FM Crash Course Material 111 | Derivative (Finance) | Net Present Value

Important Areas: 325201 rajeswari.

4:30 hsbc
1. Capital Budgeting 2. Working Capital Management 3. Cost of Capital 4. Capital Structure 5. Dividend Policy 6. Cash Management 7. Receivables Management Theory: Refer Notes Areas of least importance: • • Risk return analysis Time value of money

Capital Budgeting

Year 1 2 3 4 5 6

Cash inflow from Project A 800000 800000 400000 200000

Cash Inflow from Project B 200000 400000 400000 400000 600000 800000

1. You are

required to suggest which project would be more feasible if the cost of capital is 12% and initial investment of both the projects A & B is Rs.1500000. Calculate PBP, ARR, NPV, PI, IRR

Sol: Calculation of Depreciation: Project A = (1500000-0) /4 = 375000 Project B = (1500000-0) / 6 = 250000 Calculation of Pay Back Period:
Cash inflow from Project A Cumulative Cash flows of A Cash Inflow from Project B Cumulative Cash flows of B


1 2 3 4 5 6

800000 800000 400000 200000

800000 1600000 2000000 2200000

200000 400000 400000 400000 600000 800000

200000 600000 1000000 1400000 2000000 2800000

Project A = 1 + 700000 = 1 + 0.875 = 1.875 years 800000 Project B = 4+ 100000 = 4 + 0.17 = 4.17 years 600000 Calculation of ARR: ARR = Avg. PATAD X 100 Avg. Investment Conversion Table:

Year 1 2 3 4 5 6

Cash inflow from Project A (PATBD) 800000 800000 400000 200000

Depreciait on 375000 375000 375000 375000

PATAD 425000 425000 25000 -175000

Cash Inflow from Project B (PATBD) 200000 400000 400000 400000 600000 800000

Depreciati on 250000 250000 250000 250000 250000 250000

PATAD -50000 150000 150000 150000 350000 550000 13000 00


Project A Avg. PATAD= 700000/4 = 175000 Avg Investment = (Initial Investment + Salvage Value)/2 = (1500000 + 0) / 2 =750000 ARR = (175000 / 750000) * 100 = 23.33% Project B Avg. PATAD = 1300000/6 = 216667

8929 0.7305 0.Avg.1 02 284712.88% Calculation of NPV. PI and IRR: NPV = ∑DCI –DCO Profitability Index or Benefic cost ratio= GPI/GBCR = ∑DCI ∑DCO NPI/NBCR = NPV Or GBCR .4096 Discount ed Cash Flows @ 18% 640000 512000 204800 81920 1438720 1500000 -61280 Discoun t factor at 12% 0.6400 0.5 311 Year 1 2 3 4 NPV @ 12% = 263856. 531 1500000 263856.7118 0.8000 0.8547 0.5120 0.0 991 127103.6244 0.5337 ∑DCI Less: DCO NPV Discount ed Cash Flows @17% 683760 584400 249760 106740 1624660 1500000 124660 Discount factor at 25% 0.6 157 1763856.6355 Discounte d Cash Flows @12% 714285. Investment = (Initial Investment + Salvage Value)/2 = (1500000 + 0) / 2 =750000 ARR = (216667 / 750000) * 100 = 28.7 143 637755.5311 .1 ∑DCO IRR = LRR + Positive NPV X 100 Positive NPV + Negative NPV Project A Cash inflow from Project A (PATBD) 800000 800000 400000 200000 Discoun t factor at 17% 0.7972 0.

531 = 1.8264 0. 085 1500000 122127.GBCR = 1763856.4019 0.5 432 267918.1 134 405304.5674 0.9091 0.3 82 372552.1759 1500000 NBCR = 263856.3 813 1377872.8333 0. 32 1500000 282129.8929 0.3349 ∑DCI Less: DCO NPV Discounte d Cash Flows @20% 166666.7972 0.4 286 318877.1759 1500000 IRR = 17 + 124660 124660 +61280 X (25 – 17) = 17 + 124660 X 8 185940 = 17 +5.5066 Discounte d Cash Flows @ 12% 178571. 935 Discoun t factor at 12% 0.6830 0.7118 0.2 346 241126.6355 0.5 51 284712.6209 0.3 205 1 2 3 4 5 6 .5 12 300525.9 2 273205.8 969 1782129.7513 0.6944 0.5645 Discount ed Cash Flows @ 10% 181818. 93 1500000 410259.5311 = 0.7 94 451579.0 991 254207.4823 0.2 314 340456.5787 0.9 15 Discount factor at 10% 0.4 815 192901.3635 = 22.6 667 277777.7 778 231481.1 44 1910259.3635% Project B: Year Cash Inflow from Project B (PATBD) 200000 400000 400000 400000 600000 800000 Discount factor at 20% 0.1 82 330578.

92 Particulars Net Cash outlay Estimated life Income tax rate Cut off rate for appraisal PBDT Year 1 Year 2 Year 3 Year 4 Year 5 Project A 40000 4 years 50% 10% 12000 14000 16000 22000 Project B 50000 5 years 50% 10% 14000 16000 18000 22000 20000 = 10 + 410259. is examining two mutually exclusive proposals for new capital Investments.93 X (20 – 10) 410259.19 1500000 NBCR = 282129.NPV @ 12% = 282129 GBCR = 1782129.32 = 0.32 = 1. The data on the proposals are as follows: .7060% 2.19 1500000 IRR = 10 + 410259.93 X 10 532387.93 + 122127. A Ltd.7060 = 17.85 = 10 + 7.

Particul ars Year Year Year Year 1 2 3 4 PATBD 11000 12000 13000 16000 Cumulativ e Cash flows 11000 23000 36000 52000 Using different techniques of capital budgeting. Sol: Calculation of Depreciation: Project A = 40000-0 / 4 = 10000 Project B = 50000-0 / 5 = 10000 Conversion Table for Project A: Particul ars Year Year Year Year 1 2 3 4 Project A (PBDT) 12000 14000 16000 22000 Less Dep 10000 10000 10000 10000 PBT 2000 4000 6000 12000 Less tax at 50% 1000 2000 3000 6000 PATAD 1000 2000 3000 6000 Add Dep 10000 10000 10000 10000 PATBD 11000 12000 13000 16000 Conversion Table for Project B: Particul ars Year Year Year Year year 1 2 3 4 5 Project A (PBDT) 14000 16000 18000 22000 20000 Less Dep 10000 10000 10000 10000 10000 PBTAD 4000 6000 8000 12000 10000 Less tax at 50% 2000 3000 4000 6000 5000 PATAD 2000 3000 4000 6000 5000 Add Dep 10000 10000 10000 10000 10000 PATBD 12000 13000 14000 16000 15000 Calculation of Pay back period: Project A: PBP = 3 years + 4000 . advice which proposal would be preferable.

Investment = (50000 + 0)/2 = 25000 ARR = (4000/25000) * 100 = 16% Calculation of NPV.1 . PATAD = (1000+2000+3000+6000)/4 = 3000 Avg. Investment Project A Avg. Investment = (40000 + 0)/2 = 20000 ARR = (3000/20000) * 100 = 15% Project B Avg.25 years Project B: Particul ars Year 1 Year 2 Year 3 Year 4 year 5 PATBD 12000 13000 14000 16000 15000 Cumulativ e Cash flows 12000 25000 39000 55000 70000 PBP = 3 years + 1000 16000 = 3.16000 = 3. PATAD X 100 Avg. PI and IRR: NPV = ∑DCI –DCO Profitability Index or Benefic cost ratio= GPI/GBCR = ∑DCI ∑DCO NPI/NBCR = NPV Or GBCR . PATAD = (2000+3000+4000+6000+5000)/5 = 4000 Avg.0625 years Calculation of Accounting rate of Return: ARR = AVg.

9 GBCR = 40611.8 40000 611.6575 0.7513 Discount ed Cash flows @ 10% 10909.9 10928 40611.∑DCO IRR = LRR + Positive NPV X 100 Positive NPV + Negative NPV Project A: Discount factor @ 10% 0.7561 0.8264 0.015 40000 NBCR = 611.6575 Discount ed Cash flows @ 15% 10434.5718 Discount ed Cash flows @ 15% 9565.71 9148.30 X (15 -10) =10.1 9916.72 8547.8+3665.8 9766.30 Particul ars Year Year Year Year 1 2 3 4 PATBD 11000 12000 13000 16000 NPV @ 10% = 611.05 36334.87 9205.8 611.8696 0.8264 0.2 Discount factor at 15% 0.8 = 0.8 = 1.23 12000 13000 14000 .7513 0.015 40000 IRR = 10 + 611.2 10518.7152% Project B: Particul ars Year 1 Year 2 Year 3 PATBD Discount factor @ 10% 0.7 8 9829.22 9073.9091 0.7 0 40000 -3665.9091 0.8 Discount factor at 15% 0.2 10743.683 ∑DCI Less: DCO NPV Discount ed Cash flows @ 10% 10000.8696 0.7561 0.

1+3924.048 50000 IRR = 10 + 2412.5718 9148.00 Alternativ Alternativ 52412.1 3. Bajaj Industries can obtain a cash inflow of Rs.07 X (15 -10) = 10 + 1. By investing Rs. The internal rate of return on investment alternatives c. IRR on incremental Investment Sol: . That would produce cash inflow of Rs.6048 PV of cash inflows 90120 180240 NPV (PVCI .048 50000 NBCR = 2412.9 e e 3 Cash outflow 160000 Less: 50000 75000 50000 Cash inflow per annum 25000 50000 DCO -3924.07 PVAF @12% NPV years 2412.1 10928 0.6209 Particulars ∑DCI GBCR = 52412.5 0.1265 16000 15000 0. The representative of another equipment manufacturer presents an alternative proposal.75000 in new machinery.4972 7458.25000 for every year for 5 years.9034 = 11.6048 for 5 3.2016 1.1 2412.9034 ---------------------------3.Year 4 Year 5 NPV @ 10% = 2412. An investment of this type can be expected to yield a discounted rate of return of 12% You are required to find a. Which alternative is more attractive if discountrate is 12% b.1 46075.683 0. Bajaj Industries plans investment of Rs.50000 every year for 5 years in future .1 = 0.1 = 1.CO) 15120 20240 PI (PVCI/CO) 1.160000 in his company’s equipment.05 1st 2nd 9313.

