Test 10: answer key

Question 1 · 2 marks · Ratio Analysis · medium

Scenario. Vardhman Textiles reports sales of ₹2,400 crore, net profit after tax of ₹144 crore, EBIT of ₹240 crore, interest of ₹40 crore, profit before tax of ₹200 crore, average total assets of ₹1,200 crore and average shareholders equity of ₹600 crore. The applicable tax rate is 25 percent.

Using the three-step DuPont model, the return on equity of Vardhman Textiles is:

1. 12.0 percent
2. 24.0 percent (correct answer)
3. 18.0 percent
4. 30.0 percent

Answer: B — 24.0 percent

Working. Net profit margin = 144 / 2400 = 0.06 or 6 percent. Asset turnover = 2400 / 1200 = 2.0 times. Equity multiplier = 1200 / 600 = 2.0 times. ROE = 0.06 × 2.0 × 2.0 = 0.24 or 24.0 percent.

Explanation. The correct option is b. Three-step DuPont ROE equals net profit margin multiplied by asset turnover multiplied by equity multiplier. It gives 6 percent × 2.0 × 2.0 = 24.0 percent. Option a ignores the equity multiplier. Option c does not reconcile with the given figures. Option d overstates the product of the three components.

Where it goes wrong. Students may divide PAT by average total assets and stop at return on assets, or may use total assets instead of shareholders equity in the multiplier.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Du Pont analysis

Question 2 · 2 marks · Ratio Analysis · hard

Under the five-step DuPont decomposition, if the EBIT margin falls to 8 percent while tax burden, interest burden, asset turnover and equity multiplier remain unchanged, the revised return on equity is:

1. 16.0 percent
2. 20.0 percent
3. 19.2 percent (correct answer)
4. 24.0 percent

Answer: C — 19.2 percent

Working. Tax burden = PAT / PBT = 144 / 200 = 0.72. Interest burden = PBT / EBIT = 200 / 240 = 0.8333. Revised ROE = 0.72 × 0.8333 × 0.08 × 2.0 × 2.0 = 0.192 or 19.2 percent.

Explanation. The correct option is c. Five-step DuPont ROE equals tax burden × interest burden × EBIT margin × asset turnover × equity multiplier. Revised ROE is 0.72 × 0.8333 × 0.08 × 2.0 × 2.0 = 19.2 percent. Option a omits the interest burden effect. Option b uses an incorrect margin or omits a component. Option d is the original ROE before the EBIT margin decline.

Where it goes wrong. Students may use PAT margin directly and treat the five-step model as the three-step model, thereby missing the tax burden and interest burden components.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Du Pont analysis

Question 3 · 2 marks · Ratio Analysis · medium

ROE remains 24 percent while net profit margin is unchanged at 6 percent. Asset turnover falls from 2.0 to 1.6 and equity multiplier rises from 2.0 to 2.5. Which interpretation is most appropriate?

1. Operational efficiency improved and financial leverage fell
2. Financial leverage fell and compensated the fall in asset turnover
3. Both operational efficiency and financial leverage improved
4. Operational efficiency weakened while higher financial leverage compensated for it (correct answer)

Answer: D — Operational efficiency weakened while higher financial leverage compensated for it

Working. Revised ROE = 0.06 × 1.6 × 2.5 = 0.24 or 24 percent. Asset turnover declined from 2.0 to 1.6. Equity multiplier increased from 2.0 to 2.5.

Explanation. The correct option is d. A fall in asset turnover from 2.0 to 1.6 indicates weaker asset utilisation or operational efficiency. A rise in equity multiplier from 2.0 to 2.5 indicates higher financial leverage. The product 6 percent × 1.6 × 2.5 remains 24 percent. Options a, b and c contradict the direction of the two components.

Where it goes wrong. Students may see unchanged ROE and conclude that performance is unchanged, ignoring that ROE has been maintained by higher leverage rather than better operations.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Du Pont analysis

Question 4 · 2 marks · Cost of Capital · medium

Scenario. Deccan Cement has a risk-free rate of 7.2 percent, expected market return of 12.8 percent, levered equity beta of 1.25, debt-equity ratio of 0.6 and tax rate of 25 percent. The company is evaluating a proposed debt-equity ratio of 1.0 for a new project.

Using the Capital Asset Pricing Model, the current cost of equity of Deccan Cement is:

1. 14.20 percent (correct answer)
2. 13.60 percent
3. 15.00 percent
4. 12.80 percent

Answer: A — 14.20 percent

Working. Market risk premium = 12.8 percent − 7.2 percent = 5.6 percent. Cost of equity = 7.2 percent + 1.25 × 5.6 percent = 14.20 percent.

