1/.8  15] 10,000,000
Fixed overheads (226,675,000)
Gross contribution per annum 10,925,000
(b)
Rs. Rs.
Sales (180,000  12  110) 237,600,000
Less: Cost of sale
Material A [(180,000  12) / (0.8  1.125) 75%  48] 86,400,000
Material B [(180,000  12) / (0.8  1.125)  25%  30] 18,000,000
Labour (W-1) 54,108,000
Variable FOH [(180,000  12) / (0.8  1.125)  15%  80%] 28,800,000
Fixed overheads (Additional depreciation: 7,500,000 /5) 1,500,000
Fixed overheads [10,000,000  (1 – 0.15)] 8,500,000
(197,308,000)
Gross contribution per annum (40,292,000
(W-1)
Time required for one unit of finished product 20 minutes
Expected saving of time (20 minutes x 30%) 6 minutes
Revised time for one unit of finished product 14 minutes
Workers shares of the time saved [(6/60 x 0.45 x 2.16 million) x (18,000 / 200)] Rs.8,748,000
Labour cost (14/60 x 2.16 million) x (18,000 / 200) Rs.45,360,000
Rs.54,108,000

ANSWER-28
Cash Budget
Rs. Rs. Rs. Rs.
Opening cash balance /(Running finance) 3,500,000 (440,800) (136,200) 187,000
Receipts
Cash sales (35% x 95% of current month) 1,037,400 1,383,200 1,729,000
Credit sales (W-2) 2,028,000 2,704,000
Payments
Security deposit 240,000
Machinery 1,800,000
Office rent 80,000 80,000 80,000 80,000
Other overheads 120,000 120,000 120,000 120,000
D. materials(W-1) 1,600,000 - 1,968,000 2,448,000
Salaries - 288,000 576,000 736,000
Variable OH 100,800 244,800 344,000 424,000
Total disbursements (3,940,800) (732,800)(3,088,000) (3,808,000)
Closing cash balance /(Running finance) (440,800) (136,200) 187,000 812,000
Working:
Monthly production in units January February March April May
Sale Unit 2,400 3,200 4,000 4,800
40% of current month's sales 960 1,280 1,600
60% of next month's sales 1,440 1,920 2,400 2,880
Total production (Units) 1,440 2,880 3,680 4,480
Raw Material Consumption (600/unit) 864,000 1,728,000 2,208,000 2,688,000
Purchase of Materials
On cash 1,600,000
On credit - 50% of current month 864,000 1,104,000
On credit - 50% of next month 1,104,000 1,344,000
Total purchase of material 1,600,000 1,968,000 2,448,000
Payment of Variable Overheads
Variable overheads cost 144,000 2,880,000 368,000 448,000
70% of the current month 100,800 201,600 257,600 313,600
30% of the previous month 43,200 86,400 110,400
100,800 244,800 344,000 424,000
W-2
Sales Payments
February March April May
February 2,028
March 2,704 2,028
April 3,380 2,704
3,380
2,028 2,704 3,380

ANSWER-29
M/s. Tram-way
Balance Sheet As at 31.8.2006
Rs. Rs.
Fixed assets 9,940,000
Less: Acc. Dep. (1,900,500) 8,039,500
Stock (6,000,000 x 80%) x 80% 3,840,000
Debtors (W-1) 2,150,000
Cash and bank
1,980,940
Total assets 16,010,440
Capital 2,800,000
Accumulated profit 8,380,000
Trade creditors (W- 2)
4,640,000
15,820,000
Difference (assumed to be additional investment)
190,440
Total equity and liabilities 16,010,440
(b) Projected balance in accounts payable as on 30.9.2006(W-2) Rs. 4,160,000
(c)
Projected Income Statement
For the month of September 2006
Rs. Rs.
Sales 6,000,000
Cost of sales (80%) (4,800,000)
GP (20%) 1,200,000
Less: Operating expense
Other expenses 40,700
Depreciation 46,300
Staff salaries 50,000
Provision for bad debt (6,000,000 x 1%) 60,000 (197,000)
Net Profit 1,003,000
W-1 Calculation for debtors on 31.8.2006
Balance from August sales (5,000,000 x 44%) 2,200,000
Balance out of previous sales (190,400 - 50,000) 140,400
2,340,400
Less: Provision for bad debt 190,400
Balance on 31.8.2006 2,150,000
W-2
August September October November
Sales 5,000,000 6,000,000 5,000,000 5,500,000
Cost of sales 80% 4,000,000 4,800,000 4,000,000 4,400,000
Purchases:
80% of next month 3,840,000 3,200,000
20% of current month 800,000 960,000
Payables closing balance 4,640 4,160
Payment - 4,640 4,160

ANSWER-30
New Vision Trading Company Ltd
Cash Budget from January to June 2000
Jan Feb March April May June
('000') ('000') ('000') ('000') ('000') ('000')
Opening balance 50 (1) (41) (115) (122) (113)
Receipts:
Collections from customers (W-1) 400 715 745 820 940 810
Payments
Payment to creditors (W-3) 256 560 624 632 736 688
Various expenses:
Salaries & wages 65 65 65 65 65 65
Repair & maintenance 20 20 20 20 20 20
Insurance 1 1 1 1 1 1
Stores & spares 45 45 45 45 45 45
Duties 60 60 60 60 60 60
Legal charges 4 4 4 4 4 4
Total disbursement (451) (755) (819) (827) (931) (883)
Ending balance -Surplus (deficit) (1) (41) (115) (122) (113) (186)
Workings
W-1 Collections from customers
Sales Collections(Rs in 000)
Jan Feb Mar Apr May June
Jan 800 400 240 160 - - -
Feb 950 - 475 285 190 - -
Mar 600 - - 300 180 120 -
Apr 900 - - - 450 270 180
May 1,100 - - - - 550 330
June 600 - - - - - 300
400 715 745 820 940 810
W-2
Since there is no opening or closing balance of inventories, purchases are equal to the amount of cost
of goods sold which is 80% of sales.
(‘000’) (‘000’) (‘000’) (‘000’) (‘000’) (‘000’)
Sales 800 950 600 900 1,100 600
Purchases - 80% of sales 640 760 480 720 880 480
W-3 Payments to creditors
Payments (Rs in 000)
Jan 640 256 256 128 - - -
Feb 760 - 304 304 152 - -
Mar 480 - - 192 192 96 -
Apr 720 - - - 288 288 144
May 880 - - - - 352 352
June 480 - - - - - 192
256 560 624 632 736 688

ANSWER-31
CINEMA LIMITED
BUDGETED PROFIT AND LOSS STATEMENT
Revenue from: Rs.
Rs.
Hollywood 192,192,000
Bollywood 103,440,960
Theatre 18,240,000
313,872,960
Less: Variable Cost
Master print purchase
Hollywood (4,000,000 x 11) 44,000,000

Bollywood (6,500,000 x 7.33) 47,645,000
(91,645,000)
Setup cost (11 x 500,000 + 7.33 x 500,000) (9,165,000)
Show cost (1408 x 35000 + 703.68 x 35,000) (73,908,800)
Contribution 139,154,160
Less: Fixed cost
Admin (4,500,000)
Depreciation (30,000,000/5)
(2,000,000)
Net profit 132,654,160
Workings:
W-1 Revenue
Hollywood Bollywood
65% 70%
Total number of working weeks (52 – 8) 44 44
Weeks for each film 4 6
Number of cinemas 2 1
Number of films per year (44/4) : (44/6) 11 7.333
Number of films per week (5 x 2 + 3 x 2) 16 16
Number of films one year (16 x 4x11 x 2) : (16 x 6x7.33x1) 1408 703.68
Revenue (1408 x 600 x 0.65 x 3,500) : (703.68 x 600 x 0.7 x 350) 192,192,000 103,440,96
0
W-2 Theatres
Total days / year = 360 – 10 – 30
Working days = 320 days in a year
Number of times of plays = 45 times
Number of shows / week =1x5x2x2
= 9 shows per weeks
No of days for 1 show = 7 x 45
9
= 35 days
Number of days rent is not received = 2 (W-2.1) x 8 = 16 days
Rent received = (320 – (2 x 8) x 60,000
= Rs. 18,240,000
Alternatively rent received = (320 days – 16 days) x 60,000 = Rs. 18,240,000
W 2.1
Gap days = 40 – 35 - 3
=2
ANSWER-32
Budgeted Profit And Loss Account Rs.
Sales 4,760,000,000
Less: Sales commission (63,464,649)
Net sales 4,696,535,351
Less: cost of goods sold
Material (W 3) (1,959,562,500)
Labour (w-4) (511,500,000)
Manufacturing overhead (242,812,500+ 283,500,000 + 173,250,000) (699,562,500)
Gross profit 1,525,910,351
Less: selling expenses
Variable (W-9) (113,360,000)
Fixed (120,540,000)
Admin expenses
Fixed depreciation (17,000,000)
Fixed cash (w-8) (91,350,000)
Distribution expenses
Variable (W-9) (114,750,000)
Fixed -
Operating profit 1,068,910,351
Add: Other income (W-10) 300,000
Net profit 1,069,210,351
Workings
W-1 Sales Revenue
Capacity = 4 x 67% = 2.720 units
3,400 = 1250 / unit
Sales price / unit = 2.720
Increase in sales price = 1250 + 150 = 1400 / Unit
Capacity (increased = 2.720 x 1.25 = 3.4 Units
Revised sales = 3400,000 x 1,400
= 4760,000,000
W-2 Commission
Units No. of Units / Commission Selling Sales
(a) Employee employee rate (b) Price per Commission
Unit (c) (a x b x c)
Rs. Rs.
A 1133,333 20 56667 1.75% 1400 27,766,659
B 1133,333 30 37778 1.25% 1400 19,833,328
C 1133,333 40 28333 1% 1400 15,866,662
3,400,000 63,466,649
W-3 Direct Material
1,493,000,000
= 2,720,000 x 3,400,000 x 1.05
= 1,959,562,500

W-4 Direct Labour Units Total Cost

(Rs.)
Current efficiency 2,720,000 367,000,000 x 1.05 385,350,000
Units due to improved efficiency 408,000 385,350,000 x 0.2 77,070,000
External Labour (Bal.) 272,000 272,000 x 180 48,960,000
- -
3,400,000 511,500,000
W-5 Variable FOH

= 635,000,000 – 285,000,000 – 165,000,000
= 185,000,000 x 3,400,000 x 1.05
2,720,000
= 242,821,500
Fixed FOH = 165,000,000 x 1.05
= Rs. 173,250,000
W-6 Depreciation Rs.
Existing depreciation 285,000,000
Less: depreciation on Machinery (40−5) (7,000,000)
5
(40+35)−9
5,500,000
12
283,500,000
W-7 Selling Expense
Total variable selling = 28,700,000 x 0.6
= Rs.172,200,000
Variable distribution = Rs.85,000,000
Net variable selling cost = 172,200,000 – 85,000,000
= Rs.87,200,000
= 87,200,000 x 1.25 x 1.04
= Rs.113,360,000
Fixed selling = 287,000,000 x 0.4 x 1.05
= Rs.120,540,000
W-8 Admin Expense
Fixed cash = (105,000,000 – 18,000,000) x 1.05
= Rs.91,350,000
W-9 Distribution Expense = 85,000,000 x 1.25 x 1.08
= Rs.114,750,000
W-10 Disposal Rs.
Book value 1,500,000
Selling price 1,800,000
Profit 300,000

ANSWER-33
Shahid Limited
Budgeted income Statement
For the year ended 20X0 – X1
Rs.
Sales (W-1) 2,465,000,000
Less: Sales commission (W-2) (147,900,000)
Discount on out size footwear (W-3) (34,510,000)
Net sales 2,282,590,000
Less: Variable costs (1,120,454,545)
Net contribution 1,162,135,455
Less: Fixed Cost
Outlet operating cost (W-4) (316,800,000)
Factory fix FOH (45,000,000 x 12) (540,000,000)
Head Office fix FOH (15,000,000 x 12) (180,000,000)
Workings:
W-1
Selling price Total sales
Men Units
Rs. Rs.
60% 720,000 1,000 720,000,000
10% 120,000 4,000 480,000,000
30% 360,000 2,000 720,000,000
1920,000,000
Selling price Total sales
Women Units
Rs. Rs.
60% 300,000 1,800 240,000,000
10% 50,000 2,500 125,000,000
30% 150,000 1,200 180,000,000
545,000,000
Total sales = 1,920,000,000 + 545,000,000
= 2,465,000,000
W-2 Distribution
= 2,465,000,000 x 0.3 x 0.2
= Rs.147,900,000
W-3 Discount Expenses
Total sales = 2,465,000,000
Qualified for discount = 2,465,000,000 x 70% x 5%
= 86,275,000
Discount expense = 86,275,000 x 40%
= Rs.34510,000
100
W-4 Variable Cost = x 2,465,000,000
220
= Rs.1,120,454,545
W-5 Outlet Operating Cost = 22 x 1,200,000 x 12
= Rs.316,800,000

ANSWER-34
CASH REQUIREMENTS
Cash Requirement 2010 -11
Qtr. 1 Qtr. 2
Particulars
----Rs. in‘000----
Receipts
Cash sales (2,000 x 6,000 / 4 x 94%) 2,820 2,820
Receipts from credit sales (W-2) 5,211 9,120
Payments
Cost of goods sold - variable (37,500 x 80%) /12x2 : 3 (5,000) (7,500)
Variable cost of finished stock 30,000 / 24,000 x 1,000 (1,250) -
Variable operating expenses (105 x 3 x 2,000) (630) (630)
Payment of fixed costs (457 x 2.5) / (457 x 3.0) (1,143) (1,372)
Purchase of machinery (60,000) -
(59,992) 2,438
Month 1st Month

Qtr. 2nd Qtr.
1 2 3 4 5 6
----------Rs. in ‘000----------
Working for credit sales
Credit sales (18,000/12x2,200) 3,300 3,300 3,300 3,300 3,300 3,300
Settlement -70% 2,310 2,310 2,310 2,310 2,310
-28% 924 924 924 924
Gross receipts 2,310 3,234 5,544 3,234 3,234 3,234 9,702
Tax @ 6% (333) (582)
Receipts net of tax 5,211 9,120
W-1
Let x = cash sales selling price
1.1 x = credit sales selling price
X x 2,400 x 25% + 1.1X x 24,000 x 75% =51,600,000
6,000X + 19,800X = 51,600,000
25,800X = 51,600,000
Cash selling price/unit = Rs. 2,000
Credit selling price/unit = 1,000 x 1.1 = Rs 2,200
W-2
Operating expenses
Rs.
Total operating expenses – given 4,800
Less: Variable cost per unit (105 x 24,000) (2,520)
Bad debt expense (2,200 x 18,000 x 2%) (792)
Fixed operating expenses 1,488
Fixed cost
Fixed factory overheads 7,500
Less: Depreciation (60m - 7.5m) /15 (3,500)
Fixed operating overheads 1,488
5,488
Fixed cost per month 457

ANSWER-35
BUDGETED PROFIT
(a)(i)
Umair Enterprises
Budgeted income statement
Sales (5,000 x 20,375) 101,875,000
Less: Cost of sales (5,000 x 16,300) (81,500,000)
Gross profit 20,375,000
Less: Admin & Selling Expense
Variable (5,000 x 900) (4,500,000)
Fixed (9,000,000)
(ii) Revised profit forecast after considering consultants’ recommendation:
Rupees
Sales (6,500 sets x Rs. 24,643.37) 160,181,905
Less: Cost of goods sold for 6,500 units
Electronic Kits @ Rs 9,500 61,750,000
Cost of import and duty @ Rs 900 5,850,000
Local value addition @ Rs 3,500 22,750,000
Fixed overhead cost 12,000,000
(102,350,000)
Gross Profit 57,831,905
Less: Selling & Admin expenses

Variable (6,500 sets x Rs 900) 5,850,000
Fixed 9,000,000
Cost of advertisement campaign 5,000,000
Cost of after-sale service (6,500 x Rs. 450) 2,925,000
Retailers commission (Rs. 160,181,905 x 15%) 24,027,285
(46,802,285)
Profit by implementing the proposal of consultant 11,029,620
W-1 Budgeted cost and sales price per set
Rupees
C & F value 9,500
Import related costs and duties 900
Variable cost of local value addition 3,500
Variable cost per set 13,900
Fixed production overheads (Rs. 12,000,000/5,000 sets) 2,400
Budgeted cost of production per set 16,300
Add: Gross profit (Rs. 16,300 x 25%) 4,075
Budgeted sales price per set to distributor 20,375
W-2 Computation of budgeted consumer price of each set
Budgeted sales price of the company 20,375.00
Add: distributor margin (Rs. 20,375 x 10/90) 2,263.88
Budgeted sales price of the distributor 22,638.88
Add: wholesaler margin (Rs. 22,638.88 x 4/96) 943.29
Budgeted sales price of wholesaler 23,582.17
Add: retailer’s markup (Rs. 23,582.17 x 10%) 2,358.21
Budgeted retail price 25,940.39
Revised retail price (Rs. 25,940.39 x 95%) 24,643.37
Based on above results, management should accept the recommendation of the consultant.

