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SEMESTER- ASSIGNMENT-02
Name Roll No. Learning Center Co e Co!r"e#$rogramme SEMESTER S!'(e)t )o e +ate o, "!'mi""ion Mar&" a-ar e : SRIRAM C : 511238384 : 2851 : : : : ..................... M% * 45 * SET 2 M%A - %an&ing

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Signature of Center Head

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Signature of Evaluator

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These decisions involve large outla" of funds no! in anticipation of cash flo!s in future. The pro3ections of cash flo!s anticipated involve forecasts of man" financial variables.2 Q4. (ecisions on e)penditure for increasing the present operating level or e)pansion through improved net!ork of distribution. a. 2or e)ample. b. $eplacement decisions% These decisions ma" be decision to replace the e&uipments for maintenance of current level of business or decisions aiming at cost reductions. (ecisions for products of ne! goods or rendering of ne! services .MBA Semester 2 MB0045 –Financial Management Assignment Set. There are man" reasons that make the Capital budgeting decisions the most crucial for finance 1anagers #. E&uall" !e have empirical evidence of companies !hich took decisions on e)pansion through the addition of ne! products and adoption of the latest technolog" creating !ealth for shareholders. 2 . (ecisions on investment to build to!nship for providing residential accommodation to emplo"ees !orking in a manufacturing plant. '. huge investments in $ 5 ( in packaging industr" brought about ne! packaging medium totall" replacing metal as an important component of packing bo)es. (uring this period. The economic life of such assets has long periods. These decisions commit a firm to invest its current funds in the operating assets (i. (ecisions on penetrating into ne! geographical area. /t the end of the e)pansion 1etal 4o) 6td found itself that the market for its metal bo)es had declined drasticall". The most crucial variable is the sales forecast.rotection /ct come under this categor".Master of Business Administration.+. 2or e)ample. The best e)ample is the $eliance group. Capital budgeting decisions are the most important decisions in corporate financial management. *. Emplo"ees lost their 3obs. -nvestments in assets to compl" !ith the conditions imposed b" Environmental . -t affected the standard of lining and cash flo! position of its emplo"ees. (ecisions to compl" !ith the regulator" structure affecting the operations of the compan". Examine t e im!ortance of ca!ital "udgeting. 1etal 4o) spent large sums of mone" on e)pansion of its production facilities based on its o!n sales forecast. investment in plant and machiner". .e long-term assets !ith the hope of emplo"ing them most efficientl" to generate a series of cash flo!s in future. These decisions could be grouped into #. The end result is that 1etal 4o) became a sick compan" from the position it en3o"ed earlier prior to the e)ecution of e)pansion as a blue chip. 0. This highlights the element of risk involved in these t"pe of decisions.. These decisions make or mar a business organization.