Explanation. The correct option is a. CAPM cost of equity equals risk-free rate plus beta multiplied by the market risk premium. It is 7.2 percent + 1.25 × 5.6 percent = 14.20 percent. Option b uses an incorrect beta or risk premium. Option c uses an incorrect risk premium. Option d is the market return, not the cost of equity.

Where it goes wrong. Students may use the market return directly or may multiply beta by the market return instead of the market risk premium.

Authority. Chapter 4: Cost of Capital, Capital Asset Pricing Model approach

Question 5 · 2 marks · Cost of Capital · hard

If the proposed debt-equity ratio of 1.0 is adopted, the relevered equity beta is closest to:

1. 1.25
2. 1.51 (correct answer)
3. 1.09
4. 1.72

Answer: B — 1.51

Working. Unlevered beta = 1.25 / [1 + (1 − 0.25) × 0.6] = 1.25 / 1.45 = 0.8621. Relevered beta = 0.8621 × [1 + (1 − 0.25) × 1.0] = 0.8621 × 1.75 = 1.5086, approximately 1.51.

Explanation. The correct option is b. First unlever the current beta using the current debt-equity ratio and tax rate. Then relever it at the proposed debt-equity ratio. The relevered beta is about 1.51. Option a is the current levered beta. Option c results from an incorrect tax adjustment. Option d overstates the relevered beta.

Where it goes wrong. Students may relever the already levered beta without first unlevering it, or may ignore the tax shield in the debt-equity adjustment.

Authority. Chapter 4: Cost of Capital, Capital Asset Pricing Model approach and beta adjustment

Question 6 · 2 marks · Cost of Capital · hard

Using the relevered beta of approximately 1.5086, the cost of equity under the proposed capital structure is closest to:

1. 14.20 percent
2. 14.83 percent
3. 15.65 percent (correct answer)
4. 16.40 percent

Answer: C — 15.65 percent

Working. Cost of equity = 7.2 percent + 1.5086 × 5.6 percent = 7.2 percent + 8.448 percent = 15.648 percent, approximately 15.65 percent.

Explanation. The correct option is c. Cost of equity equals 7.2 percent + 1.5086 × 5.6 percent = 15.65 percent approximately. Option a is the current cost of equity. Option b uses an incorrect relevered beta. Option d overstates the risk premium effect.

Where it goes wrong. Students may use the original beta after computing the relevered beta, or may round the beta too early and select a materially different value.

Authority. Chapter 4: Cost of Capital, Capital Asset Pricing Model approach

Question 7 · 2 marks · Ratio Analysis · medium

Scenario. Sunrise Engineering reports sales of ₹3,600 lakh, net fixed assets of ₹900 lakh, total assets of ₹1,800 lakh, current assets of ₹600 lakh and current liabilities of ₹300 lakh. Operating current assets excluding cash are ₹600 lakh and operating current liabilities excluding short-term bank borrowing are ₹300 lakh. Capital employed is total assets less current liabilities.

The fixed asset turnover ratio and the operating working capital turnover ratio are:

1. 4.0 times and 8.0 times
2. 9.0 times and 4.0 times
3. 4.0 times and 10.0 times
4. 4.0 times and 12.0 times (correct answer)

Answer: D — 4.0 times and 12.0 times

Working. Fixed asset turnover = 3,600 / 900 = 4.0 times. Operating working capital = 600 − 300 = 300 lakh. Operating working capital turnover = 3,600 / 300 = 12.0 times.

Explanation. The correct option is d. Fixed asset turnover is sales divided by net fixed assets, giving 4.0 times. Operating working capital is operating current assets minus operating current liabilities, giving ₹300 lakh. Operating working capital turnover is 3,600 / 300 = 12.0 times. Options a, b and c use incorrect operating working capital or fixed asset figures.

Where it goes wrong. Students may use total current assets minus total current liabilities instead of operating current assets and operating current liabilities, or may divide by total assets for fixed asset turnover.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Activity ratios

Question 8 · 1 marks · Ratio Analysis · medium

The capital turnover ratio, using capital employed as total assets less current liabilities, is:

1. 2.4 times (correct answer)
2. 2.0 times
3. 3.0 times
4. 1.2 times

Answer: A — 2.4 times

Working. Capital employed = 1,800 − 300 = 1,500 lakh. Capital turnover = 3,600 / 1,500 = 2.4 times.