(b) In the light of the changes recommended by the consultant, the company will have to consider
whether it has the necessary infrastructure to:
(i) deal with a far larger number of retailers as against the present few distributors.
(ii) produce and sell extra 30% t.v. sets.
(iii) attend to after sale activities on its own. The question is silent as to who presently attends
to this activity.
(iv) conduct effective advertisement campaign.
Fixed expenses related to manufacturing as well as selling and admin are likely to increase but no such
increase has been anticipated.
ANSWER-36
Rs Enterprises
Budgeted Income Statement
Sales -A (4,579 x 500) 2,289,500
-B Normal (3,744 x 800) 2,995,200
-B Corporate (1,440 x 800 x 0.85) 979,200
6,263,900
Less: Direct Material (2,716,740)
Direct Labour (993,582)
Variable FOH (493,251)
Fixed FOH (630,000 x 40% x 1.05) (264,600)
Promotional Cost (250,000)
Admin & Selling (800,000 x 1.1) (880,000)
Net Profit 665,727
W-1 Selling Price
A B(Normal) B(Commercial)
Units 5,400 2,880 720
Price X 1.6 X 1.44
5,400X + 2,880 x 1.6X + 720 x 1.44X = 5,522,400
11,044 -8 X = 5,522,400
Product-A X = 500 Rs
B Product –B (Normal) = 500 x 1.6 = 800 Rs
Product – C (Corporate) = 500 x 1.44 = 720 Rs
Production Plan Hrs.
Available hours [(5,400 x 5 + 3,600 x 6) x 100] 54,000
90
Less: B- Corporate (1,440 x 6) (8,640)
B- Normal (3,744 x 6) (22,464)
(22,896)
A-(4,579.2 x 5) (22,896)
W-2 Raw Material Cost

[5,400 x 2.4 x 100 +3,600 x 2.4 x 100] x Price / Kg = 2,310,000 Rs
96 90
(13,500 + 9,600) x Price = 2,310,000
Price = Rs 100/Kg

W-3
Total Material Kgs Kg.
100
- A 4579 x 2.4 x 96
11,447.5
100
- B 5184 x 2.4 x 13, 824
90
25,271.5
Mat. Cost 3 Month Usage= 25,272 x 3 x 100 631,800
12
Mat. Cost 9 Month Usage= 25,272 x 9 x 100 x 1.10 2,084,940
12
2,716,740
W-4
Direct Labour
[5400 x 5 + 3600 x 6] x L. Rate = 777,600
48,600 X = 777,600
777,600
X= = Rs. 16/L.H
48,600
Budgeted L. Cost = [4579 x 5 + 5,184 x 6] x 16 x 1.5 = Rs 993,582

W-5
Variable FOH
5,400 X + 3,600 x 2X = 630,000 – 252,000
5,400X + 7,200X = 378,000
12,600 X = 378, 000
378,000
X =
12,600
A X = Rs 30/ unit
B 2X = Rs 60/ unit
Budgeted Variable FOH= 4,579 x 30 x 1.1 + 5,184 x 60 x 1.1
= Rs 493, 251

ANSWER-37
(a)
Smart Ltd
Monthly Cash Budget
October to December 2009
October November December
Rs. Rs. Rs.
Opening cash balance 2,500,000 1,476,000 1,427,920
Collection from customers
Cash sales 20% of total sale of current month 1,500,000 1,980,000 2,178,000
Credit sales 80% of total sales: 5,800,000 5,800,000 6.960,000
Cash Disbursements
Payment for purchases (W-1) 6,120,000 7,272,000 7,855,273
Marketing expenses
Fixed 150,000 150,000 150,000
Variable @ 2% of sales 150,000 198,000 217,800
Administration expenses 204,000 208,080 212,242
Office equipment 1,700,000
Total disbursement (8,324,000) (7,828,080)(8,435,315)
Ending Cash Balance 1,476,000 1,427,920 2,130,605
W-1
Oct Nov Dec
Aug-30 3,000,000 3,000,000
Sept-15 2,800,000 2,800,000
Sept-30 2,800,000 2,800,000
Oct-15 3,000,000 3,000,000
Oct-30 3,000,000 3,000,000
Nov-15 3,960,000
3,960,000
5,800,000 5,800,000 6,960,000
Fixed Assets A/c

Rs. Rs.
Million Million
Bal. b/d 8,000,000 Disposal 1,250,000
Disposal 2,000,000 Bal. C/d 8,750,000
10,000,000 10,000,000
Disposal A/c
Rs. Rs.
F.A 1,250,000 Acc. Dep 765,625
Cash 1,700,000 F.A 2,000,000
Loss 184,375
2,950,000 2,950,000
Depreciation on opening excluding fully Depreciation & Disposal
(8,000,000-1,250,000-1,600,000) x 15% x 3 193,125
12
Dep on additions (2,000,000 x 15% x 2 ) 50,000

12
Dep on Disposal (1,250,000 x 15% x 1 ) 15,625
12
258,750
W-2

Working for purchases and payments

Sale of September 5,600,000 / 80% = Rs. 7,000,000
Sept Rs. Oct Rs. Nov Rs. Dec Rs. Jan Rs.
Sales 7,000,000 7,500,000 9,900,000 10,890,000 10,000,000
Less: Effect of price increase
Sales x 10/110 -- -- 900,000 990,000 909,091
7,000,000 7,500,000 9,000,000 9,900,000 9,090,909
COGS 80% of the above 5,600,000 6,000,000 7,200,000 7,920,000 7,272,727
Add: Closing stock 6,000,000 7,200,000 7,920,000 7,272,727
11,600,000 13,200,000 15,120,000 15,192,727
Less: Opening stock 5,600,000 6,000,000 7,200,000 7,920,000
Purchases 6,000,000 7,200,000 7,920,000 7,272,727
Payment for purchases
10% of current month 720,000 792,000 727,273
90% of previous month 5,400,000 6,480,000 7,128,000
Total payment 6,000,000 6,120,000 7,272,000 7,855,273
(b)
Budgeted Profit and Loss Account
For the quarter ended 31.12.2009
Rs.
Sales 28,290,000
Cost of sales (6 + 7.2 + 7.92 million) 21,120,000
GP 7,170,000
Less: Operating expense
Marketing expenses
Fixed 450,000
Variable @ 2% of sales 565,800
Administration expenses 624,322
Depreciation (W-2) 258,750
Loss on disposal of office equipment (W-2) 184,375 2,083,247
ANSWER-38
REGRESSION METHOD
Direct labour Overheads
(xy) (x2)
Hours (x) (y)
September 20X9 50 14,800 740,000 2,500
October 20X9 80 17,000 1,360,000 6,400
November 20X9 120 23,800 2,856,000 14,400
December 20X9 40 11,900 476,000 1,600
January 20X0 100 22,100 2,210,000 10,000
February 20X0 60 16,150 969,000 3,600
450 105,750 8,611,000 38,500
b (Variable cost per unit) = n(∑xy)-( ∑x)(∑y) = 6x8,611,000-450x105,750 = 143.1053

n(∑x2)-(∑x)2 6(38,500)-(450)2
a (Fixed costs per month) = (∑y)-b(∑x) = (105,750-143.11(450)) = 6,892
n 6

ANSWER-39 Multan Stars

Budgeted Profit or Loss Statement
For the year ending 31 August 2023
Rs. in '000
Sales (W-1) 132,050
Cost of goods sold
Material (W-3) (45,938)
Labour (W-4) (30,450)
Manufacturing overheads (W-5) (11,340)
Purchase from market [4,500(W-2)×1200] (5,400)
(93,128)
Gross profit 38,922
Less: Selling & admin. [2,500,000×1.2×1.05] 3,150
Profit 35,772
W-1: Sales Rate Quantity Rs. in '000
- K-100 [90,000,000/72,000]×1.12 1,400 72,000 100,800
- K-100 (New Cont.) [90,000,000/72,000] 1,250 10,000 12,500
- K-50 750 25,000 18,750
132,050
W-2: Production K-100 K-50
Demand Units 82,000 25,000
Machine hours required Hours 3.00 1.50
Total required Hours 246,000 37,500 283,500
Available [72,000×3/0.8] Hours 270,000
Shortfall Hours 13,500
K-100 to be purchased from outside
[13,500/3] Units 4,500
To be manufactured internally:
- K-100 [72000+10000–4500] Units 77,500
- K-50 Units 25,000
W-3: Material Kgs
- K-100 [77,500(W-2)×2.5×1.05×200] 40,688
- K-50 [25,000×1×1.05×200] 5,250
45,938
W-4: Labour Hrs
- K-100 [77,500(W-2)×3] 232,500
- K-50 [25,000×1.5] 37,500
Required 270,000
Available 250,000
Overtime 20,000
Cost Rs. in '000

- Normal [25,000,000×1.05] 26,250
- Overtime [20,000×(25,000,000/250,000)×1.05×2] 4,200
30,450
W-5: Manufacturing Overheads
Machine hour rate [9,000,000×0.80 / 216,000(72,000×3)] = 33.33×1.05 35
Rs. in '000
Variable overheads
- K-100 [77,500(W-2)×3×35] 8,138
- K-50 [25,000×1.5×35] 1,312
9,450
Fixed overheads [9,000,000×0.2×1.05] 1,890
11,340

ANSWER-40
September October November December January
---------------------------- Rupees ----------------------------
Cash injection 500,000
Vehicle injection (capital in kind) -
Packing equipment (1,000,000)
Receipts from debtors (W-1) 1,477,500 6,501,000 10,342,500 13,002,000
Payments to spice suppliers (W-2) (3,000,000) (6,200,000) (8,200,000) (9,600,000)
Payments to packing material supplier (300,000) (420,000) (540,000)
Admin expenses (300,000) (300,000) (300,000)
Agent commission (2% of sales amount) (150,000) (210,000) (270,000)
Repayment of friends’ loan (500,000)
Cash from operations (2,022,500) (449,000) 1,212,500 1,792,000
Bal. brought forward - (2,064,635) (2,566,003) (1,381,701)
Bal. carried forward before markup (2,022,500) (2,513,635) (1,353,503) 410,299
Markup @ 25% (42,135) (52,367) (28,198) -
Bal. carried forward after markup (2,064,635) (2,566,003) (1,381,701) 410,299
W-1: Receipts from debtors

Sales A 7,500,000 10,500,000 13,500,000 15,000,000
Receipts
Advance: 20% 1,500,000 2,100,000 2,700,000 3,000,000
In the month of sales: 60% 4,500,000 6,300,000 8,100,000
In the following month: 20% - 1,500,000 2,100,000
1,500,000 6,600,000 10,500,000 13,200,000
Less: Tax deducted at source (@1.5%) 22,500 99,000 157,500 198,000
Net receipts 1,477,500 6,501,000 10,342,500 13,002,000
W-2: Payments to spice suppliers

Sale price per carton B 1,500 1,500 1,500 1,500
Volume of sales (in carton)
[Sales / sale price per carton] C=A/B 5,000 7,000 9,000 10,000
Material required for each carton:
– Spices (per carton) D 1,000 1,000 1,000 1,000
– Packing (per carton) E 60.00 60.00 60.00 60.00
Cost of spice C×D 5,000,000 7,000,000 9,000,000 10,000,000

Cost of packing material C×E 300,000 420,000 540,000 600,000
Timing of spices purchased

Purchase of spice 5,000,000 7,000,000 9,000,000 10,000,000
Payments to spice suppliers:

– in the month of purchase - 60% 3,000,000 4,200,000 5,400,000 6,000,000
– in the following month - 40% 2,000,000 2,800,000 3,600,000
Total payments 3,000,000 6,200,000 8,200,000 9,600,000

Chapter 15
Solution 1
Computation of Working Capital Requirement Rs. Rs. m
m
Debtor W1 900
Add FG Inventory W2 150
WIP W3 50
Raw Material Stock W4 230
Desired Cash 15
Total Current Asset 1,345
Less: Current Liabilities
Wages Actual W5 15
Overheads W6 65
Govt Levis W7 50
Creditors Fuel W8 50
Packing Materials W9 5
Other Raw Material W10 50 (235)
Desired Working Capital 1,110
W1 - Debtors W5 - Wages
Accrued
Current Utilized Capacity = 250,000 x 80 %
= 2m x 180 x 0.5 = 15m
= 200,0000
tone 12
Number of Bags = 200,000 x 1,000 = 2000,000 bags

W6 – Overhead Accrued
100
= 2m x (120 + 120 + 150) x 1 =
Sales = 2000,000 x 1,800 = 3,600 million
65m
Debtors = 3,600 x 3 = 900 m
12
12

W2 – FG Inventory W7 - Govt Levis Accrued

Costs / unit = 90 + 150 + 60 +180 +300 + 180 – 60 =
900/unit = 2m x 300 x 1 = 50m
12
FG Inventory = cost x Inventory period
= 2m bags x 900 x 1 = 150 million

12 W8 – Fuel Payable
W3 - WIP Inventory = 2m x 300 x 1 = 50m

RM Cost / bag = 90 + 150 + 60 = 300 / bag 12
Labour & overheads = 180 + 300 + 180 – 60 = 600bag

Material Portion of WIP = 2m x 300 x 0.5 = 25m
12 W9 – Paking Material Payable
C.C Portion = 2m x 600 x 0.5 x 50% = 25m

12
= 2m x 60 x 0.5 = 5m
Total WIP Inventory = 50m 12
W4 - Raw Material Inventory Rs.
Lime Stone = 2m x 90 x 1 = 15
12 W10 – Other Raw Material Payable
Other RM = 2m x 150 x 3 = 75
12
= 2m x 150 x 2 = 50m
Packing Material = 2m x 60 x 1.5 =15 12
12
Fuel = 2m x 300 x 2.5 = 125

12
230
Answer 3
Year 1 Year Year 3

2
days days days
Raw materials inventory Period
(Raw materials/Purchases) × 365 days 76 70 87
Minus Credit from suppliers
(Trade payables /Credit purchases) × 365 days (61) (50) (59)

15 21 27
WIP Inventory Period
(Work-in-progress/Cost of sales) × 365 days 37 32 32
Finished goods inventory Period
(Finished goods/Cost of sales) × 365 days 42 41 45
Credit to customers
(Trade receivables/Credit sales) × 365 days 73 73 85
Total length of working capital cycle 167 166 190
Answer 4
(a) Additional finance required:
Expected increase in assets (1,100 x 20% x 140%) 308.00

Expected increase in liabilities (1,100 x 20% x 25%) (55.00)
Retained earnings for the year (1,100 x 120% x 10% x 80%) (105.60)
Additional finances required 147.40
(b) In this case, increase in assets less liabilities must be equal to the increase in retained earnings.
(i) Let x be the required growth rate
(1,100x × 140%) – (1,100x × 25%) = 1,100 × (1+x) × 10% × (1 – 20%)
=1,540x – 275x –
88x= 88
x = 7.48%
(ii) Existing debt equity ratio = 465 / 700 = 66.43%

In this case, the company must obtain an additional loan of 66.43% of the additional
earnings in order to maintain the current debt equity ratio.
Now, the revised equation is as follows:
(1,100x × 140%) – (1,100 x × 25%) = [1,100 × (1 + x) × 10% (1 –
20%)] + [1,100 × (1 + x) × 10% × (1 – 20%) x 66.43%]
1,540x – 275x – 88x – 58.46x= 88 + 58.46 x = 13.09%

Answer 9
Decore Limited
(a) Cash operating cycle for next year
Inventory days [7,800/40,250(W-1)]×365 70.73
Trade debtors day [9,000/62,500(W-1)]×365 52.56
Trade creditors day [4,180/40,250]×365 (37.91)
Cash operating cycles 85.38
W-1: Projections for the next year Rs. in '000

Sales [50,000×1.25] 62,500
Cost of sales [35,000×1.15] 40,250
Average inventory [6,000×1.3] 7,800

Average trade debtors [7,500×1.2] 9,000
Average trade creditors [3,800×1.1] 4,180
(b) If DL does not follow industry average ratios:

Projected average inventory + Projected average trade debtors –
Projected average creditors [7,800+9,000–4,180] (W-1) 12,620
CFO has rightfully pointed out that DL would not be able to maintain its working capitalrequirement
within the bank overdraft limit next year.
If DL follows industry average ratios:

Average inventory [40,250(W-1)/365]×50 5,514
Average trade debtors [62,500(W-1)/365]×45 7,705
Average trade creditors [40,250(W-1)/365]×30 (3,308)
9,911
CFO has rightfully pointed out that DL would be able to maintain its working capitalrequirement
within the limit of bank overdraft if it follows industry average ratios.
(c) Actions and related risks are listed down below:

Action Risk
Reduce the inventory level of finishedgoods. The probability of stock-out would increase
which could adversely impact the overall
profitability of DL.
Reduce the period of credit allowed to DL might not be able to sell at the existingsales
customers. price as it would have to offer early payment
discount or else customers might switch to
competitor offering better credit
terms.
Delay the payment to suppliers. DL is already taking higher credit period as
compared to industry average. Further
delaying the payment could significantly affect
the existing relationship with thesuppliers who
might not be ready to offer
their products at the existing terms.

