Module 3 and Module 4 important theory

questions
3-Marks Questions
1. Define long-term sources of finance.
2. What are equity shares?
3. State any two features of debentures.
4. What is term loan?
5. Define deferred credit.
6. What is lease financing?
7. Mention any two hybrid financing instruments.
8. Define venture capital.
9. What is cost of capital?
10. Define payback period.

7-Marks Questions (final exam)

1. Explain the different long-term sources of finance available to a company.
2. Distinguish between equity shares and preference shares.
3. Explain debentures as a source of long-term finance, with merits and demerits.
4. Discuss lease financing and its advantages and limitations.
5. Explain venture capital, angel investing, private equity, and crowdfunding.
6. Describe the components of cost of capital.
7. Explain the cost of equity using dividend discount model and CAPM.
8. Discuss the computation of weighted average cost of capital (WACC).
9. Explain the need, importance, and process of capital budgeting.
10. Discuss payback period, discounted payback period, and accounting rate of return
methods.

10-Marks Questions (final exam)

1. Explain various long-term sources of finance in detail and compare their suitability for
different business needs.
2. Discuss the concept of cost of capital and explain the computation of cost of
debentures, term loans, preference capital, equity capital, and retained earnings.
3. Explain the determination of WACC with suitable illustration.
4. A company proposes to raise finance through equity, preference shares, and
debentures. Explain how the cost of capital for each source is computed.
5. Explain capital budgeting and discuss the techniques of capital budgeting in detail.
6. A project requires an initial investment of a given amount. Explain how NPV and IRR
are used in project appraisal.
7. Explain modified internal rate of return and profitability index with suitable examples.
8. Discuss capital rationing and explain how projects are ranked under capital constraint.
9. Explain estimation of cash flows for new projects and replacement projects.
10. A firm is evaluating two alternative projects. Explain the decision-making process
using NPV, IRR, and profitability index methods.
Module 3: Cost of Capital and Long-Term Finance
7 Marks
1. A company has issued equity shares with a market price of Rs. 100 per share,
dividend expected next year is Rs. 8 per share, and annual growth rate is 5%.
Compute the cost of equity using the dividend discount model.

2. A firm’s equity share has a beta of 1.2, the risk-free rate is 8%, and the expected
market return is 14%. Calculate the cost of equity using the CAPM model.

3. A company issued debentures of Rs. 1,00,000 at par carrying an interest rate of 12%
p.a. The corporate tax rate is 30%. Compute the after-tax cost of debentures.

4. A project is financed by 40% equity, 20% preference shares, 25% debentures, and
15% retained earnings. The cost of each source is 14%, 10%, 8%, and 12%
respectively. Calculate the WACC.

5. A company borrowed a term loan of Rs. 5,00,000 at 11% interest. Tax rate is 25%.
Compute the after-tax cost of term loan.
6. A project requires an initial investment of Rs. 2,00,000 and generates annual cash
inflows of Rs. 50,000 for 5 years. Calculate the payback period.

7. A project requires an initial investment of Rs. 1,50,000 and yields annual cash inflows
of Rs. 40,000 for 5 years. The discount rate is 10%. Compute the discounted payback
period.

8. A project costs Rs. 3,00,000 and generates annual average profit of Rs. 45,000.
Compute the accounting rate of return if the average investment is Rs. 1,50,000.

9. A project requires an initial investment of Rs. 2,50,000 and produces cash inflows of
Rs. 80,000, Rs. 90,000, Rs. 1,00,000 and Rs. 70,000 over 4 years. Compute the NPV
at 12% discount rate.

10. A project requires an initial investment of Rs. 1,20,000 and provides annual inflows of
Rs. 35,000 for 5 years. Compute the profitability index at 10% discount rate.

10 Marks
1. A company has the following capital structure: Equity 50%, Preference shares 10%,
Debentures 20%, and Retained earnings 20%. The respective costs are 16%, 12%,
10%, and 14%. Compute the weighted average cost of capital.

2. A firm issued preference shares of Rs. 10,00,000 carrying a dividend of 9% p.a. The
issue expenses are Rs. 20,000. Calculate the cost of preference capital.

3. A company has equity shares with current market price of Rs. 50, dividend expected
next year of Rs. 5, and growth rate of 6%. Calculate the cost of equity using the
 dividend growth model. Then compute the cost using CAPM if risk-free rate is 7%
and beta is 1.1, with market return 13%.

4. A firm has the following sources of finance: equity shares Rs. 6,00,000, preference
shares Rs. 2,00,000, debentures Rs. 4,00,000, and retained earnings Rs. 3,00,000.
Their costs are 15%, 11%, 9%, and 13% respectively. Calculate the WACC.

