A.1.

Following are the goals of financial management: PROFIT MAXIMISATION: Profit maximisation is based on the cardinal rule of efficiency. Its goal is to maximize the returns with the best output and price levels. Profit maximisation is the traditional and narrow approach, which aims at maximizing the profit of the concern. Allocation of resources and investors perception of the companys performance can be traced to the goal of profit maximisation. Profit maximisation is based on accounting. Ensuring continued profits ensure maximization of shareholders wealth. WEALTH MAXIMISATION: The term wealth means shareholders wealth or the wealth of the persons those who are involved in the business concern. Wealth maximisation is also known as value maximisation or net present worth maximisation. Wealth maximisation is possible only when the company pursues policies that would increase the market value of shares of the company. It has been accepted by the finance managers as it overcomes the limitations of profit maximisation. Wealth maximisation is based on the concept of cash flows. Cash flows are a reality and not based on any subjective interpretation. Wealth maximisation considers time value of money. Time value of money translates cash flow occurring at different periods into a comparable value at zero period. In this process, the quality of cash flow is considered critical in all decisions as it incorporates the risk associated with the cash flow stream. It finally crystallizes into the rate of return that will motivate investors to part with their hard earned savings. Maximising the wealth of the shareholders means positive net present value of the decisions implemented.

A.2.

Various factors affecting financial plan: NATURE OF THE INDUSTRY: Here, one must check whether the industry is a capital-intensive or labour intensive industry. This will have a major impact on the total assets that a firm owns. SIZE OF THE COMPANY: The size of the company greatly influences the availability of funds from different sources. A small company normally finds it difficult to raise funds from long-term sources, while, large companies enjoy the privilege of obtaining funds both short-term long term at attractive rates. STATUS OF THE COMPANY IN THE INDUSTRY: A well-established company enjoys a good market share, because its products normally command investors confidence. Such a company can tap the capital market for raising funds in competitive terms for implementing new projects to exploit the new opportunities emerging from changing business environment. SOURCES OF FINANCE AVAILABLE: sources of finance could be grouped into debt and equity. Debt is cheap but risky whereas equity is costly. A firm should aim at optimum capital structure that would achieve the least cost structure. A large firm with a diversified product mix may manage higher quantum of debt because the firm may manage higher financial risk with a lower business risk.

THE CAPITAL STRUCTURE OF A COMPANY: The capital structure of a company is influence by the desire of the existing management of the company to retain control over the affairs of the company. MATCHING THE SOURCE WITH UTILISATION: Any good financial plan is to match the term of the source with the term of the investment. To finance fluctuating work capital needs, the firm resorts to short-term finance. All fixed asset investments are to be financed by long term sources which are a cardinal principle of financial planning. FLEXIBILITY: The financial plan of a company should possess flexibility so as to effect changes in the composition of capital structure whenever the need arises. If the capital structure of a company is flexible, there will not be any difficult in changing the sources of funds. This has become a significant because of the globalization of capital market. GOVERNMENT POLICY: SEBI guidelines, finance ministry circulars, various clauses of Standard Listing Agreement and regulatory mechanism imposed by FEMA and Department of Corporate Affairs influence the financial plans of corporate today. Management of public issues of shares demands the compliances with many statutes in India.

A.3.

Time Value of money is the value of a unit of money at different time intervals. The value of money received today is more than its value received at a later date. Since a rupee received today has always more value, rational investors would prefer current receipts over future receipts. That is why this phenomenon is referred to as time preference of money. Consider this- we intuitively know that Rs. 100 in hand now is more valuable than Rs. 100 receivable after a year. In other words, we will not part with Rs.100 now in return for a firm assurance that the same sum will be repaid after a year. But we might part with the same Rs.100 now if we are assured that something more than Rs.100 will be paid at the end of first year. This additional compensation required for parting with Rs.100 now is called the interest or the time value of money. Some important features contributing to this nature are: Investment opportunities Preference for consumption Risk Some of the reasons of time value of money are: PRODUCTIVITY: Money can be employed productively to generate real returns. INFLATION: During periods of inflation, a rupee has a higher purchasing power than a rupee in the future. RISK AND UNCERTAINTY: We all live under conditions of risk and uncertainty. As the future is characterized by uncertainty, individuals prefer current consumption over future consumption. Most people have subjective preference for present consumption either because of their current preferences or because of inflationary pressures.

A.4.

Po D1 Ke P1

= Current Market Price of the share = ? = Expected dividend after one year = 25 = Expected Price of the share after one year = 450 = required rate of return on the equity share = 15/100 = 0.15

Calculation: Po = D1/ ( 1+ Ke ) + P1 / ( 1 + Ke) = 25/(1+0.15) + 450/(1+0.15) = 21.74 + 391.30 = Rs. 413.04 An investor would be willing to buy the share at Rs. 413.04 A.5. DOL Q S V F = Degree of Operating Leverage = to be found = Quantity = 2000 = Sales = 20000 = Variable cost = 10000 = Fixed cost = 0

Calculations: DOL = {Q (S V)} / {Q (S V) F} = {2000(20000 - 10000)} / {2000(20000 - 10000) - 0} = 2000000 / 2000000 = 1 The DOL according to the values given in the table is 1. A.6. Assumptions of MM approach are as follows: EXISTENCE OF PERFECT CAPITAL MARKETS: All investors are rational and have access to all information, free of cost. There is no floatation or transaction costs, securities are infinitely divisible and no single investor is large enough to influence the share value. NO TAXES: There are no taxes, implying there is no difference between capital gains and dividends. CONSTANT INVESTMENT POLICY: The investment policy of the company does not change. CERTAINTY ABOUT THE FUTURE INVESTMENTS: The dividends and the profits of the firm have no risk. Based on the above assumptions, MM have explained the irrelevance of dividends as the crux of the arbitrage argument. The arbitrage process refers to setting off or balancing two transactions which are entered into investment programmes, simultaneously. The two transactions which the arbitrate process refers to are: Paying out dividends

Raising external funds to finance additional investment programmes.

Symbolically, the model is given as, STEP I: The market price of a share in the beginning is equal to the PV of dividends paid and market price at the end of the period. P0={1/(1+Ke)}*(D1+P1) Where, P0 = current market price P1 = market price at the end of period 1 D1 = dividends to be paid at the end of period 1 Ke = cost of equity capital STEP II: Assuming there is no external financing, the value of the firm is: nP0={1/(1+Ke)}*(nD1+nP1) Where n is number of outstanding shares. STEP III: If the firms internal sources of financing its investment opportunities fall short of funds required, new shares are issued at the end of year 1 at price P1. The capitalized value of the number of shares outstanding is less than the value of new shares. nP0={1/(1+Ke)}*{nD1+(n+n1)P1n1P1} Firms will have to raise additional capital fund their investment requirements after utilizing their retained earnings, hence, n1P1=I(EnD1) can be written as, n1P1=IE+nD1 Where, I = total investment required nD1 = total dividends paid E = earnings during the period (EnD1) = retained earnings. STEP IV: The value of share is thus: nP0={1/(1+Ke)}*{nD1+(n+n1)P1 I+E nD1} Or,

nP0={1/(1+Ke)}*{(n+n1)P1 I+E} Thus, MM model based on assumptions shows market value of the share is not affected by the dividend policy.