Answer 10
Faran Limited
(a) Additional finance required Rs. in million
Current sales 2,200.0
Additional sales – 25% increase 550.0
2,750.0
Expected increase in:
– trade receivable (550×80%) 440.0
– inventory (550×60%) 330.0
– payables (550×35%) (192.5)
Retained profit for the year (2,750 ×15%×75%) (309.4)

Additional finance required 268.1
(i) Maximum growth in sales in case no external financing available

That would mean that any increase in net assets should be equal to increase in retained earnings:
Let 𝑥 be the required growth rate:
(2200𝑥 × 80%) + (2200𝑥 × 60%) − (2200𝑥 × 35%) = 2200 × (1+ 𝑥) × 15% × 75%
⟹ 1760𝑥 + 1320𝑥 − 770𝑥 − 247.5𝑥 = 247.5
⟹ 2062.5𝑥 = 247.5 𝑥 = 247.5 ÷ 2062.5 = 12.00%
(ii) Maximum growth limited upto the current debt equity ratio:
D/E Ratio = 465 ÷ 800 = 58.13%
A loan of 58.13% of the additional earning must be obtained so that this ratio is maintained:
(2200𝑥 × 80%) + (2200𝑥 × 60%) − (2200𝑥 × 35%) = [2200 × (1+𝑥) × 15% × 75%] + [{2200 × (1+𝑥) × 15%
× 75%} × 58.13%]
⟹ 1760𝑥 + 1320𝑥 − 770𝑥 − 247.5𝑥 − 143.87𝑥 = 247.5 + 143.87
⟹ 1918.63𝑥 = 391.37 𝑥 = 391.37 ÷ 1918.63 = 20.40%

Chapter 16
ANSWER-1
Future value = Amount today x (1+r)n
Future value = 200,000 x (1.06)3
= 238,203
ANSWER-2
Sn = So x (1 + r)n
Sn = 100,000 x 1.0810\
= Rs. 215,892
ANSWER-3
(1+i)n−1
Sn =X i
(1.08)5−1
5,000,000 =X 0.08
5,000,000 X 0.08
X =
0.469
= Rs. 852,878
ANSWER-4
(1+i)n−1
Sn =X i
50,000[(1.07)10−1]
Sn = 0.07
48,350
Sn = 0.07
= Rs. 690,714
ANSWER-5
(1+r)n−1
Sn =X r
[(1.05)20−1]
100,000,000 =X
0.05
100,000,000 X 0.05
X =
1.653
= Rs. 3,024,803
ANSWER-6
1
Present value = Future cash flow x (1+r)n
1
Present value = 13,310 x (1.1)3
Present value = 10,000
ANSWER-7
Present value = Rs.1,000 x [1/(1.005)12]
= Rs.1,000 x 0.942
= Rs. 942.
ANSWER-8
Existing Contract

PV = 120,000 x 1/(1.07)3
= Rs. 97,955
Client’s offer

PV = 140,000 x 1/(1.07)5
= Rs. 99,818
The client’s offer is acceptable as the present value of the new amount is greater than the present
value of the receipt under the existing contract.
ANSWER-9
(a)
The cash outflow in Year 0 = cost of equipment + working capital
Investment = Rs. 45,000 + Rs. 8,000
= Rs. 53,000.
The cash inflow for year 4 = project’s net cash profits + working capital recovered
= Rs. 4,000 + Rs. 8,000
= Rs. 12,000
Cost of capital 11% Cost of capital 15%

Year Cash flow Discount PV Discount PV
Rs. factor Rs. factor Rs.
0 (53,000) 1.000 (53,000) 1.000 (53,000)
1 17,000 0.901 15,317 0.870 14,790
2 25,000 0.812 20,300 0.756 18,900
3 16,000 0.731 11,696 0.658 10,528
4 12,000 0.659 7,908 0.572 6,864
NPV + 2,221 (1,918)
(b) IRR = Lower rate% + NPVat lower Rate x (high-lower)%

NPVat lower −NPV at higher
IRR = 11% + [2,221 /(2,221+1,918) x (15 – 11)%]
IRR = 11% + 2.1%
IRR = 13.1%
ANSWER-10
T0 T1 T2 T3 T4
Sales 210,000 441,000 694,575 243,101
Less: Variable Cost (129,600) (279,936) (453,496) (163,259)
Less: Fixed Cost (54,000) (58,320) (62,986) (68,025)
Initial investment (150,000)
Residual Value 12,625
Net Cash Flow (150,000) 26,400 102,744 178,093 24,442
Discount Factor @12% 1 0.893 0.797 0.712 0.636
PV (150,000) 23,575 81,887 126,802 15,545
NPV Rs. 97,809
Project should be accepted, as NPV is positive.
ANSWER-11
NPV= P.V of cash inflows – P.V of cash outflows
NPV= 3,000 x 3.169(w-1) – 2,000 x 1
NPV= 9,507 – 2,000
NPV= Rs. 7,507
W-1
−n
Annuity Factor =1−(1+r)
r
1−(1+0.10)−4
= 0.10
=3.169
ANSWER-12
NPV= 5,000 x (1+2.486) (w-1) – 6,000 x 1
NPV= 17,430 – 6,000
NPV= Rs. 11,434
W-1
−n
Annuity Factor =1−(1+r)
r
1−(1+0.10)−3
= 0.10
=2.486
ANSWER-13
NPV= 19,000 x 4.008(w-1) – 10,000 x 1
NPV= 76,152 – 10,000
NPV= Rs. 66,152
W-1
1−(1+0.10)−11
Annuity Factor T1- T11 = 0.10
= 6.495
1−(1+0.10)−3
Annuity Factor T1- T3 = = (2.486)
0.10
= 4.008
ANSWER-14
NPV= 14,000 x 10(w-1) – 10,000 x 1
NPV= 140,000 – 10,000
NPV= +130,000
W-1
Perpetuity Factor =1
𝑟
= 1/0.10
=10
ANSWER-15
NPV= (11,000 x 1 + 11,000 x 1 ) – 200,000 x 1
0.10
NPV= (11,000 + 110,000) – 200,000

NPV= -79000
ANSWER-16
NPV= (16000 x 1 ) x (1 + 0.10)−3 – 40000 x 1
0.10
NPV= (120,210) – 40,000

NPV= +80,210
ANSWER-17
(a) Errors in the original investment appraisal

 Inflation was incorrectly applied to selling prices and variable costs in calculating contribution,
since only one year's inflation was allowed for in each year of operation.
 The fixed costs were correctly inflated, but included Rs. 200,000 per year before inflation that was
not a relevant cost. Only relevant costs should be included in investment appraisal.
 Straight-line accounting depreciation had been used in the calculation, but this depreciation method
is not acceptable to the tax authorities. The approved method using 25% reducing balance capital
allowances should be used.
 Interest payments have been included in the investment appraisal, but these are allowed for by the
discount rate used in calculating the net present value.
 The interest rate on the debt finance has been used as the discount rate, when the nominal weighted
average cost of capital should have been used to discount the calculated nominal after-tax cash
flows.
(b) Nominal weighted average cost of capital = 1.07 x 1.047 = 1.12, i.e. 12% per year
NPV calculation:
T0 T1 T2 T3 T4 T5
Sales - 3,150,000 5,292,000 6,945,750 3,646,519 -
Variable Cost - (1,820,000) (3,028,480) (3,937,024) (2,047,252) -
- 1,330,000 2,263,520 3,008,726 1,599,267 -
Fixed Cost - (330,000) (349,800) (370,788) (393,035) -
Depreciation - (500,000) (375,000) (281,250) (593,750) -
500,000 1,538,720 2,356,688 612,482 -
Tax@30% - - (150,000) (461,616) (707,006) 183,745
Depreciation - 500,000 375,000 281,250 593,750 -
1,000,000 1,763,720 2,176,322 499,216 (183,745)
Loan 2,000,000 - - - (2,000,000)
Investment (2,000,000) - - - 250,000 -
- 1,000,000 1,763,720 2,176,322 (1,250,784) (183,745)
PV@12% x 1 1 (1+0.12) (1+0.12)-2 (1+0.12)-3 (1+0.12)-4 (1+0.12)-5
- 892,857 1,406,027 1,549,063 (794,896) (104,262)
NPV = Rs. 2,948,789
Tax Depreciation:
Rs.
T0 2,000,000
T1 Depreciation (2,000,000 x 25%) (500,000)
1,500,000
T2 Depreciation (1,500,000 x 25%) (375,000)
1,125,000
T3 Depreciation (1,125,000 x 25%) (281,250)
843,750
T4 (Bal. fig) (593,750)
250,000
ANSWER-18
(a) NPV calculation
Year 1 2 3 4 5
Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000
Sales revenue 5,614 7,214 9,015 7,034
Variable costs (3,031) (3,931) (5,135) (4,174)
Contribution 2,583 3,283 3,880 2,860
Fixed costs (1,530) (1,561) (1,592) (1,624)

Depreciation (1,000) (1,000) (1,000) (1,000)
Before-tax cash flow 53 722 288 236
Tax liability (16) (217) (386) (71)
Depreciation 1,000 1,000 1,000 1,000
After-tax cash flow 1,053 1,706 2,071 850 (71)
Discount at 12% 0.893 0.797 0.712 0.636 0.567
Present values 940 1,360 1,475 541 (40)
NPV = 276,000
Comment
Since the proposed investment has a positive net present value of Rs. 276,000, it is financially
acceptable.
Workings:
Sales revenue
Year 1 2 3 4
Sales of small houses (houses/yr) 15 20 15 5
Sales of large houses (houses/yr) 7 8 15 15
Small house selling price (Rs000/house) 200 200 200 200
Large house selling price (Rs000/house) 350 350 350 350
Sales revenue (small houses) (Rs000/yr) 3,000 4,000 3,000 1,000
Sales revenue (large houses) (Rs000/yr) 2,450 2,800 5,250 5,250
Total sales revenue (Rs/yr) 5,450 6,800 8,250 6,250
Inflated sales revenue (Rs/yr) 5,614 7,214 9,015 7,034
Variable costs of construction
Year 1 2 3 4
Sales of small houses (houses/yr) 15 20 15 5
Sales of large houses (houses/yr) 7 8 15 15
Small house variable cost (Rs. 000/house) 100 100 100 100
Large house variable cost (Rs. 000/house) 200 200 200 200
Variable cost (small houses) (Rs. 000/yr) 1,500 2,000 1,500 500
Variable cost (large houses) (Rs. 000/yr) 1,400 1,600 3,000 3,000
Total variable cost (Rs. /yr) 2,900 3,600 4,500 3,500
Inflated total variable cost (Rs. /yr) 3,031 3,931 5,135 4,174
ANSWER-19
(a) Net present value of investment in new machinery
Year 0 1 2 3 4 5
Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000
Sales income 6,084 6,327 6,580 6,844
Variable cost (2,374) (2,504) (2,642) (2,787)
Contribution 3,710 3,823 3,938 4,057
Fixed costs (263) (276) (289) (304)
Cash flow 3,447 3,547 3,649 3,753
Capital allowances (1,250) (938) (703) (1,859)
Taxable profit 2,197 2,609 2,946 1,894

Taxation (439) (522) (589) (379)

After-tax profit 2,197 2,170 2,424 1,305 (379)
Capital allowances 1,250 938 703 1,859
After-tax cash flow 3,447 3,108 3,127 3,164 (379)
Initial Investment (5,000)
Working capital (500) (24) (25) (26) 574
Scrap value 250
Net cash flow (5,500) 3,423 3,083 3,101 3,988 (379)
Discount at 12% 0.893 0.797 0.7I2 0.636 0.567
Present values 3,057 2,457 2,208 2,536 (215)
NPV = 10,043 - 5,000 - 500 = Rs. 4,543 million

As the net present value of Rs. 4,543 million is positive, the expansion can be recommended as
financially acceptable.
Workings
Year 1 2 3 4
Selling price (Rs. /unit) 676.00 703.04 731.16 760.41
Sales (units/year) 9,000 9,000 9,000 9,000
Sales income (Rs. 000) 6,084 6,327 6,580 6,844
Year 1 2 3 4
Variable cost (Rs. /unit) 263.75 278.26 293.56 309.71
Sales (units/year) 9,000 9,000 9,000 9,000
Variable cost (Rs. 000) 2,374 2,504 2,642 2,787
Year 1 2 3 4
Rs. 000 Rs. 000 Rs. 000 Rs. 000
Working capital 523.50 548.11 573.87
Incremental 24 25 26 (574)
ANSWER-20
(a) Revised draft evaluation of investment proposal
0 1 2 3 4 5
Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000 Rs. 000
Sales revenue 2,475 2,714 4,413 4,775
Variable costs (1,097) (1,323) (2,084) (2,370)
Fixed costs (155) (159) (164) (169)
Cash flow before tax 1,223 1,232 2,165 2,236
Tax Depreciation (450) (338) (253) (759)
Taxable profit 773 894 1,912 1,477
Taxation (170) (197) (421) (325)
After-tax profit 773 724 1,715 1,056 (325)
Tax Depreciation 450 338 253 759
Cost of Machine (1,800)
Loan 1,500 (1,500)
After-tax cash flow 1,223 1,062 1,968 315 (325)
Discount at 12% 0.893 0.797 0.712 0.636 0.567
Present values 1,092 846 1,401 200 (184)
NPV =3,055,000

The revised draft evaluation of the investment proposal indicates that a positive net present value is
expected to be produced. The investment project is therefore financially acceptable and accepting it will
increase the wealth of the shareholders of Uftin Co.
Workings:
W-1
Year 1 2 3 4
Sales (units/year) 95,000 100,000 150,000 150,000
Inflated Selling Price (Rs. /unit) 26.05 27.14 29.42 31.83
Sales revenue (Rs. 000/year) 2,475 2,714 4,413 4,775
W-2
Year 1 2 3 4
Sales (units/year) 95,000 100,000 150,000 150,000
Inflated Variable Cost (Rs. /unit) 11.55 13.23 13.89 15.80
Variable costs (Rs. 000/year) 1,097 1,323 2,084 2,370
W-3
Rs.
T0 1,800,000
T1 Depreciation (1,800,000 x 25%) (450,000)
1,350,000
T2 Depreciation (1,350,000 x 25%) (337,500)
1,012,500
T3 Depreciation (1,012,500 x 25%) (253,125)
759,375
T4 Depreciation (Bal. fig) (759,375)
-
b) The following revisions to the original draft evaluation could be discussed.
Inflation
Only one year's inflation had been applied to sales revenue, variable costs and fixed costs in years 2, 3
and 4. The effect of inflation on cash flows is a cumulative one and in this case specific inflation was
applied to each kind of cash flow.
Interest payments
These should not have been included in the draft evaluation because the financing effect is included in
the discount rate. In a large company such as Uftin Co, the loan used as part of the financing of the
investment is very small in comparison to existing finance and will not affect the weighted average cost
of capital.
Tax allowable depreciation
A constant tax allowable depreciation allowance, equal to 25% of the initial investment, had been used
in each year. However, the method "which should have been used was 25% per year on a reducing
balance basis, resulting in smaller allowances in years 2 and 3, and a balancing allowance in year 4. In
addition, although tax allowable depreciation had been deducted in order to produce taxable profit, tax
allowable depreciation had not been added back in order to produce after-tax cash flow.
Year 5 tax liability
This had been omitted in the draft evaluation, perhaps because a four-year period was being used as the
basis for the evaluation. However, this year 5 cash flow needed to be included as it is a relevant cash
flow, arising as a result of the decision to invest.
Examiner's Note: Explanation of only TWO revisions was required.
Interest payments
These should not have been included in the draft evaluation because the financing effect is included in
the discount rate. In a large company such as Uftin Co, the loan used as part of the financing of the
investment is very small in comparison to existing finance and will not affect the weighted average cost
of capital.
Tax allowable depreciation
A constant tax allowable depreciation allowance, equal to 25% of the Initial investment, had been used
in each year. However the method which should have been used was 25% per year on a reducing balance
basis, resulting in smaller charges in years 2 and 3, and a balancing allowance in year 4. In addition,
although tax allowable depreciation had been projected in order to produce taxable profit, tax allowable
depreciation had not been added back in order to produce after-tax cash flow.
Year 5 tax liability
This had been omitted in the draft evaluation, perhaps because a four-year period was being used as the
basis for the evaluation. However, this year 5 cash flow needed to be included as it is a relevant cash
flow, arising as a result of the decision to invest.
ANSWER-21
(a) Cash flows resulting from manufacture and rate of Champs.
Year 0 1 2 3
Rs.000 Rs.000 Rs.000 Rs.000

Sales (W-5) - 600 660 726
Machine (150)
Labour (W-1) - (75) (210) (252)
Materials: Alpha (W-2) (100) (110) (121) -
Beta (W-3) (90) (121) (133) -
Overheads (W-4) - (50) (55) (61)
Total outflows (340) (356) (519) (513)
Net inflow/(outflow) (340) 244 141 413
Discount factor at 20% 1 0.83 0.694 0.58
Present value (340) 203 97 240
Net present value Rs. 200,000

On die basis of die estimates given, production of Champs is worthwhile. Note: Time 0 is taken to be
the date on which manufacture would commence, i.e. L January 2009, time 1 is 31 December 2009, etc.
Workings
For explanations of the figures used, see part (b)
W-1
Labour cost
Year 1: skilled (25,000 hours at Rs. 3) = Rs. 75,000
Un-skilled: no cost Incurred.
Year 2
Skilled (25,000 x 3 x 1.2) = Rs. 90,000
Un Skilled (50,000 x 2 x 1.2) = Rs. 120,000
= Rs. 210,000
Year 3 = 210,000 x 1.2 = Rs. 252,000
W-2
Material Alpha
Quantity held is enough for one year.

