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Student Name: Sonal Bhardwaj

Course: MBA

Registration Number: 1308011363

LC Code: 2971

Subject Name: Financial Management

Subject Code: MB 0045

Question 1. When a firm follows wealth maximization goal, it achieves maximization of market value
of a share. Do you agree? Substantiate your arguments.
Answer. The term wealth means shareholders wealth or the wealth of the persons those who are
involved in the business concern. Wealth maximization is also known as value maximization or net
present worth maximization. This objective is a universally accepted concept in the field of business.
Wealth maximization 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 maximization. The following arguments are in support of the
superiority of wealth maximization over profit maximization:
Wealth maximization is based on the concept of cash flows. Cash flows are a reality and not
based on any subjective interpretation. On the other hand, profit maximization is based on
accounting profit and it also contains many subjective elements.
Wealth maximization considers time value of money. Time value of money translates cash
flow occurring at different periods into a comparable value at zero periods. In this process,
the quality of cash flow is considered critical in all decision 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. Maximizing the wealth of the
shareholders means positive net present value (the excess of present value of cash inflows of
any decision over the present value of cash out flow) of the decisions implemented.
Question 2.
A) If you deposit Rs. 10000 today in a bank that offers 8% interest, how many years will the
amount take to double?
B) What is the future value of a regular annuity of Re. 1.00 earning a rate of 12% interest p.a. for
5 Years?
Answer.
A) One way to answer it is by rule known as rule of 72. This rule states that the period within
which the amount doubles is obtained by dividing 72 by the rate of interest. Though it is a crude
way of calculating, this rule is followed by most. So, if the rate of interest is 8%, the doubling
period is 8/10, that is, 9 year. A much accurate way of calculating doubling period is by using rule
of 69. By this method, doubling period = 0.35+69/interest rate. So if the rate of interest is 8%
then doubling period=0.35+69/8%=8.975years.
B) FVAn = A * FVIFA (12%, 5yrs)
= 1 * FVIFA (12%, 5y) = 1*6.353 = rs. 6.353
Question 3. The concept of financial leverage is a significant, as it has direct relation with capital
structure. Do you agree? If so, substantiate your arguments.

Answer. Financial leverages refers to a firms use of fixed charge securities like debentures and
preferences shares in its plan of financing the assets. The concept of financial leverage is a
significant one because it has direct relation with capital structure management. It determines the
relationship that could exist between the debt and equity securities. A firm which does not issue fixedcharge securities has an equity capital structure and does not have any financial leverage. However,
it is common for firms to issue some debt securities, in which case, the leverage is either favourable
or unfavourable. Financial leverage is a process of using debt capital to increase the rate of return on
equity. For this reason, it is also referred to as trading on equity. Borrowing is done by a company
because of the financial advantages that is expected from it. The use of borrowings for the purpose of
such advantage of residual shareholders is also called trading on equity or leverage. Thus financial
leverage refers to the mix of debt and equity in the capital structure of the firm. This results from the
presence of fixed financial charges in the companys income stream. Such expenses have nothing to
do with the firms performance and earnings and should be paid off regardless of the amount of ebit.
It is the firms ability to use fixed financial charge to increase the effects of changes in ebit on the eps.
It is the use of funds obtained at fixed costs which increase the returns on shareholders. A company
earning more by the use of assets funded by fixed sources is said to be having a favourable or
positive leverage. Unfavourable leverage occurs when the firm is not earning sufficiently to cover the
cost of funds. Financial leverage is also called trading on equity. Thus, the effect of financial leverage
is also measured through another variable, viz, eps. This is done in the case of joint stock companies
which have raised their proprietary capital by selling units of such capital known as equity shares. Eps
is obtained by dividing earnings by total equity. If a company has preferences shares also on its
capital structure, net equity earnings will be arrived at after deducting interest, taxes and preference
dividend. Capital structure refers to the permanent long-term financing of a company represented by
a mix of long-term debt, preference shares, and net worth. Financial leverage and its effects are a
crucial consideration in planning and designing capital structures.
Question 4. A project requires an initial outlay of Rs. 1,00,000. It is expected to generate the cash
inflows shown in table:
YEAR
CASH INFLOWS
1
50,000
2
50,000
3
30,000
4
40,000
What is IRR of the project?
Answer. Step 1. The average of annual cash inflows is computed as shown in table
YEAR
CASH INFLOWS
1
50,000
2
50,000
3
30,000
4
40,000
TOTAL
1,70,000
Average = 1,70,000/4 = Rs. 42,500
Step 2. Divide the initial investment by the average of annual cash inflows
= 1,00,000/42,500 = 2.35

Step 3. From the PVIFA table for 4years, the annuity factor very near 2.35 is 25%. Therefore, the first
initial, rate is 25% as shown in table
YEAR
CASH FLOW
PV FACTOR AT 25%
PV OF CASH FLOWS
1
50,000
0.800
40,000
2
50,000
0.640
32,000
3
30,000
0.512
15,360
4
40,000
0.410
16,400
Total
1,03,760
As the initials investments of Rs. 1,00,000 is less than the computed value at 25% of Rs. 1,03, 760,
the next trial rate is 26%.
Hence, the changes in the calculations are as shown in table
YEAR
1
2
3
4

CASH FLOW
50,000
50,000
30,000
40,000

PV FACTOR AT 26%
0.7937
0.6299
0.4999
0.3968
Total

PV OF CASH FLOWS
39,685
31,495
14,997
15,872
1,02,049

The next trial rate is 27%, the changes are as shown in table
YEAR
1
2
3
4

CASH FLOW
50,000
50,000
30,000
40,000

PV FACTOR AT 27%
0.7874
0.6200
0.4882
0.3844
Total

PV OF CASH FLOWS
39,370
31,000
14,646
15,376
1,00,392

The next trial rate is 28%, the changes are as shown in table
YEAR
1
2
3
4

CASH FLOW
50,000
50,000
30,000
40,000

PV FACTOR AT 28%
0.7813
0.6104
0.4768
0.3725
Total

PV OF CASH FLOWS
39,065
30,520
14,3047
14,900
98,789

Because initial investment of Rs. 1,00,000 lies between 98789 (28%) and 1,00,392 (27%), the IRR by
interpolation is equal to:
27+1,00,392-1,00,000/1,00,392-98,789*1
=27+392/1603*1
=27+0.2445
=27.2445=27.24%
Question 5. Below table gives the complete details of sales and costs of the goods produced by XYZ
ltd for the year 31.03.12.

TABLE-SALES AND COSTS PRODUCED BY XYZ Ltd.


Sales
80,000
Inventory
Cost of Goods
56,000
31.03.07
9,000
31.03.08
12,000
Accounts Receivables
31.03.07
12,000
31.03.08
16,000
Accounts Payables
31.03.07
7,000
31.03.08
10,000
What is the length of the operating cycle? What is the cash cycle? Assume 365 days in a year.
Answer. Operating Cycle = Inventory Conversion Period + Accounts Receivables Conversion Period
From the above formula we need to first calculate the individual conversion periods.
Inventory conversion period =
Average Inventory/Annual Cost of goods sold*365 = (9000 + 12000) / 2 / 56000*365
= 10500*365/56000 = 68.4 days
Receivables Conversion Period =
Average Accounts Receivables/Annual Sales*365 = (12000 + 16000)/2*365/80000 = 63.9 days
Payables Conversion Period
= Average Accounts Payables/Annual Cost of Goods Sold*365 = (7000 + 10000)/2/56000*365
= 8500*365/56000 = 55.4 days
Operating Cycle = ICP + RCP = 68.4 + 63.9 = 132.3days
Cash Conversion Cycle = OC PDP = 132.3 55.4 = 76.9 days
Question 6. Facebook bought WhatsApp on Feb, 19, 2014 for $19 billion. This was split between $4
billion in cash, $12 billion worth of facebook shares, and $3 billion in restricted stock units to be paid
in four years. Do you think the market capitalization has played a significant role in pricing the
valuation. Discuss the Walters model assumptions in this context.
Answer. Prof. James E. Walter considers that dividend pay-outs are relevant and have a bearing on
the share prices of the firm. He further states that investment policies of a firm. He further states that
investment policies of a firm cannot be separated from its dividend policy and both are interlinked.
The choice of an appropriate dividend policy affects the value of the firm. Walter model clearly
establishes a relationship between the firms rate of return r and its cost of capital k to give a
dividend policy that maximizes shareholders wealth. The firm would have the optimum dividend policy
that enhances the value of the firm.
Walter model can be studied with the relationship between r and k.
If r>k, the firms earnings can be retained, as the firm has better and profitable investment
opportunities and the firm can earn more than what the shareholders could earn by reinvesting, if earnings are distributed. Firms which have r>k are called growth firms and such
firms should have zero payout ratio.

If r<k firm should have a 100% pay-out ratio as the investors have better investment
opportunities than the firm. Such a policy will maximize the firm value.
If r=k, the firms dividend policy will have no impact on the firms value. The dividend payouts can range between zero and 100% and the firm value will remain constant in all cases.
Such firms are called normal firms.
The following are the assumption on which the Walters model is based:
Financing All financing is done through retained earnings. Retained earnings are the only
source of finance, available and the firm does not use any external source of funds like debt or
equity.
Constant rate of return and cost of capital The firms r and k remain constant and any
additional investment made by the firm will not change the risk and return profile.
100% pay-out or retention All earnings are either completely distributed or immediately reinvested.
Constant EPS and DPS The earnings and dividends do not change and are assumed to be
constant forever.
Life The firm has a perpetual life.