This action might not be possible to undo. Are you sure you want to continue?
*** Please fill in all the details in complete and only in CAPITAL letters
Subject Code - MB0045
INSTRUCTIONS FOR ASSIGNMENT SUBMISSION
1. Completed assignments must be typed and formatted neatly and soft copies should be
uploaded on or before the dates mentioned on EduNxt
2. Ensure that you answer all questions according to the marks allocated. 3. Content that has been directly copied from the Internet or the Book will NOT be
Incase of any errors the student will be marked absent for the specific subject 6. (Please type the answers in the same sheet one after another and upload the soft copy on EduNxt for evaluation) Q. of equity shares Cost of equity shares Retention ratio Rate of interest (ROI) Rs.120 lakhs 12.1 Considering the following information. Late submissions will NOT be accepted. Follow assignment format and complete all the details for each assignment individually.4. Roll no/Registration Number found mentioned anywhere else except the place provided. Note: Each question carries 10 Marks. Answer all the questions. 8. They prefer certain returns to uncertain returns and therefore give a premium to the constant returns and discount uncertain returns. 9. Assignments that have been copied and shared among students will be automatically rejected and disqualified. the assignments will be rejected. the assignments will be rejected. 5. Name found listed anywhere on this document.5% Rs. 000 12% 40% 16% GORDON’S MODEL: Gordon’s model assumes investors are rational and risk averse. 7.50 lakhs@ 12% dividend 25. Please attempt all the assignments individually and independently. Please attach correct assignments to correct subjects. The shareholders therefore prefer current dividends to avoid . Incase students extra details like contact number. what is the price of the share as per Gordon’s Model? Details of the Company Net sales Net profit margin Outstanding preference shares No.
60) / (30000 – 0. b is Retention ratio.2 Examine the components of working capital & also explain the concepts of working capital. Investors prefer to pay higher price for stocks which fetch them current dividend income.40%) = 0. P is the price of the share. Ke is cost of equity capital.b) / Ke – br Where.risk. they discount future dividends.84 = 30. In other words. Retained earnings are evaluated by the shareholders as risky and therefore the market price of the shares would be adversely affected. Working capital management is concerned with managing the different components of current assets and current liabilities. According to question.60 Ke = (250000*12%)= 30000 br = 16% = 0. components and consumable stores and pre-paid expenses The components of current liabilities are: o Sundry creditors .b) = (1 . Gordon’s model can be symbolically expressed as: P = E (1 . E is Earnings Per Share.16 Therefore. P = (1500000 x 0.16) = 29. Components of current assets: o Inventories o Sundry debtors o Bills receivables o Cash and bank balances o Short-term investments o Advances such as advances for purchase of raw materials. E = (12000000*12. Gordon explains his theory with preference for current income. (1 – b) is dividend payout ratio.00 (rounded-off) Q.5%)= 1500000 b = 40% (1 . br is growth rate in the rate of return on investment.
Therefore. Gross Working Capital: Refers to the amounts invested in various components of current assets. • Management of current assets is the crucial aspect of working capital management • Gross working capital helps in the fixation of various areas of financial responsibility • Gross working capital is an important component of operating capital. Maintaining adequate working capital is crucial for maintaining the competitiveness of a firm. Temporary working capital and Permanent working capital. Concepts of Working Capital The four most important concepts of working capital are (see figure 11. neither excess nor inadequate. as applied to current assets Net working capital: Refers to the excess of current assets over current liabilities and provisions. . This concept has the following practical relevance. Net working capital is positive when current assets exceed current liabilities and negative when current liabilities exceed current assets.1) – Gross working capital. Net working capital.o Bills payable o Creditors for out-standing expenses o Provision for tax o Other provisions against the liabilities payable within a period of 12 months A firm must have adequate working capital. for improving the profitability on its investment a finance manager of a company must give top priority to efficient management of current assets • The need to plan and monitor the utilisation of funds of a firm demands working capital management. This concept has the following practical relevance.