Current buying price is Rs. 0.50 per kilo, rising at 10% per annum
Time 0 cost: Rs. 0.50 x 200,000 = Rs. 100,000
Time 1 cost: Rs. 100,000 x 1.1 = Rs. 110,000
Time 2 cost: Rs. 110,000 x 1.1 = Rs. 121,000
W-3
Material Beta
Quantity held is enough for one year
Time 0 realizable value: 100,000 x Rs. 0.90 = Rs. 90,000
Time 1 buying price: 100,000 x Rs. 1.10 x 1.1= Rs. 121,000
Time 2 buying price: Rs. 121,000 x 1.1 = Rs. 133,100
W-4
Overheads
The only relevant costs are Variable overheads, which rise at 10% per annum
Year 1 cost =100,000 x 50% = Rs. 50,000
Year 2 cost =Rs. 50,000 x 1.1 = Rs. 55,000
Year 3 cost =Rs. 55,000 x 1.1 = Rs. 60,500
W-5
Sales
The selling price rises at 10% per annum
Year 1 =100,000 x Rs.6 = Rs. 600,000
Year 2 =Rs. 600,000 x 1.1 = Rs. 660,000
Year 3 =Rs. 660,000 x 1.1 = Rs. 726,000
(b) Brief explanations of the figures used
(1) Machine
Although the machine is Owned already, it has an opportunity cost if used on this project, which is the
revenue foregone if it is not sold now for Rs. 150,000
(2) Labour
In the first year of the project, the company will have to pay for extra skilled labour only, as there is
enough surplus unskilled labour to cover the necessary 50,000 hours on the project. As this unskilled
labour is paid whether the Champs are produced or not, there is no relevant unskilled labour cost in year
1 of the project.
In year 2 and 3 of the project the company will have to pay for extra skilled and unskilled.
(3) Material Alpha
Alpha is used regularly by the company on many products. If existing stocks are used to manufacture
Champs, the company will have to buy in more stocks of Alpha for its other projects. The relevant cost
of Alpha is thus always its buying price which is expected to rise at 10% per annum.
(4) Material Beta
Present stocks of Beta are sufficient for-the first year’s production of Chimps. Since there is no
alternative use for Beta within the company, the opportunity cost of existing stocks is the realizable
value of 90p.pbr kilo. After one year present stocks will be exhausted, and the relevant cost of further
supplies of Beta will be the buying price.
(b) Overheads
Fixed costs allocated from head office will be irrelevant to this decision is they will be incurred -whether
Champs are produced or not. Depreciation is irrelevant to a project appraisal based on cash flows. The
only relevant cost is therefore the variable overhead.

ANSWER-22
(a) Calculations to show whether production of the Oakman is worthwhile:
Note: End of year 1 2 3 4 5 6
Sales in units 5,000 5,000 5,000 2,500 2,500
Rs. Rs. Rs. Rs. Rs. Rs.
Sales revenue 211,750 232,924 256,218 140,920 155,012
Materials (48,400) (53,240) (58,564) (32,210) (35,431)
Labour:
Redundancy: 20,700
Extra cash
Wages (W-5) (39,675) (45,626) (52,470) (30,170) (34,696)
Redundancy Cost: (W-4) (15,741)
Machine cost and overhaul (W-6) (209,000) (79,860)
Variable Overheads: (24,200) (26,620) (29,282) (16,105) (17,715)
Net cash income (188,300) 99,475 27,579 100,161 62,435 67,170
Discount factor at 20% 0.83 0.69 0.58 0.48 0.40 0.33
Present value (156,289) 68,638 15,996 48,077 24,974 22,166
Net present value Rs. 23,562
Conclusion: Production of the Oakam is seen to be worthwhile on the above calculations as the project
has a positive net present value of approximately Rs.13,300.
W-1
Sales revenue
Sale price for the first year of production (year 2) =Rs. 35 x 1.1 x 1.1 = Rs. 42.35
Thus sales revenue for year one = 5,000 x Rs. 42.35 = Rs. 211,750
Unit price rises by 10% per annum
W-2
Materials
Materials price in first year of production (year 2) = Rs. 8 x 1.1 x 1.1 = Rs. 9.68
Materials cost = 5,000 x Rs. 9.68 = Rs. 48,400
Unit price rises by 10% per annum
W-3
Labour
Compare labour costs with the alternative of not producing the Oakman
Year 1 Redundancy costs saved =1,000 x 3 x 1.15 x 6 = Rs. 2,700
Redundancy costs saved for year 3 and 4
Year 4 Redundancy costs incurred (3rd year of production) =1,000 x 3 x 1.15 x 6 = Rs. 15,741
W-4
Wages
Year 2 (1st year of production) =5,000 x 2 x 3 x (1.15)2 = Rs. 39,675
Year 5 (4th year of production) =2,500 x 2 x 3 x (1.15)2 = Rs. 19,838
W-5
Overhauling Cost = Rs. 60,000 x (1.1)3 = Rs. 79,860
W-6
Variable Overhead Cost in year 2 = 5,000 x Rs. 4 x (1.1)2 = Rs. 24,202

ANSWER-23
Proposal 1 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
-------------------------------------------- Rupees --------------------------------------------
Variable cost
[units produced [(W-1) ×400×1.06] - 3,339,000 3,716,419 4,136,160 4,603,646 5,123,798
Plant operation cost
[90,000×12×1.06] - 1,144,800 1,213,488 1,286,297 1,363,475 1,445,284
Annual maintenance cost
[1,380,000×1.06] - 1,462,800 1,550,568 1,643,602 1,742,218 1,846,751
Depreciation (W-2) - 1,166,667 1,166,667 688,516 688,516 688,516
Gain on disposal (W-3) - - - - - (107,315)
Total cash outflow - 7,113,267 7,647,142 7,754,575 8,397,855 8,997,034
Tax @ 30% - (2,133,980) (2,294,143) (2,326,373) (2,519,357) (2,699,110)
Less back: Depreciation - (1,166,667) (1,166,667) (688,516) (688,516) (688,516)
Add back: Gain on disposal - - - - - 107,315
Purchase cost 3,500,000 - - - - -
Overhaul of machine (W-2) - - 1,460,680 - - -
Residual value of machine (W-3) - - - - - (669,113)
Net cash outflow 3,500,000 3,812,620 5,647,012 4,739,686 5,189,982 5,047,610
Discount factor @ 14% 1.000 0.877 0.769 0.675 0.592 0.519
Present value 3,500,000 3,343,668 4,342,552 3,199,288 3,072,469 2,619,710
NPV of cost 20,077,687
Proposal 2 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

-------------------------------------------- Rupees --------------------------------------------
Variable cost [(W-1) ×380×1.06] - 3,172,050 3,530,598 3,929,352 4,317,671 4,576,731
Shortfall - to be purchased from
market [(W-1)×550× (1.06)4,5] - - - - 80,546 421,006
Plant operation cost
[70,000×12×1.06] - 890,400 943,824 1,000,453 1,060,481 1,124,109
Annual maintenance cost
[1,200,000×1.06] - 1,272,000 1,348,320 1,429,219 1,514,972 1,605,870
Depreciation - 800,000 800,000 800,000 800,000 800,000
Gain on disposal (W-3) - - - - - (338,226)
Total cash outflow - 6,134,450 6,622,742 7,159,024 7,773,670 8,189,490
Tax @ 30% - (1,840,335) (1,986,823) (2,147,707) (2,332,101) (2,456,847)
Less back: Depreciation - (800,000) (800,000) (800,000) (800,000) (800,000)
Add back: Gain on disposal - - - - - 338,226
Purchase cost 5,000,000 - - - - -
Residual value of machine (W-3)
- - - - - (1,338,226)
Net cash outflow 5,000,000 3,494,115 3,835,919 4,211,317 4,641,569 3,932,643
Discount factor @ 14% 1.000 0.877 0.769 0.675 0.592 0.519
Present Value of cost 5,000,000 3,064,339 2,949,822 2,842,639 2,747,809 2,041,042
NPV of cost 18,645,651
Conclusion:
AL should purchase the machine under proposal 2 for in house production of PQR.
W-1 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

--------------------------------------- Rupees ---------------------------------------
Units of PQR required [7500×1.05]
A 7,500 7,875 8,269 8,682 9,116 9,572
Shortfall - to be purchased
from market underProposal -
2 C=A-B - - - - 116 572

W-2: Depreciation
Proposal 1: Rupees
First 2 years (3,500,000/3) 1,166,667
For next 3 years

WDV [3,500,000–(1,166,667×2)] 1,166,667
Overhauling cost [1,300,000×(1.06)2] 1,460,680
2,627,347
Less: Residual value [500,000×(1.06)2] (561,800)
Depreciable value 2,065,547
Life (years) 3
Depreciation (Rs.) 688,516
Proposal 2:
Depreciation [(5,000,000–1,000,000)/5] 800,000
W-3: Gain on disposal Proposal 1 Proposal 2

Residual value [500,000×(1.06)5, 1,000,000×(1.06)5] 669,113 1,338,226
Less: Investment [(3,500,000+1,460,680), 5,000,000] 4,960,680 5,000,000
Less: Accumulated depreciation (4,398,882) (4,000,000)
WDV 561,798 1,000,000
Gain on disposal 107,315 338,226
ANSWER-24
If discontinue now Rupees
Resale value of equipment (given) 4,000,000
Tax on gain on sale of equipment (W-1) (356,250)
Net rent expense (W-2) (127,050)
3,516,700
If continue for three more years
Present value of cash flows (W-3) 3,745,878
Conclusion:
AG should continue to operate SC for a further period of three years as this option provides higher
return to the company.
WORKINGS
W-1: Tax on gain on sale of machine Rupees
Resale value of equipment 4,000,000
Tax WDV of equipment (W-3.2) (2,812,500)
Taxable gain 1,187,500
Tax @ 30% on gain (1,187,500×30%) 356,250
W-2: Net rent expense Rupees

Rent payable [726,000×3/12] 181,500
Tax saving on rent expense @ 30% (54,450)

Net rent expense 127,050

1 2 3
W-3:
Rupees
Sales [9,000,000 × 1.2 (W-3.1)] 10,800,000 12,960,000 15,552,000
Variable costs [7,080,000 × 1.18 (W-3.1)] (8,354,400) (98,58,192) (11,632,667)
Contribution 2,445,600 3,101,808 3,919,333
Fixed costs other than rent and depreciation (551,250) (578,813) (607,754)
[500,000 × 1.05 (W-3.1)]
Depreciation (W-3.2) (703,125) (527,344) (395,508)
Loss on disposal (186,523)
[1,000,000 – 1,186,523 (W-3.2)]
Rent expense (726,000) (798,600) (878,460)
Profit before tax 465,225 1,197,051 1,851,088
Tax @ 30% (139,568) (359,115) (555,326)
Profit after tax 325,657 837,936 1,295,762
Add back deprecation 703,125 527,344 395,508
Add back loss on disposal 186,523
Residual value of equipment 1,000,000
Net cash flows 1,028,782 1,365,280 2,877,793
Discount factor @ 16% 0.862 0.743 0.641
Present value 886,810 1,014,403 1,844,665

NPV 3,745,878
W-3.1:Trend in sales, variable costs and fixed costs other than rent and depreciation
Sales [9,000,000 ÷ 7,500,000] 1.20
Variable costs [7,080,000 ÷ 6,000,000] 1.18
Fixed costs other than rent and depreciation [525,000 ÷ 500,000] 1.05
W-3.2: Depreciation
Rupees
Cost 5,000,000
Depreciation - Year 1 1,250,000
WDV 3,750,000
Depreciation - Year 2 937,500
WDV 2,812,500
WDV 2,109,375
WDV 1,582,031
WDV 1,186,523

ANSWER-25
Net present value method:
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Rs. in’0000
--
Sales revenue - 90,000 101,115 113,603 127,633 143,396
[18,0005,0001.051.07]
Variable cost - (72,000) (80,892) (90,882) (102,106) (114,716)
[18,0004,0001.051.07]
Fixed cost - (2,400) (2,568) (2,748) (2,940) (3,146)
[(250,00050,000)121.07]
Depreciation [WDV  0.25] - (15,000) (11,250) (8,438) (8,828) (6,621)
Loss on disposal [WDV  0.2] - - - - - (3,973)
Profit before tax - 600 6,405 11,535 13,759 14,940
Income tax @30% - (180) (1,922) (3,461) (4,128) (4,482)
Profit after tax - 420 4,483 8,074 9,631 10,458
Cost of machine (60,000) - - - - -
Overhauling cost - - - (10,000) - -
Residual value [WDV  0.8] - - - - - 15,890
Add back depreciation - 15,000 11,250 8,438 8,828 6,621
Add back loss on disposal - - - - - 3,973
Net cash flows (60,000) 15,420 15,733 6,512 18,459 36,942
Discount factor @ 15% 1.00 0.87 0.76 0.66 0.57 0.50
Present value (60,000) 13,415 11,957 4,298 10,522 18,471

Net present value (1,337)
Conclusion:
Since expected NPV is negative, LL should not accept the proposal.
(b) Determination of minimum discount rate:
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Rs. in’0000
--
Net cash flows [from part (60,000) 15,420 15,733 6,512 18,459 36,942
(a)]
Discount factor @ 10% 1.00 0.91 0.83 0.75 0.68 0.62

Present value (60,000) 14,032 13,058 4,884 12,552 22,904
Net present value (NPV) 7,430
IRR = A% + [NPVa / NPVa  NPVb)  (B%  A%)]

IRR = 10% + [7,430 / 7,430  (1,337)  (15%  10%)]
IRR = 14.24% (Minimum discount rate)

ANSWER-26
Lotus Enterprises
Feasibility to accept HL's offer for establishment of manufacturing facility in Pakistan
Year 0 Year 1 Year 2 Year 3 Year 4
-----------Rs. in million-----------
Sales - (Increase of 5% in volume & 8% in price) 500.00 567.00 642.98 729.14
Royalty (15% of sales) (75.00) (85.05) (96.45) (109.37)
Variable cost (500x0.75)-50 (325.00)
(325x1.05x1.08) (368.55) (417.94) (473.94)
Accounting/tax depreciation:
- Factory building at 5% A (1.50) (1.43) (1.36) (1.29)
- Plant & other fixed assets at 25% B (27.50) (20.63) (15.47) (11.60)
Fixed cost excluding depreciation (50-A-B) (21.00)
21x1.08 (22.68) (24.49) (26.45)
Taxable profit C 50.00 68.66 87.27 106.49
Tax at 30% Cx30% (15.00) (20.60) (26.18) (31.95)
Net profit 35.00 48.06 61.09 74.54
Non-cash expenses - Depreciation (A+B) 29.00 22.06 16.83 12.89
Market value of the land (60.00) 75.00
Factory building (30.00) 24.42
Plant and its installation & other assets (110.00) 34.80
Working capital (35.00) (5.00) (5.00) 45.00
(200.00) 29.00 65.12 72.92 266.65
Present value factor 15% 1.00 0.87 0.76 0.66 0.57

Present value at 15% (200.00) 25.23 49.49 48.13 151.99
Net present value 74.84
Conclusion:
Since the net present value is positive, it is feasible for LE to accept HL's offer.
ANSWER-27
T0 T1 T2 T3 T4
Incremental Total C.M (W-3) 157.5 198.45 244.25 295.37
Incremental F.C (30 x 1.05) (30) (31.5) (33.08) (34.73)
Tax Depreciation (W-2) (117.75) (117.75) (117.75) (117.75)
Profit 9.75 49.2 93.42 142.89
Tax @ 30% (2.93) (14.76) (28.03) (42.87)
Tax Savings on loss (50-45) x 30% 1.5
Add back tax depreciation 117.75 117.75 117.75 117.75
Initial investment (W-1) (486) 60(R.V)
Net Cash flow (486) 126.07 152.19 183.14 277.77
Discount factor @ 12% 1 0.893 0.797 0.712 0.636
P.V (486) 112.58 121.3 130.4 176.7
NPV (54.78)
Discount factor @ 20% 1 0.833 0.694 0.579 0.482
P.V (486) 105.01 105.61 106.04 133.88
NPV (35.47)
IRR = Lower rate% + NPVat lower Rate x (high-lower)%


IRR = 12% + 54.78 x (20 - 12)%

54.78 −(−35.47)

= 16.85 %
Conclusion:
Since IRR is higher so GL should replace the existing plant.
W-1
Initial Investment
Purchase Cost =500
Installation Cost = 25
Inspection Cost (12 x 50%) =6
Cost 531
= Cost – S.P
= 531– 45
= 486
W-2
Calculation of Depreciation
Cost – R.V
Year 1-4 =
life
531 – 60
= 4
= 117.75/year
W-3
Incremental (Sales/C.M)
Units 1 2 3 4
Existing Sales 6 6 6 6
New Sales (6 x 1.25) : (7.5 x 1.04) 7.5 7.8 8.11 8.43
Incremental (Units) 1.5 1.8 2.11 2.43
X X X X
Incremental C.M (Units) (550 – 450) x 1.05 105 110.25 115.76 121.55
Incremental Total C.M 157.5 198.45 244.25 295.37
ANSWER-28
(a) Investment and speculation are similar in that they both involve an investor to take risk in the
expectation of making a profit. However, following are the main differences between
investment and speculation:
Investment Speculation
(i) Normally investments are made for Speculation is often made on short term
long-term periods. basis.
(ii) Attitude of investor in investment is Speculation always involves high risk.
usually risk neutral.
(iii) Investment usually involves putting money into Speculators often invest in more marketable assets
an asset that isn’t typically marketable in the as they do not plan to own them for long time.
short term. The objective is to yield a series of
returns over the life of the investment.
(iv) Investors build their strategy based on the Speculators normally expect some kind of change
expectation that a certain price movement or without necessarily knowing what.
income stream will occur.
(v) There is a low to moderate risk involved in Risk is usually moderate to high in speculation.
investment.

