Test 6: answer key

Question 1 · 2 marks · Ratio Analysis · medium

Scenario. Horizon Pharma Ltd has, after its expansion financing, equity share capital ₹600 lakh, reserves and surplus ₹300 lakh, long-term debt ₹600 lakh comprising existing 10 percent debt of ₹400 lakh and new 11 percent debt of ₹200 lakh, current liabilities ₹150 lakh and current assets ₹300 lakh. Expected EBIT is ₹300 lakh, depreciation ₹60 lakh, interest on debt ₹62 lakh and principal repayment ₹50 lakh. Ignore tax. Use closing balances.

What is the long-term debt to equity ratio of Horizon Pharma after expansion, using long-term debt only?

1. 0.50
2. 0.67 (correct answer)
3. 0.75
4. 1.00

Answer: B — 0.67

Working. Long-term debt = 400 + 200 = ₹600 lakh. Shareholders equity = 600 + 300 = ₹900 lakh. Long-term debt to equity = 600 / 900 = 0.6667, rounded to 0.67.

Explanation. Long-term debt is ₹600 lakh and shareholders equity is equity capital ₹600 lakh plus reserves ₹300 lakh, that is ₹900 lakh. Thus the ratio is 600 divided by 900 = 0.67. Option a uses ₹450 lakh debt incorrectly. Option c uses total outside liabilities of ₹750 lakh against ₹1,000 lakh. Option d treats total debt as equal to equity, which is not the case.

Where it goes wrong. Students may include current liabilities in the numerator when the question specifically asks for long-term debt to equity ratio.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Section 3.2 Long-term Solvency Ratios

Question 2 · 2 marks · Ratio Analysis · medium

What is the proprietary ratio of Horizon Pharma after expansion?

1. 45.45 percent
2. 50.00 percent
3. 54.55 percent (correct answer)
4. 60.00 percent

Answer: C — 54.55 percent

Working. Proprietary fund = 600 + 300 = ₹900 lakh. Total assets = 600 + 300 + 600 + 150 = ₹1,650 lakh. Proprietary ratio = 900 / 1,650 × 100 = 54.55 percent.

Explanation. Proprietary fund is equity capital plus reserves, that is ₹900 lakh. Total assets are equity ₹600 lakh plus reserves ₹300 lakh plus long-term debt ₹600 lakh plus current liabilities ₹150 lakh, that is ₹1,650 lakh. The ratio is 900 divided by 1,650 = 54.55 percent. Option a arises from using only equity capital. Option b ignores reserves. Option d uses a wrong total asset base.

Where it goes wrong. Students may exclude reserves from proprietary fund or may deduct current liabilities from total assets incorrectly.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Section 3.2.1 Capital Structure Ratios

Question 3 · 2 marks · Ratio Analysis · hard

Which pair gives the debt service coverage ratio and interest coverage ratio of Horizon Pharma after expansion?

1. DSCR 3.21 and interest coverage 4.84 (correct answer)
2. DSCR 2.50 and interest coverage 3.75
3. DSCR 3.21 and interest coverage 3.00
4. DSCR 4.84 and interest coverage 3.21

Answer: A — DSCR 3.21 and interest coverage 4.84

Working. DSCR = EBIT + depreciation divided by interest + principal repayment = 300 + 60 divided by 62 + 50 = 360 / 112 = 3.21. Interest coverage = EBIT / interest = 300 / 62 = 4.84.

Explanation. Earnings available for debt service are EBIT plus depreciation, that is ₹300 lakh plus ₹60 lakh = ₹360 lakh. Debt service is interest ₹62 lakh plus principal repayment ₹50 lakh = ₹112 lakh. DSCR is 360 divided by 112 = 3.21. Interest coverage is EBIT divided by interest = 300 divided by 62 = 4.84. Option b uses an incorrect interest and debt service base. Option c keeps DSCR right but distorts interest coverage. Option d swaps the two ratios.