/n up!ard bias ma" lead to a situation of the firm creating idle capacit". /n" do!n!ard bias in forecasting ma" lead the firm to a situation of losing its market to its competitors. 4ut man" firms suffer from its inabilit" to forecast the future operations and formulate strategic decision to ac&uire the re&uired assets in advance at the competitive rates. +. 1ost of the Capital budgeting decisions involve huge outla". / long term investment of funds sometimes ma" change the risk profile of the firm. 9uite a lot empirical e)amples are there in public sector in -ndia in support of this argument that cost overrun and time over run can make a compan"‟s operations unproductive. '.c. -f a firm !ere to realize after committing itself considerable sums of mone" in the process of implementing the Capital budgeting decisions taken that the decision to diversif" or e)pand !ould become a !ealth destro"er to the compan". Sometimes these e&uipments !ill be specialized costl" e&uipments. / firm incurs Capital e)penditure to build up capacit" in anticipation of the e)pected boom in the demand for its products. Capital budgeting decisions change the risk dimensions of the compan" and hence the re&uired rate of return that the investors !ant. This decision !ill totall" alter the risk profile of the business of the compan". Therefore. 4ut the ma3or challenge that the management of a firm faces in managing the uncertain future cash inflo!s and out flo!s associated !ith the plan and e)ecution of Capital budgeting decisions. Therefore. -n this connection it is to be noted that the po!er pricing is a politicall" sensitive area affecting the profitabilit" of the organization. 4oth are risk" fraught !ith grave conse&uences. The most difficult aspect of Capital budgeting decisions is the influence of time. 6oss incurred b" the firm on account of this !ould be heav" if the firm !ere to scrap the e&uipments bought specificall" for implementing the decision taken. 3 . The timing of the Capital e)penditure decision must match !ith the e)pected boom in demand for compan"‟s products. -nvestor8s perception of risk of the ne! business to be taken up b" the compan" !ill change his re&uired rate of return to invest in the compan". These t!o problems of time over run and cost overrun have to be prevented from occurring in the beginning of e)ecution of the pro3ect. The funds re&uirements during the phase of e)ecution must be s"nchronized !ith the flo! of funds. 2ailure to achieve the re&uired coordination bet!een the inflo! and outflo! ma" cause time over run and cost overrun. *. / 21C7 compan" !ith its core competencies in the business decided to enter into a ne! business of po!er generation.. Capital budgeting decisions involve assessment of market for compan" ‟s products and services. then the firm !ould have e)perienced a situation of inabilit" to sell the e&uipments bought. selection of relevant technolog" and finall" procurement of costl" e&uipment. -f it plans in advance it ma" effectivel" manage the timing and the &ualit" of asset ac&uisition. . la"ing the path for the cancer of sickness. deciding on the scale of operations. Capital budgeting decisions are irreversible. d. /n" serious error in forecasting Sales and hence the amount of capital e)penditure can significantl" affect the firm.

roactive firms cannot avoid the risk of taking challenging Capital budgeting decisions for gro!th.orld Trade organization. Ex!lain t e conce!ts of $or%ing ca!ital . &ualit" and timing. C@ACE. These factors make these decisions highl" comple). /bilit" of 7 E to sell its products in -ndia at a rate less than the rate at !hich -ndian Companies sell cannot be ignored.0. !e can sa" that !orking capital is the investment needed for carr"ing out da"-to-da" operations of the business smoothl". :. !hich is emplo"ed in short-term operations. To implement these decisions firm ‟s !ill have to tap the Capital market for funds. Therefore. viz. -n simple !ords. /n" lapse on the part of the firm in understanding the effect of these elements on implementation of Capital e)penditure decision taken !ill strategicall" affect the firm‟s profitabilit". political. These three elements are cost.T @2 . accounts receivable (debtors and inventories of ra! materials. !ork-in process and finished goods. economic and technological forces generate high level of uncertaint" in future cash flo!s streams associated !ith Capital budgeting decisions. =. Capital e)penditure decisions are ver" e)pensive. 6iberalization and globalization gave birth to economic institutions like . The composition of debt and e&uit" must be optimal keeping in vie! the e)pectation of investors and risk profile of the selected pro3ect Q#. Capital budgeting decisions for gro!th have become an essential characteristics of successful firms toda".orking Capital refers to firm?s investment in short-term assets. /ll Capital budgeting decisions have three strategic elements. >. The social. Therefore. (ecisions must be taken at the right time !hich !ould enable the firm to procure the assets at the least cost for producing the products of re&uired &ualit" for customer. . These are% &ross $or%ing ca!ital' ()otal *urrent Assets+ The gross !orking capital.-T/6 There are t!o concepts of !orking capital. -t can also be regarded as that portion of the firm?s total capital. short-term securities. The management of !orking capital is no less important than the management of long-term financial investment. simpl" called as !orking capital refers to the firm8s 4 . -t refers to all aspects of current assets and current liabilities. the gro!th and survival of an" firm in toda"‟s business environment demands a firm to be proactive.@$<-A7 C/. 7eneral Electrical can e)pand its market into -ndia snatching the share alread" en3o"ed b" firms like 4a3a3 Electricals or <irloskar Electric Compan". cash.

