Test 11: answer key

Question 1 · 2 marks · Management of Working Capital · medium

Scenario. Aakash Exporters has annual credit sales of Rs 90,00,000 and an average collection period of 60 days. It currently incurs credit administration cost of Rs 1,20,000 per year, of which two-fifths is avoidable if receivables are factored. Bad debts are 1.5 percent of credit sales. A factor offers non-recourse factoring with a commission of 2 percent on average receivables, a reserve of 10 percent of receivables, and an advance carrying interest at 15 percent per annum for the collection period. Assume 360 days in a year and ignore one-time costs.

What is the factoring commission charged on average receivables?

1. Rs 30,000 (correct answer)
2. Rs 1,80,000
3. Rs 15,000
4. Rs 27,000

Answer: A — Rs 30,000

Working. Average receivables = 90,00,000 x 60 / 360 = Rs 15,00,000. Factoring commission = 15,00,000 x 2 percent = Rs 30,000.

Explanation. Factoring commission is computed on average receivables because the factor purchases or administers the receivables. Average receivables are annual credit sales multiplied by collection period divided by 360. Commission at 2 percent on Rs 15,00,000 is Rs 30,000. The other options either apply the commission to annual sales or use incorrect rates.

Where it goes wrong. Applying 2 percent directly to annual credit sales of Rs 90,00,000 gives Rs 1,80,000, which is incorrect for a commission on average receivables.

Authority. Chapter 9: Management of Working Capital - Financing Receivables - Factoring

Question 2 · 2 marks · Management of Working Capital · hard

What is the net advance available to Aakash Exporters after reserve and interest?

1. Rs 13,20,000
2. Rs 15,00,000
3. Rs 12,87,000 (correct answer)
4. Rs 12,00,000

Answer: C — Rs 12,87,000

Working. Average receivables = Rs 15,00,000. Commission = Rs 30,000. Reserve = 10 percent x 15,00,000 = Rs 1,50,000. Amount available for advance = 15,00,000 - 30,000 - 1,50,000 = Rs 13,20,000. Interest = 13,20,000 x 15 percent x 60/360 = Rs 33,000. Net advance = 13,20,000 - 33,000 = Rs 12,87,000.

Explanation. The amount available for advance is average receivables less factoring commission and reserve. Interest is deducted on this amount for the collection period. The net advance is Rs 13,20,000 less interest of Rs 33,000, giving Rs 12,87,000. Options a and b ignore interest or reserve, and option d uses an arbitrary deduction.

Where it goes wrong. Deducting reserve but not commission, or deducting interest on gross receivables instead of on the amount available for advance.

Authority. Chapter 9: Management of Working Capital - Financing Receivables - Factoring

Question 3 · 2 marks · Management of Working Capital · hard

What is the effective annualised cost of factoring, ignoring savings, based on net advance?

1. 21.3 percent
2. 29.4 percent (correct answer)
3. 31.2 percent
4. 35.0 percent

Answer: B — 29.4 percent

Working. Total cost = Rs 30,000 + Rs 33,000 = Rs 63,000. Effective annualised cost = 63,000 / 12,87,000 x 360/60 x 100 = 29.37 percent, approximately 29.4 percent.

Explanation. Total factoring cost before savings is commission plus interest, namely Rs 63,000. This cost is compared with net advance and annualised by multiplying by 360 divided by 60. The result is about 29.4 percent. Option a is a rough nominal estimate, while options c and d use incorrect bases.

Where it goes wrong. Using gross receivables or amount available for advance instead of net advance as the denominator.

Authority. Chapter 9: Management of Working Capital - Financing Receivables - Factoring

Question 4 · 2 marks · Financing Decisions - Capital Structure · medium

Scenario. Zenith Ltd requires Rs 50,00,000 for expansion. Plan A is to issue equity shares of Rs 10 each for the entire amount. Plan B is to raise Rs 20,00,000 by 10 percent debt and the balance by equity shares of Rs 10 each. The corporate tax rate is 30 percent. EBIT is expected to vary across years.

What is the indifference EBIT between Plan A and Plan B?

1. Rs 3,00,000
2. Rs 4,00,000
3. Rs 5,00,000 (correct answer)
4. Rs 6,00,000

Answer: C — Rs 5,00,000

Working. Plan A shares = 50,00,000 / 10 = 5,00,000. Plan B shares = 30,00,000 / 10 = 3,00,000. Indifference: EBIT x 0.70 / 5,00,000 = (EBIT - 2,00,000) x 0.70 / 3,00,000. 3 EBIT = 5 EBIT - 10,00,000. EBIT = Rs 5,00,000.

