Test 5: Management of Working Capital: answer key

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

Scenario. Bharat Renewables Ltd manufactures solar-inverter components and procures specialised electronic parts from domestic suppliers. The finance director is reviewing supplier credit terms because the company intends to increase production without unnecessarily raising its bank borrowing requirement. All purchases are made on credit and are distributed evenly throughout the year. The company currently makes supplier payments on the final permissible credit date rather than availing early-payment discounts. Projected annual procurement and financing information: Annual credit purchases: ₹4,90,00,000 Supplier credit terms: 2/10, net 50 days Existing payment date: 50th day Proposed payment date: 10th day Annual bank overdraft interest rate: 15% Working capital assessment period: 365 days The company can arrange additional bank overdraft finance to settle supplier invoices within the discount period. Assume the borrowing is outstanding for the additional 40 days and that the full annual purchases qualify for the supplier discount. No additional processing charges or tax effects arise from the borrowing decision. Additional corporate information: Equity share capital: ₹8 crore Retained earnings: ₹2 crore 10% secured term debt: ₹5 crore Projected EBIT: ₹3.40 crore Corporate tax rate: 25% Equity beta: 1.10 Risk-free rate: 6.50% Market risk premium: 6.50% Forecast annual operating cash flow: ₹3.90 crore The operating cycle consists of raw-material storage of 25 days, WIP holding of 15 days, finished-goods storage of 20 days, debtor collection of 40 days and supplier credit of 50 days. The resulting net operating cycle is 50 days. Management has also received proposals from its bankers for cash-credit and overdraft facilities. The finance manager must evaluate the implicit cost of trade credit against the actual cost of alternative bank borrowing. Assume all supplier invoices are paid in full when their respective due dates arrive and no default or loss of supplier goodwill occurs.

Calculate the annualised nominal cost of not availing the cash discount offered by suppliers to Bharat Renewables Ltd under the terms 2/10, net 50 days. Use the prescribed simple annualised cost formula and a 365-day year.

1. 15.25%
2. 18.62% (correct answer)
3. 20.40%
4. 22.15%

Answer: B — 18.62%

Explanation. Cost of not taking the discount = [d/(100 − d)] × [365/(Credit Period − Discount Period)] × 100. Substituting, = (2/98) × (365/40) × 100 = 18.6224%, approximately 18.62%. The additional credit period is 50 − 10 = 40 days, not 50 days. Option a understates the implicit financing cost, while option c results from using an incorrect net payment denominator.

Where it goes wrong. Using the entire net credit period instead of the additional credit period obtained by foregoing the discount, or dividing the discount by 100 instead of the discounted payment.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

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

If Bharat Renewables Ltd avails the supplier discount by borrowing the discounted invoice amount from its bank for the additional 40 days, calculate the annual interest cost of such borrowing on the projected annual purchases.

1. ₹6,75,000
2. ₹8,40,000
3. ₹7,89,370 (correct answer)
4. ₹9,80,000

Answer: C — ₹7,89,370

Explanation. Annual purchases = ₹4,90,00,000. Discounted payment amount = ₹4,90,00,000 × 98% = ₹4,80,20,000. Interest on borrowing = Principal × Rate × Time = ₹4,80,20,000 × 15% × 40/365 = ₹7,89,369.86, approximately ₹7,89,370. Option d represents the discount saving rather than borrowing interest. Option a understates the borrowing period or applies an incorrect interest rate.

Where it goes wrong. Charging bank interest on the full invoice value instead of the discounted amount actually financed, or using 50 days rather than the additional 40 days.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

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

Determine the net annual financial benefit to Bharat Renewables Ltd from availing the supplier discount and financing the payment through its overdraft facility, instead of continuing to pay suppliers on the 50th day.

1. ₹1,90,630 (correct answer)
2. ₹2,10,000
3. ₹1,50,000
4. ₹2,75,000

Answer: A — ₹1,90,630

Explanation. Annual cash discount saving = ₹4,90,00,000 × 2% = ₹9,80,000. Bank interest on the discounted payment amount for 40 days, calculated in the preceding question, is ₹7,89,370. Net annual benefit = ₹9,80,000 − ₹7,89,370 = ₹1,90,630. The saving exceeds the financing cost, making early payment financially advantageous. Option b incorrectly ignores the precise cost of borrowing, while option c understates the discount saving.