Explanation. The correct option is a. Capital employed is ₹1,800 lakh − ₹300 lakh = ₹1,500 lakh. Capital turnover is ₹3,600 lakh / ₹1,500 lakh = 2.4 times. Option b uses total assets as the denominator. Option c uses an incorrect capital employed figure. Option d halves the correct turnover.

Where it goes wrong. Students may use total assets instead of capital employed, or may deduct all current assets rather than current liabilities.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Activity ratios

Question 9 · 2 marks · Strategic Analysis: External Environment · medium

Scenario. In the automobile industry, strategic groups include luxury full-range makers at high prices, mass-market limited-range makers at low prices, electric vehicle niche makers at high prices with limited range, and SUV specialists at mid prices with narrow range. A strategist is preparing a strategic group map and assessing competitive pressures and possible empty niches.

Which pair of characteristics is most appropriate as axes for a strategic group map of automobile makers?

1. Price level and product range (correct answer)
2. Total assets and employee count
3. Debt-equity ratio and dividend payout
4. Research spend and tax rate

Answer: A — Price level and product range

Working. Strategic group mapping plots firms on two competitive dimensions. Price level and product range directly differentiate automobile makers by market positioning and competitive strategy.

Explanation. The correct option is a. Strategic group maps use competitive strategy dimensions that separate firms in the market, such as price and product range. Options b, c and d are financial or structural variables that do not directly position firms by competitive strategy in the automobile market.

Where it goes wrong. Students may choose financial size variables because they are easy to measure, but strategic group maps require dimensions reflecting competitive positioning.

Authority. Chapter 2: Strategic Analysis: External Environment, Industry environment analysis

Question 10 · 2 marks · Strategic Analysis: External Environment · medium

A mass-market limited-range maker is likely to face the strongest competitive pressure from:

1. Luxury full-range makers only
2. Other mass-market makers and SUV specialists whose price and range overlap (correct answer)
3. Suppliers only
4. Regulators only

Answer: B — Other mass-market makers and SUV specialists whose price and range overlap

Working. Firms close together on price and product range compete for similar buyers. The mass-market maker is closest to other mass-market makers and overlapping SUV specialists.

Explanation. The correct option is b. Competitive pressure is strongest among firms in the same or adjacent strategic groups with overlapping price and product-range positions. Options a, c and d are not the closest strategic-group rivals in the map.

Where it goes wrong. Students may treat all firms in the industry as equally close rivals, ignoring that strategic group distance affects the intensity of rivalry.

Authority. Chapter 2: Strategic Analysis: External Environment, Strategic groups and competitive pressures

Question 11 · 2 marks · Strategic Analysis: External Environment · medium

An empty space in the high-price limited-range electric vehicle segment on the strategic group map indicates:

1. That no demand can exist in that segment
2. That a legal barrier definitely blocks entry
3. A possible opportunity if demand and firm capabilities align (correct answer)
4. An assured monopoly position for any entrant

Answer: C — A possible opportunity if demand and firm capabilities align

Working. Strategic group mapping identifies gaps in competitive positioning. A gap is a candidate for further evaluation, not a conclusion about demand or entry barriers.

Explanation. The correct option is c. An empty niche may represent an opportunity, but it must be tested against demand, profitability and the firm capabilities needed to serve it. Options a, b and d treat an empty space as certain absence of demand, certain legal barrier or certain monopoly, which is not supported by strategic group mapping.

Where it goes wrong. Students may treat an unoccupied strategic space as an automatic opportunity or as automatically unattractive, without assessing demand and capabilities.

Authority. Chapter 2: Strategic Analysis: External Environment, Strategic group mapping

Question 12 · 2 marks · Strategic Choices · medium

Scenario. AirConnect offers advanced cabin features, multiple routes and lower fares than full-service airlines while providing better service than low-cost carriers. It targets a broad set of traveller segments and seeks to align cost reduction with features valued by customers.

AirConnect is pursuing which generic strategy?

1. Pure cost leadership
2. Pure differentiation
3. Focus cost leadership
4. Hybrid cost and differentiation strategy (correct answer)

Answer: D — Hybrid cost and differentiation strategy

Working. Hybrid cost and differentiation requires offering perceived value while maintaining a cost position that supports lower prices than differentiated rivals and better features than pure low-cost rivals.