(vi) Investment involves moderate returns due to low Speculation involves high returns in exchange for
to moderate risk. high risks.
(b)
Valika Limited
Introduction of new product - AX
------------------- Rs. in million -------------------
Contribution margin (W-1) - 18.00 20.79 22.05 22.69
Tax/Accounting depreciation (50×0.25, 0.75) - (12.50) (9.38) (7.04) (5.28)
Net profit before tax - 5.50 11.41 15.01 17.41
Tax liability @ 30%. - (1.65) (3.42) (4.50) (5.22)
Net profit after tax - 3.85 7.99 10.51 12.19
Add back depreciation - 12.50 9.38 7.04 5.28
Rent income lost 1.8×1.07 (1.93) (2.07) (2.21) (2.36) -
Tax saved on rent income 1.93×30% 0.58 0.62 0.66 0.71
Residual value receipts (50–34.2 Total dep.) 15.80
Initial investment (50.00) - - - -
Working capital (W-2) (10.00) (1.00) (1.10) (1.21) 13.31
Net cash (outflows)/inflows (61.93) 13.86 14.68 14.64 47.29
Discount rate @ 10% 1.0000 0.9091 0.8264 0.7513 0.6830
Present value (61.93) 12.60 12.13 10.99 32.29
Net present value 6.08
Opinion: VL's should start production of AX.

W-1: Annual contribution margin Year 1 Year 2 Year 3 Year 4
Contribution margin per unit (Rs.) A 100.00 105.00 110.25 115.76
100 100×1.05 105×1.05 110.25×1.05
Annual demand (Units) 180,000 198,000 217,800 196,020
180,000×1.10 198,000×1.10 217,800×90%
Production - Restricted to capacity (Units) (Up to 200,000 units p.a)B 180,000 198,000 200,000 196,020
Annual CM (Rs. in million) (A×B) 18.00 20.79 22.05 22.69

W-2: Working capital requirement Year 1 Year 2 Year 3
Working capital current year 11.00 12.10 13.31
10×1.1 11×1.1 12.10×1.1
Working capital last year 10.00 11.00 12.10
(Increase)/Decrease (1.00) (1.10) (1.21) 13.31
ANSWERS-29
T0 T1 T2 T3 T4
------ Rs in Million ------
Sales 800 1,100 1306.8 1,543.96
Less: V. Cost (640) (880) (1045.4) (1,235.17)
Contribution Lost (X85) (11) (24.2) (39.93) (58.56)
Inc. Fixed cost (30) (33) (36.3) (39.93)
Dep. (112.5) (84.38) (63.28) (47.46)
Taxable profit 6.5 78.42 121.84 162.83
Tax@30% (1.95) (23.53) (36.55) (48.85)
Add: Back tax dep. 112.5 84.38 63.28 47.46
Initial investment (450) 142.38
Net cash flow (450) 117.05 139.27 148.58 303.81
D.F-12% 1 0.893 0.797 0.712 0.635
P.V (450) 104.53 110.99 105.78 192.933

NPV Rs. 64.126

Million
D.F-20% 1 0.833 0.694 0.578 0.482
PV (450) 97.5 96.65 86.025 146.44
NPV = - Rs. 23.385 Million
W-1
Depreciation
T0 Cost 450
T1 Dep. 25% (112.5)
337.5
T2 Dep. 25% (84.38)
253.12
T3 Dep. 25% (63.28)
189.84
T4 Dep. 25% (47.46)
142.38
IRR = Lower rate% + NPVat lower Rate

x (high-lower)%
64.126
= 12% + 64.126+23.385 x (20-12)%
= 12% + 0.732(8)%
= 12% + 5.86%
If IRR greater than cost of capital = Accept
ANSWER-30
Modern Transport Limited
Evaluation of BRC’s proposal
-----------[Cash inflows/(outflows)]-----------
--------------Rupees--------------
Revenue - 1,800,000 1,890,000 1,984,500 2,083,725
(1,800,000×1.05)
Salaries of drivers - (900,000) (945,000) (992,250) (1,041,863)
(3×300,000×1.05)
Maintenance cost - (60,000) (69,300) (80,042) (92,448)
(60,000×1.05×1.10)
Insurance premium (50,000- (50,000) (45,000) (40,000) (35,000) -
5,000)
Tax allowance (W-1) (558,750) (386,563) (291,172) (143,515)
Taxable Profit 236,250 449,137 586,036 805,899
Taxation 30% - (70,875) (134,741) (175,811) (241,770)
Car's cost (2,000,000) - - - -
Registration charges (35,000) - - - -
Initial investment A (2,035,000) - - - -
Cost of three mobile (45,000) - - - -
phones(15,000×3)
Tax allowance add back 558,750 386,563 291,172 143,515
Residual value of car 750,000
Net cash flows (2,130,000) 724,125 700,959 701,397 1,457,644
Discount factor @ 12% 1.0000 0.8929 0.7972 0.7118 0.6355

Present value (2,130,000) 646,571 558,805 499,254 926,333

Net present value 500,963

Conclusion: The net present value is positive; therefore, the proposal should be accepted.

-------------Rupees-------------
W-1: Adjustment for tax liability
Accounting/tax depreciation (A×25%) 508,750 381,563 286,172 108,515
Mobiles' cost charged off 45,000 - - -
Insurance premium allowable for tax-next 5,000 5,000 5,000 35,000
year
558,750 386,563 291,172 143,515
W-1.1
Rs.
T0 2,035,000
T1 Depreciation (2,035,000 x 25%) (508,750)
1,526,250
T2 Depreciation (1,526,000 x 25%) (381,563)
1,144,687
T3 Depreciation (1,144,687 x 25%) (286,172)
858,515
T4 Depreciation (Bal. fig) (108,515)
750,000
ANSWERS-31
Tropical Juices
Investment appraisal - Expansion of production facility
Cash inflow s/(outflows)
Rs.
Loss of opportunity (Bldg, rent) - (6,300,000) (6,615,000) (6,945,750) (7,293,038)
Cost of plant and its installation (60,000,000) 6,000,000
Working capital (25,000,000) - - - 25,000,000
Sales 91,875,000 115,762,500 129,654,000 123,373,884
Variable cost (47,250,000) (59,535,000) (66,679,200) (63,449,426)
Fixed cost (12,600,000) (13,230,000) (13,891,500) (14,586,075)
Net cash flows (85,000,000) 25,725,000 36,382,500 42,137,550 69,045,345
Present value factor at 15% 1.000 0.870 0.756 0.658 0.572

Present value at 15% (85,000,000) 22,380,750 27,505,170 27,726,508 39,493,937
Net present value (NPV) at 15% 32,106,365
Conclusion: The expansion of production facility is generating positive NPV at TJs cost of capital of
15%. Therefore, it is feasible for TJ to expand the production facility.

ANSWERS-32
Digital Electronics
Evaluating acquisition of a plant on lease
Receipts and payments:
1-Jan-16 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19
-----------------Rs. in million-----------------
Net cash inflows - 5.90 5.20 2.45 1.00
Disposal price - - - - 0.5
Payments (2.00) (3.90) (3.90) (3.90) -
Amount payable on expiry of
- - - -
lease (0.89)
Net receipts (2.00) 2.00 1.30 (2.34) 1.50
NPV at 10% (A %) NPVA

PV factor 1.00 0.91 0.83 0.75 0.68
PV (Rs. in million) (2.00) 1.82 1.08 (1.76) 1.02 0.16
NPV at 20% (B %) NPVA

PV factor 1.00 0.83 0.69 0.58 0.48
PV (Rs. in million) (2.00) 1.66 0.90 (1.36) 0.72 (0.08)
Internal rate of return (IRR) = Lower rate% + NPVat lower Rate x (high-lower)%
= 10%+ [0.16 /(0.16-(-0.08) x (20%-10%)]
= 16.67%
Conclusion: As internal rate of return (IRR) is higher than the company's cost of capital, it is advisable
to acquire the plant on lease.
ANSWERS-33
Project’s Internal rate of return Year 0 1 2 3 4
-----------Rs. in million-----------
Sales - 155.00 155.00 65.00 65.00
Cost of sales (50%) - (77.50) (77.50) (32.50) (32.50)
Operating expense (10%) - (15.50) (15.50) (6.50) (6.50)
5% of sales for technical support by CL - (7.75) (7.75) (3.25) (3.25)
Investment (175.00) - - - 100.00
Net cash flows (175.00) 54.25 54.25 22.75 122.75
Discount factor (15%) 1.00 0.87 0.76 0.66 0.57
Present value (175.00) 47.20 41.23 15.02 69.97
Net present value at 15% NPVA (1.58)
Discount factor (12%) 1.00 0.89 0.79 0.71 0.63
Present value (175.00) 48.28 42.86 16.15 77.33
Net present value at 12% NPVB 9.62
Internal rate of return (IRR) = Lower rate% + NPVat lower Rate x (high-lower)%
= 15% + [-1.58 ÷ (-1.58 - 9.62)1 x (12% - 15%)
= 14.58%

ANSWERS-34
Diamond Investment Limited
(1) Net Present Value (NPV) of the project
Cash inflows/(outflows)-Rupees in million
Sales - 300.00 333.90 371.63 413.62
Cost(Sales÷1.25) - (240.00) (267.12) (297.30) (330.90)
Plant depreciation at 25% of WDV - (32.00) (25.60) (20.48) (16.38)
Net profit - 28.00 41.18 53.85 66.34
Tax@34% - (9.52) (14.00) (18.31) (22.56)
Add: back depreciation - 32.00 25.60 20.48 16.38
Cost of plant and its installation (160.00) - - - 65.54
Working capital (20.00) - - - 20.00
Projected cash flows (180.00) 50.48 52.78 56.02 145.70
PVfactorat18% 1.00 0.85 0.72 0.61 0.52
Present value (180.00) 42.91 38.00 34.17 75.76
NPVat18% 10.84
(NPVA)
(2) Internal Rate of Return (IRR) of the project:
PV factor at 22% 1.00 0.82 0.67 0.55 0.45
PV at 22% (Projected cash flow × PV (180.00) 41.39 35.36 30.81 65.57
PV at 22% (NPVB) Rs. (6.87) Million
NPVat lower Rate
IRR = Lower rate% + NPVat lower −NPV at higher
x (high-lower)%
IRR = 18% + [10.84/(10.84 – (-6.87)] x (22% - 18%)

IRR = 20.45%
ANSWERS-35
Omega Limited
Net present value of the project
Year 0 1 2 3 4 5 6
Cash inflows/(outflows)–Rs.in million
Sales(10%growth) - - 300.00 330.00 363.00 399.30 439.23
Cost of goods sold (8% growth) (W-1)
(195.00) (210.60) (227.45) (245.64) (265.30)
Royalty(3%ofsales) (9.00) (9.90) (10.89) (11.98) (13.18)
Land (40.00) - - - - - 70.00
Factory building (10.00) (20.00) 15.00
Plant installation (100.00) 10.00
Working capital (15.00) - - - - 15.00
Net cash flows (50.00) (135.00) 96.00 109.50 124.66 141.68 270.75
PVfactorat12% 1.00 0.89 0.80 0.71 0.64 0.57 0.51
Present value (50.00) (120.5) 76.80 77.75 79.78 80.76 136.7
Net present value of the project is Rs. 280 Million.

Workings:Cost of goods sold:
Rs.in million

Cost of own production (Including depreciation) (300 × 80% × 90%) 216.00

Depreciation - factory building (30 × 50%) ÷ 5 (3.00)
(18.00)

Depreciation - Plant (100 × 90%) ÷ 5 195.00

ANSWER-36
DCF AND RELEVANT COSTS
Year 0 1 2 3 4 5
Rs.000 Rs.000 Rs.000 Rs.00 Rs.000 Rs.000
Sales 7,400 8,300 9,800 5,800
Wages (550) (580) (620) (520)
Materials (340) (360) (410) (370)
Licence fee (300) (300) (300) (300) (300)
Overheads (100) (100) (100) (100)
Equipment (5,200) (5,200) 2,000
Specialised equipment (150)
Working capital (650) 650
(5,500) (6,150) 5,960 6,960 8,370 7,460
Discount factor at 10% 1.000 0.909 0.826 0.751 0.683 0.621
Present value (5,500) (5,590) 4,923 5,227 5,717 4,633
NPV = + Rs. 9,409,000
The project has a positive NPV. The project should be undertaken because it will increase the value of the
company and the wealth of its shareholders.
ANSWER-37
(a)
T0 T1 T2 T3 T4 T5 T6
Rs. Rs. Rs. Rs. Rs. Rs. Rs.
Inflow 75,000 75,000 75,000 75,000 75,000 75,000
Net Cash Flow (325,000) 75,000 75,000 75,000 75,000 750,00 75,000
0
Discount factor @ 8.8% 1 0.919 0.845 0.776 0.714 0.656 0.603
Present value (325,000) 68,934 63,358 58,234 53,524 49,195 45,216
Net present value +13,461 Accept
(b) NPV = P.V of Cash Inflows – P.V of Cash −1Outflows

-1
= 50,000 (1.088) + 75,000 [( 1−(1.088) ) – (1.088)-1] – 325,000 (1)
0.088
= 45,956 + 269,550 – 325,000
= - Rs. 9,494 Reject
(c) NPV = 50.000 – 325,000 (1)

0.088
= Rs. 243,182 Accept

ANSWER-38
(a)
T0 T1 T2 T3 T4 T5
Rs Rs Rs Rs Rs Rs
Sales 150,000 150,000 150,000 150,000 150,000
Less: Direct Material (37,500) (37,500) (37,500) (37,500) (37,500)
Labour (25,000) (25,000) (25,000) (25,000) (25,000)
Incremental FOH (37,500) (37,500) (37,500) (37,500) (37,500)
Net cash flow (205,000) 50,000 50,000 50,000 50,000 50,000
Discount factor @ 10% 1 0.909 0.826 0.751 0.683 0.621
Present value (205,000) 45,450 41,300 37,550 34,150 31,046
Net present value - Rs. 15,504 Reject
(b)
T0 T1 T2 T3 T4 T5
Rs Rs Rs Rs Rs Rs
Sales 160,500 171,735 183,756 196,619 210,383
Less: Direct Material (39,375) (41,344) (43,411) (45,581) (47,861)
Labour (26,500) (28,090) (29,775) (31,562) (33,456)
Incremental FOH (38,250) (39,015) (39,795) (40,591) (41,403)
Net cash flows (205,000) 56,375 63,286 70,775 78,885 87,663
Discount factor @ 10% 1 0.909 0.826 0.751 0.683 0.621
Present value (205,000) 51,245 52,274 53,152 53,878 54,439
Net present value Rs. 59,988 Accept
ANSWER-39
(a) NPV = P.V of Cash Inflows−4
– P.V of Cash Outflows
= 500,000 [ 1−(1.08) ] + 400,000 (2.435) + 300,000 × (0.96) + 100,000 × (1.08)-10
0.08 0.08
– 3,000,000 (1)
NPV = 497650 Accept
Workings:
W-1
1−(1.08)−8
Annuity Factor (1-8) [ ] 5.747
0.08 −4
Annuity Factor (1-4) [1−(1.08) ] (3.312)
0.08
Annuity Factor 5-8 2.435
W-2
1−(1.08)−10
Annuity Factor 1-10 [ ] 6.710
0.08−8
Annuity Factor (1-8) [1−(1.08)
0.08
] (5,747)
Annuity Factor (9-10) 0.963
(b)
T0 T1 T2 T3 T4
Rs. Rs. Rs. Rs. Rs.
Sales 824,000 848,720 655,636 450,204
Less Variable cost (420,000) (441,000) (405,169) (364,652)
Initial investment (900,000) 243,101
Net cash flow (900,000) 404,000 407,720 250,467 328,657