• Net working capital indicates the ability of the firm to effectively use the spontaneous finance in managing the firm’s working capital requirements • A firm’s short term solvency is measured through the net working capital position it commands Permanent working capital: It is the minimum amount of investment required to be made in current assets at all times to carry on the day to day operation of firm’s business. This minimum level of current assets has been given the name of core current assets. This decision may be the result of a conservative policy pursued by a firm.3 Internal capital rationing is used by firms for exercising financial control. Restriction may be imposed on divisional heads on the total amount that they can commit on new projects. The extra working capital required as per the changing production and sales levels of a firm is known as temporary working capital. Permanent working capital is also known as fixed working capital. The firm’s working capital requirements vary depending upon the seasonal and cyclical changes in demand for a firm’s products. • Private owned company . Generally internal capital rationing is used by a firm as a means of financial control. Dilution and Debt constraints. The various factors relating to the internal constraints imposed by the management are (see figure) – Private owned company. Human resource limitations. Temporary working capital: It is also known as variable working capital or fluctuating working capital. Q. How does a firm achieve this? Impositions of restrictions by a firm on the funds allocated for fresh investment is called internal capital rationing. Divisional constraints. Another internal restriction for capital budgeting decision may be imposed by a firm based on the need to generate a minimum rate of return. Under this criterion only projects capable of generating the management’s expectation on the rate of return will be cleared.
Let us now look at the different types of capital rationing in the following topic. There exists a positive co-relation between sales and firm’s return on its investment.Under internal constraint. The cost of capital or the cost structure of the management. • Human Resource limitations The management of the firm or the company should see that excessive labour is being used for the project.4 What are the objectives of working capital management? Briefly explain the various elements of operating cycle. Lack of proper man-power can become an internal constraint. the budget constraints imposed by the senior officials or decisions coming from the headoffice and wholly owned subsidiary decisions relate to the internal constraints. These are the methods by which various factors are effecting the capital rationing of a particular firm or a management. • Divisional constraints Another constraint might lead to the allocation of fixed amount for each division in a firm by the upper management. Firms make sales on credit. This constraint occurs mainly when a reluctance in the issuing of further equity takes place. This procedure can also be considered as an overall corporate strategy. Therefore. Q. There is always a time gap between sale of goods on credit and the realisation of earnings of sales from the firm’s customers. This kind of condition arises only when the management of a firm fears losing the control in the company. • Debt constraints Debt constraints also constitute to the internal constraints in capital rationing. • Dilution Dilution refers to the dilution of the company. objective of working capital management is to ensure smooth functioning of the normal business operations of a firm. due to the fear of management losing the control over the company. This constraint occurs mainly due to the issue of earlier debt which prohibits the issue of debts in the firm up-to a certain level. These situations arise mainly from the point of view of a department. The firm has to decide on the amount of working capital to be employed. the management of the firms might decide that expansion of the company might be a problem and not worth taking. . A firm must earn sufficient returns from its operations to ensure the realisation of this objective.
Credit obtained by a firm from its suppliers is known as spontaneous finance. There is also another risk of firm losing on maintaining its liquidity position. Since cash inflows do not match with cash out flows. . Examine the need for assessing the risks in a project. There is no synchronisation between the activities in the operating cycle. However.The firm may have a conservative policy of holding large quantum of current assets to ensure larger market share and to prevent the competitors from snatching any market for their products. Cash outflows are certain. • Acquisition of resources from suppliers • Making payments to suppliers • Conversion of raw materials into finished products • Sale of finished products to customers • Collection of cash from customers for the goods sold The five phases of the operating cycle occur on a continuous basis. This excess funds locked in current assets will reduce the firm’s profitability on operating capital. Inventory conversion period is the average length of time required to produce and sell the product. Objective of working capital management is achieving a trade–off between liquidity and profitability of operations for the smooth conduct of normal business. The firm will have returns higher than the required amount of investment in current assets. However. cash inflows are uncertain because of uncertainties associated with effecting sales as per the sales forecast and ultimate timely collection of amount due from the customers to whom the firm has sold its goods.5 Define risk. Accounts payables period = (Payables deferral period) Purchases per day = Cash conversion cycle is the length of time between the firms actual cash expenditure and its own cash receipt. Accounts payables period is also known as payables deferral period. any error in forecasting can affect the operations of the firm unfavourably if the error is fraught with the down side risk. The time gap between acquisition of resources and collection of cash from customers is known as the operating cycle Operating cycle of a firm involves the following elements. However such a policy will affect the firm’s returns on its investment. Q. Here a firm will try to reduce its investments in current assets as much as possible but checks that they are not affecting the firm’s ability to meet working capital needs for sales growth targets. firm has to invest in various current assets to ensure smooth conduct of day to day business operations. Receivables conversion period is the average length of time required to convert the firm’s receivables into cash. Such a policy will ensure higher return on its investment as the firm will not be locking in any excess funds in current assets.