Where it goes wrong. Considering the full cash discount as net benefit without deducting the interest cost required to finance early payment.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 4 · 2 marks · Management of Working Capital · medium

The bank overdraft rate available to Bharat Renewables Ltd is 15% per annum, whereas the calculated implicit cost of foregoing the supplier discount is 18.62%. Which financing decision should the finance manager recommend?

1. Continue taking the full 50-day supplier credit because the discount is only 2%.
2. Reject the bank overdraft because the cost of borrowing is greater than 2%.
3. Continue paying on the 50th day because supplier credit is always interest-free.
4. Borrow from the bank and pay suppliers within 10 days to avail the cash discount. (correct answer)

Answer: D — Borrow from the bank and pay suppliers within 10 days to avail the cash discount.

Explanation. The implicit annualised cost of foregoing the discount is 18.62%, while the alternative bank overdraft costs 15%. Since 15% is lower than 18.62%, borrowing to avail the discount is economical, subject to the stated absence of additional fees. The earlier calculation also confirms a net annual saving of ₹1,90,630. Options a and c incorrectly assume that supplier credit has no economic cost merely because no explicit interest is charged.

Where it goes wrong. Comparing the 2% discount directly with the annual bank interest rate instead of comparing the annualised implicit trade-credit cost with the alternative borrowing rate.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 5 · 2 marks · Management of Working Capital · medium

Scenario. Zenith Power Systems Ltd manufactures industrial power-control equipment and supplies large infrastructure customers on credit. The company has applied for renewal and enhancement of its working capital limits. Its bankers have requested a comparative assessment using the historical Maximum Permissible Bank Finance framework associated with the Tandon Committee recommendations. Projected balance-sheet information (₹ lakh): Raw-material inventory: 160 Work-in-process: 70 Finished-goods inventory: 110 Trade receivables: 100 Cash and bank balances: 40 Total current assets: 480 Other current liabilities, excluding bank borrowings: Trade creditors and other operating liabilities: 120 Existing bank working capital borrowing: 150 Core current assets: 80 For the purpose of the questions, calculate MPBF using the conventional historical formulations: Method I = 75% of (Current Assets − Other Current Liabilities); Method II = 75% of Current Assets − Other Current Liabilities; and Method III = 75% of (Current Assets − Core Current Assets) − Other Current Liabilities. Existing bank borrowing is excluded from Other Current Liabilities and is deducted separately when determining additional drawing headroom. the RBI withdrew the mandatory MPBF prescription in April 1997 and that banks were thereafter free to formulate their own working-capital assessment methods. Accordingly, these calculations are presented as historical Tandon-method academic exercises, not as a representation of a universally mandatory current banking prescription. Additional corporate information: Equity share capital: ₹6 crore Retained earnings: ₹2 crore 9.5% term loan: ₹4 crore Projected EBIT: ₹2.70 crore Corporate tax rate: 25% Equity beta: 0.98 Risk-free rate: 6.25% Market risk premium: 6.50% Forecast annual operating cash flow: ₹3.10 crore The operating cycle comprises raw-material storage of 30 days, WIP holding of 18 days, finished-goods storage of 22 days, debtor collection of 45 days and supplier credit of 35 days. Management wishes to assess the funding gap, borrower contribution and additional bank financing availability while ensuring that long-term sources provide the prescribed contribution under each historical lending method.

Calculate the Maximum Permissible Bank Finance available to Zenith Power Systems Ltd under Method I of the historical Tandon Committee recommendations.

1. ₹2,70,00,000 (correct answer)
2. ₹3,60,00,000
3. ₹2,40,00,000
4. ₹1,80,00,000

Answer: A — ₹2,70,00,000

Explanation. Method I MPBF = 75% × (Current Assets − Other Current Liabilities). Working capital gap = ₹480 lakh − ₹120 lakh = ₹360 lakh. MPBF = 75% × ₹360 lakh = ₹270 lakh or ₹2.70 crore. The borrower contributes the remaining 25% of the gap, i.e. ₹90 lakh. Option b represents the complete working-capital gap, while option c corresponds to Method II rather than Method I.

Where it goes wrong. Applying the 75% margin to total current assets instead of the working-capital gap, or including existing bank borrowings among other current liabilities.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 6 · 2 marks · Management of Working Capital · medium

Determine the Maximum Permissible Bank Finance for Zenith Power Systems Ltd under Method II of the historical Tandon Committee recommendations.

1. ₹2,70,00,000
2. ₹1,80,00,000
3. ₹2,40,00,000 (correct answer)
4. ₹3,00,00,000

Answer: C — ₹2,40,00,000

Explanation. Method II MPBF = 75% of Total Current Assets − Other Current Liabilities. = 75% × ₹480 lakh − ₹120 lakh = ₹360 lakh − ₹120 lakh = ₹240 lakh or ₹2.40 crore. The borrower contributes at least 25% of total current assets, i.e. ₹120 lakh, from long-term sources. Option a represents Method I and option d fails to deduct other current liabilities.

Where it goes wrong. Applying the 75% margin to the working-capital gap instead of total current assets, or deducting the other current liabilities before applying 75%.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

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

Calculate the Maximum Permissible Bank Finance under Method III for Zenith Power Systems Ltd, considering that core current assets of ₹80 lakh must be fully funded from long-term sources.

1. ₹2,40,00,000
2. ₹1,80,00,000 (correct answer)
3. ₹2,70,00,000
4. ₹1,20,00,000

Answer: B — ₹1,80,00,000

Explanation. Method III MPBF = 75% × (Current Assets − Core Current Assets) − Other Current Liabilities. Substitution: 75% × (₹480 lakh − ₹80 lakh) − ₹120 lakh = 75% × ₹400 lakh − ₹120 lakh = ₹300 lakh − ₹120 lakh = ₹180 lakh. Core current assets are entirely financed by long-term funds. Option c incorrectly applies Method I, while option a incorrectly applies Method II.

Where it goes wrong. Failing to deduct core current assets before applying the 75% borrowing margin, or mistakenly treating core current assets as a short-term bank-financed requirement.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 8 · 2 marks · Management of Working Capital · hard

Under Method II, Zenith Power Systems Ltd has a maximum permissible bank finance limit of ₹2.40 crore. If the company has already utilised ₹1.50 crore of working capital bank borrowing, calculate the additional drawing headroom available.

1. ₹60,00,000
2. ₹1,20,00,000
3. ₹1,50,00,000
4. ₹90,00,000 (correct answer)

Answer: D — ₹90,00,000

Explanation. Maximum permissible bank finance under Method II = ₹2.40 crore. Existing bank borrowing = ₹1.50 crore. Additional drawing headroom = ₹2.40 crore − ₹1.50 crore = ₹0.90 crore or ₹90 lakh. Existing bank borrowing is excluded when determining Other Current Liabilities for the original MPBF calculation, but it must be considered when calculating the unused portion of the sanctioned permissible limit. Option a understates the available balance.

Where it goes wrong. Deducting existing bank borrowing while first calculating the MPBF formula and then deducting it again, or confusing total permissible finance with additional available finance.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 9 · 2 marks · Management of Working Capital · medium

Scenario. Aditya Automotive Ltd manufactures precision components for commercial vehicle manufacturers and imports specialised electronic control units. The company is evaluating three alternative working-capital financing arrangements: commercial paper, a letter of credit and a bank guarantee. The treasury department has been asked to quantify the cost and cash implications of each arrangement before final approval. Commercial paper proposal: Face value: ₹1,00,00,000 Discount from face value: 2% Issue and placement expenses: ₹50,000 Maturity period: 90 days The company will receive the discounted proceeds less issue expenses and repay the full face value at maturity. It satisfies the required credit-rating conditions and intends to issue commercial paper in a denomination permitted under the applicable instrument terms. Its competing bank overdraft facility carries interest at 12.50% per annum. Assume the overdraft is available for the same 90-day period on the same amount of net funds received. Letter of credit proposal: Import purchase value: ₹60,00,000 Bank cash margin: 20% Bank commission: 0.75% of the letter-of-credit amount Bank guarantee proposal: Performance guarantee amount: ₹40,00,000 Cash margin: 15% Commission: 0.60% per annum Guarantee duration: 6 months Additional corporate information: Equity share capital: ₹7 crore Retained earnings: ₹2.50 crore 10% secured term debt: ₹3.50 crore Projected EBIT: ₹3.60 crore Corporate tax rate: 25% Equity beta: 1.15 Risk-free rate: 6.50% Market risk premium: 6.00% Forecast annual operating cash flow: ₹4 crore The operating cycle comprises raw-material storage of 30 days, WIP holding of 15 days, finished-goods storage of 20 days, debtor collection of 42 days and supplier credit of 35 days. The finance director must distinguish the immediate cash margin from the bank's contingent exposure and compare the financing cost of commercial paper with bank borrowing. All stated bank fees are calculated on the stipulated face value or assured amount.

Calculate the effective annualised financing cost of the proposed commercial paper issue of Aditya Automotive Ltd, after considering the discount and issue expenses.

1. 8.75%
2. 9.60%
3. 10.40% (correct answer)
4. 12.50%

Answer: C — 10.40%

Explanation. Face value = ₹1,00,00,000. Discount = 2% × ₹1 crore = ₹2,00,000. Issue expenses = ₹50,000. Net proceeds = ₹1,00,00,000 − ₹2,00,000 − ₹50,000 = ₹97,50,000. Effective annualised cost = (₹2,50,000/₹97,50,000) × (365/90) × 100 = 10.3989%, approximately 10.40%. Option b ignores issue expenses.

Where it goes wrong. Calculating commercial paper yield using the face value rather than net funds actually received, or ignoring issue and placement expenses.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 10 · 2 marks · Management of Working Capital · hard

Under the proposed letter-of-credit arrangement for Aditya Automotive Ltd, calculate the bank's net documentary payment exposure after the stipulated cash margin and the total initial cash outflow comprising margin money and bank commission.

1. Bank exposure ₹48,00,000; initial cash outflow ₹12,45,000 (correct answer)
2. Bank exposure ₹60,00,000; initial cash outflow ₹12,00,000
3. Bank exposure ₹45,00,000; initial cash outflow ₹15,00,000
4. Bank exposure ₹48,00,000; initial cash outflow ₹13,20,000

Answer: A — Bank exposure ₹48,00,000; initial cash outflow ₹12,45,000

Explanation. LC amount = ₹60,00,000. Cash margin = 20% × ₹60,00,000 = ₹12,00,000. Net bank exposure = ₹60,00,000 − ₹12,00,000 = ₹48,00,000. Commission = 0.75% × ₹60,00,000 = ₹45,000. Initial cash outflow = ₹12,00,000 + ₹45,000 = ₹12,45,000. The bank undertakes payment against stipulated compliant documents. Option b ignores the cash margin when determining net exposure.

Where it goes wrong. Calculating the letter-of-credit commission on the bank's net exposure instead of the full LC amount, or confusing the cash margin with the total payment undertaking.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 11 · 2 marks · Management of Working Capital · hard

Calculate the total initial cash requirement of Aditya Automotive Ltd under the proposed performance bank guarantee arrangement, including cash margin and prorated bank commission for six months.

1. ₹6,00,000
2. ₹6,24,000
3. ₹6,40,000
4. ₹6,12,000 (correct answer)

Answer: D — ₹6,12,000

Explanation. Guarantee amount = ₹40,00,000. Cash margin = 15% × ₹40,00,000 = ₹6,00,000. Six-month commission = ₹40,00,000 × 0.60% × 6/12 = ₹12,000. Total initial cash requirement = ₹6,00,000 + ₹12,000 = ₹6,12,000. The commission is calculated for the actual guarantee period, not a full year. Option a omits the bank commission, while option b overstates the prorated charge.

Where it goes wrong. Applying the annual guarantee commission for a complete year instead of six months, or calculating the cash margin on the commission rather than the guarantee amount.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 12 · 2 marks · Management of Working Capital · hard

Compare the 90-day financing cost of commercial paper with the cost of the bank overdraft for Aditya Automotive Ltd. Determine the net saving from using commercial paper instead of the overdraft.

1. ₹35,000
2. ₹50,514 (correct answer)
3. ₹75,000
4. ₹1,00,000

Answer: B — ₹50,514

Explanation. Commercial paper financing cost = ₹1,00,00,000 − ₹97,50,000 = ₹2,50,000. Bank overdraft interest = ₹97,50,000 × 12.50% × 90/365 = ₹3,00,514 approximately. Net saving = ₹3,00,514 − ₹2,50,000 = ₹50,514. Therefore, commercial paper is cheaper on the stated 90-day financing comparison. Option a understates the difference, while option c overstates the overdraft interest saving.

Where it goes wrong. Comparing annual interest rates alone without converting both financing alternatives into actual costs for the same 90-day period.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 13 · 2 marks · Management of Working Capital · medium

Scenario. A manufacturer receives credit terms of 3/15, net 75 days from its major raw-material supplier. Calculate the annualised nominal cost of foregoing the discount and making payment on the 75th day.

A manufacturer receives credit terms of 3/15, net 75 days from its major raw-material supplier. Calculate the annualised nominal cost of foregoing the discount and making payment on the 75th day.

1. 18.81% (correct answer)
2. 16.50%
3. 20.25%
4. 22.40%

Answer: A — 18.81%

Explanation. Discount percentage = 3%. Additional credit period = 75 − 15 = 60 days. Nominal annualised cost = [3/(100 − 3)] × [365/60] × 100 = (3/97) × 6.08333 × 100 = 18.8144%, approximately 18.81%. Option b uses an incorrect additional credit period, while option c overstates the cost by using the wrong discounted payment denominator.

Where it goes wrong. Using 75 days as the additional credit period instead of 60 days, or calculating the discount percentage on the gross invoice value rather than the net discounted amount.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 14 · 2 marks · Management of Working Capital · hard

Scenario. A company has been offered supplier credit terms of 2/10, net 40 days. Calculate the nominal annualised cost of not availing the discount, using the 365-day year.

A company has been offered supplier credit terms of 2/10, net 40 days. Calculate the nominal annualised cost of not availing the discount, using the 365-day year.

1. 18.62%
2. 22.50%
3. 24.83% (correct answer)
4. 27.40%

Answer: C — 24.83%

Explanation. Discount = 2%; net invoice payment after discount = 98% of invoice value. Additional credit period = 40 − 10 = 30 days. Nominal annualised cost = (2/98) × (365/30) × 100 = 24.8299%, approximately 24.83%. Option a uses 40 days instead of the 30-day additional period. Option d arises from an incorrect discount denominator or annualisation period.

Where it goes wrong. Confusing the net credit period with the additional period gained by foregoing the cash discount.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 15 · 2 marks · Management of Working Capital · medium

Scenario. A supplier offers credit terms of 1/10, net 60 days. A company can earn only 6% per annum on surplus cash available for payment. The annualised nominal cost of foregoing the discount is 7.37%. Which alternative should the company adopt?

A supplier offers credit terms of 1/10, net 60 days. A company can earn only 6% per annum on surplus cash available for payment. The annualised nominal cost of foregoing the discount is 7.37%. Which alternative should the company adopt?

1. Reject the discount because retaining cash always provides greater liquidity.
2. Avail the discount only if the bank interest rate exceeds 10%.
3. Pay on the 60th day because the supplier does not charge explicit interest.
4. Pay within 10 days and avail the discount because the implied cost of foregoing it exceeds the return on surplus cash. (correct answer)

Answer: D — Pay within 10 days and avail the discount because the implied cost of foregoing it exceeds the return on surplus cash.

Explanation. The additional credit period is 60 − 10 = 50 days. Implied annualised cost of not taking the discount = (1/99) × (365/50) × 100 = 7.37%. The available surplus funds earn only 6%. Since the economic return from using cash to obtain the supplier discount exceeds the opportunity cost of those funds, early payment is preferable. Options a and c incorrectly treat trade credit as economically free.

Where it goes wrong. Comparing the 1% cash discount directly with the 6% annual return instead of comparing annualised returns over the actual additional credit period.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 16 · 2 marks · Management of Working Capital · hard

Scenario. A highly rated company issues commercial paper having a face value of ₹75,00,000 at a discount of 2%. Issue and placement expenses are ₹30,000. The paper matures after 60 days. Calculate its effective annualised financing cost on the actual net proceeds received.

A highly rated company issues commercial paper having a face value of ₹75,00,000 at a discount of 2%. Issue and placement expenses are ₹30,000. The paper matures after 60 days. Calculate its effective annualised financing cost on the actual net proceeds received.

1. 13.75%
2. 14.96% (correct answer)
3. 15.50%
4. 16.25%

Answer: B — 14.96%

Explanation. Issue discount = ₹75,00,000 × 2% = ₹1,50,000. Proceeds before expenses = ₹73,50,000. Net proceeds = ₹73,50,000 − ₹30,000 = ₹73,20,000. Total financing cost = ₹75,00,000 − ₹73,20,000 = ₹1,80,000. Effective annualised cost = (₹1,80,000/₹73,20,000) × (365/60) × 100 = 14.959%, approximately 14.96%. Option a ignores issue expenses.

Where it goes wrong. Calculating the yield on the face value or deducting the discount but ignoring the additional issue and placement expenses.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 17 · 2 marks · Management of Working Capital · medium

Scenario. A company requires at least ₹47,50,000 in net funds from a commercial paper issue. The paper is issued at a 2% discount on face value and fixed issue expenses are ₹25,000. Commercial paper must be issued in denominations of ₹5 lakh or multiples thereof. Determine the minimum face value that should be issued.

A company requires at least ₹47,50,000 in net funds from a commercial paper issue. The paper is issued at a 2% discount on face value and fixed issue expenses are ₹25,000. Commercial paper must be issued in denominations of ₹5 lakh or multiples thereof. Determine the minimum face value that should be issued.

1. ₹45,00,000
2. ₹55,00,000
3. ₹50,00,000 (correct answer)
4. ₹60,00,000

Answer: C — ₹50,00,000

Explanation. Net proceeds = Face Value × 98% − ₹25,000. For a ₹45 lakh issue, proceeds = ₹44.10 lakh − ₹0.25 lakh = ₹43.85 lakh, which is insufficient. For a ₹50 lakh issue, proceeds = ₹49 lakh − ₹0.25 lakh = ₹48.75 lakh, which exceeds the requirement. Therefore, the minimum permissible denomination satisfying the requirement is ₹50 lakh. Option b unnecessarily raises additional funds.

Where it goes wrong. Ignoring the fixed issue expense or selecting the required net cash amount as the face value without accounting for the issue discount and permitted denominations.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 18 · 2 marks · Management of Working Capital · hard

Scenario. A company has a cash-credit limit of ₹80,00,000 but its average utilisation during a 90-day period is ₹60,00,000. The bank charges interest at 12% per annum on actual utilisation and a one-time processing fee of 0.50% of the sanctioned limit. Calculate the effective annualised cost of the facility, using the 360-day convention and average utilisation as the financing base.

A company has a cash-credit limit of ₹80,00,000 but its average utilisation during a 90-day period is ₹60,00,000. The bank charges interest at 12% per annum on actual utilisation and a one-time processing fee of 0.50% of the sanctioned limit. Calculate the effective annualised cost of the facility, using the 360-day convention and average utilisation as the financing base.

1. 14.67% (correct answer)
2. 12.00%
3. 13.50%
4. 16.00%

Answer: A — 14.67%

Explanation. Interest = ₹60 lakh × 12% × 90/360 = ₹1.80 lakh. Processing fee = ₹80 lakh × 0.50% = ₹0.40 lakh. Total financing cost = ₹1.80 lakh + ₹0.40 lakh = ₹2.20 lakh. Effective annualised cost = (₹2.20 lakh/₹60 lakh) × (360/90) × 100 = 14.6667%, approximately 14.67%. Option b ignores the processing fee and the distinction between sanctioned and utilised limits.

Where it goes wrong. Calculating interest on the full sanctioned limit rather than actual utilisation, or ignoring the fixed processing fee when determining the effective financing cost.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 19 · 2 marks · Management of Working Capital · hard

Scenario. A borrower has projected total current assets of ₹6 crore and other current liabilities, excluding bank borrowings, of ₹1.50 crore. Its existing bank working-capital borrowing is ₹1.20 crore. Under the historical Tandon Method II, calculate the additional permissible bank finance available to the borrower.

A borrower has projected total current assets of ₹6 crore and other current liabilities, excluding bank borrowings, of ₹1.50 crore. Its existing bank working-capital borrowing is ₹1.20 crore. Under the historical Tandon Method II, calculate the additional permissible bank finance available to the borrower.

1. ₹1,20,00,000
2. ₹3,00,00,000
3. ₹4,50,00,000
4. ₹1,80,00,000 (correct answer)

Answer: D — ₹1,80,00,000

Explanation. Method II MPBF = 75% of Total Current Assets − Other Current Liabilities. = 75% × ₹600 lakh − ₹150 lakh = ₹450 lakh − ₹150 lakh = ₹300 lakh. Deduct existing bank borrowing of ₹120 lakh to obtain additional finance availability = ₹300 lakh − ₹120 lakh = ₹180 lakh. Option b reports total MPBF without deducting the existing utilisation. Existing bank borrowing is excluded from other current liabilities in the initial calculation.

Where it goes wrong. Failing to deduct existing bank borrowing when calculating additional headroom, or incorrectly including bank borrowing within the other current liabilities used in the Method II formula.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 20 · 2 marks · Management of Working Capital · hard

Scenario. An importer requires a letter of credit of ₹1,20,00,000 to purchase equipment from an overseas supplier. The bank requires a cash margin of 25% and charges commission of 0.50% of the full letter-of-credit amount. Calculate the total initial cash requirement comprising margin money and bank commission, and identify the bank's net documentary exposure after margin.

An importer requires a letter of credit of ₹1,20,00,000 to purchase equipment from an overseas supplier. The bank requires a cash margin of 25% and charges commission of 0.50% of the full letter-of-credit amount. Calculate the total initial cash requirement comprising margin money and bank commission, and identify the bank's net documentary exposure after margin.

1. Cash ₹30,00,000; exposure ₹90,60,000
2. Cash ₹30,60,000; exposure ₹90,00,000 (correct answer)
3. Cash ₹31,20,000; exposure ₹1,20,00,000
4. Cash ₹30,00,000; exposure ₹1,20,00,000

Answer: B — Cash ₹30,60,000; exposure ₹90,00,000

Explanation. Cash margin = ₹1,20,00,000 × 25% = ₹30,00,000. Bank commission = ₹1,20,00,000 × 0.50% = ₹60,000. Initial cash requirement = ₹30,00,000 + ₹60,000 = ₹30,60,000. Net bank documentary exposure after margin = ₹1,20,00,000 − ₹30,00,000 = ₹90,00,000. Option d incorrectly treats the bank's exposure as the full LC value without considering the margin.

Where it goes wrong. Applying the commission rate to the amount remaining after margin rather than the full LC amount, or confusing the cash margin with the bank's payment commitment.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 21 · 2 marks · Management of Working Capital · hard

Scenario. A contractor obtains a performance bank guarantee of ₹75,00,000 for a period of nine months. The bank requires a 20% cash margin and charges an annual commission of 0.80% on the guarantee amount. Determine the total initial cash requirement, including cash margin and prorated commission.

A contractor obtains a performance bank guarantee of ₹75,00,000 for a period of nine months. The bank requires a 20% cash margin and charges an annual commission of 0.80% on the guarantee amount. Determine the total initial cash requirement, including cash margin and prorated commission.

1. ₹15,45,000 (correct answer)
2. ₹15,60,000
3. ₹16,20,000
4. ₹15,00,000

Answer: A — ₹15,45,000

Explanation. Cash margin = ₹75 lakh × 20% = ₹15 lakh. Commission = ₹75 lakh × 0.80% × 9/12 = ₹45,000. Total initial cash requirement = ₹15,00,000 + ₹45,000 = ₹15,45,000. A bank guarantee is an undertaking issued by the bank on behalf of its client in favour of a beneficiary. Option d omits the commission, while option b incorrectly applies a full-year or excessive charge.

Where it goes wrong. Calculating the guarantee commission for 12 months instead of nine months, or confusing a bank guarantee's cash margin with the guarantee's full face value.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 22 · 2 marks · Management of Working Capital · hard

Scenario. A company is comparing two 75-day working-capital financing alternatives. Commercial paper has a face value of ₹1 crore and net proceeds of ₹98,25,000 after discount and issue charges. A bank overdraft would provide the same amount at an annual interest rate of 10.50%. Calculate the monetary saving from issuing commercial paper instead of using the overdraft. Use a 365-day year.

A company is comparing two 75-day working-capital financing alternatives. Commercial paper has a face value of ₹1 crore and net proceeds of ₹98,25,000 after discount and issue charges. A bank overdraft would provide the same amount at an annual interest rate of 10.50%. Calculate the monetary saving from issuing commercial paper instead of using the overdraft. Use a 365-day year.

1. ₹21,978
2. ₹50,000
3. ₹36,978 (correct answer)
4. ₹75,000

Answer: C — ₹36,978

Explanation. Commercial paper cost = ₹1,00,00,000 − ₹98,25,000 = ₹1,75,000. Bank overdraft interest = ₹98,25,000 × 10.50% × 75/365 = approximately ₹2,11,978. Saving from CP = ₹2,11,978 − ₹1,75,000 = ₹36,978. Commercial paper is less expensive under the stated assumptions. Option a understates the difference by confusing the bank interest calculation with a shorter borrowing period.

Where it goes wrong. Comparing the commercial paper issue discount with the bank's annual rate directly instead of computing the actual financing cost for the same 75-day period.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 23 · 2 marks · Management of Working Capital · hard

Scenario. A company receives supplier credit terms of 2/10, net 50 days. Calculate the effective annualised cost of foregoing the cash discount using the compounded effective annualised cost formula rather than the simple nominal annualised formula.

A company receives supplier credit terms of 2/10, net 50 days. Calculate the effective annualised cost of foregoing the cash discount using the compounded effective annualised cost formula rather than the simple nominal annualised formula.

1. 18.62%
2. 19.50%
3. 22.15%
4. 20.24% (correct answer)

Answer: D — 20.24%

Explanation. Discount = 2%; additional credit period = 50 − 10 = 40 days. The compounded annual cost is [(100/(100 − d))^(365/t) − 1] × 100. Substituting = [(100/98)^(365/40) − 1] × 100 = 20.2436%, approximately 20.24%. The simple nominal cost for the same terms is 18.62%, which does not incorporate compounding. Option a is therefore the simple cost, not the effective compounded cost.

Where it goes wrong. Using the simple annualised trade-credit formula when the question specifically requires the compounded effective cost.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 24 · 2 marks · Management of Working Capital · hard

Scenario. A supplier offers terms of 1.5/10, net 70 days. A company regularly pays on the 70th day rather than availing the discount. Calculate the nominal annualised cost of foregoing the discount using a 365-day year.

A supplier offers terms of 1.5/10, net 70 days. A company regularly pays on the 70th day rather than availing the discount. Calculate the nominal annualised cost of foregoing the discount using a 365-day year.

1. 8.10%
2. 9.26% (correct answer)
3. 10.50%
4. 11.75%

Answer: B — 9.26%

Explanation. The discount is 1.5%, and the net amount payable after discount is 98.5% of the invoice. Additional credit period = 70 − 10 = 60 days. Nominal annualised cost = (1.5/98.5) × (365/60) × 100 = 9.264%, approximately 9.26%. Option a uses an incorrect annualisation period, while option c may result from dividing by the gross invoice value rather than the discounted payment.

Where it goes wrong. Using 70 days rather than the additional 60 days or calculating the cost using the invoice's gross value instead of the amount payable after discount.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital

Question 25 · 2 marks · Management of Working Capital · hard

Scenario. A company obtains short-term bank finance of ₹80,00,000 for 90 days. The bank deducts a one-time processing fee of 0.50% of the sanctioned amount upfront and charges interest at 13% per annum on the full principal for the 90-day period. Calculate the effective annualised financing cost on the net funds received. Use a 365-day year.

A company obtains short-term bank finance of ₹80,00,000 for 90 days. The bank deducts a one-time processing fee of 0.50% of the sanctioned amount upfront and charges interest at 13% per annum on the full principal for the 90-day period. Calculate the effective annualised financing cost on the net funds received. Use a 365-day year.

1. 15.10% (correct answer)
2. 13.50%
3. 14.25%
4. 16.00%

Answer: A — 15.10%

Explanation. Processing fee = ₹80,00,000 × 0.50% = ₹40,000. Net funds received = ₹80,00,000 − ₹40,000 = ₹79,60,000. Interest = ₹80,00,000 × 13% × 90/365 = ₹2,56,438. Total financing cost = ₹40,000 + ₹2,56,438 = ₹2,96,438. Effective annualised cost = (₹2,96,438/₹79,60,000) × (365/90) × 100 = 15.10%. Option b ignores the processing fee and the reduction in net proceeds.

Where it goes wrong. Using the sanctioned amount as the effective-cost denominator despite the upfront fee deduction, or calculating interest on the net proceeds instead of the full principal stipulated by the bank.

Authority. ICAI SM: Financial Management and Strategic Management, Management of Working Capital