Where it goes wrong. Students may use PAT instead of EBIT plus depreciation for DSCR or may divide EBIT by total debt service instead of interest for interest coverage.

Authority. Chapter 3: Financial Analysis and Planning - Ratio Analysis, Section 3.2.2 Coverage Ratios

Question 4 · 2 marks · Financing Decisions - Leverages · medium

Scenario. Alpine Resorts reports sales ₹1,000 lakh, variable cost 60 percent of sales and fixed operating cost ₹300 lakh. It has no interest-bearing debt for this analysis. The management examines the link between operating leverage, break-even sales and margin of safety.

What are the degree of operating leverage and margin of safety of Alpine Resorts at the current sales level?

1. DOL 2.50 and MOS 40.00 percent
2. DOL 3.00 and MOS 33.33 percent
3. DOL 4.00 and MOS 20.00 percent
4. DOL 4.00 and MOS 25.00 percent (correct answer)

Answer: D — DOL 4.00 and MOS 25.00 percent

Working. Contribution = 1,000 − 600 = ₹400 lakh. EBIT = 400 − 300 = ₹100 lakh. DOL = 400 / 100 = 4.00. MOS = EBIT / contribution = 100 / 400 = 25 percent.

Explanation. Contribution is sales ₹1,000 lakh less variable cost ₹600 lakh = ₹400 lakh. EBIT is contribution ₹400 lakh less fixed cost ₹300 lakh = ₹100 lakh. DOL is contribution divided by EBIT = 400 divided by 100 = 4.00. MOS is EBIT divided by contribution = 100 divided by 400 = 25 percent. Option a and b use wrong contribution or EBIT figures. Option c has correct DOL but wrongly uses 20 percent MOS.

Where it goes wrong. Students may calculate MOS as fixed cost divided by sales or may invert the DOL formula.

Authority. Chapter 6: Financing Decisions - Leverages, Section 3 Operating Leverage and Section 3.3 Margin of Safety

Question 5 · 2 marks · Financing Decisions - Leverages · hard

If Alpine Resorts fixed operating cost rises by ₹50 lakh with sales unchanged, what is the new degree of operating leverage?

1. 6.00
2. 8.00 (correct answer)
3. 4.00
4. 5.00

Answer: B — 8.00

Working. Contribution = ₹400 lakh. New EBIT = 400 − 350 = ₹50 lakh. New DOL = contribution / EBIT = 400 / 50 = 8.00.

Explanation. Contribution remains ₹400 lakh because sales and variable cost do not change. New fixed cost is ₹350 lakh. New EBIT is ₹50 lakh. New DOL is 400 divided by 50 = 8.00. Option a results from using an incorrect EBIT of ₹66.67 lakh. Option c ignores the fixed cost increase. Option d uses an incorrect contribution base.

Where it goes wrong. Students may recalculate contribution after a fixed cost change, but fixed cost does not affect contribution.

Authority. Chapter 6: Financing Decisions - Leverages, Section 3.1 Degree of Operating Leverage

Question 6 · 2 marks · Financing Decisions - Leverages · hard

At the original fixed cost of ₹300 lakh, what sales level gives Alpine Resorts a margin of safety of 20 percent?

1. ₹875.00 lakh
2. ₹900.00 lakh
3. ₹937.50 lakh (correct answer)
4. ₹1,000.00 lakh

Answer: C — ₹937.50 lakh

Working. MOS = 1 − FC / contribution = 0.20. So FC / contribution = 0.80. Contribution = 300 / 0.80 = ₹375 lakh. Sales = contribution / P/V ratio = 375 / 0.40 = ₹937.50 lakh.

Explanation. P/V ratio is 40 percent. MOS equals 1 minus fixed cost divided by contribution. For MOS of 20 percent, fixed cost divided by contribution must be 80 percent. Contribution required is ₹300 lakh divided by 0.80 = ₹375 lakh. Sales required is ₹375 lakh divided by 0.40 = ₹937.50 lakh. Option a is the break-even sales at the original fixed cost. Option b and d do not satisfy the 20 percent MOS condition.

