(a) X Limited has its present annual sales amounting to ₹ 60 lakhs at ₹ 24 per unit. Variable costs are ₹ 16 per unit and fixed…

(a) Best credit policy for X Limited

Present units = 60,00,000 ÷ 24 = 2,50,000. Contribution per unit = 24 − 16 = ₹8. All figures are in ₹ lakh. Investment in receivables is taken at total cost (variable plus fixed) for the credit period, since that is the money actually tied up; the required return is 20% of it.

1 month (present policy). Sales 60.00; units 2,50,000; contribution 20.00; fixed cost 5.00; bad debts 1% × 60.00 = 0.60. Profit before required return = 20.00 − 5.00 − 0.60 = 14.40. Total cost = variable 40.00 + fixed 5.00 = 45.00; receivables = 45.00 × 1/12 = 3.75; required return 20% = 0.75. Net reward = 14.40 − 0.75 = 13.65.

2 months. Sales = 60.00 × 1.08 = 64.80; units 2,70,000; contribution 21.60. The rise of 8% does not exceed 25%, so fixed cost stays 5.00. Bad debts 2% × 64.80 = 1.296. Profit before required return = 21.60 − 5.00 − 1.296 = 15.304. Total cost = variable 43.20 + fixed 5.00 = 48.20; receivables = 48.20 × 2/12 = 8.033; required return = 1.607. Net reward = 15.304 − 1.607 = 13.697.

3 months. Sales = 60.00 × 1.30 = 78.00; units 3,25,000; contribution 26.00. The rise of 30% exceeds 25%, so fixed cost = 5.00 + 1.00 = 6.00. Bad debts 6% × 78.00 = 4.68. Profit before required return = 26.00 − 6.00 − 4.68 = 15.32. Total cost = variable 52.00 + fixed 6.00 = 58.00; receivables = 58.00 × 3/12 = 14.50; required return = 2.90. Net reward = 15.32 − 2.90 = 12.42.

Net rewards are 13.65, 13.70 and 12.42 lakh, so the most rewarding policy is two months' credit, though its advantage over the present policy is small (about ₹4,700 a year). Three months' credit should be rejected because the extra bad debts and fixed cost outweigh the added contribution. Taking variable cost only for receivables gives the same ranking. If receivables were taken at sales value, the present policy would come first, but funds are locked in at cost, so cost is the sounder base.

(b) Value of an equity share under Walter's model

Walter's model: P = [D + (r/k)(E − D)] / k, where D is dividend per share, E earnings per share, r the return on retained earnings and k the cost of capital. It assumes all financing is from retained earnings, r and k are constant and the firm has an infinite life. Here E = ₹10 and k = 10%.

Payout 20%: D = ₹2. A (r/k = 1.5): P = [2 + 1.5 × 8] / 0.10 = 14 / 0.10 = ₹140. B (r/k = 1): P = [2 + 8] / 0.10 = ₹100. C (r/k = 0.8): P = [2 + 0.8 × 8] / 0.10 = 8.4 / 0.10 = ₹84.

Payout 50%: D = ₹5. A: P = [5 + 1.5 × 5] / 0.10 = 12.5 / 0.10 = ₹125. B: P = [5 + 5] / 0.10 = ₹100. C: P = [5 + 0.8 × 5] / 0.10 = 9 / 0.10 = ₹90.

Payout 0%: D = 0. A: P = [0 + 1.5 × 10] / 0.10 = ₹150. B: P = 10 / 0.10 = ₹100. C: P = [0 + 0.8 × 10] / 0.10 = ₹80.

Interpretation: A is a growth firm (r > k), so value falls as payout rises and is highest at zero payout. B has r = k, so value stays at ₹100 at any payout. C has r < k, so value rises with payout and would be ₹100 at full payout.

(c) Venture capital

Venture capital is long-term risk capital, mostly equity or equity-linked, provided to new and fast-growing enterprises with high potential and high risk, usually along with management guidance, in return for a share of ownership and an exit through a public issue or sale. In India, venture capital funds are registered as Category I Alternative Investment Funds under the SEBI (Alternative Investment Funds) Regulations, 2012.

Functions in economic development: it mobilises savings into innovative ventures that banks would not finance; it creates new firms, jobs and entrepreneurs; it brings in technology, professional management and market links; it supports sectors such as software, biotechnology and clean energy, and so exports and competitiveness; and it builds an exit-led ecosystem of incubators, angels and professional advisers.

Stages of financing:

• Seed stage: small funds for an idea, research and a prototype; the risk is highest.
• Start-up or early stage: funds for product development, initial operations and first customers.
• Expansion or growth stage: funds to scale up production, marketing and capacity as revenues appear.
• Bridge or pre-IPO stage: short-term finance to prepare for a public issue or acquisition.
• Later or mezzanine stage: funds for large projects or restructuring, close to the exit, often convertible debt.