Explanation. The indifference EBIT equates EPS under the two financing plans. Plan A has 5,00,000 shares and no interest. Plan B has 3,00,000 shares and interest of Rs 2,00,000. Solving the EPS equality gives EBIT of Rs 5,00,000. Other options arise from arithmetic errors in the equation.

Where it goes wrong. Ignoring tax in the equation is harmless because the same tax rate applies, but ignoring the lower number of shares under Plan B gives an incorrect answer.

Authority. Chapter 5: Financing Decisions - Capital Structure - EBIT-EPS Indifference Point

Question 5 · 2 marks · Financing Decisions - Capital Structure · hard

If EBIT is Rs 4,00,000, which plan gives higher EPS?

1. Plan A gives higher EPS (correct answer)
2. Plan B gives higher EPS
3. Both plans give equal EPS
4. EPS cannot be compared without dividend data

Answer: A — Plan A gives higher EPS

Working. Plan A EPS = 4,00,000 x 0.70 / 5,00,000 = Rs 0.56. Plan B EPS = (4,00,000 - 2,00,000) x 0.70 / 3,00,000 = Rs 0.47.

Explanation. At EBIT below the indifference point, the all-equity plan gives higher EPS because the fixed interest burden of debt is not fully absorbed by operating earnings. EPS under Plan A is Rs 0.56, while under Plan B it is about Rs 0.47. Dividend data is not needed for EPS.

Where it goes wrong. Assuming debt always increases EPS. Debt increases EPS only when EBIT exceeds the indifference level.

Authority. Chapter 5: Financing Decisions - Capital Structure - EBIT-EPS Analysis

Question 6 · 2 marks · Financing Decisions - Capital Structure · medium

What is the financial risk implication of Plan B when EBIT falls below the indifference point?

1. Plan B has no financial risk because interest is tax deductible
2. Plan B has lower financial leverage than Plan A
3. Plan B keeps WACC constant at all EBIT levels
4. Plan B has higher financial leverage and EPS is more sensitive to EBIT changes (correct answer)

Answer: D — Plan B has higher financial leverage and EPS is more sensitive to EBIT changes

Working. Financial leverage magnifies the effect of EBIT changes on EPS. Plan B has interest of Rs 2,00,000 and fewer shares, so EPS is more volatile.

Explanation. Plan B uses fixed-interest debt, so it has higher financial leverage. EPS becomes more sensitive to changes in EBIT, and below the indifference point the fixed interest charge reduces EPS relative to the all-equity plan. Tax deductibility of interest does not eliminate financial risk.

Where it goes wrong. Treating tax deductibility of interest as removing financial risk, or confusing operating leverage with financial leverage.

Authority. Chapter 5: Financing Decisions - Capital Structure - Financial Leverage and Risk

Question 7 · 2 marks · Management of Working Capital · medium

Scenario. Venus Retail purchases goods on credit terms of 2/10 net 45. It can borrow funds from its bank at 18 percent per annum. The financial manager is examining whether the firm should forgo the cash discount and pay on day 45. Assume 365 days in a year.

What is the effective annual cost of forgoing the cash discount, using compounding?

1. 21.28 percent
2. 23.45 percent (correct answer)
3. 18.00 percent
4. 36.50 percent

Answer: B — 23.45 percent

Working. Discount period = 10 days. Net period = 45 days. Extra credit period = 35 days. Effective cost = (100/98)^(365/35) - 1 = 23.45 percent approximately. Nominal cost = 2/98 x 365/35 = 21.28 percent.

Explanation. The effective annual cost of forgoing the discount uses the formula (100/98)^(365/35) minus 1. This gives about 23.45 percent. Option a is the nominal annual cost without compounding, and option c is the bank borrowing rate.

Where it goes wrong. Reporting the nominal cost of 21.28 percent when the question requires the effective annual cost with compounding.

Authority. Chapter 9: Management of Working Capital - Management of Payables - Cost of Trade Credit

Question 8 · 1 marks · Management of Working Capital · medium

Given that Venus Retail can borrow at 18 percent, what action is most appropriate?