1st alternative is better choice Calculation of IRR: Particulars Cash outflow Cash inflow per annum PVAF @20% for 5 years PV of cash inflows NPV (PVCI . 2nd alternative is better choice where as according to PI method.Accoridng to NPV.8776 =19.8776% IRR for 2nd alternative =12 + 20240 X (20 – 12) 20240 + 10470 =12 + 5.9906 149530 -10470 IRR for 1st alternative= =12 + 15120 15120 + 235 =12 + 7.2725% X (20 – 12) Calculation of Incremental IRR .9906 74765 -235 2nd Alternativ e 160000 50000 2.CO) 1st Alternativ e 75000 25000 2.2725 =17.

then the interest rate will be 12% and equity capitalization rate will be 20% You are required to compute the value of the firm and its overall cost of capital under different options. The firm has two options to raise debgt to the extent of 30% or 50% of total funds.3522 83805 -1195 =14 + 827.5 + 1195 =14 + 0.4091% Capital Structure Traditional Approach 4.Particulars Incremental Cash Outlfow (160000 75000) Incremental cash invlow (50000-25000) PVAF for 5 years PV of Cash inflows NPV DF @ 14% 85000 25000 3. The firm is now contemplating to redeem a part of capital by introducing debt financing.4091 =14. 300000. Sol: Particulars Total Debt Rate of interest EBIT Less Interest 0% debt 30% Debt 600000 10% 300000 60000 50% debt 1000000 12% 300000 120000 300000 . 2000000 by issue of equity with equity capitalization rate of 16%.5 DF @ 15% 85000 25000 3. if the firm opts for 50% debt. IT is expected that for debt financing up to 30% the rate of interest will be 10% and equity capitalization rate is expected to increase to 17%. However.5 X (15. XYZ Ltd is expecting an EBIT of Rs.14) 827.5 827. The Company presently raise its entire fund requirement of Rs.4331 85827.

18000 0 18000 Nil 18000 Nil 18000 2016 360 1656 .2% shares of Y Less Interest on loan of 6000 Net return Income from Y Ltd. Explain how under MM Approach.EBT Cost of equity Value of Equity (E) = EBT/Ke Value of Debt (D) Total value of the firm V = (E + D) Overall cost of capital (EBIT /V) 300000 16% 1875000 240000 17% 1411765 600000 2011765 14.2 60000 18000 Y 150000 1 18000 Step 1: Investor will sell I the market 10% of shares in Co.Y Particulars No. X and will realize Rs.X will be better off in switching his holdings to Co.79% 1875000 16% Modigliani and Miller Approach: 5. X at 6% interest) Step 3: The investor will invest in 16800 in shares of Co.2*10/100) Step 2: He will borrow a sum or Rs. of equity shares Market price of shares 65 debentures PBIT X 90000 1. The following is the data regarding the two companies X and Y belonging to the same equivalent risk class. 18000 3600 14400 Nil 14400 nil 14400 1440 0 1440 Particulars EBIT less Interest EBT Less tax EAT Less Pref dividend EAESH Return on 10% investment in shares of X and 11. an investor holding 10% of share in co. Y by purchasing 16800 (16800/Rs.91% 180000 20% 900000 1000000 1900000 15.6000 (10% of debt of Co. 1) Present income in X Ltd.10800 (90000*1.

12*0.e 10.5+(0.12*0.12*0.12*0.200000 through debentures or term loan at the rate of 10% p.5)= (0.12*0. 200000 by issuing 8% oreference shares.7)= (0.The investor will be better of by switching of his investment from X to Y because he can get better returns.5 13% 14% 16% 20% Weighted avg.4)= 12% 11. Rs.a.20% The optimal debt equity mix is 30:70 as the weighted average cost of capital is lowest at this mix i. has equity share capital of Rs.6)+(0.05*0. a.12*0.25% 12.05*0. by calculating composed cost of capital. cost of capital (0. plans the following financing alternatives.50% 6% 6.8)= (0.100 each. the following estimates of the debt equity capital (after tax) have been made at various levels of debt equity mix Debt as a % of total Capital employed 0% 10% 20% 30% 40% 50% 60% Cost of debt in % 5% 5% 5% 5. 100000 by issuing equity shares at Rs.2)+(0.05*0.6)= (0.30% 11% 10.05*0)+(0..75% 10.05*0. In considering the most desirable capital structure of a Co.a d.75% --------------------------------7. It wishes to raise further 3 lakhs for expansion scheme. 500000 divided into shares of Rs. ABC ltd.5 13% 14% 16% 20% Calculate the optimal debt equity mix of the co.05*0. By issuing equity shares only b.1)+(0. By raising term loan only at 10% p. Debt as a % of total Capital employed 0% 10% 20% 30% 40% 50% 60% Cost of debt in % 5% 5% 5% 5. Rs. 6.9)= (0.4)+(0.05*0. 100000 by issuing equity shares and Rs.50% 7% Cost of equity in % 12% 12% 12. The co. c.50% 6% 6.12*100)= (0. You are required to suggest the best alternative giving your comment .3)+(0.50% 7% Cost of equity in % 12% 12% 12.80% 11.

of eq.187 5 2 500000 100000 0 200000 6000 150000 20000 130000 45500 84500 0 84500 14. of equity shares EBIT Less int EBT Less Tax at 35% EAT Less Pref dividend EAESH EPS (EAESH / No. 200000 .08333 33 3 500000 0 0 300000 5000 150000 30000 120000 42000 78000 0 78000 15.6 4 500000 100000 200000 0 6000 150000 0 150000 52500 97500 16000 81500 13.e further financing of Rs.5833 33 Conclusion: From the analysis it is observed that EPS is highest with 3rd alternative i. 300000 can be done by raising term loan only at 10% p. XYZ corporation has planned for expansion which calls for 50% increase in assets. The alternatives before the corporations are issue of equity shares or debt at 14%.a. 150000 and corporate tax rate is 35% Sol: Calculation of earnings per share: particulars Equity existing New equity 8% preference shares 10% debt No. Indifference point: 8. Its balance sheet and P&L account are as given below Balance sheet Liabilities 12% Debentures Rs Assets 250000 Total Assets Rs. shares) 1 500000 300000 0 0 8000 150000 0 150000 52500 97500 0 97500 12.assuming that the estimated EBIT after expansion is Rs.

10 each) General reserve 100000 00 750000 0 200000 00 0 200000 00 P&L Account Particulars Sales Less total cost excluding interest EBIT Less Interest on debentures EBT Less tax at 50% EAT EPS PE ratio market price (EPS* PE ratio) Amt 750000 00 675000 00 750000 0 300000 720000 0 360000 0 360000 0 3. If EBIT is 10% of sales. Using PE ratio. calculate the market value of shares at each sales level for both debt and equity financing Sol: . the EPS would remain the same whether new funds are raised by equity or debt c.6 5 times 18 If the corporation finances the expansion with debt. the incremental financing charges will be @ 14% and PE ratio is expected to be 4 times. determine a. The co. expects that its new issues will be subscribed to at a premium of 25% With the above information. the PE ratio will remain at 5 times. 80000000 and 100000000 b.0 Equity shares (1000000 eq shares of Rs. If expansion is through equity. calculate EPS at sales levels of 40000000. After expansion determine at what level of EBIT.

15 3 97 48.a. Sol: Particulars Plan A Plan B Plan C .03 8 crore Debt Equity 80 80 17 63 31.5) 1000000 By solving above two equations you get EBIT = 3450000. (Internal paper) X co.5) 1800000 = EBIT – 1700000(1-0.5 No.5 18 lakh 2.15 3 77 38.5 10 lakh 3. Calculation of EPS at different levels particulars EBIT @ 10% Less interest (3 + 14) = 17 EBT Less tax at 50% EAT No.5 10 lakh 1. is considering three different plans to finance its total project cost of Rs.5 38. Compute EPS under different plans. Indifference between two alternative financing EBIT – 300000(1-0. 100 lakhs and 20% EBIT is forecasted.100 lakhs.5 10lakh 4.5 48.e EPS of both options will be same -----------------------------9.14 10 crore Debt Equity 100 100 17 83 41. of Equity shares Eps 4 crore Debt Equity 40 40 17 23 11. At this level of EBIT.5 b.15 3 37 18.5 18 lakh 1.5 41. there exists indifference point i.69 Note: Existing share New issue [ (10*25%) + 10] 10 12.5 11.5 31. Tax rate 50%.5 18.5 18 lakh 2. ltd.100 per share) 8% debentures Plan A 50 50 Plan B 34 66 Plan C 25 75 Sales are estimated at Rs. The plans are: particulars Equity (Rs. of shares = 10000000 = 800000 +1000000 = 1800000 12.

What is the firms ROI b. the firms EBT will be equal to zero. d. 200000 and 10% debentures of Rs.5500000. What will be the new EBIT.65 II 20 6 14 7 7 25000 28 I ----------------------------10.72 7. variable cost of Rs. of Eq. 4200000 and fixed cost of Rs. 1000000. At what level of sales. financial and combined leverages c.7500000. A firm has a sales of Rs. financial and combined leverages.5000000.EBIT in laksh Less Interest EBT in lakhs Less tax @ 50% EAT in lakhs No. It has a debt of Rs 4500000 @ 9% and equity of Rs.28 14. . What are the operating. fixed cost of Rs. What are the operating. Leverages (internal paper): A firm has a sales of Rs.60000. If the sales drop to Rs. 700000. Sol: Particulars Sales Less VC Contribution Less FC EBIT Less Interest @ 10% on 500000 EBT Operating Leverage (Cont / EBIT) Financial Leverage (EBIT / EBT) Combined Leverage (Cont / EBT) Amoun t 100000 0 700000 300000 200000 100000 50000 50000 3 2 6 11. variable cost of Rs.36 34000 21. a. 500000.36 7. shares ( Equity capital / 100) EPS Rank 20 4 16 8 8 50000 16 III 20 5.