Where it goes wrong. Students may set fixed cost divided by sales equal to 20 percent instead of using contribution and P/V ratio.

Authority. Chapter 6: Financing Decisions - Leverages, Section 3.3 Margin of Safety

Question 7 · 2 marks · Financing Decisions - Leverages · medium

Scenario. Orion Components has revenue ₹800 lakh, variable cost 60 percent of revenue, fixed operating cost ₹160 lakh, interest ₹40 lakh and tax rate 25 percent. It has no preference dividend. The finance team tests combined leverage and EPS sensitivity.

What is the degree of combined leverage of Orion Components, and what is the percentage change in EPS for a 10 percent increase in revenue?

1. 2.67 and 26.67 percent (correct answer)
2. 2.00 and 20.00 percent
3. 1.33 and 13.33 percent
4. 3.20 and 32.00 percent

Answer: A — 2.67 and 26.67 percent

Working. Contribution = 800 − 480 = ₹320 lakh. EBIT = 320 − 160 = ₹160 lakh. DOL = 320 / 160 = 2.00. DFL = 160 / 120 = 1.333. DCL = 2.00 × 1.333 = 2.667. EPS change = 10 percent × 2.667 = 26.67 percent.

Explanation. Contribution is ₹320 lakh and EBIT is ₹160 lakh, so DOL is 2.00. Interest is ₹40 lakh, so EBT is ₹120 lakh and DFL is 160 divided by 120 = 1.333. DCL is 2.00 × 1.333 = 2.667. A 10 percent rise in revenue raises EPS by 10 × 2.667 = 26.67 percent. Option b is only DOL. Option c is only DFL. Option d assumes interest of ₹60 lakh.

Where it goes wrong. Students may use DFL instead of DCL for the EPS sensitivity or may apply the sales change only to DOL.

Authority. Chapter 6: Financing Decisions - Leverages, Section 5 Combined Leverage

Question 8 · 1 marks · Financing Decisions - Leverages · medium

If Orion Components interest rises to ₹60 lakh with EBIT unchanged, what is the revised degree of combined leverage?

1. 2.00
2. 2.67
3. 1.60
4. 3.20 (correct answer)

Answer: D — 3.20

Working. DOL = 2.00. New EBT = 160 − 60 = ₹100 lakh. New DFL = 160 / 100 = 1.60. New DCL = 2.00 × 1.60 = 3.20.

Explanation. DOL remains 2.00 because EBIT is unchanged. Revised EBT is ₹160 lakh less ₹60 lakh = ₹100 lakh. Revised DFL is 160 divided by 100 = 1.60. Revised DCL is 2.00 × 1.60 = 3.20. Option a is DOL only. Option b is the original DCL. Option c is the revised DFL only.

Where it goes wrong. Students may forget to multiply DOL and DFL after changing interest.

Authority. Chapter 6: Financing Decisions - Leverages, Section 4 Financial Leverage and Section 5 Combined Leverage

Question 9 · 2 marks · Introduction to Strategic Management · medium

Scenario. Indus Conglomerate operates cement, renewables and retail businesses. Its board approves exit from retail and fresh capital allocation to renewables. The cement strategic business unit launches green premium cement for institutional builders. Procurement and logistics teams consolidate vendors and shift to rail dispatch to reduce delivered cost.

Which decision of Indus Conglomerate is a corporate-level strategy?

1. Cement SBU launching green premium cement for institutional builders
2. Board approving exit from retail and fresh capital allocation to renewables (correct answer)
3. Procurement team consolidating vendors
4. Logistics team shifting to rail dispatch to reduce delivered cost

Answer: B — Board approving exit from retail and fresh capital allocation to renewables

Working. Corporate level: portfolio choice, divestment and capital allocation. Business level: how the cement SBU competes. Functional level: procurement and logistics execution.