1. Forgo the discount because 18 percent is lower than 23.45 percent
2. Forgo the discount because the nominal cost is 21.28 percent
3. Pay on day 45 because borrowing costs are always irrelevant
4. Borrow at 18 percent and pay within 10 days because the effective cost of forgoing the discount is about 23.45 percent (correct answer)

Answer: D — Borrow at 18 percent and pay within 10 days because the effective cost of forgoing the discount is about 23.45 percent

Working. Effective cost of forgoing discount = 23.45 percent. Borrowing cost = 18 percent. Since 18 percent is lower, borrow and take the discount.

Explanation. The effective cost of forgoing the discount is about 23.45 percent, which exceeds the 18 percent borrowing rate. Therefore, borrowing to pay within the discount period reduces financing cost. Option a reverses the comparison, and option c ignores the cost comparison.

Where it goes wrong. Comparing the discount percentage of 2 percent directly with the annual borrowing rate of 18 percent instead of annualising the cost of forgoing the discount.

Authority. Chapter 9: Management of Working Capital - Management of Payables - Cost of Trade Credit

Question 9 · 2 marks · Strategy Implementation and Evaluation · medium

Scenario. NovaTech Ltd follows a formal strategic management process. It scans external opportunities and threats and reviews internal strengths and weaknesses; then selects related diversification; thereafter prepares budgets, staffing plans and information systems; finally compares actual performance with standards and takes corrective action.

In NovaTech Ltd, the diagnostic phase involving environmental scanning and organisational analysis belongs to which stage of the strategic management process?

1. Strategy formulation
2. Environmental and organisational analysis (correct answer)
3. Strategy implementation
4. Strategic evaluation and control

Answer: B — Environmental and organisational analysis

Working. No numerical working required. Identify the stage from the stated activities of scanning and organisational review.

Explanation. The strategic management process identifies environmental and organisational analysis as the diagnostic stage. It involves scanning external opportunities and threats and reviewing internal strengths and weaknesses. Strategy formulation follows this diagnosis and selects alternatives.

Where it goes wrong. Confusing environmental analysis with strategy formulation. Analysis diagnoses the situation; formulation selects the strategy.

Authority. Chapter 5: Strategy Implementation and Evaluation - Strategic Management Process

Question 10 · 2 marks · Strategy Implementation and Evaluation · medium

Preparing budgets, staffing plans and information systems after choosing related diversification is an example of which stage?

1. Strategic vision and mission development
2. Environmental and organisational analysis
3. Strategy implementation (correct answer)
4. Strategic evaluation and control

Answer: C — Strategy implementation

Working. No numerical working required. Match the described actions with implementation activities.

Explanation. Budgets, staffing, policies and information systems are means of executing the chosen strategy. They convert strategic plans into action and are therefore part of strategy implementation. Evaluation and control occur after implementation.

Where it goes wrong. Treating budgeting as strategy formulation. Budgeting is an implementation and execution activity when it follows strategic choice.

Authority. Chapter 5: Strategy Implementation and Evaluation - Strategy Implementation

Question 11 · 2 marks · Introduction to Strategic Management · medium

Which feature is generally associated with strategic decisions?

1. They are long-term, directional and involve major resource commitments (correct answer)
2. They are routine and repetitive operational choices
3. They require no environmental appraisal
4. They are always delegated to functional managers

Answer: A — They are long-term, directional and involve major resource commitments

Working. No numerical working required. Apply the definition and dimensions of strategic decisions.

Explanation. Strategic decisions are long-range, shape the direction of the organisation and commit significant resources. They are not routine operational choices and normally involve top management and environmental appraisal. Delegation to functional managers is not a defining feature.

Where it goes wrong. Treating all managerial decisions as strategic. Routine purchasing or staffing actions are operational unless they affect long-term direction and competitive position.

Authority. Chapter 1: Introduction to Strategic Management - Concept of Strategy

Question 12 · 2 marks · Strategy Implementation and Evaluation · medium

Scenario. Global Aerospace uses a matrix structure for a complex satellite project. Engineers report to both the project director and the functional head of engineering. The firm wants to manage resource conflicts and dual authority.

What is the key structural feature of the matrix structure at Global Aerospace?

1. Only one reporting line from engineer to project director
2. Only one reporting line from engineer to functional head
3. A simple structure with the owner-manager making all decisions
4. Dual reporting lines to both the project manager and the functional manager (correct answer)

Answer: D — Dual reporting lines to both the project manager and the functional manager

Working. No numerical working required. Identify dual reporting from the scenario.