44 c. Operating Leverage: Cont/EBIT = 3300000/2700000 = 1.22 Financial Leverage: EBIT/EBT = 2700000/2295000 = 1. Calculation of Return on investment: EBIT/Capital employed = 2700000/ (5500000 +4500000) = 27% b. EBIT Sales Less VC (5000000*56%) Contribution Less FC EBIT 5000000 2800000 2200000 600000 1600000 d.Sol: Sales Less VC Contribution Less FC EBIT Less int @ 9% on 4500000 EBT 7500000 4200000 3300000 600000 2700000 405000 2295000 a. Sales Less VC (56% of sales) Contribution(44% of sales) Less FC EBIT Less int @ 9% on 4500000 EBT 2284091 1279091 1005000 600000 405000 405000 0 .17 Combined leverage: Cont/EBT = 3300000/229500 = 1. Sales level at which EBT of the firm will be equal to zero.

53% Po d. You have been given below the company’s capital structure. which it considers to be optimal. Present total capital = 1000000 Expansion in total assets = 50% Total capital required for expansion = 1000000*50% = 500000 b. Calculate WACC using marginal weights.50000. Calculation of WACC based on marginal rates Source Book Weights Cost Weighted .95. Calculation of cost of new issues: Cost of debentures= Kd = Kd(1-t) = 14% (1-0. Particulars 8% debt 9% Pref shares Equity shares Amt. Equity share currently selling at Rs.100 can be sold at Rs. How much of the capital must be financed by issuing new equity shares to maintain the optimal capital structure. 400000 100000 500000 New debentures would be sold at 14% coupon rate (interest) and will be sold at par. b. Preference shares will have 15% rate and will also be sold at par. by the end of the current year. What is the required amt. of capital. A fast growing co. The retained earnings for the year are estimated to be Rs.12.5) = 7% Cost of preference shares = 15% Cost of equity shares = D1 X 100 + G = (10/95)*100+7 = 17. Sol: a. Assuming all asset expansion is included in the capital budget. d. The tax rate is 50%. 14% debt = 200000 15% Preference shares = 50000 Equity shares = 200000 Retained earnings = 50000 c. c. Calculate the cost of new issues of equity shares and retained earnings. Calculate: a. wants to expand its total assets by 50%. The share holders required rate of return is 17% consisting of a dividend yield of 10% and an expected growth rate of 7%.

0175 0.02)/11.58)/11.16-11.76)/12. Cost of floatation is Rs.3 c.4 d.4-12.07 0.5 = 4.0612 Weighted average cost of capital 13.5)/10.16 = 4.76-12.59% Operating Cycle .0150 0. From the following.1 0.4 0.1 0. Dividend paid on outstanding shares over past 6 years year 1 2 3 4 5 6 Dividend per share 10.02 = 5.58 12. a.16)/12. determine the cost of equity shares of x Ltd.4 0.150 b.0007 0.58-11.08% (12.5 11.02% Ke = (D1/Po)*100 + G = (3/150)*100 + 5 = 14. Current market price of a share is Rs.10 per share Sol: Approximate growth rate is: 5% (11.15 0. Assume a fixed dividend pay out ratio e.93% (13.95% (11. Expected dividend on new shares at the end of current year is Rs.14% Debt 15% Preference Equity Retained earnings value 200000 50000 200000 50000 0.76 13.76 = 5.02 11.18% 0.58= 5.00% (12.16 12.02-10.0280 0. 14.1753 cost 0.

accounts payable Average raw materials and stores consumed per day Average cost of production per day Avg cost of goods sold per day Average sales per day Avg. stock of work in progress Avg. stock of RM Avg Raw materials consumed Amount (Rs.5 = 24 days Finished goods = Avg. Calculate the operating cycle duration and working capital requirements of the company Particulars Avg. cost of production = 300/12. The following information is available for a company. In Lakhs) 200 300 180 300 180 10 12.5 18 20 10 = 200 = 20 days 10 Work in progress = Avg. stock of finished goods Avg cost of goods sold per day = 180/18 = 10 days .14. stock of raw materials and stores Avg. WIP Avg. finished goods inventory Average accounts receivables Avg. credit purchases per day Sol: Raw materials = Avg.

Accounts payable Avg. Calculate Gross working capital requirements in the cash required for contingency is Rs. 4. Particulars Raw material WIP Finished goods Opening Closing Balance Balance 230 250 50 52 260 300 . credit purchases per day = 180/10 = 18 Operating Cycle = Raw materials + work in progress + finished goods + Debtors = 20 + 24 + 10 + 15 = 69 days Cash cycle = Raw materials + work in progress + finished goods + Debtors – Creditors = 20 + 24 + 10 + 15 -18 = 51 days Working capital requirement = (Cost of goods sold * Cash cycle) + desired cash balance = [18 * 51] + 0 = 918 ----------------------------------15. sales per day = 300/20 = 15 days Creditors = Avg.Debtors = Average Accounts receivable Avg.75 lakh. from the following information.

stock of RM = 230 + 250 / 2 = 480 / 2 = 240 Avg.810 lakhs Manufacturing expenses is Rs. stock of work in progress = 50 + 52 / 2 = 102 / 2 = 51 Avg.380 lakhs Depreciation Rs.2000 lakhs 450 300 Sol: Avg.240 lakhs Sales Rs.160 lakhs Selling and distribution and financial cost Rs. stock of finished goods = 260 + 300 / 2 = 560 / 2 = 280 Avg. stock of accounts payable = 250 + 300 /2 = 550/2 = 275 Cost Sheet: Opening Stock of RM Add: Purchase Less closing stock of raw materials Raw Materials Consumed Add: Manufacturing Exp Depreciation Exercise Duty 230 810 1040 250 790 380 60 160 600 . stock of accounts receivables = 380 + 450 /2 = 830 /2 = 415 Avg. 60 lakhs Excise duty Rs.Book debts (Receivables) 380 Trade creditors 250 Purchase of raw materials and stores is Rs.

25 lakhs Operating Cycle = Raw materials + Work in progress + Finished goods + Debtors + Creditors Raw materials: 240 / 2.41 lakhs Avg.56 lakhs Avg.86 lakhs Avg. Cost of production per day = 1388/360 = 3.64 – 122.49+74. credit sales per day = 2000/360 = 5.71 Working Capital Requirements: .40 days Debtors = 415/ 5.22 = 138.41 = 63.25 = 122.64 days Creditors = 275 / 2.21+ 63.86 = 13.22 days Operating Cycle = 109.49+74.21+ 63.56 = 74.19 = 109. credit purchases per day = 810 / 360 = 2.19 lakhs Avg.Add: Opening work in progress Less: Closing Work in progress Cost of production ADD: Selling and distribution and financial exp. cost of goods sold per day = 1588/360 = 4.59 + 13.59 + 13.59 days Work in progress = 51/ 3.21 days Finished goods = 280 / 4.93 Cash cycle = 109. Add: Opening stock of finished goods Less: Opening stock of Finished goods Cost of goods sold 1390 50 1440 52 1388 240 1628 260 1888 300 1588 Calculation of Averages: Average Raw materials consumed per day = 790/360 = 2.64 = 260.

00.000 960000 1200000 480000 200000 400000 The company enjoys one month credit from the suppliers of raw material and maintains 2 month sock of raw materials and half month finished goods stock. Particulars Sales at 3 months credit Raw materials Wages paid (paid 15 days in arrears) manufacturing Expenses (paid 1 month in arrears) Administration expenses (paid 1 month in arrears) Sales promotion exp. sells its product at a gross profit of 20% on sales. cost of goods sold * Cash cycle)+ Cash balance = (4. XYZ ltd.00. The following information is extracted from the Co’s annual accounts for the year ended 31/12/08.000 12. Assuming a 10% margin. Cash balance is maintained at Rs.100000 as precautionary balance.75 = 617.(Avg. Find out the W C requirement for the company.74 lakhs ------------------------------Working Capital Estimation 16.41 *139)+4. Payable 1/2 year in advance Income tax payable quarterly (last installment due) Amount (In RS) 40. Sol: Sales Less: Gross Profit (4000000*20%) Cost of Goods Sold 4000000 800000 3200000 .

provides the following particulars The following particulars are available: .Particulars Current Assets Cash Raw materials stock (1200000 *2/12) Amount/unit Stock of finished goods (3200000* 0.5/52) Elements of Cost (Rs) Debtors (3200000 * 3/12) 80 Advance paymentRaw materials of sales promotion expenses (200000* Direct labour 30 6/12) Current LiabilitiesOverheads 60 Creditors ( 1200000*1/12) Total cost 170 O/S wages (960000 * 15/360) Add: Profit 30 o/s administrationSelling Price expenses (480000*1/12) 200 O/s manufacturing expenses (1200000 *1/12) O/s Income Tax (40000*1/4) Working Capital Add: 10% Margin Net working capital requirement Amount 100000 200000 133333 800000 100000 100000 40000 40000 100000 100000 1333333 380000 953333 95333 1048666 17. A proforma cost sheet of a co.

• • • • • • • • • Raw materials are in stock for an average of 1 month Materials are in process on an avg.5/12) Direct Labour (104000*30*0.25000 You are required to prepare a statement showing the working capital need to finance a level of activity 104000 units production. Sol: Statement showing net working capital: Particulars Current assets Raw material (104000*80*1/2) Work in progress (2 weeks or 0.5/12*50/100) Over heads (104000*60*0.5 months) RM (104000*80*0.5/12*50/100) Finished Goods RM (104000*80*1/12) Direct Labour (104000*30*1/12) Over heads (104000*60*1/12) Debtors(75% of sales) RM (104000*75/100*80*2/12) Labour (104000* 75/100*30*2/12) Overheads(104000*75/100*60*2/12) Cash in hand and at bank Amt Amt 693333 346667 65000 130000 693333 260000 520000 1040000 390000 780000 541667 1473333 2210000 25000 4943333 Current Liabilities: . for ½ month Finished goods are in stock on an avg for 1 month Credit allowed by suppliers in 1 month Credit allowed to customers is 2 months Lag in payment of wages is 1 ½ weeks Lag in payment of overheads is 1 month The ¼ th of the output is sold against cash Cash in hand and at bank is expected to be Rs.