Explanation. The correct option is d. AirConnect offers valued features and also lower fares than full-service rivals while keeping service better than low-cost carriers, so it combines cost and differentiation elements for a broad market. Options a and b describe only one source of advantage. Option c limits the strategy to a narrow segment, which is not supported by the scenario.

Where it goes wrong. Students may see lower fares and immediately select cost leadership, missing the simultaneous emphasis on valued features and service quality.

Authority. Chapter 4: Strategic Choices, Competitive strategies

Question 13 · 2 marks · Strategic Choices · medium

Which risk is most closely associated with AirConnect's strategy?

1. Being stuck in the middle if cost and differentiation advantages erode (correct answer)
2. Automatic premium pricing because of advanced features
3. No need to manage the value chain
4. Complete immunity from imitation

Answer: A — Being stuck in the middle if cost and differentiation advantages erode

Working. Hybrid strategy requires continuous alignment of cost drivers and customer-valued features. If either side erodes, the firm may lose its competitive position.

Explanation. The correct option is a. A hybrid cost and differentiation strategy carries the risk of being stuck in the middle if the firm loses both cost advantage and differentiation advantage. Options b, c and d are inconsistent with competitive strategy principles.

Where it goes wrong. Students may think combining cost and differentiation removes risk, but the combination is demanding and can fail if both advantages weaken.

Authority. Chapter 4: Strategic Choices, Competitive strategies

Question 14 · 2 marks · Strategic Choices · medium

Which action is most consistent with AirConnect sustaining its strategy?

1. Cut all service features to match pure low-cost carriers
2. Re-engineer the value chain to lower cost while adding features customers value (correct answer)
3. Raise prices without adding valued features
4. Target only luxury travellers and abandon broad segments

Answer: B — Re-engineer the value chain to lower cost while adding features customers value

Working. Value chain re-engineering can reduce cost in non-value activities while preserving or adding features that customers value, supporting the hybrid position.

Explanation. The correct option is b. Sustaining a hybrid strategy requires cost reduction aligned with customer-valued features. Option a destroys differentiation. Option c weakens value for money. Option d changes the broad-market positioning.

Where it goes wrong. Students may choose cost cutting or premium pricing as single levers, but hybrid strategy needs coordinated value-chain actions.

Authority. Chapter 4: Strategic Choices, Competitive strategies and value chain

Question 15 · 2 marks · Strategic Choices · medium

Scenario. Heritage Foods, a dairy company, acquires a packaging unit that supplies it, acquires a rival dairy brand, acquires a breakfast cereal brand and also acquires an information technology services firm. The management is assessing merger categories and post-merger integration challenges.

The acquisition of the packaging unit and the acquisition of the rival dairy brand are respectively classified as:

1. Conglomerate merger and horizontal merger
2. Vertical forward merger and congeneric merger
3. Vertical backward merger and horizontal merger (correct answer)
4. Congeneric merger and vertical backward merger

Answer: C — Vertical backward merger and horizontal merger

Working. Packaging unit supplies Heritage Foods, so it is backward vertical. Rival dairy brand is a direct competitor, so it is horizontal.

Explanation. The correct option is c. Acquiring a supplier packaging unit is vertical backward integration. Acquiring a rival dairy brand in the same industry and at the same stage is a horizontal merger. Options a, b and d misclassify one or both transactions.

Where it goes wrong. Students may confuse backward integration with forward integration or may treat any related acquisition as congeneric.

Authority. Chapter 4: Strategic Choices, Mergers and acquisitions

Question 16 · 1 marks · Strategic Choices · medium

Which post-merger synergy challenge is most likely in the breakfast cereal acquisition if it is treated as a congeneric merger?

1. No integration effort is needed because the products are unrelated
2. Immediate market power without any operational change
3. Only tax savings matter and operating fit can be ignored
4. Integrating different distribution and brand positions while sharing procurement and marketing capabilities (correct answer)

Answer: D — Integrating different distribution and brand positions while sharing procurement and marketing capabilities

Working. Congeneric merger means related business lines with common capabilities. Synergy arises only if distribution, brand and procurement linkages are actively integrated.

Explanation. The correct option is d. A congeneric merger involves related but not identical businesses, so synergy requires integrating distribution, brands and shared capabilities such as procurement and marketing. Options a, b and c understate the integration effort and operating fit required.

Where it goes wrong. Students may treat congeneric mergers as either fully unrelated or fully identical, missing the related-but-different nature of integration.

Authority. Chapter 4: Strategic Choices, Mergers and acquisitions