Discount factor @ 12% 1 0.893 0.797 0.712 0.636
Present value (900,000) 360,772 324,953 178,333 209,023
NPV Rs. 173,082 Accept
ANSWER-40
CONTO COMPANY
T0 T1 T2 T3 T4
Rs. Rs. Rs. Rs. Rs.
Sales - 240,000 360,000 500,000 200,000
Less Variable cost - (120,000) (180,000) (250,000) (110,000)
Initial investment (440,000) - - - -
Net cash loss (440,000) 120,000 180,000 250,000 90,000
Discount factor @ 9% 1 0.917 0.842 0.772 0.708
Present value (440,000) 110,040 151,560 193,046 63,758
Net present value Rs. 78,404 Accept
ANSWER-41
T0 T1 T2 T3 T4
Rs. Rs. Rs. Rs. Rs.
Sales - 4,780,750 7,603,000 9,585,000 6,548,800
Less Variable cost - (3,347,500) (5,304,500) (6,146,589) (4,051,832)
Less: Incremental Fixed Cost - (1,248,000) (1,297,920) (1,349,837) (1,403,830)
Taxable cash flows - 185,250 1,000,580 2,088,574 1,093,138
Tax @ 30% - (55,575) (300,174) (626,572) (327,941)
Net cash flows - 129,675 700,406 1,462,002 765,197
Initial investment (2,000,000)
Discount factor @ 10% 1 0.909 0.826 0.751 0.683
Present value (2,000,000) 117,875 578,535 1,097,964 522,630
Net present value Rs. Accept
317,004
ANSWER-42
(a) Strategy-1
T0 T1 T2 T3 T4 T5
Sales 824,000 891,156 963,785 1,042,338 1,127,287
Less Variable cost (309,000) (334,184) (355,396) (384,362) (408,642)
Contribution 515,000 556,972 608,389 657,976 718,645
Discount factor @ 10% 1 0.909 0.826 0.751 0.683 0.621
Present value 468,135 460,059 456,900 449,398 446,279 PV of
contribution Rs. 228,0771
Strategy-2
T0 T1 T2 T3 T4 T5
Sales 793,100 939,427 1,112,751 1,318,052 1,561,237
Less Variable cost (334,235) (389,191) (445,100) (508,391) (568,736)
Contribution 458,865 550,236 667,651 809,661 992,501

Discount factor @ 10% 1 0.909 0.826 0.751 0.683 0.621

Present value 417,108 454,984 501,406 552,998 616,343PV of
contribution Rs.
2,542,350
Contribution
As the present value of contribution is higher under strategy-2, we should implement strategy-2
W-1
Sales Strategy-1 Strategy-2
Year-1 100,000 110,000
Year-2 (100,000 x 1.05) 105,000 (110,000 x 1.15) 126,500
Year-3 (100,000 x 1.052) 110,250 (110,000 x 1.152) 145,475
3 3
Year-4 (100,000 x 1.05 ) 115,763 (110,000 x 1.15 ) 167,296
Year-5 (100,000 x 1.054) 121,551 (110,000 x 1.154) 192,391
W-2
Variable cost Strategy-1 Strategy-2
Year-1 3 2.95
Year-2 3 2.90
Year-3 2.95 2.80
Year-4 2.95 2.70
Year-5 2.90 2.55
(b)
Year T0 T1 T2 T3 T4 T5
Rs. Rs. Rs. Rs. Rs.
Total contribution 458,865 550,236 667,651 809,661 992,501
Fixed costs (114,400) (118,976) (123,735) (128,684) (133,832)
Initial investment (1,600,000
)
Net cash flow (1,600,000) 344,465 431,260 543,916 680,977 858,669
10% discount factors 1 0.909 0.826 0.751 0.683 0.621
Present value (1,600,000) 313,119 356,221 408, 481 465,107 533,233
NPV 476161
20% discount factors 1 0.833 0.694 0.579 0.482 0.402
Present value of profits (1,600,000) 286,939 299,294 314,927 328,231 345,185
- Rs. 25,424
476,161
IRR = 10% + x(20% − 10%)
476,161−(−25,424)
= 19.49%

ANSWER-43
T0 T1 T2 T3 T4
Rs.(M) Rs.(M) Rs.(M) Rs.(M) Rs.(M)
Sales (W-1) 79 103 175 179
Payment to creditor (W-2) (32) (48) (57) (73)
Payment to sub-contract (6) (9) (8) (8)
Incremental FOH (13) (10) (9) (10)
Labour cost (3) (3) (3) (3)
Redundancy cost (6)
Disposal cost 2
Opportunity cost (3)
Initial investment (new) (180) 25
(old) 2 (1)
Net cash flow (179) 25 27 98 109
Discount factor @ 10% 1 0.909 0.826 0.751 0.683
Present value (179) 23 22 74 74
NPV Rs. 15 Accept
Workings:
W-1
2013 2014 2015 2016
Market Size 1,122 1,144 1,167 1,191
Market Share 78.54 102.96 175.05 178.65
W-2 Payable Account

2013 Rs. 2013 Rs. (M)
(M)
Cash (balance) 32 b/d -
c/d 8 Purchases 40
2014 Rs. 2014 Rs. (M)
(M)
Cash (balance) 48 b/d 8
c/d 10 Purchases 50
2015 Rs. 2015 Rs. (M)
(M)
c/d 11 Purchases 58
2016 Rs. 2016 Rs. (M)
(M)
c/d - Purchases 62

ANSWER-44
Comfort Wear Limited
0 1 2 3
----------------------- Rupees -----------------------
Kiosks - setup cost
[250,000×4] (1,000,000) - - -
Revenue 8,500,000 10,395,000 12,006,225
[4000×2500×0.85] [4000×2500×0.9 [4000×2500×0.9
×1.1×1.05] ×(1.1)2×(1.05)2]
Cost of goods sold (5,500,000) (6,352,500) (7,337,138)
[4000×1375] [4000×1375×1.1 [4000×1375×(1.1) 2
×1.05] ×(1.05)2]
Gross profit 3,000,000 4,042,500 4,669,087
Gross profit - lost (W-1) (1,181,250) (1,364,342) (1,575,814)
Rent cost (600,000) (660,000) (726,000)
[150000×4] [150000×4×1.1] [150000×4×(1.1)2]
Marketing cost (50,000) (27,500) (30,250)
[50000×0.5×1.1] [50000×0.5×(1.1)2]
Staff cost - fixed cost (960,000) (1,056,000) (1,161,600)
[20000×4×12] [20000×4×12× [20000×4×12×
1.1] (1.1)2]
Staff cost - commission (100,000) (115,500) (133,403)
[4000×2500×0.01] [4000×2500×0.0 [4000×2500×0.01
1×1.1×1.05] ×(1.1)2×(1.05)2]
Depreciation (400,000) (240,000) (144,000)
[1000000×0.4] [400000×0.6] [240000×0.6]
Loss on disposal
[1,000,000–(400,000+240,000+144,000)] - - (216,000)
Profit before tax (291,250) 579,158 682,020
Tax @ 30% 87,375 (173,747) (204,606)
Profit after tax (203,875) 405,411 477,414
Add back depreciation 400,000 240,000 144,000
Add back loss on disposal - - 216,000
Net cashflows (1,000,000) 196,125 645,411 837,414
Discount factor @ 18% 1.000 0.847 0.718 0.609
Present value (1,000,000) 166,118 463,405 509,985
Net present value 139,508
Recommendation: CWL should set-up kiosks as it would result in positive NPV.
W-1: Gross profit lost 1 2 3

-------------- Rupees --------------
Revenue lost (2,625,000) (3,031,875) (3,501,816)
[5000×0.2×2500 [5000×0.2×2500 [5000×0.2×2500
×1.05] ×(1.05)2×1.1] ×(1.05)3×(1.1)2]
CoGS saved 1,443,750 1,667,531 1,925,999
[5000×0.2×1375 [5000×0.2×1375 [5000×0.2×1375
×1.05] ×(1.05)2×1.1] ×(1.05)3×(1.1)2]
Gross profit lost (1,181,250) (1,364,344) (1,575,817)

ANSWER-45
0 1 2 3 4 5
Sales in units A 10,000 9,000 7,650 7,650 7,650
------------------- Inflation @ 8% per annum -------------------

Sales price/unit B 1,600 1,728 1,866 2,016 2,177 2,351
Variable cost of sales/unit C 750 810 875 945 1,020 1,102
Variable operating cost/unit D 100 108 117 126 136 147
----------------------------- Rs. in '000 -----------------------------

Sales A×B - 17,280 16,794 15,422 16,654 17,985
Cost of goods sold A×C - (8,100) (7,875) (7,229) (7,803) (8,430)
Operating costs – Variable A×D - (1,080) (1,053) (964) (1,040) (1,125)
Operating costs – Fixed - (1,080) (1,166) (1,260) (1,360) (1,469)
Machine purchase (25,000) - - - - -
Depreciation
Machine (W-1) - (6,250) (4,688) (3,516) (2,637) (1,978)
Overhauling (W-1) - - - - (787) (591)
Loss on sale of machine (W-1) - - - - - (357)
Profit before tax (25,000) 770 2,012 2,453 3,027 4,035
Less: Tax @ 30% - (231) (604) (736) (908) (1,211)

Profit after tax (25,000) 539 1,408 1,717 2,119 2,824
Scrap value (W-1) - - - - - 7,347
Overhauling cost - - - (3,149) - -
Add back:
Depreciation - 6,250 4,688 3,516 3,424 2,569
Loss on sale of machine - - - - - 357
Cash flows (25,000) 6,789 6,096 2,084 5,543 13,097
Discount factor @ 12% 1.000 0.893 0.797 0.712 0.636 0.568
Present value of cash flows (25,000) 6,063 4,859 1,484 3,525 7,439
Net present value (1,630)
Discount factor @ 9% 1.000 0.917 0.841 0.772 0.708 0.650

Present value of cash flows (25,000) 6,226 5,127 1,609 3,924 8,513
Net present value 399
NPV A
IRR = A% + ( ) × (B − A)%
NPV A−NPV B
399
IRR = 0.09 + ( ) × (0.12 − 0.09) = 𝟗. 𝟓𝟗%
399+1630
Conclusion: At 9.59%, the launching of Gladiator would be financially feasible.
W-1: Depreciation & Loss of sale of machine

Machine Overhauling Total
Depreciation Depreciation
cost NBV cost NBV NBV
----------------------------- Rs. in '000 -----------------------------
Cost of machine - 25,000 - - 25,000
Year 1 6,250 18,750 - - 18,750
Year 2 4,688 14,063 - - 14,063
Year 3 3,516 10,547 - - 10,547
Overhauling cost 2.5m×(1.08)3 - 10,547 - 3,149 13,696
Year 4 2,637 7,910 787 2,362 10,272
Year 5 1,978 5,933 591 1,771 7,704
Less: Scrap value 5m×(1.08)5 - - - - (7,347)
Loss on sale of machine 357

ANSWER-46
Cherat Mobiles
Y0 Y1 Y2 Y3 Y4 Y5
------------------------- Rs. in million -------------------------
Research cost - - - - - -
Machinery and equipment (250.00) - - - - -
Loan – receipt and repayment - - - - - -
Working cap. – invest. & release (15.00) - - - - 12.00
Loss of rental income - (6.00) (6.54) (7.13) (7.77) (8.47)
Profit after tax (W-1) - 33.95 48.80 64.83 82.42 102.15
Add: Depreciation - 37.50 31.88 27.09 23.03 19.58
Add: Loss/(gain) on disposal - - - - - (2.00)
Sale value - machinery & equip. - - - - - 112.93
Cash flows (265.00) 65.45 74.14 84.79 97.68 236.19
Discount factor 1.000 0.833 0.694 0.579 0.482 0.402
Discounted cash flow (265.00) 54.52 51.45 49.10 47.08 94.95
NPV 32.10
Conclusion: As the company has a positive NPV, the company should proceed with the investment
W-1: Accounting profit after tax Y1 Y2 Y3 Y4 Y5

Annual sales volume (3,000 watches×12×5%) 36,000 37,800 39,690 41,675 43,758
Contribution margin (4,000×9%) 4,000.00 4,360.00 4,752.40 5,180.12 5,646.33
--------------------- Rs. in million ---------------------
Contribution margin 144.00 164.81 188.62 215.88 247.07
Fixed cost (excluding depreciation) (58.00) (63.22) (68.91) (75.11) (81.87)
Depreciation - machinery & equipment(W-2) (37.50) (31.88) (27.09) (23.03) (19.58)
Gain on disposal of machine - - - - 2.00
Dismantling cost - - - - (1.69)
Interest on loan (to be ignored) - - - - -
Profit before tax 48.50 69.71 92.62 117.74 145.93
Taxation 30% (14.55) (20.91) (27.79) (35.32) (43.78)
Profit after tax 33.95 48.80 64.83 82.42 102.15
W-2: Depreciation @ 15% Y1 Y2 Y3 Y4 Y5

------------------------- Rs. in million -------------------------
Depreciation for the year (37.50) (31.88) (27.09) (23.03) (19.58)
Carrying amount 250.00 212.50 180.62 153.53 130.50 110.93

Multiple Choice Questions (MCQs)
ANSWER-47
Y0 Y1 Y2 Y3 Y4
-------------------------- Rs. in '000 --------------------------
Machine (250,000.00)
Working capital invest. & release (W-1) (75,000.00) (11,250.00) (12,937.50) (14,878.13) 68,439.38
Accounting profit after tax (W-2) (882.00) 38,907.05 57,324.24 75,442.41 74,363.18
Add: Depreciation – Machine 62,500.00 46,875.00 35,156.25 26,367.19
Add: Inventory write-off 45,626.25
Less: Gain on disposal of Machine (19,573.01)
Sale value of machine 98,674.58
Cash flows (325,882.00) 90,157.05 91,261.74 95,720.53 293,897.57
Discount rate at cost of capital @ 20% 1.00 0.833 0.694 0.578 0.482
Discounted Cashflows (325,882.00) 75,100.82 63,335.65 55,326.47 141,658.63
Net present value 9,539.56
Discount rate at cost of capital @ 22% 1.00 0.820 0.672 0.551 0.452
Discounted Cashflows (325,882.00) 73,928.78 61,327.89 52,742.01 132,841.70
Net present value (5,041.62)
NPVa 9,539.56
IRR = A% + × (B–A)% = 20% + × (22%–20%) = 21.31%
NPVa–NPVb 9,539.56–(–5,041.62)
Conclusion:
IRR is less than the cost of capital of the company. So this project should not be under taken.
W-1: Working Capital Year 0 Year 1 Year 2 Year 3 Year 4

WC (Investment)/Release (75,000.00) (11,250.00) (12,937.50) (14,878.13) 68,439.38
Balance (75,000.00) (86,250.00) (99,187.50) (114,065.63) (45,626.25)
W-2: Accounting profit after tax

Y0 Y1 Y2 Y3 Y4
Sales volume 30,000 30,000 30,000 30,000
-------------------------- Rs. in '000 --------------------------
Sales price -11% inflation from year 1 4.44 4.93 5.47 6.07
Sales 133,200.00 147,852.00 164,115.72 182,168.45
11% inflation from year 1:

Material cost - BW (W-3) (1,831.50) (2,032.97) (2,256.59) (2,504.82)
Material cost - SB (W-3) - (6,209.78) (6,892.86) (7,651.07)
Relevant contribution foregone (W-4) (3,519.00)
Labour (W-5) (7,770.00) (8,624.70) (9,573.42) (10,626.49)
Fixed overheads - excl. dep. (1,998.00) (2,217.78) (2,461.74) (2,732.53)
Sale value of 600 kg SB @ 50% (1,260.00) - - - -