5. A company plans to raise Rs. 20,00,000 through a combination of debentures and

term loans. Debentures carry 10% interest and term loans carry 12% interest. The tax
rate is 30%. Calculate the after-tax cost of each source and compare them.
Module 4: Capital Budgeting

Module 4: Capital Budgeting

7 Marks
1. A project requires an initial investment of Rs. 2,00,000 and generates annual cash
inflows of Rs. 50,000 for 5 years. Calculate the payback period and comment on
acceptability.

2. A project requires an initial investment of Rs. 1,50,000 and yields annual cash inflows
of Rs. 40,000 for 5 years. The discount rate is 10%. Compute the discounted
payback period.

3. A project costs Rs. 3,00,000 and generates annual average profit of Rs. 45,000.
Compute the Accounting Rate of Return (ARR) if the average investment is Rs.
1,50,000.

4. A project requires an initial investment of Rs. 2,50,000 and produces cash inflows of
Rs. 80,000, Rs. 90,000, Rs. 1,00,000 and Rs. 70,000 over 4 years. Compute the Net
Present Value (NPV) at 12% discount rate.

5. A project requires an initial investment of Rs. 1,20,000 and provides annual inflows of
Rs. 35,000 for 5 years. Compute the Profitability Index (PI) at 10% discount rate.

6. A firm is considering two projects with the following data:

Project A: Initial investment Rs. 2,00,000, cash inflows Rs. 70,000 per year for 4
years.
Project B: Initial investment Rs. 2,50,000, cash inflows Rs. 80,000 per year for 4
years.
Calculate the payback period for both projects and recommend the better one.

7. A project requires an initial investment of Rs. 4,00,000 and produces annual cash
inflows of Rs. 1,10,000, Rs. 1,20,000, Rs. 1,30,000 and Rs. 1,40,000. Compute the
NPV at 10% and decide whether to accept the project.
 8. A project costs Rs. 5,00,000 and gives annual net cash inflows of Rs. 1,25,000 for 6
years. Calculate the ARR and payback period.

9. A project requires an initial outlay of Rs. 3,00,000 and yields cash inflows of Rs.
75,000, Rs. 90,000, Rs. 1,00,000, Rs. 1,10,000 and Rs. 1,20,000. Compute the
discounted payback period at 10%.

10. Two projects are given below:

Project X: Investment Rs. 2,00,000, annual inflow Rs. 65,000 for 5 years.
Project Y: Investment Rs. 2,50,000, annual inflow Rs. 80,000 for 5 years.
Calculate the Profitability Index for both projects and choose the better one.

10 Marks
1. A project requires an initial investment of Rs. 5,00,000 and yields cash inflows of Rs.
1,50,000, Rs. 1,80,000, Rs. 1,60,000, Rs. 1,40,000 and Rs. 1,20,000 over 5 years.
Compute the NPV at 10% and advise whether the project should be accepted.

2. A project needs Rs. 4,00,000 as initial investment and generates cash inflows of Rs.
1,20,000 annually for 5 years. Compute the IRR and decide on acceptance if the
required rate is 12%.

3. Two mutually exclusive projects are given below:

Project A: Initial investment Rs. 3,00,000; inflows Rs. 1,20,000, Rs. 1,10,000, Rs.
1,00,000.
Project B: Initial investment Rs. 3,00,000; inflows Rs. 90,000, Rs. 1,30,000, Rs.
1,40,000.
Compute NPV for both projects at 10% and select the better project.

4. A company is considering a replacement of an existing machine. The new machine

costs Rs. 6,00,000 and gives annual savings of Rs. 1,80,000 for 5 years. The old
machine can be sold now for Rs. 1,00,000. Prepare the incremental cash flows and
evaluate the proposal using NPV at 12%.

5. A company has two projects but funds are limited to Rs. 5,00,000. The projects are:
Project A: Investment Rs. 3,00,000, PI = 1.25
Project B: Investment Rs. 2,50,000, PI = 1.18
Project C: Investment Rs. 1,50,000, PI = 1.30
Select projects under capital rationing.

6. A project requires an initial investment of Rs. 5,00,000 and yields cash inflows of Rs.
1,50,000, Rs. 1,80,000, Rs. 1,60,000, Rs. 1,40,000 and Rs. 1,20,000 over 5 years.
Compute the Net Present Value (NPV) at 10% and advise whether the project should
be accepted.
 7. A project needs Rs. 4,00,000 as initial investment and generates cash inflows of Rs.
1,20,000 annually for 5 years. Compute the Internal Rate of Return (IRR) and
decide on acceptance if the required rate is 12%.