Risk exists on account of the inability of a firm to make perfect forecasts of cash flows. monetary policies. strikes or lockouts affect company’s cost and revenue positions Types and Sources of Risk in Capital Budgeting Stand alone risk: In a project it is considered when the project is in isolation. Stand-alone risk is measured by the variability of expected returns of the project. Every business decision involves risk. Market risk is measured by the effect of the project on the beta of the firm. wage negotiations with the workers. Corporate risk is the projects risks of the firm. The inability can be attributed to factors that affect forecasts of investment. taxation.Risk in capital budgeting may be defined as the variation of actual cash flows from the expected cash flows. cost and revenue. Some of these are as follows: • The business is affected by changes in political situations. The market risk for a project is difficult to estimate. Corporate risk: Focuses on the analysis of the risk that might influence the project in terms of entire cash flow of the firms. When new project is added to the existing portfolio of project. interest rates and policies of the central bank of the country on lending by banks • Industry specific factors influence the demand for the products of the industry to which the firm belongs • Company specific factors like change in management. market risk is also referred to as systematic risk. The degree of the change in the risk depends on: • The co-variance of return from the new project • The return from the existing portfolio of the projects Market risk: It is defined as the measure of the unpredictability of a given stock value. Sources of risk The five different sources of risk are: • Project – specific risk • Competitive or Competition risk • Industry – specific risk • International risk • Market risk • Technological risk . However. Portfolio risk : A firm can be viewed as portfolio of projects having a certain degree of risk. the risk profile of the firm will alter. The market risk has a direct influence on stock prices.
the firm may have to face the public wrath through PILs entertained at the Supreme Court and High courts. • Expand capacity to meet the emerging market at demand for company’s products • Add new technology based process of manufacture that will reduce the cost of production. Proactive organisations encourage a continuous flow of investment proposals from all levels in the organisation. Many projects fail to achieve the planned targets on profitability and cash flows if the firm could . generation of ideas with the feasibility to convert the same into investment proposals occupies a crucial place in the capital budgeting decisions. These new business opportunities could be potential investment ideas.• • • • Commodity risk Legal risk International risk Market risk There are many techniques of incorporation of risk perceived in the evaluation of capital budgeting proposals. Q. • Companies which invest in Research and Development constantly get exposure to the benefit of adapting the new technology quite relevant to keep the firm competitive in the most dynamic business environment.6 Briefly examine the significance of identification of investment opportunities in capital budgeting process A firm is in a position to identify investment proposal only when it is responsive to the ideas of capital projects emerging from various levels of the organisation. • Market surveys on customer’s perception of company’s product could be a potential investment proposal to redefine the company’s products in terms of customer’s expectations. In this connection following points deserve to be considered: • Analysing the demand and supply conditions of the market for the company’s product could be a fertile source of potential investment proposals. The proposal may be to: • Add new products to the company’s product line. Reports emerging from R & D section could be a potential source of investment proposal. are accepted by well managed firms. • Economic growth of the country and the emerging middle class endowed with purchasing power could generate new business opportunities in existing firms. Therefore. • Public awareness of their rights compels many firms to initiate projects from environmental protection angle. If ignored. They differ in their approach and methodology as far as incorporation of risk in the evaluation process is concerned. Relevant forecasting technologies are employed to get a realistic picture of the potential demand for the proposed product or service. Therefore project ideas that would improve the competitiveness of the firm by constantly improving the production process with the sole objective of cost reduction and customer welfare.
.not succeed in forecasting the demand for the product on a realistic basis. Capital budgeting process involves three steps– Financial appraisal. Technical appraisal and Economic appraisal.