Credit allowed by suppliers is 1 month You are required to prepare a statement of working capital and forecasted profit and loss account and balance sheet of the company assuming that Share capital 1500000 8% debentures 200000 Fixed assets 1300000 Statement of Net working Capital: Particulars Current assets Amt Amt . Raw materials are expected to remain in stores for an avg. A proforma cost sheet of a company provides the following particulars Elements of Cost Material 40% Direct Labour 20% Overheads 20% The following further particulars are available: a. Materials will be in process on an avg. period of 1 month f. It is proposed to maintain a level of activity of 200000 units b.5/52) Outstanding overheads(104000*60*1/12) Net working capital ------------------------------------ 693333 90000 520000 1303333 3640000 18.Creditors RM (103000*80*1/12) Outstanding wages (104000*30*1. Finished goods are required to be in stock for an avg.12 per unit c. period of 1 month d. Selling price is Rs. Credit allowed to debtors is 2 months g.-1/2 month e.

5/12*50/100) Finished Goods RM (200000*12*40/100*1/12) Direct Labour (200000*12*20/100*1/12) Over heads (200000*12*20/100*1/12) Debtors(75% of sales) RM (200000*12*40/100*2/12) Labour (200000*12*20/100*2/12) Overheads(200000*12*20/100*2/12) 80000 40000 10000 10000 80000 40000 40000 160000 80000 80000 60000 160000 320000 620000 Current Liabilities: Creditors(200000*12*40/100*1/12) 80000 540000 Forecasted P & L a/c To materials (200000*12*40/100) To labour (200000*12*20/100) To overheads (200000*12*20/100) 960000 By Cost of Goods sold 480000 (2400000*80/100) 480000 1920000 To COGS To GP C/d 1920000 By sales 480000 2400000 To int on debentures (200000*8/12) To N/P 192000 0 240000 0 240000 0 192000 0 16000 464000 480000 480000 480000 .5/12) Direct Labour (200000*12*20/100*0.Raw material (200000*12*40/100*0.5/12*50/100) Over heads (200000*12*20/100*0.5/12) Work in progress RM (200000*12*40/100*0.

Foods Ltd. Lag in wages and overhead payment is 1 month . The following data is available Unit Cost structure of the packet at current level: Raw material Wages (variables) Overheads (Variables) Fixed Overhead Profit Selling price 4 2 2 1 3 12 a. is present to operating at 60% level producing 36000 packets fo snack food and proposes to increase capacity utilization in the coming year by 33 1/3% over the existing level of production. Suppliers grant 3 month credit to the co.Forecasted balance sheet Share capital 18% debentures Net profit Creditors 1500000 200000 464000 80000 Fixed assets Current assets RM WIP FG Debtors Cash and bank balance 130000 0 80000 60000 160000 320000 324000 224400 0 2244000 --------------------------------19. c. Finished goods remain in warehouse for 1 month d. RM will remain in stores for 1 month before issuing for production material will remain in process for further 1 month b. Debtors are allowed credit for 2 months e.

Prepare a projected profitability statement and the working capital requirement at the new level.12 (A) Less: Cost RM @ Rs.19500 is to be maintained. 2 overheads fixed Total Cost (B) Profit (A –B) Per Annum 576000 192000 96000 96000 36000 420000 156000 Per Month 48000 16000 8000 8000 3000 35000 13000 Statement of net working capital Current assets Cash Raw materials(48000*1/12*4) Work in progress Raw materials Wages (48000*2*1/12*50/100) Overheads (48000*2*1/12*50/100) Fixed overheads (36000*1/12*50/100) Finished goods Raw materials Wages (48000*2*1/12) Overheads (48000*2*1/12) Fixed overheads (36000*1/12) Debtors Raw Materials (48000*4*2/12) Wages (48000*2*2/12) Overheads (4800*2*2/12) Fixed overheads(36000*2/12) 19500 16000 16000 4000 4000 1500 16000 8000 8000 3000 32000 16000 16000 6000 25500 35000 70000 166000 .2 Overheads @ Rs.4 Wages @ Rs. assuming that a minimum cash balance of Rs. Sol: Units at 80% capacity = 36000/60*80 = 48000 Projected profitability statement at 80%: particulars Sales @ Rs.

Less: Current Liability Creditors (48000*4*3/12) outstanding wages(48000*2*1/12) Overheads: Variable (48000*2*1/2) Fixed (36000*1/12) Net working capital 20.5000 in the first week of August. selling and dist.30000 is due to be collected with a premium of Rs.10000 Dividends from Investment amount to Rs. • • • • • • .65000 will be purchased and paid for the month of august Dividends of Rs.1000 are expected in July Lag in payment of wage is 1/4th month Share call money of Rs. prepare a cash budget for 3 months commencing form 1/6 when the bank balance to likely to be Rs.10000 Administration. 48000 8000 8000 3000 67000 99000 From the following forecast of income and expenditure. Exp 10000 14000 15000 17000 13000 Month April May June July August Sales 80000 76500 78500 90000 95500 Purchases 41000 40000 38500 37000 35000 Wages 5600 5400 5400 4800 4700 Factory expenses 3900 4200 5100 5100 6000 Additional Information: • • • Assume 50% of sales are for cash There are 2 month credit period allowed to customers and received from suppliers A sales commission of 5% on total sales is payable in the 2nd month after sales A plant valued at Rs.15000 has to be paid in july Advance Income tax is to be paid in June to the extent of Rs.

June = 5400*1/4 = 1350 July = 4800*3/4 = 3600 4950 August . sales and dist.Sol: Cash budget for 3 months commencing from 1st June: Particulars 1. From the following data forecast cash position at the end of April. Exp Sales commission Purchase of plant Payment of dividend Advance Income tax Closing Balance (1+2-3) June 10000 39250 40000 July 8750 45000 38250 1000 August 7125 47750 39250 35000 41000 5400 5100 15000 4000 40000 4950 5100 17000 3825 15000 10000 8750 7125 -2025 38500 4725 6000 13000 3925 65000 Working Note: Calculation of wages June – May = 5400*1/4 = 1350 June = 5400 * ¾ = 4050 5400 July . May and June .July = 4800*1/4 = 1200 Aug = 4700 *3/4 = 3525 4725 21. Receipts Cash sales of 50% Collection from debtors Dividend from investment Share call money premium Payments Payment to creditors Wages Factory expenses Admn. Opening Balance 2.

Month FEB March Apl May June Sales 120000 130000 70000 116000 85000 Purchases 80000 98000 100000 103000 80000 Wages 10000 12000 80000 10000 80000 selling expenses 5000 9000 5000 10000 6000 Further Information: a.20000 is payable in June f.2000 received half yearly in march and September h. Sales at 10% are realized in the month of sales. Receipts June 29700 . Selling expenses are paid in the month itself e. Dividend of Rs. Income from investment of Rs. balance is realized equally in two subsequent months b. Income tax of Rs.12000 is also payable in June g. 20% of wages paid in arrears in the following month d. Opening Balance 40000 47700 2. May and June Particulars April May 1. Cash on hand on 1st April is estimated to be 40000 Sol: Working Notes: Calculation of wages April 20% of march 12000 80% of April 8000 May 20% of April 8000 80% of May 10000 2400 6400 8800 1600 8000 9600 June 20% of May 10000 80% of June 8000 2000 6400 8400 Cash budget for the month of April. Creditors are paid for in the month following the month of supply c.

3.000 and an avg. The company wants to experiment with more liberal credit policy on the ground that increase in collection period will generate addl.5 and the average cost per unit at current level is Rs. Sales.10. Collection period of 45 days. A company currently has an annual turnover of Rs. 2/5 * 100 = 40% Bad Debts (Expected sales * %ge of Existing 45 1000000 1 60 1050000 50000 20000 21000 2 75 1080000 80000 32000 32400 3 85 1100000 100000 40000 44000 4 105 1125000 125000 50000 67500 10000 . The current bad debts losses is 1% and the required rate is 20% Sol: Particulars Collection period in days Expected sales Expected additional sales Contribution on sales (sales – vc/Sales)*100) i. kindly indicate which of the policies you would like the co.Cash sales @ 10% Collection from drs I st Installment 2nd Installment 3. From the following information. Payments Payments to creditors Wages Selling expenses Income tax Dividend paid Closing Balance (1+2-3) 7000 58500 54000 98000 8800 5000 11600 31500 58500 100000 9600 10000 8500 52200 31500 103000 8400 6000 20000 12000 -27500 47700 29700 Receivables Management 22. to adopt Increase in collection period 15 days 30 days 40 days 60 days Credit Policy 1 2 3 4 Increase in sales 50000 80000 100000 125000 Increase in default 2% 3% 4% 6% The selling price of the product is Rs.4 and variable cost per u it is Rs.e.00.

collection period is 50 days.1000000.e extension of credit upto 60 days is recommended for adoption by the company. bad debt losses 6% of sales and collection xpenses Rs. has sales of Rs. -----------------------------------------23. policy 1 i. The co. Avg.a. has 2 alternative collection programmes particulars Avg. The cost of funds is 15% p. Hence.1 only.default) Additional Bad debts Contribution of addl sales – addl bad debts (A) Average receivables (Expected sales*Credit period/360) Investment in receivables at variable cost (Receivables * Variable cost /selling price) Increase in investment in receivables Required return on addl invt at 20%(B) Excess of addl contribution over required rate of return on addl invt. (A-B) 11000 9000 22400 9600 34000 6000 57500 -7500 125000 175000 225000 259722 328125 75000 105000 30000 6000 135000 60000 12000 155833 80833 16167 196875 121875 24375 3000 -2400 -10167 -31875 Conclusion: The addl. Contribution over required rate of return on additional investment in receivables is positive under credit policy no. collection period Receivables (sales*50/365) Reduction in receivables Savings in interest at 15% (A) % bad debts Present 1000000 50 136987 1 1000000 40 109589 27398 4109 4 2 1000000 30 82192 54795 8219 3 6 . A co.10000. collection period reduced to Bad debts losses reduced to Collection expenses 1 40days 4% of sales 20000 2 30 days 3% of sales 30000 Evaluate which programme is viable Sol: Particulars Sales Avg.