Depreciation (W-6) (62,500.00) (46,875.00) (35,156.25)
(26,367.19)
Gain on disposal 19,573.01
Inventory write-off (45,626.25)
Profit before tax (1,260.00) 55,581.50 81,891.77 107,774.87 106,233.12
Taxation 30% 378.00 (16,674.45) (24,567.53) (32,332.46) (31,869.93)
Profit after tax (882.00) 38,907.05 57,324.24 75,442.41 74,363.18
W-3: Material cost BW SB

Annual requirement - kgs 3,000 1,200
Cost per kg 550 4,200
Total cost (to be inflated by 11% from Y1) 1,650,000 5,040,000

W-4: Net relevant contribution foregone Rupees

Contribution on 600 kg @ 1,500 per kg 900,000
11% inflation 99,000
999,000
Raw material cost for 600 kg @ 4,200 per kg 2,520,000
3,519,000
W-5: Labour cost Semi-Skilled Skilled Total

Hours per annum 30,000 10,000
Rate per hour 150 250
Labour Cost (to be inflated by 11% from Y1) 4,500,000 2,500,000 7,000,000
W-6: Depreciation Year 0 Year 1 Year 2 Year 3 Year 4

-------------------------- Rs. in '000 --------------------------
Depreciation @ 25% reducing bal. (62,500.00) (46,875.00) (35,156.25) (26,367.19)
Carrying amount 250,000.00 187,500.00 140,625.00 105,468.75 79,101.56

Chapter 1
i. Which of the following is not Political factors:
(a) Taxation (b) National Income
(c) Infrastructure (d) Education Policy
ii. Which of the following is Political factor:

(a) Taxation (b) Subsidy
(c) Environmental Policy (d) All of the above
iii. Which of the following is threat for the business:

(a) Taxation (b) Subsidy
(c) Privatisation (d) Education budget increase
iv. Which of the following is opportunity for the business:

(a) Nationalisation (b) Low budget for infrastructure
(c) Decrease in education budget (d) None of the above
v. Taxation policies may be used to:

(a) Exercise control over the private sector investment
(b) Provide resources for public expenditures (roads, public schools, hospitals or parks)
(c) Improve country’s business competitive position
(d) All of the above
vi. Free market and open competition are the elements of ideology.
(a) democratic (b) radicals (c) dictatorial (d) communist (01)
vii. Advocacy advertising focuses on:
(a) a particular product that needs marketing support

(b) core services offered by an organization
(c) an organization’s CSR activities
(d) an organization’s views on controversial political issues (01)

Chapter 2
i. National Income can be measured using:
(a) Income Method (b) Output Method
(c) Expenditure Method (d) All of the Above
ii. In inflation who will gain:

(a) Govt. (b) Lender
(c) Household (d) Borrower
iii. In inflation who will lose:

(a) Business (b) Household
(c) Lender (d) All of the above
iv. Number of workers in employment:

(a) Leading Economic Indicator (b) Coincident Economic
Indicator
(c) Lagging Economic Indicator (d) All of the above
v. Inflation adjusted value of GDP is:

(a) Money GDP (b) Nominal GDP
(c) Normal GDP (d) Real GDP
vi. Market capitalization is:

(a) market value of a publicly traded company's outstanding shares
(b) It reflects what investors are willing to pay for its stock
(c) Market capitalization could be based on Full-Cap and Free-Float
(d) All of the above
vii. The factors predict economic trends are:

(a) Leading Economic Indicator (b) Coincident Economic Indicator
(c) Lagging Economic Indicator (d) All of the above
viii. Which of the following is NOT a component of the microeconomic environment?

(a) Consumer behaviour
(b) Broad economic factors that affect the entire economy
(c) Demand and supply forces in the marketplace
(d) Market environment (01)

Chapter 3
i. A permission to carry out certain business activities or practice under specific government
regulation or certification body:
(a) Copy right (b) Patent
(c) Franchise (d) License
ii. Which of the following is not Ease of Doing Business:

(a) Resolving insolvency (b) Getting credit
(c) Business starts-up (d) Construction permit
iii. When two or more business entities secretly agree to do something for their mutual benefit that
is against the public interest is called:
(a) Cartel (b) Collusion
(c) Joint Venture (d) Monopoly
iv. Which one of following is not a role of laws in business:

(a) Fair treatment with suppliers
(b) Ensure the protection of employees from unfair treatment
(c) Ensure a fair competition in businesses (d)
Protect investors, creditors and consumers
v. A registered right that gives the owner exclusive right to features and processes of inventions
(including its formula):
(a) Copy right (b) Patent
(c) Franchise (d) License
vi. To provide safe work place to employees is:

(a) Data Protection Law (b) Health & safety Law
(c) Competition Law (d) Cyber Law
vii. To protect individual data from unauthorized used is:

(a) Employment Law (b) Health & safety Law
(c) Competition Law (d) Data Protection Law
viii. To provide protection to employees against employment is:

(a) Employment Law (b) Health & safety Law
(c) Competition Law (d) Data Protection Law
ix. Nowadays, consumers increasingly rely on ratings and reviews from previous buyers,
especially through online means, when making purchasing decisions. This is an example of
which social factor:
(a) Attitudes and lifestyles (b) Demography
(c) Law and order (d)Health (01)

Chapter 4
i. Removing one or more levels of management in the organisation structure:
(a) Downsizing (b) Delayering
(c) Franchising (d) Outsourcing
ii. A systems for processing routine transactions, such as bookkeeping systems is:
(a) Management Information System (b) Decision Support System
(c) Expert System (d) None of Above
iii. A system to help managers to prepare their own forecasts and to make decisions on the basis of
their forecast estimates is called:
(a) Management Information System (b) Decision Support System
(c) Expert System (d) All of Above
vi. An executive can use to obtain summary information about a range of issues, and also to
‘drill down’ into greater detail if this is required:
(a) Management Information System (b) Transaction Processing System
(c) Expert System (d) Executive Information System
v. Which of following is not a general IT control:

(a) Physical protection for cables
(b) Installing smoke detectors, fire alarms and fire doors
(c) insurance cover against losses in the event of a fire or flooding
(d) None of Above
vi. The coding of data into a form that is not understandable to the casual reader:
(a) Data Encryption (b) Firewalls
(c) Password (d) Anti-Virus
vii. Reduction in size of a business organisation:

(a) Downsizing (b) Delayering
(c) Franchising (d) Outsourcing
viii. Which of the following statements is correct about the firewall?

(a) It is a device installed at the boundary of a company to prevent unauthorized physical access
(b) It is a device installed at the boundary of an entity’s system to protect it against the
unauthorized access
(c) It is a kind of wall built to prevent fires from damaging the corporate assets
(d) None of the above (01)
ix. Tracking employee training, skills and performance appraisals are examples of a human resource
information system operating at the :
(a) operational level (b) management level
(c) knowledge level (d) strategic level (01)
x. ERP (Enterprise Resource Planning) systems are extensively utilized in organizations across
various industries and sectors. These software solutions play a pivotal role in optimizing business
processes.

Which of the following statements about ERP systems is true?
(a) ERP systems are primarily used for processing routine transactions like salesorders
and bookkeeping
(b) ERP systems are designed exclusively for providing senior executives withup-to-
date information for decision-making
(c) ERP systems are expert systems that offer advice and recommendations inspecific
areas of expertise
(d) ERP systems aim to integrate multiple information systems across the organization
and enhance overall business strategy and operations (01)
xi. Which of the following statements distinguishes application controls from generalcontrols?
(a) They are applied universally to all IT systems
(b) They are unique to a particular IT system or application
(c) They focus on physical security measures
(d) They are primarily concerned with IT standards (01)

Chapter 5
i. is a global network of interconnected computers, enabling users to share
information along multiple channels linking individuals and organizations.:
(a) Disruptive Technology (b) E-Business
(c) Internet (d) Social Networking
ii. A system using technology to connect, explore interests and share activities around world:
(a) Disruptive Technology (b) E-Business
iii. A web-based journal maintained by an individual with regular entries of commentary,

descriptions, or accounts of events or other graphics or video etc:
(a) M-Commerce (b) Blog
(c) Disruptive Technology (d) All of Above
vi. facilitates in money transfers, investment management, finance, and banking:

(a) M-Commerce (b) Blog
(c) Disruptive Technology (d) Fintech
v. relates to instances where technology is used to fundamentally change and

‘disrupt’ the existing business model in an industry:
(a) Exception Reporting (b) Telecommunication
(c) Encryption (d) None of Above
vi. The transformation of key business process through the use of internet technologies:
(a) Fintech (b) E-Business
vii. Recording transactions between two parties and moves transactions from a centralized server-
based system to a transparent cryptographic network is called:
(a) Fintech (b) M-Commerce
(c) Blockchain (d) E-Business
viii. Commerce conducted via mobile or cell phones, provides consumers with an electronic wallet
when using their mobile phones:
(a) Fintech (b) Disruptive Technology
(c) Blockchain (d) None of Above
ix. Which of the following is NOT an example of ‘disruptive technology’ at its inceptionin the
market?
(a) A mobile application through which customers can order food from a choice oflarge number of
restaurants
(b) A media streaming platform allowing customers to watch movies of their choice
(c) Smartphone with improved users interface and camera resolution
(d) An online social networking website where people can connect and share information with each
other (01)
x. Which of the following statements correctly defines disruptive technology?

(a) An innovation that has a minimal impact on existing systems or habits

(b) An innovation that significantly alters the way consumers operate but doesn't affect industries or
businesses
(c) An innovation that significantly alters the way consumers, industries, or businesses operate and
sweeps away the systems or habits it replaces due to its superior attributes
(d) An innovation that affects only industries and businesses but not consumers (01)
xi. Which of the following technologies best exemplifies a disruptive innovation?
(a) Incremental software update enhancing existing features

(b) Introduction of a faster processor in a laptop
(c) Emergence of electric cars replacing traditional combustion engine vehicles
(d) Addition of new automatic machine in the existing product line (01)

Chapter 7
i. The industries that are going into decline: total sales are falling and the number of competitors in
the market is also falling:
(a) Global Industries (b) Mature Industries
(c) Fragmented Industries (d) None of Above
ii. When two or more industries or industrial segments merge, and become part of the same industry,
with the same customer markets:
(a) Merger (b) Industrialization
(c) Convergence (d) All of Above
iii. Bargaining power of customers will be high in case of:

(a) Undifferentiated products (b) Differentiated products
(c) Low barrier to entry (d) high barrier to entry
vi. Bargaining power of supplier will be low in case of:

(a) Small number of suppliers (b) Large number of suppliers
(c) No substitute of supplier products (d) All of Above
v. Which of following is not a barrier to entry in respect to threat from potential entrants in the
industry:
(a) Economies of Scale (b) Govt. regulations
(c) low switching cost (d) Know how
vi. Clusters of firms within an industry that have common specific assets and thus follow common
strategies in key decision variables’ is called:
(a) Strategic Space (b) Market segmentation
(c) Market penetration (d) Strategic group
vii. A section of the total market in which the potential customers have certain unique and
identifiable characteristics and needs is called:
(a) Strategic Space (b) Market segmentation
(c) Market penetration (d) Strategic group
viii. At which phase of life cycle total sales demand in the market grows at a faster rate:
(a) Decline phase (b) maturity phase
(c) Growth phase (d) Introduction phase
ix. The benefit of life cycle costing is:

(a) used to reduce costs over the life of the product
(b) monitoring the actual performance of products against plans
(c) profitability of products can be assessed before major development of the product
(d) All of above
x. Best Cook Limited (BCL) is engaged in processed frozen food (food) production. The market for
food is highly competitive where key players are striving hard to increase their profits and there has
been no major new competitor entered into the market in the past 2 years. The prices are mostly
stable and competitors are trying to attract targeted customers by using different tactics.
BCL’s product is in stage of lifecycle and it is recommended to .

(a) growth, differentiate product

(b) maturity, differentiate product
(c) maturity, market product aggressively
(d) decline, leave the market (02)
xi. There is significant gas shortage in A-town. Tech Appliances (TA) is considering importing
economical variants of electric ovens and geysers to meet the ever increasing market demand.
TA has contacted supplier in China who has agreed to supply these products shortly. Currently,
no competitor is offering such variants in A-town.
By using Porter’s five forces model, it can be inferred that:
(a) threat of new entrants is high and bargaining power of buyers is high
(b) threat of new entrants is high and bargaining power of buyers is low
(c) threat of new entrants is low and bargaining power of buyers is high
(d) threat of new entrants is low and bargaining power of buyers is low (01)

Chapter 8
i. The activities concerned with converting the purchased materials into an item that customers will
buy:
(a) Inbound Logistics (b) Outbound Logistics
(c) Operations (d) Services
ii. The activity concerned with recruiting, training, developing and rewarding people in the
organisation:
(a) Purchasing (b) Corporate Infrastructure
(c) Human Resource (d) None of Above
iii. The tangible assets of an entity and include property, plant and equipment and also access to
sources of raw materials is called:
(a) Human Resources (b) Physical Resources
(c) Financial Resources (d) Intellectual Resources
vi. The activities concerned with purchased material/components receiving handling and storing until
needed:
(a) Inbound Logistics (b) Outbound Logistics
(c) Operations (d) Services
v. The resources such as patents, trademarks, brand names and copyrights are called:
(a) Human Resources (b) Physical Resources
(c) Financial Resources (d) Intellectual Resources
vi. Reductions in costs producing two or more products is called:

(a) Economies of Scale (b) Economies of Scope
(c) Economies of business (d) All of Above
vii. Strategic capability means:

(a) the ability of an entity to perform and prosper, by achieving strategic objectives.
(b) the ability of an organisation to use its core competences to create competitive
advantage.
(c) the ability of [an entity] to use and exploit the resources available to it
(d) All of above
viii. An entity might compare its own performance and its own products with those of its most
successful competitors:
(a) Internal benchmarking (b) Competitive benchmarking
(c) Operational benchmarking (d) Customer benchmarking
ix. A technique used to analyse strategic position of business is:

(a) PESTEL analysis (b) Value chain analysis
(c) Five Forces analysis (d) SWOT analysis

Chapter 9
i. Complying with relevant laws and regulations and avoiding any action that may bring discredit to
the profession is:
(a) Confidentiality (b) Professional Competence
(c) Professional Behavior (d) Due Care
ii. Not to act diligently in accordance with applicable technical and professional standards when
performing professional activities is breach of:
(a) Confidentiality (b) Professional Competence
(c) Professional Behavior (d) All of above
iii. Disclosure of confidential information is prohibited :

(a) If disclosure is required by law or court
(b) When there is professional right or duty to disclose
(c) If disclosure is permitted by client
(d) None of Above
vi. The five tests used for ethical decision making under Tucker’s model are:
(a) Profitable, Economic, Legal, Fair, Decent
(b) Legal, Right, Sustainable, Fair, Decent
(c) Sustainable, Legal, Right, Profitable, Fair
(d) Profitable, Legal, Decent, Fair, Sustainable
v. Not perform a professional activity or service if a circumstance or relationship biases or unduly

influences accountant's professional judgment for that service is called:
(a) Integrity (b) Professional Competence
(c) Professional Behavior (d) Objectivity
vi. The code of ethics implies fair dealing and truthfulness:

(a) Integrity (b) Professional Competence
(c) Professional Behavior (d) Objectivity
vii. In Tucker’s five-question model, the question "Is it right?" primarily considers:
(a) Personal values (b) Market values
(c) Environmental values (d) Social values (01)

Chapter 10
i. Businesses often use loans or overdrafts or both as a source of finance.
Which of the following is a benefit, to the borrower, of a loan as opposed to an overdraft?
(a) Flexible repayment schedule
(b) Only charged for the amount drawn down
(c) Easy to arrange
(d) Lower interest rates
ii. According to the creditor hierarchy, list the following from high risk to low risk:
1 Ordinary share capital
2 Preference share capital
3 Trade payables
4 Bank loan with fixed and floating charges
(a) 1,2,3,4
(b) 2,1,4,3
(c) 1,2,4,3
(d) 4,1,2,3
iii. Which one of the following is issued at a discount to its redemption value and pays its holder no
interest during its life?
(a) A deep discount bond
(b) A long-term bond issued by the government
(c) An unsecured loan note
(d) A zero coupon bond
iv. Which of the following sources of finance to companies is the most widely used in practice?
(a) Bank borrowings (c) New share issues
(b) Rights issues (d) Retained earnings
v. A company has 12% loan notes in issue, which have a market value of $135 per $100 nominal
value. What is the coupon rate?
(a) 10% (c) 12%
(b) 13.5% (d) 1.2%
vi. A company has 12% loan notes in issue, which have a market value of $135 per $100 nominal
value. What is the amount of interest payable per annum per $100 (nominal) of loan note?
(a) 100 (c) 120
(b) 135 (d) 12
vii. Individuals who invest directly in small businesses, usually by purchasing new equity shares, and
do not get involved in the management of the company
(a) Venture capitalist (c) Private equity funds
(b) Business angles (d) Debt-holders
viii. Danish Ibrahim is considering a start-up business. He has performed the feasibility of business
and is very optimistic about its future prospects. The business would require the investment of Rs. 5
million for financing capital assets and working capital. Danish has Rs. 2 million as savings and
looking for Islamic mode of financing for the remaining amount. He does not want any interference
from finance provider in making business decisions.