Current liabilities are those claims of outsiders. 4ills . Short Term 4orro!ings (Commercial 4anks and @thers 0.rogress. !hich are e)pected to mature for pa"ment !ithin an accounting "ear. -t includes #. !hich can be converted into cash !ithin an accounting "ear or operating c"cle. there is no !orking capital. *. -t includes • • • • • • • -nventories ($a! materials and Components. . Aet .ork-in-.rovisions :. Aet !orking capital ma" be positive or negative.C 5 .C B7ross !orking capital refers to the amount of funds invested in current assets that are emplo"ed in the business process !hile. +. /ccrued or @utstanding E)penses.. Current assets are the assets. 7ross !orking capital. short term creditors.a"able. Thus.orking Capital refers to the difference bet!een current assets and current liabilities.ia"ilities+ Aet !orking capital refers to the difference bet!een current assets and current liabilities. @thers Trade (ebtors 6oans and /dvance Cash and 4ank 4alances 4ills $eceivables. 4ank @verdraft B.C B.orking Capital represents the amount of current assets that have not been supplied b" current.investment in current assets. is the total of all current assets. Trade Creditors. '. Trade /dvances . Short-term -nvestment .et -or%ing *a!ital' ()otal *urrent Assets – )otal *urrent . 2inished 7oods.e. / positive net !orking capital !ill arise !hen current assets e)ceed current liabilities and a negative net !orking capital !ill arise !hen current liabilities e)ceed current assets i. .orking Capital is the e)cess of current assets that has been supplied b" the long-term creditors and the stockholders. but there is a !orking capital deficit.

The t!o concepts of !orking capital. the investment p olic" of the compan" ma" not be the optimal one 0easons for *a!ital 0ationing' External Factors% Fnder this the firm does not have funds 5 it also cannot raise them from financial markets. gross !orking capital and net !orking capital are e)clusive. -t indicates the li&uidit" position of the firm and suggests the e)tent to !hich !orking capital needs ma" be financed b" permanent sources of funds Q5. -$$ or A. 4oth are e&uall" important for the efficient management of !orking capital.rogramming Techni&ue should be used to ma)imize A.hile. net !orking capital concept is &ualitative. The gross !orking capital focuses attention on t!o aspects% • • Ho! to optimize investment in current assetsD Ho! should current assets be financedD . Some reasons can be% • imperfections in capital markets • non-availabilit" of market information • investor8s attitude • 2irm8s lack of credibilit" in market • High 2lotation costs 1nternal Factors' 1nternal capital rationing arise due to the self-imposed restrictions imposed b" management . Briefl/ ex!lain t e !rocess of ca!ital rationing Meaning' *a!ital 0ationing is a situation !here a constraint or budget ceiling is placed on the total size of capital e)penditures during a particular period.E. Some reasons can be % • not to take additional burden of debt funds • la"ing do!n a specified minimum rate of return on each pro3ect • Ao further E&uit" -ssue to prevent dilution of control . 6inear .E pro3ects it has identified because of shortage of capital C.reference should be given to interdependent pro3ects. .Fnder this though the funds can be arranged but firm itself impose restrictions on investment e)penditure . • (ivisional 4udgets used to prevent an" inefficienc" or !astage of funds b" them 2ifferent Situations of *a!ital 0ationing' 6 .E.E. . -n other !ords BCapital $ationing refers to a situation !here a compan" cannot undertake all positive A. -n times of Capital $ationing. .ro3ects are to be ranked in the order of A.E are the best basis of evaluation even under Capita l $ationing situations. The ob3ective is to select those pro3ects !hich have ma)imum and positive A. here there is multi-period Capital $ationing.

