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MB0029 Financial Management Set 1

MB0029 Financial Management Set 1

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Published by Saurabh MIshra12

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Published by: Saurabh MIshra12 on Nov 21, 2009
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ASSIGNMENTSubject Code: MB0029SET 1Subject Name: Financial ManagementQN.1a. Explain why wealth maximization is superior over profit maximization.Answer:
Maximization of profits is regarded as the proper objective of the firm, but it is not asinclusive a goal as that of maximizing stockholder wealth. For one thing, total profits arenot as important as earnings per stock. Therefore, wealth maximization is superior in away that it is based on cash flow, not on the accounting profit.Wealth maximization is superior because it values the duration of expected returns.Since distant flows are uncertain, converting them into comparable values at base periodfacilitated better comparison of financial projects. This can be achieved by for example;by discounting all future earnings to establish their net present value.When a firm follows wealth maximization goal, it achieves maximization of market valueof share. When a firm practices wealth maximization goal, it is possible only when itproduces quality goods at low cost. On this account therefore, society gains because of the societal welfare.
1b. Briefly explain the steps involved in financial plan.Answer:
The financial planning process turns your own personal objectives into specific plansand outlines methods and strategies to implement these plans.Establish Financial Goals and Objectives: Your Financial Consultant will assist you inidentifying your objectives. For example, you may be asked the following questions: Atwhat age and income level would you like to retire? What level of income would you liketo provide to your surviving spouse? How would you like your estate to be distributed?Gather Data: Information reviewed may include, for example, tax returns, brokeragestatements, insurance policies, wills, trusts, estate planning documents, or businessagreements. The more information that is available, the more accurate your financialplan will be.Process and Analyze Information: Appropriate advisors will consider various alternativesto meet your objectives.Adopt a Comprehensive Financial Plan: Illustrations and analyses showing youstrategies to consider meeting your goals.Implement the Plan: You choose to implement the strategies with which you feelcomfortable.Monitor the Plan: Periodically, you and your Financial Consultant will review your financial plan. Circumstances change and you may need to make revisions to your plan.
QN.2a. Explain the two theories of capitalization.Answer:
1. Cost Theory: According to the cost theory of capitalization, the value of a company isarrived at by adding up the cost of fixed assets like plants, machinery patents, etc., thecapital regularly required for the continuous operation of the company (working capital),the cost of establishing business and expenses of promotion. The original outlays on allthese items become the basis for calculating the capitalization of company. Suchcalculation of capitalization is useful in so far as it enables the promoters to know theamount of capital to be raised. But it is not wholly satisfactory. On import objection to it isthat it is based o a figure (i.e., cost of establishing and starting business) which will notchange with variation in the earning capacity of the company. The true value of anenterprise is judged from its earning capacity rather than from the capital invested in it.If, for example, some assets become obsolete and some others remain idle, theearnings and the earning capacity of the concern will naturally fall. But such a fall will notreduce the value of the investment made in the company's business.2. Earnings Theory: The earnings theory of Capitalization recognizes the fact that thetrue value (capitalization) of an enterprise depends upon its earnings and earningcapacity. According to it, therefore, the value or Capitalization of a company is equal tothe capitalized value of its estimated earnings. For this purpose a new company has toprepare an estimated profit and loss account. For the first few year of its life, the salesare forecast ad the manager has to depend upon his experience for determining theprobable cost. The earnings so estimated may be compared with the actual earnings of similar companies in the industry and the necessary adjustments should be made. Thenthe promoters will study the rate at which other companies in the same industry similarlysituated are earnings. The rate is then applied to the estimated earnings of the companyfor finding out the capitalization. To take an example a company estimates its averageprofit in the first few years at Rs. 50,000. Other companies of the same type are, let usassume, earnings a return of 10 per cent on their capital. The Capitalization of thecompany will then be 50,000x100=Rs.500,000.
QN. 2b. A customer wants to deposit Rs.10,000 in ICICI bank for 5 years. Theprevailing interest rate is 9.50% what will be the value of the deposit on maturity.Answer:
FV = PV (1+i) ^nFV = 10000(1+0.095) ^5FV= Rs.15, 742.39
QN.3a. Reliant Ltd has to redeem 12% Rs. 30 million debenture 5 years hence.How much should it deposit annually in sinking fund account so that it canaccumulate Rs. 30 million at the end of 5 years.Answer:
FV = installment * PVIFA (i, y)30,000,000 = installment * PVIFA (12%, 5)30,000,000 = installment *3.60530,000,000 ÷ 3.605 = installment.Installment = 8,321,775.31
QN.3b. Road Transport Corporation issued deep discount bonds in 1996 whichhas a face value of Rs. 2, 00, 000 maturing after 25 years. The bond was issued atRs. 5300. What is the effective interest rate earned by the investor from this bond?Answer:
A = Po (1+i) n200,000 = 5300(1+i) 25Solving for r, 200,000/5300 = (1+i) 25 37.7358 = (1+i) 2537.73581/25 = (1+i)i = 15.63% is the effective interest rate per annum.
QN.4. A bond has a par value of Rs. 1000 bearing a coupon rate of 10% maturingafter 10 years. If the YTM is 12% what is the market value of the bond? If the YTMis increase to 14%, what is the market value of the bond? Compare and give theinference.Answer:
Interest payable = 1000*10% = Rs 100Principal payment = 1000YTM = 12%

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