Explanation. Corporate-level strategy covers portfolio scope, entry and exit from businesses and allocation of resources across businesses. The board decision on retail exit and renewables capital allocation is therefore corporate-level. Option a is business-level because it concerns competitive positioning of the cement SBU. Options c and d are functional-level operating actions.

Where it goes wrong. Students may classify any important decision as corporate-level, but SBU product positioning and functional efficiency are lower-level strategies.

Authority. Chapter 1: Introduction to Strategic Management, Section 1.6 Strategic Levels in Organisations

Question 10 · 2 marks · Introduction to Strategic Management · medium

Which action of Indus Conglomerate is a business-level competitive strategy?

1. Board approving exit from retail
2. Procurement team consolidating vendors
3. Cement SBU launching green premium cement for institutional builders (correct answer)
4. Logistics team shifting to rail dispatch

Answer: C — Cement SBU launching green premium cement for institutional builders

Working. Cement SBU strategy: target institutional builders with green premium cement. This is a how-to-compete choice at business level.

Explanation. Business-level strategy translates corporate direction into concrete competitive positioning for a particular business or SBU. The cement SBU green premium launch is a competitive move in its product market. Option a is corporate-level. Options b and d are functional-level operating decisions.

Where it goes wrong. Students may treat a product launch as corporate strategy, but here it is specific to the cement SBU market position.

Authority. Chapter 1: Introduction to Strategic Management, Section 1.6 Strategic Levels in Organisations

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

Which action of Indus Conglomerate is a functional-level strategy?

1. Procurement and logistics teams consolidating vendors and shifting to rail dispatch (correct answer)
2. Board approving exit from retail
3. Cement SBU launching green premium cement
4. Corporate office allocating fresh capital to renewables

Answer: A — Procurement and logistics teams consolidating vendors and shifting to rail dispatch

Working. Procurement and logistics are functions. Their actions support cost reduction and execution of the cement SBU plan.

Explanation. Functional-level strategy develops within specific functions such as procurement and logistics to support business and corporate plans. Vendor consolidation and rail dispatch are operational efficiency actions. Option b and d are corporate-level. Option c is business-level.

Where it goes wrong. Students may overlook that functional strategies can be strategic even though they are confined to one function.

Authority. Chapter 1: Introduction to Strategic Management, Section 1.6 Strategic Levels in Organisations

Question 12 · 2 marks · Strategic Choices · medium

Scenario. EcoClean Solutions serves pharmaceutical cleanroom cleaning chemicals. Its standard cleanroom line is redesigned for a narrow set of small pharma cleanrooms and priced below specialized rivals through process savings. Its customized line supplies validation documentation and technical support for biologics clients. The firm considers expanding into general industrial cleaning with both low price and premium customized features.

EcoClean standard cleanroom line targets a narrow small pharma cleanroom segment and is priced below specialized rivals through process savings. Which Porter strategy is most appropriate?

1. Cost leadership across the broad cleaning chemicals market
2. Differentiation across the broad cleaning chemicals market
3. Focused differentiation
4. Focused cost leadership (correct answer)

Answer: D — Focused cost leadership

Working. Narrow target segment plus low-cost process advantage equals focused cost leadership.

Explanation. The line serves a narrow segment and competes through lower cost and price, so it is focused cost leadership. Option a is broad cost leadership because it lacks a narrow segment. Option b is broad differentiation. Option c is focused differentiation because the basis is not low cost.

Where it goes wrong. Students may see low price and choose broad cost leadership, ignoring the narrow small pharma cleanroom segment.

Authority. Chapter 4: Strategic Choices, Competitive Strategies

Question 13 · 2 marks · Strategic Choices · medium

EcoClean customized line supplies validation documentation and technical support for biologics clients. Which strategy is it pursuing and what is its main risk?