profit motive or not is considered to be a financial concern and its success or failure to a large extent depends on its financial decisions. DIVIDEND DECISIONS. etc Thus Financial Management is an area of business which deals with 3 major decisions namely: 1. and 3. Debtors and other Current assets? How much of its earnings should the company distribute as dividends?. What are the objectives/goals of financial management? . Financial Management as a discipline helps the finance manager to address the following key issues of business: 1. 2. What will be the total fund requirement of the business? Whether a particular investment alternative is profitable? Is a merger or acquisition or a strategic alliance advisable? What should be the ideal Inventory. 3. 2.. 5. 2.Bad debts Reduction in bad debt from present level (B) incremental Benefits (A+B) Collection expenses Incremental collection expenses © Net incremental benefits (A+BC) 60000 40000 20000 24109 20000 10000 14109 30000 30000 38219 30000 20000 18219 10000 Collection policy 2 is recommended as it results in higher profits THEORY MATERIAL TWO MARK QUESTIONS: 1.. Cash. Define Financial Management? Ans: Any business for that matter whether large or small. 4. INVESTMENT DECISIONS. FINANCING DECISIONS.

e. Define CAPM? Explain its importance and assumptions? Ans: The Capital asset pricing model was an extension of Markowitz’s Porfolio Theory by William Sharpe and others. The financial decisions taken by a firm must confine and complement to its objectives.. A rupee one worth today is more valuable than a rupee worth tomorrow. What is time value of money? Ans: There exists an inverse relationship between ‘time’ and ‘value of money’ i. What is Venture Capital Financing? Ans: It is a long term investment in growth oriented small and medium firms. 5. Such investments can be an Equity investment or in the form of loan finance/Convertible debt. Causes: a) Inflation. The CAPM is based on the following assumptions: 1. Thus CAPM theory predicts the relationship between risk of an asset and its expected return. as time increases. c) Current consumption is preferred rather than future consumption. 4. The major objectives of Financial management include Profit maximization and Wealth maximization. 3. The model attempts to determine the true price of an asset reflecting the expected return and risk associated with the asset.Ans: Operations of a firm must be with a focus to achieve its objectives in a timely and well planned manner. b) Capital carries interest along with it. It is a high risk-high return financing. value of money decreases and vice-versa. All investors prefer that security that provides highest return for a given level of risk or the lowest risk for a given level of return. thereby makes an attempt to price an asset based on its risk – return relationship. . The main objective of venture capital financing is to earn capital gain on equity investments.

Variance. Options. 6. 4. Holding period among investors are common. There are no taxes. 5. All investors have similar or homogenous expectations regarding the expected returns. Swaps etc. Futures: A Futures contract is a standardized forward contract where quantity. . Investors can Borrow and Lend money at risk free rate of return which is assumed to remain constant over a period of time. Co-variance and Co-relation of returns among all securities. 3. Futures. Derivative has a derived value or a dependent value and its value changes with changes in the value of the underlying asset. Options: An Option gives its Holder the right to buy or sell an underlying asset on or before a given date at a fixed price but with no obligation to buy or sell the same on payment of a fixed premium to the writer.2. The Futures contracts are traded on organized exchanges which are settled with differences. Derivative instruments include Forwards. Forward: A Forward contract is a tailor made contract whose terms are negotiated between the buyer and the seller which are not traded on organized exchanges and are useful to hedge forward receivables and payables where the exact date of such transaction is not fixed or known. date and delivery conditions are standardized. Swaps may either be an interest rate or currency swaps. Define Derivative Instrument? Ans: A Derivative may be a commodity derivative or a financial derivative whose value is derived from the value of an underlying asset. Swaps: A Swap is a contract between two counter parties to exchange two streams of payments for an agreed period of time. Standard deviation.

c. Heavy Expenditure Long Duration Irreversibility of decision making Complexity of decision making Direct Impact on organization 10.7. Projects are ranked based on Profitability Index and are selected in the order of Highest to lowest till the level of capital availability. sale of financial asset by the Originator of asset to the SPV and the issuance of securities by the SPV to investors against the financial asset held by it. 8. d. Securitization involves creation of a Special purpose vehicle (SPV) to hold the financial assets underlying the securities. Define Capital Rationing? Ans: It is the process of allocating scarce capital resource to unlimited capital requirement in an optimal manner so as to maximize overall Net present value. Define Capital Budgeting. ‘capital’ refers to capital assets or fixed assets and the term ‘budgeting’ refers to a financial statement prepared for a specific future period with the approval of top management. e. Importance: a. Explain its importance? Ans: The term. b. 9. Thus. the term capital budgeting refers to future investment decision of a firm in purchase or acquisition of fixed assets. Define Securitization? Ans: Securitization is a process of pooling and repacking of homogenous illiquid assets into liquid marketable securities that can be sold to investors. What are ADR and GDR? .

Since the offer is not made to Public at large. A share split affects the par value and the number of outstanding shares of the company but however the Networth of the firm remains unaltered.S. The shares trade as domestic shares.S. mutual funds. Define Stock Split? Bonus share? (Stock dividend) Reverse Stock split? Rights Issue? (Preferential allotment) Ans: It is a method to increase the number of outstanding shares through a proportional reduction in the par value of the share. . An ADR is a negotiable certificate issued by a U. ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction. with the underlying security held by a U. exchange.S. dollars. ADRs are denominated in U. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U. What are Sweat Equity Shares? Ans: It refers to shares issued to owners. IPO’s are generally issued by small and newly established companies seeking capital from the public to expand. It is a bank certificate issued in more than one country for shares in a foreign company. employees or any other related persons to the company for contributing their time and effort for a particular project or to the company in general. financial institution overseas. 12. 14. Define IPO? Ans: It is the first sale of shares by a Private company to the Public. insurance companies and pension funds. 11. What is a Private Placement? Ans: It is the sale of security to a relatively small group of investors like large banks. The IPO offer can be either fixed Price issue or a Book building issue. 13. ADR enables an US investor to buy shares in foreign companies without undertaking cross border transactions. detailed financial information is not disclosed and no need to prepare prospectus. A GDR is a financial instrument used by private markets to raise capital denominated in either U. The shares are held by a foreign branch of an international bank. dollars or Euros.S.Ans: An ADR represents the ownership in the shares of a foreign company trading on US financial markets. It represents the efforts put into start up company by the promoters and employees in exchange for ownership shares. the placement does not have to be registered with the Securities and Exchange Commission. but are offered for sale globally through the various bank branches. ADR carries prices in US dollars and can be traded like the shares of US based companies.S.

To signify future growth. the equity share capital remains unchanged and only the par value of the share and the number of shares changes. With a Stock split. DIFFERENCES BETWEEN BONUS ISSUE AND STOCK SPLIT: In case of Bonus issue. If Internal rate of return is greater than the cost of capital then the project is said to yield positive NPV or else it is not worthy accepting the project. The declaration of bonus shares will increase the paid up share capital and reduces the reserves and surplus of the company.REASONS FOR SHARE SPLIT: a) b) c) d) e) To make small investors interested. 15. To avoid future dilution of control. To signify future profit opportunities. REVERSE SPLIT: It is the opposite of Stock Split wherein the number of outstanding shares are reduced with increase in Par value of share so as to increase the market price of share. keeping the networth (Share capital + Retained Earnings) constant. It is the discount rate that equates the present value of cash inflows with the initial investment associated with a project. It increases the number of outstanding shares of the company proportionately. To increase dividend. Define Internal rate of return? Ans: It is at the rate of return at which NPV of a project becomes zero. the balance of Reserves and Surplus will decrease and Share capital increases proportionately keeping the par value of the share unchanged. Right Issue: The existing shareholders have right to subscribe to the new issue on a preferential basis before issuing it to the general public by the company. Bonus share or Stock Dividend: It is the payment of dividend in kind through Bonus issue. It is a right to prevent diversion of control. .

Equity. What is Concentration Banking? Ans: It is a collection procedure used in Cash management where payments are made to regionally dispersed collection centres. c) Modigliani and Miller Approach. Preference. c) Modigliani and Miller Approach. Define operating cycle and cash cycle? . 21. b) Gordon Approach. reduces float by shortening the lethargy as well as postal and bank floats. It reduces float by shortening the postal and bank float.16. What is Lock Box system? Ans: It is a collection procedure in which payers send their payments/cheques to a nearby post box that is emptied by the firm’s bank several times and the bank deposits the cheque in the firm’s account. 20. 17. Reserves and term loan in proportion to each sources of funds in the Capital structure. What is Marginal Cost of Capital? Ans: It is the cost of raising additional unit of finance over and above the current cost. 18. Identify various theories of Dividend? Ans: The various theories of Dividend include: a) Walter relevance theory. Define Weighted Average Cost of Capital? Ans: It is the Overall cost of various sources of funds being Debt. then deposited in local banks for quick clearing. Identify various theories of Capital Structure? Ans: The various theories of Capital structure include: a) Net Income Approach. In short it is the cost of raising new source of finance. b) Net Operating Income Approach. Calculation of Weighted Average Cost of Capital WACOC or KA = WD KD + WP KP + WE KE + WR KR + WT KT 19. 22.