Danish should opt for:

(a) Murabaha (b) Ijarah
(c) Mudaraba (d) None of the above (01)
ix. Agha (Private) Limited (APL), a family-owned business, registered as a private company two
years ago. The business has grown exponentially and now Salman, CEO, is considering to expand
the business by introducing a new product. He has developed a comprehensive business plan and
is looking for source of finance for expansion. Salman is not sure regarding the tenure for which
finance would be needed as it is highly dependent on how product would perform in the initial years.
Salman has approached a venture capitalist to finance the expansion of business. Theventure capitalist
would:
(a) likely finance the project as APL has excelled in the past two years
(b) likely finance the project as APL has a comprehensive business plan
(c) less likely finance the project as there is no clear exit route for venture capitalist
(d) less likely finance the project as it has only been two years since APL has registered as a
private company (1.5)
x. Furqan runs a chain of retail outlets of electronic items (items). Due to economic downturn, the
demand for items has declined significantly. Furqan is considering to sell the items on credit to customers
but he wants to charge some additional profit for allowing the customers to pay later. He is seeking the
Islamic mode of financing forthese transactions.
Which of the following modes of financing would be most appropriate?
(a) Mudaraba, however, Furqan would need to expressly mention the retail priceof the items and
the additional profit he would charge
(b) Murabaha, however, Furqan would need to expressly mention the cost of itemsand the additional
profit he would charge
(c) Musharaka, however, Furqan would need to mutually agree the profit over thecost with the
customers.
(d) Credit transactions cannot be financed through Islamic mode of financing as Furqan wants to
charge profit over the retail price (1.5)
xi. Which of the following best explains a deep-discounted bond?

(a) A bond with a low coupon rate that adjusts annually
(b) A bond with a low coupon rate that is sold at a significant discount to its fairvalue
(c) A bond with a high coupon rate but sold at a significant discount to its fair value
(d) A bond that is available in the market at a significant discount to its issue price (01)
x. Which of the following is a characteristic of a zero-coupon bond?

(a) Investor return is gained through capital appreciation
(b) It can have only one annual interest payment
(c) It is ideal for those investors who require a periodic return
(d) It cannot be sold before its maturity date (01)
xi. Which of the following statements does NOT represent the characteristic of asset
securitization and sale?

(a) It is commonly employed within the financial services sector

(b) It facilitates the transformation of non-marketable assets into marketable ones
(c) It enables companies to obtain borrowing rates reflective of the assets’ ratingrather
than the company’s own rating
(d) It is commonly utilized for short-term financing needs (01)
xii. Which of the following correctly distinguishes between investment returns and
speculation returns?
(a) Investment returns are usually generated only through capital appreciation,while
speculation returns result from both capital appreciation and yield
(b) Speculation returns are usually derived from non-marketable assets, while
investment returns are derived from marketable assets
(c) Speculation returns are usually generated through capital appreciation, while
investment returns result from both capital appreciation and yield
(d) Speculation returns are usually derived from marketable assets, while investment returns
are derived from non-marketable assets (01)
xiii. Which factor primarily influences the duration of finance sought for purchasing anasset?
(a) Expectations of interest rate movements
(b) Availability of collaterals
(c) Revenue generating time period of the asset
(d) Current market rates (01)
xiv. Which of the following is correct regarding a bonus issue and a right issue?
(a) A bonus issue involves the issuing of shares to existing shareholders while a right issue
involves offering shares to the general public
(b) A bonus issue increases the company’s assets, while a right issue increases the number of
shares in circulation
(c) A bonus issue increase the number of shares in circulation, while a right issueincreases the
company’s assets
(d) A bonus issue requires purchase of additional shares at a discount while right shares are
given at a premium (01)

Chapter 11
i. A company has recently paid a dividend Rs. 3 per share and the dividend is expected to grow by
5% into the foreseeable future. The next annual dividend will be paid in one year’s time. The
shareholders require an annual return of 12%. What is the market value of each equity share is:
(a) 450 (b) 4500
(c) 4.5 (d) 45
ii. A company’s share price is Rs.8.20. The company has just paid an annual dividend of Rs.0.70 per
share, and the dividend is expected to grow by 3.5% into the foreseeable future. The next annual
dividend will be paid in one year’s time. What is Ke?
(a) 12.3% (b) 1.23%
(c) 30% (d) 12%
iii. A company has just achieved annual earnings per share of Rs.50 of which 40% has been paid in
dividends and 60% has been reinvested as retained earnings. The cost of equity capital is 8%. The
expected value per share is:
(a) 16.5 (b) 655
(c) 90 (d) 330
vi. The rate of return available for investors on government bonds is 4%. The average return on
market investments is 7%. The company’s equity beta is 0.92. What is Ke?
(a) 16.76% (b) 15%
(c) 6.76% (d) 13.5%
v. A company’s shares are currently valued at Rs.8.20 and the company is expected to pay an annual
dividend of Rs.0.70 per share for the foreseeable future. The next annual dividend is payable in the
near future and the share price of Rs.8.20 is a cum dividend price. The cost of equity is?
(a) 93 (b) 9.30%
(c) 0.093 (d) both (b) and (c)
vi. A company’s share price is Rs.5.00. The next annual dividend will be paid in one year’s time and
dividends are expected to grow by 4% per year into the foreseeable future. The next annual dividend
is expected to be Rs.0.45 per share. What is Ke?
(a) 13.9% (b) 125
(c) 9% (d) 13%
vii. Which of the following information is NOT required while computing cost of equity under
capital assets pricing model (CAPM)?
(a) Risk free interest rate
(b) The expected earnings
(c) The beta for the firm
(d) The expected market return (01)
viii. Fortune Limited (FL) is in the process of issuing bonds to finance its project. It hasbeen
decided to issue bonds that are redeemable at par (i.e. Rs. 100) in three years’time. The bonds
would carry annual interest at 10.4%, payable at the end of each year.
The annual spot yield curve for a bond of this class of risk is as follows:
Maturity 1 year 2 years 3 years 4 years
Yield 8.0% 9.5% 11.0% 12.5%
FL should issue the bonds at:

(a) an approximate discount of Re. 1 per bond (b) an approximate discount of Rs. 5 per bond
(c) an approximate premium of Re. 1 per bond (d) a par value (02)
ix. A negative or inverse yield curve indicates that the market expects:
(a) long-term interest rates to fall at some time in the future

(b) short-term interest rates to fall at some time in the future
(c) short-term interest rates to rise at some time in the future
(d) long-term interest rates to rise at some time in the future (01)
x. GG Limited (GGL) has achieved an annual earnings per share of Rs. 60 and has reinvested
70% of the earnings as retained earnings while distributing 30% as dividends. Assuming that GGL is
expected to continue this practice every year, and with a cost of equity capital of 18%, what is the
approximate expected value of each GGL’s share?
(a) Rs. 876 (b) Rs. 151 (c) Rs. 375 (d) Rs. 502 (02)
xi. Which TWO of the following can be used to estimate the cost of equity of a company?
(a) Gordon growth model (b) Internal rate of return
(c) Capital asset pricing method (d) Weighted average cost of capital (01)
xii. When shares are traded “ex dividend (XD)”, which of the following TWO statements accurately describe the
situation?
(a) Buyers of shares at XD price are entitled to receive the dividend upon selling theirshares
(b) The XD share price reflects the anticipation of future dividends
(c) Buyers of shares at XD price are not entitled to receive the upcoming dividendpayment
(d) The XD share price is typically lower than when shares are traded “cum dividend” (1.5)

Chapter 12
i. Which of the following is NOT the step for implementation of a risk management system?
(a) Demonstrating commitment to risk management and allocating appropriate resources

(b) Developing an appropriate implementation plan including deadlines
(c) Identifying where, when and how different types of decisions are made and by whom
(d) Ensuring that the organization’s arrangements for managing risk are clearly understood and
practiced (01)
ii. HQ Group is considering entering into a business of coal extraction. The process ofcoal extraction
is subject to strict environmental regulations. Any mishandling could result in heavy fines. The given
risk can be classified as:
(a) pure risk that cannot be reduced (b) pure risk that can be reduced by internal controls
(c) speculative risk that cannot be reduced (d) speculative risk that can be reduced by internal controls
(01)
iii. Alpha Limited is engaged in manufacturing consumer goods. The goods are manufactured in two
factories and staff at head office is mostly involved in maintenance of accounting record. The CEO
has directed the management to develop a risk management program. The management has identified
various risks and classified them as high, moderate or low. Most of the high risks pertain to factories
therefore, the management has prepared a risk management program for factories. It has a plan to train
the factories’ staff to learn to manage and respond tothe risks. It is also agreed that management
would proactively look for new risks atfactories and continually incorporate such risks into risk
management program.
Which of the following elements of Risk Management Framework: ISO 31000 ismissing?
(a) Leadership and commitment (b) Integration (c) Implementation (d) Evaluation (01)
iv. The higher management is considering to implement a structured risk management process in the
organization. Which of the following should be considered the mostfundamental step?
(a) Procuring tools for risk evaluation
(b) Establishing a dedicated risk management department
(c) Formulating a response to potential risk
(d) Setting clear expectations about the importance of risk awareness and open dialogue (01)
v. Which TWO of the following are examples of operational (pure) risks?

(a) Workers’ strike (b) Fire incident
(c) Stock market crash (d) Product failure (01)
vi. Which TWO of the following are examples of strategic or enterprise (speculative) risks?
(a) Buying earthquake insurance for a property located in a seismic zone
(b) Investing in a start-up company
(c) Taking out a mortgage on a house
(d) Developing a new product (01)

Chapter 13
(i) An investor has purchased a put option on the shares of Vortex Limited (VL) at a strike
price of Rs. 50 per share and paid a premium of Rs. 7 per share. If at expiration, the
shares of VL are trading at Rs. 42, what will the investor most likely do?
(a) Exercise the option and make a net loss of Rs. 15 per share
(b) Not exercise the option as the shares can be bought at lower than the strike price
(c) Not exercise the option and make a net loss of Rs. 7 per share
(d) Exercise the option and make a net profit of Re. 1 per share (1.5)
(ii) A company has purchased an interest rate call option with a strike price of 18% perannum
and a premium of 1% per annum for a notional three-month deposit ofRs. 100 million. Ifat
expiration, the interest rate is 15%, what would be the net annualized interest as a percentage
annual rate?
(a) 17% (b) 16% (c) 19% (d) 14% (1.5)
iii. A company entered into a 3 v 9 Forward Rate Agreement (FRA) with a bank for a notional principal of
Rs. 5 million at 17.4% per annum to hedge its future borrowings. If at the end of the third month, the KIBOR is
18.65% per annum, what will be the settlement amount?
(a) Rs. 28,585 payable by the bank
(b) Rs. 31,250 payable by the bank
(c) Rs. 28,585 payable by the company
(d) Rs. 31,250 payable by the company (02)

Chapter 14

Chapter 15
i. Which of the following statements is correct about aggressive working capital funding
policy?
(a) All permanent assets as well as part of the fluctuating current assets are financed by long-
term funding
(b) All permanent assets as well as part of the fluctuating current assets are financed by short-
term funding
(c) All fluctuating current assets as well as some of the permanent part of current assets are
financed by short-term funding
(d) Only fluctuating current assets are financed by short-term funding (1.5)
ii. Which of the following is the main objectives of an efficient capital structure?
(a) maximizing short-term funding, minimizing long-term liabilities, and
maintaining high liquidity
(b) maximizing equity capital, minimizing debt financing, and ensuring highprofitability
(c) minimizing equity capital, maximizing debt financing, and reducing overallfinancial risk
(d) striking a balance between equity and debt financing, ensuring adequate working capital, and balancing
short- and long-term funding (1.5)
iii. Following is the data extracted from the books of Zadran Limited (ZL). Assuming a 365 days’ year, what
is the length of ZL’s cash operating cycle (in days)?
Inventory turnover 7.5 times

Trade receivables turnover 6.5 times
Trade payables turnover 5.0 times
(a) 177.82 days (b) 19.81 days (c) 31.82 days (d) 40.56 days
(02)

Chapter 16

Answers to (MCQs)
Chapter 1 Chapter 2
i – b i – d
ii – d ii – d
iii – a iii – d
iv – d iv – b
v – d v – d
vi – a vi – d
vii – d vii – a
viii – b
Chapter 3 Chapter 4
i – d i – b
ii – c ii – d
iii – b iii – b
iv – a iv – d
v – b v – d
vi – b vi – a
vii – d vii – a
viii – a viii – b
ix – a ix – d
x–d
Chapter 5 Chapter 7
i – c i – d
ii – d ii – c
iii – b iii – a
iv – d iv – b
v – d v – c
vi – b vi – d
vii – c vii – b
viii – d viii – c

ix – c ix – d
x–c x–
xi –
Chapter 8 Chapter 9
i – c i– c
ii – c ii – b
iii – b iii – d
iv – a iv – c
v – d v – d
vi – b vi – a
vii – d
viii – b
ix – d
Chapter 10 Chapter 11
i– d i – d
ii – a ii – a
iii – d iii – b
iv – d iv – c
v–c v – d
vi – d vi – d
vii – b vii –
viii – viii – a
ix – c ix – b
x–b x–c
xi – b
x–a
xi – d
xii – c
i– i– d

ii – b ii – a
iii – b
iv - d
i– i–
Chapter 16
i–
(THE END)

CAF 6 – MFA (Past Papers Analysis)

Model Spring Autumn Spring Autumn Spring
Chapter Topic Paper 2022 2022 2023 2023 2024
Political environment
1 2 8 1
andbusiness
Economy and the
2 1 1.5 1
businessperspective
Impact of social and
3 1
legalenvironment on
business
Information and
4 2 7 1 3 7 9
communicationtechnologies
Technological disruption
5 1 1 8 1 1
andbusiness environment
Comprehensive examples 8
6 9 10
ofChapter 1 to 5
7 Competitive forces 17 18 14 2.5 14
8 Internal analysis 14 10 10 16
9 Ethical decision making 7 7 6 6 6 5
10 Sources of finance 9 3 6 2 4 3
11 Cost of finance 7 12 12 12 14 13.5
12 Identifying and assessing risk 7 2 1 1 2
13 Financial risk management 5 9 8 6 11 10
14 Budgeting 10 12 13 13
15 Working capital management 7.5 10 9 3.5
16 Introduction to project 14 15 12 16 17 16
appraisal

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CA

Autumn 2024 EDITION

Currently he is working with RISE School of Accountancy and teaching CA

Chapters Page no.

2 Economy and the business perspective 10

3 Impact of social and legal environment on business 19

4 Information and communication technologies 26

5 Technological disruption and business environment 39

6 Comprehensive examples of Chapter 1 to 5 42

9 Ethical decision making 91

10 Sources of finance 100

11 Cost of finance 114

12 Identifying and assessing risk 146

13 Financial risk management 151

14 Budgeting and forecasting 175

15 Working capital management 228

16 Introduction to project appraisal 241

Answers to practice questions 280

Multiple Choice Questions (MCQs) 451

ICAP Past Papers Analysis 475

RISE School of Accountancy Page 1

CAF 06 – Managerial & Financial Analysis (FMA)

Managerial Analysis Financial Analysis & Budgeting and

External Analysis Ethical Financial and Budgeting

Statistics of ICAP MFA Examination Result

Attempt Students appeared Students passed

RISE School of Accountancy Page 2

Understanding the environment should be an on-going activity.

Methods for Environmental scan/analysis

Michael Porter’s 5 forces model PESTEL analysis

RISE School of Accountancy Page 3

The scope of political and legal influence on business

RISE School of Accountancy Page 4

THE SPECTRUM OF POLITICAL IDEOLOGIES

Communism Conservatism Right Fascist Capitalism

• They consider Everyone is equal There is a

RISE School of Accountancy Page 5

including Major over international

Authoritarian vs. Democratic Regimes

RISE School of Accountancy Page 6

IMPACT OF POLITICAL IDEOLOGIES ON BUSINESSES

International relationship and policies

RISE School of Accountancy Page 7

INTERACTION BETWEEN BUSINESSES AND THE GOVERNMENT

Financial incentive strategy

Promoting a Constituency-Building Strategy

(a) Stakeholder Coalitions

(b) Advocacy Advertising

(c) Trade Association

Public Affairs Department

Nothing is permanent in this world except change

RISE School of Accountancy Page 8

Q.1 (Autumn 2022 - Q.2)

RISE School of Accountancy Page 9

INDICATORS OF PHASES OF ECONOMIC / BUSINESS CYCLE

RISE School of Accountancy Page 10

PHASES OF ECONOMIC / BUSINESS CYCLE

Boom / Recession/ Recovery/

Coincident Economic Indicators: