The document provides financial information about Zip Zap Zoom Car Company over several years. It discusses the company's need to invest in upgrading technology and facilities to compete with increasing competition. It presents two views on determining the company's additional debt capacity. Mr. Shortsighted assumes a maximum 10% reduction in sales and 6% reduction in prices during a recession, and calculates the company can service Rs. 100 crore of additional debt. Mr. Longsighted argues a more probabilistic analysis of cash flows is needed that accounts for dividend payments and continued R&D/marketing spending. His analysis finds the company can service an additional Rs. 35 crore of debt while maintaining a 10% dividend with 95% certainty of adequate

1. Attempt Only Five Case Study
Case 1: Zip Zap Zoom Car Company
Zip Zap Zoom Company Ltd is into manufacturing cars in the small car (800 cc)
segment. It was set up 15 years back and since its establishment it has seen a
phenomenal growth in both its market and profitability. Its financial statements are
shown in Exhibits 1 and 2 respectively.
The company enjoys the confidence of its shareholders who have been rewarded
with growing dividends year after year. Last year, the company had announced 20 per
cent dividend, which was the highest in the automobile sector. The company has never
defaulted on its loan payments and enjoys a favourable face with its lenders, which
include financial institutions, commercial banks and debenture holders.
The competition in the car industry has increased in the past few years and the
company foresees further intensification of competition with the entry of several foreign
car manufactures many of them being market leaders in their respective countries. The
small car segment especially, will witness entry of foreign majors in the near future, with
latest technology being offered to the Indian customer. The Zip Zap Zoom’s senior
management realizes the need for large scale investment in up gradation of technology
and improvement of manufacturing facilities to pre-empt competition.
Whereas on the one hand, the competition in the car industry has been
intensifying, on the other hand, there has been a slowdown in the Indian economy, which
has not only reduced the demand for cars, but has also led to adoption of price cutting
strategies by various car manufactures. The industry indicators predict that the economy
is gradually slipping into recession.

2. Exhibit 1 Balance sheet as at March 31,200 x
(Amount in Rs. Crore)
Source of Funds
Share capital 350
Reserves and surplus 250 600
Loans :
Debentures (@ 14%) 50
Institutional borrowing (@ 10%) 100
Commercial loans (@ 12%) 250
Total debt 400
Current liabilities 200
1,200
Application of Funds
Fixed Assets
Gross block 1,000
Less : Depreciation 250
Net block 750
Capital WIP 190
Total Fixed Assets 940
Current assets :
Inventory 200
Sundry debtors 40
Cash and bank balance 10
Other current assets 10
Total current assets 260
-1200
Exhibit 2 Profit and Loss Account for the year ended March 31, 200x
(Amount in Rs. Crore)

3. Sales revenue (80,000 units x Rs. 2,50,000) 2,000.0
Operating expenditure :
Variable cost :
Raw material and manufacturing expenses 1,300.0
Variable overheads 100.0
Total
1,400.0
Fixed cost :
R & D 20.0
Marketing and advertising 25.0
Depreciation 250.0
Personnel 70.0
Total
365.0
Total operating expenditure 1,765.0
Operating profits (EBIT)
235.0
Financial expense :
Interest on debentures 7.7
Interest on institutional borrowings 11.0
Interest on commercial loan 33.0 51.7
Earnings before tax (EBT) 183.3
Tax (@ 35%) 64.2
Earnings after tax (EAT) 119.1
Dividends 70.0
Debt redemption (sinking fund obligation)** 40.0
Contribution to reserves and surplus 9.1
* Includes the cost of inventory and work in process (W.P) which is dependent on
demand (sales).
** The loans have to be retired in the next ten years and the firm redeems Rs. 40
crore every year.
The company is faced with the problem of deciding how much to invest in up
gradation of its plans and technology. Capital investment up to a maximum of Rs. 100
crore is required. The problem areas are three-fold.
1 The company cannot forgo the capital investment as that could lead to reduction
in its market share as technological competence in this industry is a must and
customers would shift to manufactures providing latest in car technology.
2 The company does not want to issue new equity shares and its retained earning
are not enough for such a large investment. Thus, the only option is raising debt.

4. 3 The company wants to limit its additional debt to a level that it can service
without taking undue risks. With the looming recession and uncertain market
conditions, the company perceives that additional fixed obligations could become
a cause of financial distress, and thus, wants to determine its additional debt
capacity to meet the investment requirements.
Mr. Shortsighted, the company’s Finance Manager, is given the task of determining
the additional debt that the firm can raise. He thinks that the firm can raise Rs. 100 crore
worth debt and service it even in years of recession. The company can raise debt at 15
per cent from a financial institution. While working out the debt capacity. Mr.
Shortsighted takes the following assumptions for the recession years.
4 A maximum of 10 percent reduction in sales volume will take place.
5 A maximum of 6 percent reduction in sales price of cars will take place.
Mr. Shorsighted prepares a projected income statement which is representative of the
recession years. While doing so, he determines what he thinks are the “irreducible
minimum” expenditures under recessionary conditions. For him, risk of insolvency is the
main concern while designing the capital structure. To support his view, he presents the
income statement as shown in Exhibit 3.
Exhibit 3 projected Profit and Loss account
(Amount in Rs. Crore)
Sales revenue (72,000 units x Rs. 2,35,000) 1,692.0
Operating expenditure
Variable cost :
Raw material and manufacturing expenses 1,170.0
Variable overheads 90.0
Total
1,260.0
Fixed cost :
R & D ---
Marketing and advertising 15.0
Depreciation 187.5
Personnel 70.0
Total

5. 272.5
Total operating expenditure 1,532.5
EBIT
159.5
Financial expenses :
Interest on existing Debentures 7.0
Interest on existing institutional borrowings 10.0
Interest on commercial loan 30.0
Interest on additional debt 15.0
62.0
EBT
97.5
Tax (@ 35%)
34.1
EAT
63.4
Dividends --
Debt redemption (sinking fund obligation) 50.0*
Contribution to reserves and surplus 13.4
* Rs. 40 crore (existing debt) + Rs. 10 crore (additional debt)
Assumptions of Mr. Shorsighted
6 R & D expenditure can be done away with till the economy picks up.
7 Marketing and advertising expenditure can be reduced by 40 per cent.
8 Keeping in mind the investor confidence that the company enjoys, he feels that
the company can forgo paying dividends in the recession period.
He goes with his worked out statement to the Director Finance, Mr. Arthashatra, and
advocates raising Rs. 100 crore of debt to finance the intended capital investment. Mr.
Arthashatra does not feel comfortable with the statements and calls for the company’s
financial analyst, Mr. Longsighted.
Mr. Longsighted carefully analyses Mr. Shortsighted’s assumptions and points out
that insolvency should not be the sole criterion while determining the debt capacity of the
firm. He points out the following :
9 Apart from debt servicing, there are certain expenditures like those on R & D and
marketing that need to be continued to ensure the long-term health of the firm.
10 Certain management policies like those relating to dividend payout, send out
important signals to the investors. The Zip Zap Zoom’s management has been
paying regular dividends and discontinuing this practice (even though just for the

6. recession phase) could raise serious doubts in the investor’s mind about the health
of the firm. The firm should pay at least 10 per cent dividend in the recession
years.
11 Mr. Shortsighted has used the accounting profits to determine the amount
available each year for servicing the debt obligations. This does not give the true
picture. Net cash inflows should be used to determine the amount available for
servicing the debt.
12 Net Cash inflows are determined by an interplay of many variables and such a
simplistic view should not be taken while determining the cash flows in recession.
It is not possible to accurately predict the fall in any of the factors such as sales
volume, sales price, marketing expenditure and so on. Probability distribution of
variation of each of the factors that affect net cash inflow should be analyzed.
From this analysis, the probability distribution of variation in net cash inflow
should be analysed (the net cash inflows follow a normal probability distribution).
This will give a true picture of how the company’s cash flows will behave in
recession conditions.
The management recognizes that the alternative suggested by Mr. Longsighted rests
on data, which are complex and require expenditure of time and effort to obtain and
interpret. Considering the importance of capital structure design, the Finance Director
asks Mr. Longsighted to carry out his analysis. Information on the behaviour of cash
flows during the recession periods is taken into account.
The methodology undertaken is as follows :
13 Important factors that affect cash flows (especially contraction of cash flows), like
sales volume, sales price, raw materials expenditure, and so on, are identified and
the analysis is carried out in terms of cash receipts and cash expenditures.
14 Each factor’s behaviour (variation behaviour) in adverse conditions in the past is
studied and future expectations are combined with past data, to describe limits
(maximum favourable), most probable and maximum adverse) for all the factors.
15 Once this information is generated for all the factors affecting the cash flows, Mr.
Longsighted comes up with a range of estimates of the cash flow in future

7. recession periods based on all possible combinations of the several factors. He
also estimates the probability of occurrence of each estimate of cash flow.
Assuming a normal distribution of the expected behaviour, the mean expected
value of net cash inflow in adverse conditions came out to be Rs. 220.27 crore with
standard deviation of Rs. 110 crore.
Keeping in mind the looming recession and the uncertainty of the recession
behaviour, Mr. Arthashastra feels that the firm should factor a risk of cash inadequacy of
around 5 per cent even in the most adverse industry conditions. Thus, the firm should
take up only that amount of additional debt that it can service 95 per cent of the times,
while maintaining cash adequacy.
To maintain an annual dividend of 10 per cent, an additional Rs. 35 crore has to
be kept aside. Hence, the expected available net cash inflow is Rs. 185.27 crore (i.e. Rs.
220.27 – Rs. 35 crore)
Question:
Analyse the debt capacity of the company.

8. CASE – 2 GREAVES LIMITED
Started as trading firm in 1922, Greaves Limited has diversified into manufacturing and
marketing of high technology engineering products and systems. The company’s mission
is “manufacture and market a wide range of high quality products, services and systems
of world class technology to the total satisfaction of customers in domestic and overseas
market.”
Over the years Greaves has brought to India state of the art technologies in
various engineering fields by setting up manufacturing units and subsidiary and associate
companies. The sales of Greaves Limited has increased from Rs 214 crore in 1990 to Rs
801 crore in 1997. The sales of Greaves Limited has increased from Rs 214 crore in 1990
to Rs 801 crore in 1997. Profits before interest and tax (PBIT) of the company increased
from Rs 15 crore to Rs 83 crore in 1997. The market price of the company’s share has
shown ups and downs during 1990 to 1997. How has the company performed? The
following question need answer to fully understand the performance of the company:
Exhibit 1
GREAVES LTD.
Profit and Loss Account ending on 31 March (Rupees in crore)
1990 1991 1992 1993 1994 1995 1996 1997

9. Sales
Raw Material and Stores
Wages and Salaries
Power and fuel
Other Mfg. Expenses
Other Expenses
Depreciation
Marketing and Distribution
Change in stock
214.38
170.67
13.54
0.52
0.61
11.85
1.85
4.86
1.18
253.10
202.84
15.60
0.70
0.49
15.48
1.72
5.67
3.10
287.81
230.81
18.03
1.11
0.88
16.35
1.52
5.14
4.93
311.14
213.79
37.04
3.80
2.37
25.54
4.62
5.17
0.48
354.2
5
245.6
3
37.96
4.43
2.36
31.60
5.99
9.67
- 1.13
521.56
379.83
48.24
6.66
3.57
41.40
8.53
10.81
5.63
728.1
5
543.5
6
60.48
7.70
4.84
45.74
9.30
12.44
11.86
801.11
564.35
69.66
9.23
5.49
48.64
11.53
16.98
- 5.87
Total Op Expenses 202.72 239.40 268.91 291.85 338.7
7
493.41 672.2
0
731.75
Operating Profit
Other Income
Non-recurring Income
11.61
2.14
1.30
13.70
3.69
2.28
18.90
4.97
0.10
19.29
4.24
10.98
15.48
7.72
16.44
28.15
14.35
0.46
55.95
11.35
0.52
69.36
13.08
1.75
PBIT 15.10 19.67 23.97 34.51
39.64
42.98
65.67
82.64
Interest 5.56 6.77 11.92 19.62
17.17
21.48
28.25
27.54
PBT 9.54 12.90 12.05 14.89
22.47
21.50
37.42
55.10

10. Tax
PAT
Dividend
Retained Earnings
3.00
6.54
1.80
4.74
3.60
9.30
2.00
7.30
4.90
7.15
2.30
4.85
0.00
14.89
4.06
10.83
4.00
18.47
7.29
11.18
7.00
14.50
8.58
5.92
8.60
28.82
12.85
15.97
15.80
39.30
14.18
25.12
Exhibit 2
GREAVES LTD.
Balance Sheet (Rupees in crore)
1990 1991 1992 1993 1994 1995 1996 1997
ASSETS
Land and Building
Plant and Machinery
Other Fixed Assets
Capital WIP
Gross Fixed Assets
Less: Accu. Depreciation
Net Tangible Fixed Assets
Intangible Fixed Assets
3.88
11.98
3.64
0.09
19.59
12.91
6.68
0.21
4.22
12.68
4.14
0.26
21.30
14.56
6.74
0.19
4.96
12.98
4.38
10.25
23.57
15.79
7.78
0.05
21.70
33.49
5.18
11.27
71.64
19.84
51.80
4.40
30.82
50.78
6.95
34.84
123.3
9
25.74
97.65
22.03
39.71
75.34
8.53
14.37
137.95
33.90
104.05
22.45
42.34
92.49
8.87
13.92
157.6
2
42.56
115.06
20.04
43.07
104.45
10.35
14.36
172.23
53.87
118.86
21.11
Net Fixed Assets 6.89 6.93 7.83 56.20 119.68 126.50 135.1
0
139.97

11. Raw Materials
Finished Goods
Inventory
Accounts Receivable
Other Receivable
Investments
Cash and Bank Balance
Current Assets
Total Assets
LIABILITIES AND CAPITAL
Equity Capital
Preference Capital
Reserves and Surplus
5.26
29.37
34.63
38.16
32.62
3.55
8.36
117.32
124.21
9.86
0.20
27.60
6.91
33.72
40.63
53.24
40.47
14.95
8.91
158.20
165.13
9.86
0.20
32.57
7.26
38.65
45.91
67.97
49.19
15.15
12.71
190.93
198.76
9.86
0.20
37.42
21.05
53.39
74.44
93.30
24.54
27.58
13.29
233.15
289.35
18.84
0.20
100.35
28.13
52.26
80.39
122.2
0
59.12
73.50
18.38
353.5
9
473.2
7
29.37
0.20
171.0
3
44.03
58.09
102.12
133.45
64.32
75.01
30.08
404.98
531.48
29.44
0.20
176.88
53.62
69.97
123.5
9
141.8
2
76.57
75.07
33.46
450.5
1
585.6
1
44.20
0.20
175.4
1
50.94
64.09
115.03
179.92
107.31
76.45
48.18
526.89
666.86
44.20
0.20
198.79
Net Worth 37.66 42.63 47.48 119.39 200.6
0
206.52 219.8
1
243.19

12. Bank Borrowings
Institutional Borrowings
Debentures
Fixed Deposits
Commercial Paper
Other Borrowings
Current Portion of LT Debt
14.81
4.13
4.77
12.31
0.00
2.33
0.00
19.45
3.43
16.57
14.45
0.00
3.22
0.00
26.51
9.17
19.99
15.03
0.00
3.10
0.08
24.82
38.09
4.56
14.08
0.00
3.18
0.12
55.12
38.76
4.37
15.57
15.00
17.08
15.08
64.97
69.69
4.37
17.75
0.00
1.97
0.02
70.08
89.26
2.92
20.81
0.00
2.36
1.49
118.28
63.60
1.49
19.29
0.00
2.57
1.57
Borrowings 38.35 57.12 73.72 84.61 130.8
2
158.73 183.9
4
203.66
Sundry Creditors
Other Liabilities
Provision for tax, etc.
Proposed Dividends
Current Portion of LT Dept
37.52
5.70
3.18
1.80
0.00
49.40
10.16
3.82
2.00
0.00
59.34
10.70
5.14
2.30
0.08
77.27
3.59
0.31
4.06
0.12
113.66
1.42
4.40
7.29
15.08
148.13
1.99
7.70
8.58
0.02
153.6
3
1.70
12.19
12.85
1.49
179.79
3.04
21.43
14.18
1.57
Current Liabilities 48.20 65.38 77.56 85.35 141.8
5
166.42 181.8
6
220.01
TOTAL LIABILITIES
Additional information:
Share premium reserve
Revaluation reserve
124.21 165.13 198.76 289.35
47.69
8.91
473.2
7
107.4
531.67
107.91
8.50
585.6
1
666.86
93.35
8.15

13. Bonus equity capital 8.51 8.51 8.51 8.51 0
8.70
8.51
8.51 93.35
8.31
23.25
23.25
Exhibit 3
GREAVES LTD.
Share Price Data
1990 1991 1992 1993 1994 1995 1996 1997
Closing share price (Rs)
Yearly high share price (Rs)
Yearly low share price (Rs)
Market capitalization (Rs crore
EPS (Rs)
Book value (Rs)
27.19
29.25
26.78
65.06
4.79
35.64
34.7
4
45.2
8
21.6
1
67.7
7
6.82
37.2
2
121.2
7
121.2
7
34.36
236.5
6
9.73
42.54
66.67
126.33
48.34
274.84
1.93
57.75
78.34
90.00
42.67
346.35
2.66
40.61
71.67
100.01
68.34
316.87
7.16
64.98
47.5
90.00
45.00
210.02
5.03
45.35
48.25
85.00
43.75
213.3
4
9.01
50.73
Questions
16 How profitable are its operations? What are the trends in it? How has growth
affected the profitability of the company?
17 What factors have contributed to the operating performance of Greaves Limited?
What is the role of profitability margin, asset utilisation, and non-operating
income?
18 How has Greaves performed in terms of return on equity? What is the
contribution of return on investment, the way of the business has been financed
over the period?

15. ?