Define Leverage? Explain the types of leverages? Ans: The term Leverage refers to the firm’s ability to use fixed cost funds to magnify the return to the shareholders.RAW-MATERIAL----WIP----FG----DEBTORS----CASH OC = R+W+F+D CC = OC – Crs period. Financial Leverage may be defined as the effect of interest on the level of EPS. FINANCIAL LEVERAGE: It measures the percentage change in EPS for percentage change in EBIT. the changes in net income and the level of business risk. changes in EPS and Financial Risk. Business risk also called as Operating risk is the risk associated with the normal day to day operations of the firm. Operating Leverage = Contribution EBIT Degree of Operating Leverage = %Change in EBIT %Change in Sales 2. The objective of using financial leverage is to finance the incremental capital required through debt financing which is relatively cheaper . 23.Ans: Operating cycle also called as Working capital cycle or Current asset cycle refers to total time involved in conversion of cash to cash equivalents and back to cash. CASH ---. The components of Financial Risk is the chances of the firm will fail because of its inability to meet interest burden and the variability of earnings available to equity shareholders caused by fixed financial charges. OPERATING LEVERAGE: It measures the percentage change in EBIT for percentage change in sales. In other words Leverage is the employment of fixed assets or funds for which a firm has to meet fixed costs like interest obligation. Operating leverage may be defined as the effect of fixed expenses on the level of Net income. TYPES OF LEVERAGES: 1. The components of business risk are the chances that the firm will fail to create sufficient earnings before interest and taxes and the variability of earnings before interest and taxes. irrespective of the level of operating.

Define JIT Policy? Ans: Just in Time is an inventory strategy where zero level of inventories are maintained. It aims at maximizing return on investment . The difference between Return on Investment & Borrowing Cost is enjoyed by the equity shareholders. Combined Leverage may be defined as the effect of both Fixed expenses and interest on the level of EPS. Financial Leverage = EBIT EBT Degree of Financial Leverage = %Change in EPS %Change in EBIT 3. But however too much of debt financing is not advisable since the organization may fall into a ‘DEBT TRAP’ An ideal debt equity ratio of 1:2 is always preferable to be maintained. COMBINED OR COMPOSITE OR TOTAL LEVERAGE: It measures the percentage change in EPS for percentage change in SALES.compared to equity financing. Trading on Equity: According to this concept borrowing in debt is feasible provided Return on Investment is greater than Borrowing Cost. They reduce the cost of carrying inventories to large extent and they aim at production based on the available orders. Combined Leverage = Contribution EBT Degree of Combined Leverage = %Change in EPS %Change in sales 24. changes in EPS and Total risk associated with it. This magnifies the extra return to equity shareholders and hence Financial leverage is also called as “Trading on equity”.

Ex: 30% of debtors to be received within 1month. change in discount factor.Com. V. RUDRAMURTHY COMMENCING 5TH BATCH FROM 3rd WEEK OF AUG. 20% within 1 to 2month and 50% above 2months. CA Inter. PGDMM.25. 9845620530/9844519866 . 26. Define Ageing Schedule? Ans: It is a schedule of Total Debtors breakup based on age or time period. change in expected cash flow estimates etc. B. MAK MUKESH ACADEMY FOR KNOWLEDGE IN PURSUIT OF KNOWLEDGE TECHNICAL ANALYSIS COURSE & ADVANCED DERIVATIVES "Investment in stock market is not a bet on your luck instead it is bet on your knowledge". PGDBA (Symbiosis). MFM. Larger the debtors in the earlier days. BY: Prof. M-Phil. better it is. Define Sensitivity Analysis? Ans: It is the study of change in NPV for changes in factors such as change in Life expectancy of the asset. 2009 AT MALLESHWARAM M.

He has a very high level of practical experience in the areas of Accounting. 5. St-Joseph etc. Real time learning with live Charts and Stocks.. 3. He has also authored a book on Income Tax for Undergraduate students and has presented papers in various conferences. 4. Certificate issued on successful completion of the course. M-Phil. 7. 2. EIGHT AND TWELVE MARK QUESTIONS: 1. Define Working Capital? What are the factors affecting Working capital requirement? Ans: MEANING OF WORKING CAPITAL: The term Working Capital refers to investment required for the day today business administration. WORKING CAPITAL MANAGEMENT: It is the management of problems relating to Current assets and Current liabilities. PGDMM. HURRY UP !!!!!!!!!!!!!!!!!! LIMITED SEATS ONLY……………. . E-Contact with the faculty round the clock. BLOCK YOUR SEATS BY MAKING EARLY REGISTRATIONS FACULTY PROFILE: Prof. Convenient weekend Classes only on Saturdays and Sundays. 6. Examples drawn from Indian Capital Markets for better understanding. It also studies the interrelationship that exists between current assets and current liabilities. Auditing.Com. Suitable for aspiring executives and students who want to learn the art of Capital markets. He is the Chairman of Technical Study India. Corporate specific workshops and Institute specific training is also provided. Two days Workshop on weekends or 6 months of complete learning of technical’s from basics to advanced levels. He has conducted many workshops and one day seminars in various B-Schools like Christ. 8. MFM. B V Rudramurthy: M.Program Highlights: 1. 5years of teaching experience in various top B-Schools of Bangalore. PGDBA (Symbiosis). Finance and Taxation. A well honed curriculum to suit the Industry requirement and Personal Investments. In other words it is the excess of Current assets over Current Liabilities. an institute of excellence on training corporate and student executives on areas of Capital Markets. 9. CA Inter.

Dividend policy. Tax level: Higher the tax level. Nature of Business: Automated and manufacturing units require higher working capital compared to labour intensive and service units. higher the working capital requirement and viceversa. Vagaries in purchase of raw materials: A smooth and undisturbed supplies results in lesser stock holding and lower working capital requirement and vice-versa. . Business cycle: During the periods of business prosperity. higher the working capital requirement and vice-versa. 4. Liberal dividend policy results in higher working capital requirement and strict dividend policy will lead to higher profits being transferred to reserves and thereby lower working capital requirement. require higher working capital compared to organization which adapt seasonal production policy. higher is the working capital requirement due to higher provisions for tax and vice-versa. Growth opportunities: More the future growth prospectus. Production cycle: Longer the production cycle. 6. Profit level: Higher the profits. Production policy: Organisations which follow continuous production policy through out the year. higher the amount transferred to reserves and higher is the cash profits available for working capital and vice-versa. 5. 10. higher working capital is required and viceversa. 3. 2.FACTORS AFFECTING WORKING CAPITAL REQUIREMENT: 1. 7. 8. 9. Credit policy: Liberal Credit policy from supplier leads to lower working capital requirement and strict credit policy of the supplier leads to higher working capital.

lesser the money transferred to reserves and higher is the dependence on external equity which results in greater diversion of control and viceversa. 7. 4. What do you mean by Dividend Policy/Decision? Explain the factors affecting dividend policy of a firm? Ans: MEANING OF DIVIDEND POLICY: Dividend policy of an organisation refers to amount of earnings to be distributed as dividend to shareholders and the amount of earnings to be retained by the firm. 9. Access to capital markets: Companies having better access to capital markets need not depend heavily on their reserves and hence can pay higher dividend whereas companies having poor access to capital markets will pay lesser dividends and transfer more amount to reserve. higher is the dividend payment and vice-versa. higher is the difference between external equity and retained earnings and vice-versa. The following factors affecting the dividend policy of the firm: 1. Difference in cost of external equity and retained earnings: Higher the floatation cost. Thus they demand higher dividends keeping in mind the tax benefit. lower the dividend paid and vice-versa. companies pay lesser dividend and transfer higher amount to reserve. Liquidity: Higher the liquidity.2. Tax benefits: On payment of dividends. share holders pay no tax and they end up paying higher tax on capital appreciation. 8. companies are bound to pay higher and if shareholders prefer capital appreciation. 2. 6. 5. Diversion of control: Higher the dividend. Fund requirement: Higher the fund requirement. Shareholders preference: If shareholders prefer higher dividend. 3. Investment opportunities: . Legal restrictions: More the legal restrictions on payment of dividend. Thus companies with higher floatation cost will pay lesser dividend and depend more on retained earnings and vice-versa. lesser is the dividend and vice-versa.

State of economy: During periods of recession. At any given payout ratio. 14. higher is the interest burden and lower is the profits leftover for distribution of dividend and vice-versa. Briefly explain the dividend policy? Ans: 1. 3.Companies having better investment prospects pay lesser dividend and transfer more funds to reserves and vice-versa. Debt obligation: Higher the debt obligation. 15. Inflation: Higher the inflation. higher should be the level of current dividends too and vice-versa. company is forced to pay higher dividend to meet the raising prices and vice-versa. Nature of earnings: Higher the cash earnings. Stable or Constant Dividend Payout ratio: The ratio of dividend to earnings is known as payout ratio. Past dividend rates: Higher the past dividend rates and better the track record of payment of dividend. the percentage of earnings paid out as dividend remains constant. . The above Dividend policy transmits the variability of earnings to dividends. higher is the dividend and vice-versa. 10. the amount of dividend and additions to reserve will increase with increase in earnings and vice versa. companies pay lesser dividend and transfer more amount to reserves and vice-versa. Loan covenants: Presence of loan covenants results in lesser payment of dividend and vice-versa. 11. 13. 12. According to this policy.

3. irrespective of the fluctuations in earnings. the policy to pay a minimum dividend per share with an Extra dividend based on earnings is desirable. Constant Dividend per share or dividend rate: It is the policy of firm to pay a fixed amount per share as dividend or a fixed percentage on paid up capital as dividend every year. The above policy is suggested to those firms whose earnings are stable and do not fluctuate much.2. the annual dividend per share or the dividend rate may be increased. This policy does not mean that dividend will always remain constant and never increase. Constant Dividend per share plus extra dividend: For companies with fluctuating earnings. When the firm reaches new level of earnings and expects to maintain it. The small amount of fixed dividend .

3. Confidence among shareholders. Financial Instruments. MUKESH ACADEMY FOR IN PURSUIT OF KNOWLEDG E . 2. Financial Markets. Market for Debenture and Preference shares. Raising additional finance. 4. 6. Stability in market prices of shares. Investors desire for current income. 3. 4. Institutional investor’s attitude. Explain briefly Indian financial system? Ans: THE FINANCIAL ENVIRONMENT: Financial decisions are to be made keeping in mind the finance environment surrounding it. Financial Institutions.ensures minimum dividend every year and in years of prosperity the company pays an additional dividend over and above the minimum dividend. SIGNIFICANCE OF STABILITY OF DIVIDENDS: 1. The financial environment comprises of subsystems such as: 1. 5. Large number of investors with small holdings reduces chances of dilution. 2. 7. and Financial Services. 4. The growth of any economy is largely depended on the strength of its financial system.