Explanation. A matrix structure combines functional and product or project forms at the same level. Employees have two superiors: a project or product manager and a functional manager. Options a and b describe single-line structures, and option c describes a simple structure.

Where it goes wrong. Describing matrix simply as a project team. The defining feature is dual authority and dual reporting.

Authority. Chapter 5: Strategy Implementation and Evaluation - Organisation Structure - Matrix Structure

Question 13 · 2 marks · Strategy Implementation and Evaluation · hard

A matrix structure is most appropriate for Global Aerospace when:

1. The firm is a small single-product firm with a simple structure
2. Product, technology, customer and functional priorities have roughly equal strategic importance and information processing needs are high (correct answer)
3. Only functional efficiency matters and project coordination is unnecessary
4. The firm wants to eliminate all conflicts between departments

Answer: B — Product, technology, customer and functional priorities have roughly equal strategic importance and information processing needs are high

Working. No numerical working required. Apply the conditions for matrix structure effectiveness.

Explanation. Matrix structures are used when several dimensions such as product, customer, technology and functional area have roughly equal strategic priority. They support cross-functional coordination in complex environments. Matrix does not eliminate conflicts; it manages them through dual authority.

Where it goes wrong. Assuming matrix removes conflict. It can increase conflicts over resources and authority unless roles are clearly understood.

Authority. Chapter 5: Strategy Implementation and Evaluation - Organisation Structure - Matrix Structure

Question 14 · 2 marks · Strategy Implementation and Evaluation · medium

Which mechanism is most appropriate for making the matrix structure effective and resolving authority conflicts?

1. Giving the functional head final authority in all project matters
2. Making the project manager report to the functional manager
3. Planning, training, clear mutual understanding of roles, excellent communication and mutual trust (correct answer)
4. Avoiding communication between project and functional teams to reduce conflict

Answer: C — Planning, training, clear mutual understanding of roles, excellent communication and mutual trust

Working. No numerical working required. Match the described mechanism with matrix implementation requirements.

Explanation. Matrix effectiveness depends on planning, training, clearly defined roles and responsibilities, strong internal communication and mutual trust. Single-line authority arrangements defeat the purpose of the matrix. Avoiding communication increases conflict.

Where it goes wrong. Thinking that one manager must always prevail. Matrix requires balanced dual authority with clear role understanding.

Authority. Chapter 5: Strategy Implementation and Evaluation - Organisation Structure - Matrix Structure

Question 15 · 2 marks · Strategy Implementation and Evaluation · hard

Scenario. An internal strategic audit team at Orion Ltd compares its warranty claim process with the industry leader. It finds a gap in response time. Management classifies the comparison and the gap for further action.

What type of benchmarking and gap is represented by comparing the warranty claim process with the industry leader and finding a response-time gap?

1. Competitive benchmarking and performance gap (correct answer)
2. Internal benchmarking and process slack
3. Functional benchmarking and value gap
4. Generic benchmarking and planning gap

Answer: A — Competitive benchmarking and performance gap

Working. No numerical working required. Classify the benchmarking type and gap from the scenario facts.

Explanation. Comparison with an industry leader is competitive benchmarking. The difference between current response time and the leader's response time is a performance gap. Internal benchmarking compares within the same organisation. Planning gap relates to difference between desired and projected outcomes.

Where it goes wrong. Calling any external comparison functional benchmarking. Competitive benchmarking specifically compares with competitors or industry leaders.

Authority. Chapter 5: Strategy Implementation and Evaluation - Strategic Control and Strategic Audit

Question 16 · 1 marks · Strategy Implementation and Evaluation · medium

What is the primary purpose of a strategic audit in this context?

1. To record day-to-day cash vouchers
2. To compute only the current ratio
3. To prepare the annual financial statements
4. To identify gaps between current performance and desired strategic standards (correct answer)

Answer: D — To identify gaps between current performance and desired strategic standards

Working. No numerical working required. Apply the definition of strategic audit.

Explanation. A strategic audit evaluates whether strategy is being implemented as planned and whether results are as intended. It helps identify performance gaps against strategic standards. Cash voucher recording, ratio computation and financial statement preparation are narrower accounting tasks.

Where it goes wrong. Confusing strategic audit with statutory financial audit or routine accounting. Strategic audit focuses on strategic performance and implementation gaps.

Authority. Chapter 5: Strategy Implementation and Evaluation - Strategic Control and Strategic Audit