1. Two mutually exclusive projects are given below:

Project A: Initial investment Rs. 3,00,000; inflows Rs. 1,20,000, Rs. 1,10,000, Rs.
1,00,000.
Project B: Initial investment Rs. 3,00,000; inflows Rs. 90,000, Rs. 1,30,000, Rs.
1,40,000.
Compute NPV for both projects at 10% and select the better project.

2. A company is considering replacement of an existing machine. The new machine

costs Rs. 6,00,000 and gives annual savings of Rs. 1,80,000 for 5 years. The old
machine can be sold now for Rs. 1,00,000. Prepare the incremental cash flows and
evaluate the proposal using NPV at 12%.

3. A company has two projects, but funds are limited to Rs. 5,00,000. The projects are:
Project A: Investment Rs. 3,00,000, PI = 1.25
Project B: Investment Rs. 2,50,000, PI = 1.18
Project C: Investment Rs. 1,50,000, PI = 1.30
Select the projects under capital rationing.

4. A project costs Rs. 2,50,000 and generates annual net cash inflows of Rs. 70,000, Rs.
80,000, Rs. 90,000, Rs. 1,00,000, and Rs. 1,10,000. Calculate the discounted
payback period at 10% and decide whether the project is acceptable within 4 years.

5. A project requires an initial investment of Rs. 3,50,000 and produces annual cash
inflows of Rs. 90,000 for 6 years. Compute the Profitability Index (PI) at 12% and
interpret the result.

6. A project requires an initial investment of Rs. 4,50,000 and gives annual profits of Rs.
1,00,000. The salvage value at the end of the project is Rs. 50,000. Compute the
Accounting Rate of Return (ARR) and comment on acceptance.

7. A project has the following cash inflows: Year 1 = Rs. 60,000, Year 2 = Rs. 80,000,
Year 3 = Rs. 1,00,000, Year 4 = Rs. 1,20,000, Year 5 = Rs. 1,40,000. Initial
investment is Rs. 3,00,000. Compute the NPV at 10% and the IRR, then recommend
acceptance or rejection.

A firm is evaluating a replacement project. The existing machine has a book value of Rs.
1,20,000 and can be sold for Rs. 80,000. The new machine costs Rs. 5,00,000 and will save
Rs. 1,50,000 annually for 5 years. Compute the incremental cash flows and evaluate the
project using NPV at 12%.
Here are 4 numerical case-study problems for Module 3 and Module 4, with realistic
company names, and each mapped to the relevant CO and Bloom’s level. I have kept them
application-oriented so students can use formulas and concepts directly.

Module 3 Case Studies

1) Tata Motors Ltd. – Cost of Equity and WACC
Tata Motors Ltd. plans to expand its electric vehicle division. The company’s equity share
has a current market price of Rs. 400, expected dividend next year is Rs. 28, and the dividend
is expected to grow at 6% annually. The company also has 10% debentures and 12% term
loans in its capital structure. The capital mix is: Equity 60%, Debentures 25%, and Term
Loan 15%. The corporate tax rate is 30%.

Required:

 Calculate the cost of equity using the dividend growth model.

 Compute the after-tax cost of debentures and term loan.
 Determine the WACC.

2) Infosys Ltd. – Preference Capital and Retained

Earnings
Infosys Ltd. is planning a new technology center. It has issued preference shares of Rs.
8,00,000 carrying a dividend rate of 9%. Issue expenses are Rs. 20,000. The company’s
retained earnings are expected to generate an implicit cost of 13%. The existing capital
structure includes 40% preference shares, 35% retained earnings, and 25% equity shares. The
cost of equity is estimated at 15%.

Required:

 Calculate the cost of preference capital.

 Determine the weighted average cost of capital.

Module 4 Case Studies

3) Maruti Suzuki India Ltd. – NPV and IRR
Maruti Suzuki India Ltd. is considering launching a new compact hybrid car. The project
requires an initial investment of Rs. 12 crore. The expected net cash inflows are Rs. 3.5 crore,
Rs. 4 crore, Rs. 4.2 crore, Rs. 3.8 crore, and Rs. 3 crore over 5 years. The company’s required
rate of return is 11%.

Required:

 Compute the NPV of the project.

 Estimate whether the project is acceptable.
 If possible, determine the IRR and compare it with the required rate of return.

4) HDFC Bank Ltd. – Replacement Project and PI

HDFC Bank Ltd. is considering replacing its existing document-processing system with an
automated digital platform. The new system costs Rs. 45 lakh and will generate annual
savings of Rs. 12 lakh for 5 years. The existing system can be sold today for Rs. 8 lakh.
Additional installation cost is Rs. 2 lakh. The discount rate is 10%.

Required:

 Prepare the incremental cash flows for the replacement decision.

 Compute the NPV of the proposal.
 Calculate the Profitability Index.
 Decide whether the replacement should be accepted.