Amity Campus

Uttar Pradesh
India 201303

ASSIGNMENTS
PROGRAM: MFC
SEMESTER-II
Subject Name : FINANCIAL MANAGEMENT
Study COUNTRY : GHANA
Roll Number (Reg.No.) : MFC001632010-2012094
Student Name : ENTSUAH LAURENCIA BENTSIWAA

INSTRUCTIONS
a) Students are required to submit all three assignment sets.

ASSIGNMENT DETAILS MARKS

Assignment A Five Subjective Questions 10
Assignment B Three Subjective Questions + Case Study 10
Assignment C Objective or one line Questions 10

b) Total weightage given to these assignments is 30%. OR 30 Marks

c) All assignments are to be completed as typed in word/pdf.
d) All questions are required to be attempted.
e) All the three assignments are to be completed by due dates and need to be submitted for
evaluation by Amity University.
f) The students have to attached a scan signature in the form.

( √ ) Tick mark in front of the assignments submitted

Assignment √ Assignment ‘B’ √ Assignment ‘C’ √
‘A’
Assignment A

1.What is stock split, What are its advantages?

 A stock split is a corporate action that increases the number of the corporation's outstanding shares by
dividing each share, which in turn diminishes its price. There are several ways stock can split. The most
common ways are 2-for-1 and 3-for-2. However, in theory, a company can split the stock in many more
proportions.
 The stock's market capitalization, however, remains the same, just like the value of the $100 bill does
not change if it is exchanged for two $50s. For example, with a 2-for-1 stock split, each stockholder
receives an additional share for each share held, but the value of each share is reduced by half: two
shares now equal the original value of one share before the split.
 A stock split is usually done by companies that have seen their share price increase to levels that are
either too high or are beyond the price levels of similar companies in their sector. The primary motive is
to make shares seem more affordable to small investors even though the underlying value of the
company has not changed.

ADVANTAGES

 PSYCHOLOGY
The first reason is psychology. As the price of a stock gets higher and higher, some investors may feel
the price is too high for them to buy, or small investors may feel it is unaffordable. Splitting the stock
brings the share price down to a more "attractive" level. The effect here is purely psychological. The
actual value of the stock doesn't change one bit, but the lower stock price may affect the way the
stock is perceived and therefore entice new investors. Splitting the stock also gives existing
shareholders the feeling that they suddenly have more shares than they did before, and of course, if
the prices rises, they have more stock to trade.

 LIQUIDITY
Another reason, and arguably a more logical one, for splitting a stock is to increase a stock's liquidity,
which increases with the stock's number of outstanding shares. When stocks get into the hundreds of
dollars per share, very large bid or ask spreads can result. A perfect example is Warren Buffett’s
Berkshire Hathaway, which has never had a stock split. At times, Berkshire stock has traded at nearly
$100,000 and its bid or ask spread can often be over $1,000. By splitting shares a lower bidor ask
spread is often achieved, thereby increasing liquidity.

 INDICATION OF HIGHER FUTURE PROFIT

Share split is generally considered a method of management communication to investors that the
company is expecting high profits in future.

 HIGHER DIVIDEND TO SHAREHOLDERS

When shares are split, the company does not resort to reducing the cash dividends. If the company
follows a system of stable dividend per share, the investors would surely get higher dividends with
stock split..

When a stock splits, there is usually a short term rise in value, but in a short period of time the market
usually normalizes and the value drops somewhat. One disadvantage of a split is that it can create a
false perception of a company in the eyes of the investor, causing them to expect more from a
company's performance. When these performance expectations are not met, investor confidence could
be shaken and this can result in a drop in prices per share.
 2. Discuss the techniques of inventory control.

ANSWER:
Inventory Control is the art and science of maintaining the stock level of a given group of items,
incurring the least total cost, consistent with other relevant targets and objectives set by the management.
Generally, this is measured in terms of service level which is measured in terms of percentage of
compliance of demands (requisitions for materials) of user departments and Inventory Turnover ratio as
explained above.

Various techniques employed for controlling stock levels are

 Selective Management :- In this technique, various items of stores are classified in various
classifications depending upon their consumption, value, unit price, criticality for the organization,
source of supply, purchasing problems, rate of drawal from stores, seasonality and stores balances on
a particular date. Different approaches of control are being followed for different types of items.
Two such classifications ABC & VED

ABC analysis classifies all the inventory items in an organization into three categories.

 A: Items are of high value but small in number. A items require strict control.
 B: Items of moderate value and size which require reasonable attention of the management.
 C: Items represent relatively small value items and require simple control.

Since this method concentrates attention on the basis of the relative importance of various items of
inventory it is also known as control by importance and exception. As the items are classified in
order of their relative importance in terms of value, it is also known as proportional value Analysis.

V-E-D Classification: A-B-C Classification is on the basis of consumption value of an item and does
not give any importance to the criticality of the item and therefore, only A-B-C Classification is not
adequate. Classification done on the basis of criticality of the item is known as V-E-D, where the items
are classified as Vital, Essential and Desirable.

 Vital items are those items which are very critical for the operations and do not permit
any corrective time i.e. they cannot be procured off the shelf if they are not available.
 Essential items are comparatively less vital and work without them cannot be managed
for few days.
 All remaining items are known as Desirable items.

 Management by exception-- In this technique, items with certain exceptions are tackled on different
points of time. For example, overstock items, surplus items and inactive items may require more
attention.
 Designing of recoupments policies -- Recoupment policies are designed in such a manner that
average stocks of materials are optimum.
 Rationalization :- Techniques of standardization and variety reduction are used to minimize lead
time of the material, and reduce unnecessary inventory carrying costs.
 Value Analysis :- Functions performed by the materials are analyzed and alternative designs/raw
materials are suggested to achieve the same function at minimum cost.
 Computerization :- Computer Outputs can be used for scientific forecast of demand to solve many
inventory models, providing optimum safety stocks and for controlling funds.
 3. Examine risk adjusted discount rate as a technique of incorporating risk factor in capital
budgeting.

 The basis of this approach is that there should be adequate reward in the form of return to firms
which decide to execute risky business projects. Man by nature is risk averse and tries to avoid
risk. To motivate firms to take up risky projects returns expected from the project shall have to
be adequate, keeping in view the expectations of the investors. Therefore risk premium need to
be incorporated in discount rate in the evaluation of risky project proposals. Therefore the
discount rate for appraisal of projects has two components. The more uncertain the returns of the
project the higher the risk greater the premium. Therefore, risk adjusted Discount rate is a
composite rate of risk free rate and risk premium of the project.

 Advantages:
1. It is simple and easy to understand.
2. Risk premium takes care of the risk element in future cash flows.
3. It satisfies the businessmen who are risk – averse.

 Limitations:
1. There are no objective bases of arriving at the risk premium. In this process the premium
rates computed become arbitrary.
2. The assumption that investors are risk – averse may not be true in respect of certain investors
who are willing to take risks. To such investors, as the level of risk increases, the discount
rate would be reduced.
3. Cash flows are not adapted to incorporate the risk adjustment for net cash in flows.

4.Critically examine the pay back period as a technique of approval of projects.

 The payback is another method to evaluate an investment project. The payback period is the
length of time that it takes for a project to recoup its initial cost out of the cash receipts that it
generates. The payback period is expressed in years. When the net annual cash inflow is the
same every year, the following formula can be used to calculate the payback period.

The formula or equation for the calculation of payback period is as follows:

Payback period = Investment required / Net annual cash inflow*

Payback period = Cost of project / Annual cash inflow*

 Merits:
 Simple in concept and application.
 Since emphasis is on recovery of initial cash outlay it is the best method for evaluation of
projects with very high uncertainty.
 With respect to accept or reject criterion pay back method favors a project which is less
than or equal to the standard pay back set by the management. In this process early cash
flows get due recognition than later cash flows. Therefore, pay back period could be used
as a tool to deal with the ranking of projects on the basis of risk criterion.
 For firms with shortage funds this is preferred because it measures liquidity of the
project.
  Demerits:
 It ignores time value of money.
 It does not consider the cash flows that occur after the pay back period.
 It does not measure the profitability of the project.
 It does not throw any light on the firm’s liquidity position but just tells about the ability
of the project to return the cash out lay originally made.
 Project selected on the basis of pay back criterion may be in conflict with the wealth
maximization goal of the firm.

 Accept or reject criterion:

 If projects are mutually exclusive, select the project which has the least pay back period.
 In respect of other projects, select the project which have pay back period less than or
equal to the standard pay back stipulated by the management.

5.Examine the relationship of financial management with other functional areas of finance

The relationship between financial management and other functional areas can be defined as follows:

1. Financial Management and Production Department: The financial management and the production
department are interrelated. The production department of any firm is concerned with the production cycle,
skilled and unskilled labour, storage of finished goods, capacity utilisation, etc. and the cost of production
assumes a substantial portion of the total cost. The production department has to take various decisions like
replacing machinery, installation of safety devices, etc. and all the decisions have financial implications.

2. Financial Management and Material Department: The financial management and the material department
are also interrelated. Material department covers the areas such as storage, maintenance and supply of materials
and stores, procurement etc. The finance manager and material manager in a firm may come together while
determining Economic Order Quantity, safety level, storing place requirement, stores personnel requirement,
etc. The costs of all these aspects are to be evaluated so the finance manager may come forward to help the
material manager.

3. Financial Management and Personnel Department: The personnel department is entrusted with the
responsibility of recruitment, training and placement of the staff. This department is also concerned with the
welfare of the employees and their families. This department works with finance manager to evaluate
employees welfare, revision of their pay scale, incentive schemes, etc.

4. Financial Management and Marketing Department: The marketing department is concerned with the
selling of goods and services to the customers. It is entrusted with framing marketing, selling, advertising and
other related policies to achieve the sales target. It is also required to frame policies to maintain and increase the
market share, to create a brand name etc. For all this finance is required, so the finance manager has to play an
active role for interacting with the marketing department.
Assignment B

1. What are the assumptions of MM(Modigliani Miller) approach?

 It is a financial theory stating that the market value of a firm is determined by its earning power
and the risk of its underlying assets and is independent of the way it chooses to finance its
investments or distribute dividends

A firm usually chooses between three methods of financing

 Issuing shares
 Borrowing profits
 Spending profits

 The Modigliani-Miller Theorem comprises four distinct results from a series of papers (1958,
1961, 1963). The first proposition establishes that under certain conditions, a firm’s debt-equity
ratio does not affect its market value. The second proposition establishes that a firm’s leverage
has no effect on its weighted average cost of capital (i.e., the cost of equity capital is a linear
function of the debt-equity ratio). The third proposition establishes that firm market value is
independent of its dividend policy. The fourth proposition establishes that equity-holders are
indifferent about the firm’s financial policy.

 Assumptions
1. The capital markets are assumed to be perfect. This means that investors are free to buy and sell securities.
They are well informed about the risk-return on all type of securities. These are no transaction costs. The
investors behave rationally. They can borrow without restrictions on the same terms as the firms do.

2. The firms can be classified into ‘homogeneous risk class’. They belongs to this class if their expected
earnings is having identical risk characteristics. The driving force in a perfect market for a homogeneous good
is the “law of one price.”

3. All investors have the same expectations from a firm’s net operating income (EBIT) which are necessary to
evaluate the value of a firm.

4. The dividend payment ratio is 100%. In other words, there are no retained earnings.

5. There are no corporate taxes. However this assumption has been removed later.

The relevant assumptions are important because they set conditions for effective arbitrage: When a financial
market is not distorted by taxes, transaction or bankruptcy costs, imperfect information or any other friction
which limits access to credit, then investors can costlessly replicate a firm’s financial actions. This gives
investors the ability to ‘undo’ firm decisions, if they so desire.

In the presence of all these assumptions, the value of a firm is unaffected by how the firm is affected. It doesnot
matter if the firm’s capital is raised by issuing stock or selling debt, it doesnot matter what the fir’s dividend
policy is therefore the Modigliani and Miller is often called capital structure irrelevance principle.
 2. Summaries the features of DCF(Discounted cash flow) technique.

 Essential features of the discounted cash flow model are the following:

 The model uses published accounting data as input. Historical income statements and balance sheets are
used to derive certain critical financial ratios. Those historical ratios are used as a starting point in
making predictions for the same ratios in future years.

 The object of the discounted cash flow model is to value the equity of a going concern. Even so, the
asset side of the balance sheet is initially valued. The value of the interest-bearing debt is then
subtracted to get the value of the equity. Interest-bearing debt does not include deferred income taxes
and trade credit (accounts payable and other current liabilities). Credit in the form of accounts payable is
paid for not in interest but in higher operating expenses (i. e., higher purchase prices of raw materials)
and is therefore part of operations rather than financing.

 The value of the asset side is the value of operations plus excess marketable securities. The latter can
usually be valued using book values or published market values. Excess marketable securities include
cash that is not necessary for operations. For valuation purposes, the cash account may hence have to be
divided into two parts, operating cash (which is used for facilitating transactions relating to actual
operations), and excess cash. (In the case of McKay, excess marketable securities have been netted
against interest-bearing debt at the date of valuation. Hence there are actually no excess marketable
securities in the McKay valuation. This is one of the modelling choices that were alluded to in the
introduction.)

 The operations of the firm, i. e., the total asset side minus excess marketable securities, are valued by the
WACC method. In other words, free cash flow from operations is discounted to a present value using the
WACC. There is then a simultaneity problem concerning the WACC. More precisely, the debt and equity
values enter into the WACC weights. However, equity value is what the model aims to determine.

 The asset side valuation is done in two parts: Free cash flow from operations is forecasted for a number
of individual years in the explicit forecast period. After that, there is a continuing (post-horizon) value
derived from free cash flow in the first year of the post-horizon period (and hence individual yearly
forecasts must be made for each year in the explicit forecast period and for one further year, the first one
immediately following the explicit forecast period).

 For any future year, free cash flow from operations is calculated from forecasted income statements and
balance sheets. This means that free cash flow is derived from aconsistent scenario, defined by
forecasted financial statements. This is probably the mainstrength of the discounted cash flow model,
since it is difficult to make reasonable forecasts of free cash flow in a direct fashion. Financial
statements are forecasted in nominal terms. This implies that nominal free cash flow is discounted using
a nominal discount rate.

 Continuing value is computed through an infinite discounting formula. In other words, free cash flow in
the post-horizon period increases by some constant percentage from year to year, hence satisfying a
necessary condition for infinite discounting. As can be inferred from this list of features, and as will be
explained below, the discounted cash flow model combines three rather different tasks: The first one is
the production of forecasted financial statements. The second task is deriving free cash flow from
operations from financial statements. The third task is discounting forecasted free cash flow to a present
value.
 3. Examine the type and sources of risk in capital budgeting.

Risks in a project are many. It is possible to identify three separate and distinct types of risk in
any project.

TYPES

 Stand – alone risk: it is measured by the variability of expected returns of the project. Stand alone risk
is the risk of a project when the project is considered in isolation.

 Portfolio risk: A firm can be viewed as portfolio of projects having as certain degree of risk.
When new project added to the existing portfolio of project the risk profile the firm will alter.
The degree of the change in the risk depend on the covariance of return from the new project
and the return from the existing portfolio of the projects. If the return from the new project is
negatively correlated with the return from portfolio, the risk of the firm will be further diversified
away.

 Market or beta risk: It is measured by the effect of the project on the beta of the firm. The
market risk for a project is difficult to estimate.

Corporate risk is the projects risks to the risk of the firm. Market risk is systematic risk. The market risk
is the most important risk because of the direct influence it has on stock prices.

Sources of risk: The sources of risks are

1. Project – specific risk

2. Competitive or Competition risk
3. Industry – specific risk
4. International risk
5. Market risk

 Project – specific risk: The sources of this risk could be traced to something quite specific
to the project. Managerial deficiencies or error in estimation of cash flows or discount rate
may lead to a situation of actual cash flows realised being less than that projected.

 Competitive risk or Competition risk: unanticipated actions of a firm’s competitors will

materially affect the cash flows expected from a project. Because of this the actual cash
flows from a project will be less than that of the forecast.

 Industry – specific: industry – specific risks are those that affect all the firms in the industry.
It could be again grouped into technological risk, commodity risk and legal risk. All these risks
will affect the earnings and cash flows of the project. The changes in technology affect all the
firms not capable of adapting themselves to emerging new technology.
The best example is the case of firms manufacturing motor cycles with two strokes engines.
When technological innovations replaced the two stroke engines by the four stroke engines those
firms which could not adapt to new technology had to shut down their operations.
- Commodity risk is the risk arising from the effect of price – changes on goods produced and
marketed.
- Legal risk arises from changes in laws and regulations applicable to the industry to which the
firm belongs. The best example is the imposition of service tax on apartments by the
Government of India when the total number of apartments built by a firm engaged in that
 industry exceeds a prescribed limit. Similarly changes in Import – Export policy of the
Government of India have led to the closure of some firms or sickness of some firms.
 International Risk: these types of risks are faced by firms whose business consists mainly
of exports or those who procure their main raw material from international markets. For
example, rupee – dollar crisis affected the software and BPOs because it drastically reduced
their profitability. Another best example is that of the textile units in Tirupur in Tamilnadu,
exporting their major part of the garments produced. Rupee gaining and dollar Weakening
reduced their competitiveness in the global markets. The surging Crude oil prices coupled
with the governments delay in taking decision on pricing of petro products eroded the
profitability of oil marketing Companies in public sector like Hindustan Petroleum Corporation
Limited. Another example is the impact of US sub prime crisis on certain segments of Indian
economy. The changes in international political scenario also affect the operations of certain firms.
 Market Risk: Factors like inflation, changes in interest rates, and changing general economic
conditions affect all firms and all industries. Firms cannot diversify this risk in the normal course of
business. Techniques used for incorporation of risk factor in capital budgeting decisions.There are many
techniques of incorporation of risk perceived in the evaluation of capital budgeting proposals. They
differ in their approach and methodology so far as incorporation of risk in the evaluation process is
concerned.

4.(a) Deepak steel has issued non convertible debentures for Rs.5 Cr. Each debenture is of par value of Rs.100,
carrying a coupon rate of 14%, interest is payable annually and they are redeemable after 7yrs at a premium of 5
%. The company issued the Non convertible debentures at a discount of 3 %. What is the cost of debenture to
the company? Tax rate is 40%.
(b) Supersonic Industries Ltd. has entered into an agreement with Indian Overseas bank for a loan of Rs.10Cr.
with an interest rate of 10%. What is the cost of loan if the tax rate is 45%?

ANSWERS:
a) Kd = I(1—T) + {(F—P)/n}
(F+P)/2

Kd = 14(1—0.4) + (103—97)/7
(103+97)/2

Kd = (14 – 5.6) + 0.857

200/2
Kd = 0.09257

Kd = 0.093 or 9.3 %

b) Cost of Term Loan

Kt = (I –F)

Kt = I (1 – T)
Kt = 10(1 – 0.45)

Kt = 10 – 4.5 Kt = 5.5%
 Assignment 3 (40 MCQs)
QUESTION ANSWER QUESTION ANSWER
1. B 21 C
2. C 22 C
3 B 23 C
4 A 24 A
5 C 25 C
6 A 26 A
7 A 27 B
8 B 28 A
9 A 29 D
10 C 30 A
11 D 31 C
12 A 32 A
13 B 33 A
14 Yes 34 B
15 A 35 B
16 C 36 B
17 C 37 A
18 A 38 C
19 B 39 B
20 A 40 A