de"entures $ort 0s.• • • • Single 3eriod *a!ital 0ationing' 2unds limitation is there onl" for one "ear.E is also ad3usted to the same fraction as cash outflo!s. Q7. no financial constraints. Assuming a tax rate of 40.< and cost of e8uit/ ca!ital to "e 22. 50<00<000. )$o com!anies are identical in all res!ects exce!t in t e de"t e8uit/ !rofile. Thereafter. "efore interest and taxes on t eir total assets of 0s. not in fractions. Multi 3eriod *a!ital 0ationing' 2unds limitation is there in more than one "ears.>1 a!!roac ? @int' use t e formula A0 B CBD(BES+FAd E CSD(BES+FAe Solution' 7 . • B/ ma%ing full utili6ation of "udget as !rimar/ consideration ' -n Capital $ationing it ma" also be more desirable to accept several small investment proposals than a fe! large investment proposals so that there ma" be full utilisation of budgeted amount. -a/s of 0esorting *a!ital 0ationing' There are various !a"s of resorting to capital rationing. Thus Capital $ationing does not al!a"s lead to optimum results. *om!an/ 9 as :4. This ma" result in accepting relativel" less profitable investment proposals if full utilisation of budget is a primar" consideration. 2i4isi"le 3ro5ects' These are the pro3ects !hich can be accepted full" as !ell as in fractions. !hereb" management ma" introduce capital rationing b" authorising a particular department to make investment onl" up to a specified limit. Bot com!anies earn 20. Since the amount of capital e)penditure in that situation cannot e)ceed the amount of retained earnings. 1ndi4isi"le 3ro5ects' These are the pro3ects !hich can onl" be accepted full". some of !hich are% • B/ $a/ of 0etained Earnings ' / firm ma" put up a ceiling !hen it has been financing investment proposals onl" b" !a" of retained earnings (ploughing back of profits . it is said to be an e)ample of capital rationing. be"ond !hich the investment decisions are to be taken b" higher-ups.< find out t e 4alue of t e com!anies 9 and = using . • B/ $a/ of 0es!onsi"ilit/ Accounting ' Capital $ationing ma" also be introduced b" follo!ing the concept of Gresponsibilit" accounting8. A. 25<00<000 $ ereas com!an/ = does not a4e an/ de"t.

II.#=LI.#+' H.5la% s< cost of de"t :7..0:P.+.IIIIIL+. !ro4ides t e information as s o$n in ta"le #.I+>0L. bonds and an" other long-term debt O are included in a .+.+. M. @int' Hse t e e8uation -A** B -e Ae E -! A! E-r Ar E -d Ad E -t At Solution' / calculation of a firm8s cost of capital in !hich each categor" of capital is proportionatel" !eighted.'' H+.+.IIIIIL+.J'..0 Q2. 2e"t 0s.+.#+0 or #+. 8 ./CC calculation.III H<IHK'.+. preferred stock.IIIJK'./CC of a firm increases as the beta and rate of return on e&uit" increases..:0la% s< cost of ca!ital :G.#+LK+.**P#*(#-.II.SH #III./CC H I.#.IIIIIIJI.td.'' I...2: regarding t e cost< sales< interests and selling !rices. *alculate t e 2F.+. /s long as ki is constant.+.#>#.00I. there is no one optimal capital structure Q:. as an increase in .. Thus. /n increase in cheaper debt funds is e)actl" offset b" an increase in the re&uired rate of return on e&uit". *alculate t e $eig ted a4erage cost of funds ta%ing mar%et 4alues as $eig ts assuming tax rate as 40. ke is a linear function of the debt-to-e&uit" ratio.N E H .+. ) e follo$ing data is a4aila"le in res!ect of a com!an/ ' E8uit/ 0s.+.: • • • Critical assumption is ko remains constant. the . or #>. /ll else e&ual. H '0. /ll capital sources O common stock...+.#I>. 4H'. M. AB* .IIIJ.+./CC notes a decrease in valuation and a higher risk -A** B -e Ae E -! A! E-r Ar E -d Ad E -t At .+I HI.#>#.

SJE.td.7<500 0s.SS T QRE4-TJE4-TS @r (26 H E4-T T QE4-TU-UQ(pJ(#-T SS 9 .2etails of AB* .20 Hint (26 H Solution% (26HQRE.05 !er unit .il 0.0. >ut!ut Fixed costs Iaria"le cost 1nterest on "orro$ed funds Selling !rice !er unit 20<000 units 0s.