1. Broad cost leadership with risk of mass-market price war
2. Focused differentiation with risk that narrow segment demand contracts or specialized features are imitated (correct answer)
3. Stuck in the middle with risk of low cost
4. Conglomerate diversification with risk of unrelated business

Answer: B — Focused differentiation with risk that narrow segment demand contracts or specialized features are imitated

Working. Narrow biologics segment plus unique validation support equals focused differentiation. Risk follows from narrow segment dependence and imitation.

Explanation. Validation documentation and technical support create perceived uniqueness for a narrow biologics client group, so this is focused differentiation. Its main risks are dependence on a narrow segment and imitation of specialized features. Option a is broad cost leadership. Option c is a failed generic strategy. Option d is unrelated diversification.

Where it goes wrong. Students may label any customized service as broad differentiation, but the client segment is narrow.

Authority. Chapter 4: Strategic Choices, Competitive Strategies

Question 14 · 2 marks · Strategic Choices · hard

If EcoClean enters general industrial cleaning with both low price and premium customized features without a clear segment, what outcome is most likely under Porter competitive strategy analysis?

1. Focused cost leadership becomes stronger
2. Focused differentiation becomes stronger
3. The firm risks being stuck in the middle due to conflicting cost and differentiation signals (correct answer)
4. Market penetration automatically improves margins

Answer: C — The firm risks being stuck in the middle due to conflicting cost and differentiation signals

Working. Low price signals cost leadership, premium features signal differentiation, and broad general market removes focus. The combined position lacks a clear advantage.

Explanation. Porter warns that trying to be all things to all buyers without a clear cost or differentiation advantage can create conflicting signals and a stuck-in-the-middle position. Option a and b assume focus remains clear, but the expansion is general and mixed. Option d is unrelated because market penetration is an Ansoff growth option, not a remedy for strategy conflict.

Where it goes wrong. Students may assume adding features and lowering price is always beneficial, but it can blur competitive position.

Authority. Chapter 4: Strategic Choices, Competitive Strategies

Question 15 · 2 marks · Strategic Choices · hard

Scenario. Delta Electronics has three strategic business units. Its smart sensors unit is in a growth industry with a favourable competitive position. Its power tools unit is in a mature industry with a strong position. Its legacy calculator unit is in an ageing industry with a weak position. The planners apply the Arthur D. Little matrix.

For Delta Electronics legacy calculator unit in an ageing industry with a weak competitive position, which ADL matrix prescription is most appropriate?

1. Withdraw or divest (correct answer)
2. Invest for fast growth
3. Defend and renew the position
4. Hold a niche and harvest

Answer: A — Withdraw or divest

Working. ADL cell: ageing industry plus weak position. Appropriate action: withdraw or divest.

Explanation. In the ADL matrix, a weak competitive position in an ageing industry calls for withdrawal or divestment. Option b suits a dominant or strong position in an embryonic or growth industry. Option c suits a stronger position in a mature stage. Option d is not adequate for a weak position in an ageing industry.

Where it goes wrong. Students may recommend harvest for every ageing business, but ADL links the prescription to both maturity and competitive position.

Authority. Chapter 4: Strategic Choices, Section 4.4.2 ADL Matrix

Question 16 · 1 marks · Strategic Choices · medium

Which ADL competitive position is comparatively rare and often attributable to a monopoly or strong protected technological leadership?

1. Strong
2. Favourable
3. Tenable
4. Dominant (correct answer)

Answer: D — Dominant

Working. ADL competitive positions: dominant, strong, favourable, tenable and weak. Dominant is the rarest and strongest.

Explanation. The dominant position is described as comparatively rare and often linked to monopoly or protected technological leadership. Strong, favourable and tenable are lower competitive positions with less freedom and more vulnerability.

Where it goes wrong. Students may confuse strong with dominant, but dominant is the exceptional position with the greatest strategic freedom.

Authority. Chapter 4: Strategic Choices, Section 4.4.2 ADL Matrix