Bangalore -03 FOR FURTHER DETAILS CONTACT: 9845620530/9844519866/080 23311916 . keeping students career in view. 6. 3. Malleshwaram. who can impart rich industry experience and currently working as a Professor in Finance. Convenient class timings with separate morning and evening batches. M-Phil.500/Rs. 6. He has a very high level of practical experience in the areas of Accounting. 6..500/Rs. Finance and Taxation. Prof. 3. St-Joseph etc. MFM. Santanam: A Senior Professor who has taught in various reputed B-Schools and has 40 years of teaching experience. He has also authored a book on Income Tax for Undergraduate students and has presented papers in various conferences. 100% syllabus coverage with complete theory as well as problem notes. PGDMM. 4 Main.HURRY UP !!!!!!!!!! LIMITED SEATS ONLY…ADMISSIONS OPEN….500/Rs.Com. 3. FEES STRUCTURE I SEM BU ONE SUBJECT BOTH SUBJECTS Rs. 2. B V Rudramurthy: M. He has conducted many workshops and one day seminars in various B-Schools like Christ. Next to ICICI Bank. 11 Cross. 9. Prof. BLOCK YOUR SEATS BY PICKING UP YOUR APPLICATION. FACULTY PROFILE: 1. (PhD). All previous year question papers of respective universities solved. 5years of teaching experience in various top B-Schools of Bangalore. 6. 3. Shilpa A V: Has worked in Oracle Financial Services Software Ltd.000/- I SEM VTU ONE SUBJECT BOTH SUBJECTS Rs. 3. an institute of excellence on training corporate and student executives on areas of Capital Markets. 12000/- Iii SEM BU ONE SUBJECT TWO SUBJECTS ALL SUBJECTS IV SEM VTU ONE SUBJECT TWO SUBJECTS THREE SUBJECTS ALL SUBJECTS APPLICATION FORMS ARE AVAILABLE AT THE FOLLOWING ADDRESS: th th #48.500/Rs. 100% results assured or else 100% fee back. Complete revision after the completion of the course.. Auditing. Teaching with web support and online learning.500/Rs.500/Rs. SPECIAL FEATURES:         Concept based learning. CA Inter. Practical application of concepts taught. He is the Chairman of Technical Study India.500/Rs.500/Rs.9. PGDBA (Symbiosis).500/Rs.

etc. 7. 6. Financial Instruments include Primary issues were the company directly issues these instruments to the ultimate investor and Secondary market issues where the financial intermediaries exchange them at competitive prices. Unorganised bankers include Money lenders and Indigenous bankers. . 2. Financial Institutions: They act as intermediaries who bring investors and borrowers on a common platform. Banking institutions in India fall under the category of both Organised and Unorganised Sectors. Financial Instruments: Financial instruments represents claim against future income in the form of interest and dividends. Bonds and other long term instruments 3. Treasury bills.FUNCTION OF FINANCIAL ENVIRONMENT: Functions performed by a financial system or environment consist of: 1. Acts as intermediary between Lenders and Borrowers. They facilitate price discovery mechanism and provide liquidity to financial assets. Money markets deal with short term financing instruments such as Call money. Financial markets can be classified into Money market and Capital Markets. Financial institutions are classified into Banking and Non-Banking Institutions. 4. 3. Provides payment system for exchange of goods and services. as well as capital appreciation in the form of increase in the principal value of the asset. RRB’S. NABARD. Provides symmetry of information to all its participants. 2. Whereas Capital markets provides markets for long term borrowings and lending’s exceeding 1year. Preference shares. Provides a mechanism for managing and controlling risk. It channelises savings into productive investment avenues. It includes instruments such as Equity shares. COMPONENTS OF INDIAN FINANCIAL SYSTEM: 1. Certificate of Deposits (CD’S) and Commercial papers (CP’S). Co-Operative Banks. 5. Helps in Capital formation. Organised banking sector includes Commercial Banks. Decreases transaction costs. They mobilize savings from investors and channelise them to productive resources. Financial Markets: Financial markets are market for creation and exchange of Financial assets and other credit instruments.

Hire purchase. enjoy the rewards and bear the risk of ownership. Portfolio management. right to control. c) Equity dividends won’t get any tax benefit. right to income. e) Encourages company to venture into new projects. Preference Capital: It represents hybrid form of financing which combines the features of equty and debenture. whereas services such as Credit rating. Disadvantages: a) Raising of external equity results in dilution of control. They include both Fund based and Fee based services. Advantages: a) Payment of equity dividend is not compulsory. Financial Services. Their liabilities are limited to the extent of their capital contribution. d) Dividends are tax exempt for shareholders. Explain the various sources of long term finance? Ans: The various sources of Long term finance are: 1. Equity Capital: It represents ownership capital as equity shareholders own the company. c) Helps in raising other sources of finance. b) Cost of Equity is very high. Explain various Capital Structure theories? Ans: (Refer Notes) 6. Preference dividend is fixed in nature and redeemable after a specific period .4. The rights of Equity shareholders include Pre-emptive right. d) Higher Floatation cost. 5. b) No redemption date or repayment date for capital. right in liquidation and right to vote. Venture capital etc are fund based services. Factoring. Services such as Leasing. Loan syndication etc are fee based services. Financial services include intangible services rendered by Financial institutions to its users. 2.

of time. Preference shareholders generally do not enjoy voting power and payment of preference dividend is not a tax deductible expense. Advantages: a) Payment of Preference dividend is not compulsory. b) No financial crisis on redemption date. c) Helps in raising other sources of finance. d) No dilution of control. e) Encourages company to venture into new projects. f) No assets are pledged in favour of preference shareholders. g) Cheaper than cost of Equity capital. Disadvantages: a) Expensive compared to debenture capital. b) Any default on payment of dividend or redemption affects the goodwill of the company. c) Preference shareholders acquire voting power if dividends are skipped for more than four continous years. . d) Higher Floatation cost compared to debt capital.
3. Debentures:

It represents instruments for raising long term debt. Debentures are similar to any other borrowing where interests and principal is paid at specific periods of time. It is more flexible than term loan as they offer greater flexibility with regard to maturity, interest rate, repayment and security. Advantages: a) Payment of interest is a tax deductible expense . b) It doesn’t result in dilution of control. c) Lower floatation cost. d) Debt holders do not participate in the surplus funds of the company.

e) The burden of financing debt is fixed in nominal terms. Disadvantages: a) Non payment of interest or principal in time results in loss of goodwill. b) Higher debt financing increases financing leverage and thereby financial risk of the company. c) Debt covenants restricts the company in its decision making. d) Lower Inflation cost results in higher payment in nominal terms since it is fixed in nominal terms. 4. Term Loan: It represents long term loans given by banks and other financial institutions. Similar to debenture issue, interest and principal is repaid at fixed intervals of time. Advantages: a) Payment of interest is a tax deductible expense . b) It doesn’t result in dilution of control. c) Lower floatation cost. d) Debt holders do not participate in the surplus funds of the company. e) The burden of financing debt is fixed in nominal terms. Disadvantages: a) Non payment of interest or principal in time results in loss of goodwill. b) Higher debt financing increases financing leverage and thereby financial risk of the company. c) Debt covenants restrict the company in its decision making. d) Lower Inflation cost results in higher payment in nominal terms since it is fixed in nominal terms.
5. Retained Earnings or Reserves and Surplus:

It represents that portion of earnings which are not distributed as dividend. Depreciation even forms source of internal accruals and generally these funds are used for acquisition of Fixed assets.

Advantages: a) Readily available internally. b) It doesn’t result in dilution of control. c) Eliminates floatation cost. d) Does not carry any negative or bad impression on the company. Disadvantages: a) The amount of capital to be raised is restricted. b) Higher cost of financing since it is equal to cost of equity. c) May invest in sub marginal projects since few company view reserves as cost less.

7. Explain international financing instruments? Ans: 1. Euromarkets: Euromarkets refer to a collection of international banks that help firms in raising capital in a global market which is beyond the purview of national regulatory body.

2. American Depository Receipt: An ADR represents the ownership in the shares of a foreign company trading on US financial markets. ADR enables an US investor to buy shares in foreign companies without undertaking cross border transactions. ADR carries prices in US dollars and can be traded like the shares of US based companies. An ADR is a negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help to reduce administration and duty costs that would otherwise be levied on each transaction. 3. Global Depository Receipt: A GDR is a financial instrument used by private markets to raise capital denominated in either U.S. dollars or Euros. It is a bank certificate issued in more than one country for shares in a

Collection Cost: It is the administrative cost incurred in the collecting of receivables. 7. 5. Nature of Industry. Timing issues. It results in blocking up of funds for extended time period. 8. accounting records. etc 2.Attitude of the management towards control. 6. Default Cost: . Delinquency Cost: It is the cost arising out of failure to pay on due date. Factors influencing Credit policy of a firm? Ans: 1. 2. 4. It even includes expenses incurred to acquire credit information. 4. Leverage ratios for other firms in the industry. costs associated with collecting the overdues etc. The shares trade as domestic shares. 9. Profitability Aspect – EBIT-EPS analysis. Control Aspect. It includes costs such as additional costs on creation and maintenance of credit department with staff. Tax Planning. Liquidity Aspect – The cash flow ability of the firm to finance its fixed charges.Comparing the debt equity ratio in the industry in which the firm is operating. stationery. postage expenses etc.foreign company. The shares are held by a foreign branch of an international bank. Capital Cost: It is the cost incurred on the use of additional capital to support the extra debtors due to higher credit sale or extending the credit period. but are offered for sale globally through the various bank branches. 3. 3. Explain various factors influencing Capital Structure Decisions? Ans: 1.

The firm should select those decisions which have the effect of increasing the market price of the firms stock. Advantages of Wealth Maximization being the primary objective of a firm include: a) It is conceptually possible to adapt wealth maximization as an objective in different financial decisions. It ignores the degree of risk levels among different investment alternatives. Wealth of a shareholder is measured by the present market value of shareholders equity holding and total wealth of the firm equals the number of shares outstanding times the market price per share. d) It does consider the value of money at different time intervals. It ignores the concept of time value of money.It is cost of funds which cannot be recovered because of inability of the customer to pay. 10. It is said that “Let the business of business be business” and thus profit maximization can be considered as the main objective of business. b) It is an impersonal and democratic policy where the shareholders who may be offended by the firm’s policy are at liberty to sell their holdings and switch over to other companies. 1. However the above objective suffers from the following serious drawbacks: d) It is a vague and static concept which doesn’t distinguish between short term and long run profits. c) It considers risk too as a criterion for financial decision making and selection of best alternative. The major objectives of Financial management include Profit maximization and Wealth maximization. Such debts are treated as bad debts and have to be written off as they cannot be realized. It takes into consideration the returns available from different investment alternatives and their risk levels over a definite time period. What are the objectives of financial management? Ans: Operations of a firm must be with a focus to achieve its objectives in a timely and well planned manner. PROFIT MAXIMIZATION: Profit maximization being the predominant objective of any micro economic study can be extended to even to area of financial management. The financial decisions taken by a firm must confine and complement to its objectives. WEALTH MAXIMIZATION: It is the present value of all future benefits what a shareholder of a firm expects to receive over a defined period of time. f) g) . 2. e) It gives maximum weightage to shareholders of firm who are the real owners of the firm. e) It doesn’t define the term profit which is so ambiguous.

. 11. etc which was a rare phenomenon and laid less stress on day today financial problems (Working capital Management problems) which occurred often. For better understanding. c) It ignored the area of allocation of capital. the scope of financial management can be studied under 2 approaches.Considering the drawbacks of Profit maximization as an Objective of financial management and superiority of wealth maximization objective. b) Its Scope was restricted to procurement of funds to meet corporate financial needs and commitments. one can reasonably assume wealth maximization as a reasonable guide to financial management decisions. c) Different sources through which the required capital can be raised. MODERN APPROACH: a) It was viewed in a broader sense. Explain the scope of financial management? Ans: The Scope of Financial Management refers to the discipline. namely: I. reorganizations. area and subject matters that is covered under the heading Financial Management. as well as its allocation. b) It concentrated too much on events like mergers. TRADITIONAL APPROACH: a) It was viewed in a narrow sense. which is a central issue of Financial Management. Accounting and Procedural aspects of Capital markets. d) Institutional arrangements and Financial instruments through which the required funds are raised. e) Legal. b) Its Scope covered both the aspects of procurement of funds. acquisitions. II. Criticisms: a) It concentrated only on external sources of financing and completely ignored internal sources of financing.

technical and more important in steering the organisation wheels in proper direction. Investment Decision. Risk management and Hedging decisions. 12. the role of finance manager is becoming more complex. Financial relationships. Currency and other forex management decisions. Corporate governance. It covers both Capital budgeting decisions (Long term) and Working capital management decisions (Short term). 3. 3. 13. 9. It includes areas such as: 1. It is concerned with allocation or deployment of funds among various short term and long term assets. Mergers. 6. Financial Planning decisions. 2. Explain the organization of finance function Ans: Functions of Financial Management covers different areas of Financial decision making. Working Capital management decisions. Explain the changing roles of the finance manager? Ans: With the growth of business boundaries to global arena. 10. d) It covered the 3 major functions of finance namely: 1.c) It considered financial management as an integral part of overall Business management. Acquisitions. Dividend Decision. . 4. alliances and restructuring decisions. 2. which are considered to be of prime importance to steer the ship of business. Business ethics and transparency of external information. Capital Budgeting decisions.. INVESTMENT DECISION: Investment decisions refer to selection of various assets on which funds are invested. 8. 5. In short it is concerned with asset mix decision. Financing Decision. 7. Addressing and resolving agency problems. His key role in business covers the following areas: 1.

2. also called as Capital Structure decisions are concerned with selection of various sources of financing and their appropriate mix. Dividend decisions are to be decided based on Financing decisions of firm. Commercial banks. FINANCING DECISION: Financing decisions. Ans: Net present value It is the excess of total discounted cash inflow over total discounted cash outflow. Fixed deposits for a period less than 1year. available investment opportunities and preference of Shareholders. Explain various Dividend theories? Ans: (Refer Notes) 16. Higher the NPV better the proposal. 4. It involves the study of proportion of internal and external sources of financing. Advance received from customers. Briefly explain the different methods and techniques of capital budgeting? a) NPV b) IRR c) PI d) PBP e) ARR. Explain the sources of short term financing? Ans: 1. 3. Trade Credit. It covers both Debt (External) and Equity (Internal) sources of financing. 15. Internal rate of return . DIVIDEND DECISION: Dividend decisions are concerned with the firms decision of retaining a part of its earnings in the form of reserves and declaring the balance as dividends. 14. This method takes into consideration the time value of money and attempts to calculate return on investments by introducing the factor of time element. 3.2.

accept the proposal or else reject. GPI > 1 shall be accept or else rejected. PBP= Initial investment Uniform annual cash inflow . b. 2. IRR=LRR+ +ve NPV *D. It is the relationship between present value of cash inflows and the present value of cash outflows.It is the rate of return at which NPV for the proposal is zero. It is also known as ‘time adjusted rate of return’ discounted cash flow’ ‘discounted rate of return. Gross profitability index Higher the GPI better the proposal. The ‘pay back’ sometimes called as pay out or pay off period method represents the period in which the total investment in permanent assets pays back itself.’ ‘yield method.’ and ‘trail and error yield method’. In the net present value method the net present value is determined by discounting the future cash flows of a project at a predetermined or specified rate called the cut-off rate. Payback period It is the period within which we get back our initial investment.R +ve NPV + -ve NPV LRR=Lower rate of return. Incase of independent projects. Steps to calculate IRR. 1. Profitability index or Benefit Cost Ratio It is also time-adjusted method of evaluating the investment proposals. Using trial and error method identify two r values in such a manner that one gives positive NPV and other negative NPV. This method is based on the principle that every capital expenditure pays itself back within a certain period out of the additional earnings generated from the capital assets. NPI > 0 zero shall be accepted. It is also a modern technique ofcapital budgeting that takes into account the time value of money. Net profitability index. Higher the NPI better the proposal incases of independent projects. If IRR is greater than cost of capital. Calculation of IRR a. a. Profitability index also called as benefit cost ratio. DR = Difference in rate.

FLEXIBLE POLICY: It is also called as Conservative approach where a firm does not want to take the risk of maintaining a low level of current assets. inventory and will have a strict credit policy. Steps to calculate the ARR 1.scrap value 17. Calculation of ARR ARR= Average profit Initial investment . Ans: CURRENT ASSET POLICY OR LEVEL OF CURRENT ASSETS: A. CURRENT ASSETS FINANCING POLICY: It is the decision of the firm on mix of long term debt to be used to finance current assets. marketable securities. In other words. it establishes the relationship between average annual profits to total investments. capital * 100 B. RESTRICTIVE POLICY: It is also called as Aggressive approach where a firm makes low level of investment in Current assets. The above benefits come with a higher cost of investment in current assets called Carrying Cost. ensures quick deliveries to customers and stimulates sales due to liberal credit policy. . late delivery of goods to customers. and loss of sales. The firm maintains huge balance of cash and marketable securities carries large amounts of inventories and grants liberal credit to customers.Lower the PBP better the proposal.P) 2. The firm maintains low levels of cash. A restrictive policy results in frequent production stoppages. Explain the Working capital policy (Current asset policy) and also Working financing policy. These costs which a firm has to bear for maintaining low level of investment in current assets is called as Shortage cost. Calculation of average profit (A. Average Rate of Return: Under this method average profit after tax and depreciation is calculated and then it is divided by the total capital outlay or total investment in the project. A Flexible policy results in fewer stoppages in production.

permanent working capital and a portion of Fluctuating working capital requirements. Modigiliani and Miller’s Irrelevant Dividend Theory: According to Modigiliani and Miller.STRATEGY A: Long term financing used to finance both fixed assets requirement as well as Working capital requirement. share holders enjoy capital appreciation equal to the amount of earnings retained. Thus according to MM. The discount rate applicable to risk class for which the firm belongs remains unchanged. Hence the division of earnings between dividend and retained earnings is irrelevant from the point of view of share holders. Share valuation formula: Po = (D1 + P1)*1/ (1+r)n Where Po= Market price per share at time 0 D1 = Dividend per share at time 1 . if a co. instead of retaining it the share holders enjoy. retains earnings instead of giving it out as dividends. Firms can issue stock without incurring any flotation cost. the value of firm solely depends on its earning power and it is not influenced by the manner in which its earnings are split between dividend and retained earnings. If it distributes earnings by way of dividends. associated with dividends b. No tax advantage. e. Perfect capital Market conditions Substances of MM argument: According to MM. Assumptions of MM approach: a. STRATEGY C: Long term financing used to finance fixed assets requirement and permanent working capital requirements. dividend equal in value to the amount by which their capital would have appreciated. The investment and dividend decision of the firm are independent c. the value of firm or Market price will not be affected by changes in Dividend Pay Out Ratio and it will get affected only by changes in EPS. d. Short term financing is used to meet Fluctuating working capital requirements. STRATEGY B: Long term financing used to finance fixed assts requirement.

change in capital structure (DE ratio) has no bearing on value of firm.P1 = Expected market price per share at time ! R= Discount rate applicable to the risk class to which the firm belongs MM Dividend Irrelevance Theory.e. . rests on the “Leverage Irrelevance Theory” i.

Sign up to vote on this title
UsefulNot useful

Master Your Semester with Scribd & The New York Times

Special offer for students: Only $4.99/month.

Master Your Semester with a Special Offer from Scribd & The New York Times

Cancel anytime.