KSHITIZ CHOUDHARY

20121114

FINANCIAL MANAGEMENT

(a) The objective of Financial Management is Profit Maximization only.

No, Profit Maximization is an objective of Financial Management but not the only objective. Some other
objective of financial management are ensuring safety of funds by creating reserves, effective utilization
of funds, to maintain a balanced capital structure , ensure funds are available when needed as well as
wealth maximization not just profit maximization. For ex, for a business of timber financial management
would not only require that the profit are maximized it would also require that there is funds available for
purchase of raw material, the business has reserves for safety and the capital structure is according to the
business requirement.

(b) The Time Value of Money concept states that as time passes by, the purchasing power of money goes
down.

Yes,the concept states that the money we have today because of its potential earning power, is worth
more than the same amount in the future. It is based on the principle that money can gain interest, the
earlier it is earned, any sum of money is worth more. 

For example, if a person if  invest a Rs. 5000 today – the returns will be more compared to the same
investment made 2 months from now ,i.e the rate being 10%, one year from now the person will have
5500 while if the investment is made 2 months after the amount will be 5333.

(c) Capital Budgeting is a long-term and strategic decision.

Yes, Capital Budgeting is a long term and strategic decision as it is related to long term future of the
company and it requires detailed financial analysis, predicted the rate of return as well as many other data
for the decision making it a strategic and long term decision. 

(d) Distribution of dividend by the company doesn’t affect the movement of share prices of the same
company

No, the distribution of dividends by the company can affect the prices of shares of the same company, for
example, there are many short term traders who buy the company’s share for a month or so before the
dividend distribution. This causes the prices of the share to go higher. Once they receive the dividend, the
investors sell the shares.

(e) Working Capital Management finds a trade-off between liquidity and profitability.

No, Working Capital Management finds the trade off between risk and return. The trade off between risk
and return is the concept that higher risk is associated with a chances of higher return and vice versa.
Answer 2-
In this question following are the cost of machine A&B

Particulars Cost
Machine A 2500000
Machine B 4000000

CASH INFLOW

Year Machine A. Machine B

1 - 1000000
2 500000 1400000
3 2000000 1600000
4 1400000 1700000
5 1400000 1500000
COST OF CAPITAL 10%
1) NET PRESENT VALUE

Year CFAT CFAT PVIF(10%) Present Value Present Value

Machine A Machine B Machine A Machine B
1 - 1000000 0.909 909000
2 500000 1400000 0.826 413000 1156400
3 2000000 1600000 0.751 1502000 1201600
4 1400000 1700000 0.683 956200 1161100
5 1400000 1500000 0.621 869400 931500
Total Present 3740600 5359600
Value
Less: Initial (2500000) (4000000)
Investment
1240600 1359600

Decision
As the margin of employing machinery is more according to the Net Present Value Method as cash
inflow is more in Machinery B, then Machinery B should be selected.

1) Payback Period

Year CFAT CUMULATIVE CFAT Cumulative

(MACHINE CFAT (MACHINE Cfat
A) B)
1 - 1000000 1000000
2 500000 500000 1400000 2400000
 3 2000000 2500000 1600000 4000000
4 1400000 1400000 1700000 5700000
5 1400000 5300000 1500000 7200000

Payback Period = P+B/C

P=No. Of Years Immediately Preceding The Year Of Final Recovery

B=Balance Amount To Be Recovered In The Year Of Final Recovery.
C=Cash Flow In The Year Of Final Recovery
Machine A
In 3 Years There Is Full Recovery Of The Purchased Amount Of Machinery

Machine B
As Well As In 3 Years Only There Is Full Recovery Of Purchased Amount .

Decision:- As Payback Period Of Both The Machinery Is Same So The Manager Can Choose
Any Machinery.

Discount Payback Period

Machine A

Year CFAT (RS) P.V FACTOR P.V OF CFAT Cumulatiove(Rs.)

@10% P.V (RS)
1 - 0.909 - -
2 500000 0.826 413000 413000
3 2000000 0.751 1502000 1915000
4 1400000 0.683 956200 2871200
5 1400000 0.621 869400 3740600

Discounted Payback Period (Years) = 3+ (2500000-1915000)/956200

= 3+ 585000/956200
= 3+ 0.611
= 3.61 Years

Machine A

Year CFAT (RS) P.V FACTOR P.V OF CFAT Cumulatiove(Rs.)

@10% P.V (RS)
1 1000000 0.909 909000 909000
2 1400000 0.826 1156400 2065400
3 1600000 0.751 1201600 3267000
4 1700000 0.683 1161100 4428100
5 1500000 0.621 931500 5359600

Discounted Payback Period (Years) = 3+ (4000000-3267000)/1161100

= 3+ 733000/1161100
 = 3+ 0.631
= 3.63 Years
Decision:-
There is a small difference between machine A and machine B due to the discounted payback
period, so that the manager can select either machinery or whether he wants to go for machinery
A in particular.

Final Decision:
The manager should pick machinery B as the payback duration is the same by both methods , i.e.
payback method and discounted payback method, so it will not make any difference, but as the
cash inflow of machine B is more than comparable to machine A according to the net present
value method, so he should go for machine B

Answer 3
The conflict of interest between the owner of the company (shareholders) and the agent (manager) is the
Agency Conflict. The cost of solving the issue of the agency between the shareholder and management is
called the cost of the agency. The business manager functions as an agent and works for the shareholder's
owner and maximizes the shareholder's value. Managers often ignore the interest of shareholders and
strive to maximize their own profit. Conflict of interest occurs in this situation between manager and
shareholder, which is called the agency problem.
The costs of the agency are mainly due to the operating costs and the control difference, the separation of
ownership and control, and the separate goals rather than the maximization of the managers by the
shareholders. Most of the recent focus in corporate governance is concerned with the avoidance of
stakeholder conflicts of interest. These occur when a person or organization is engaged in multiple
interests that can lead to conflicts in their ability to act in one party's best interest. The question of the
principal agent or agency dilemma concerns the difficulties of convincing one party to act on another's
behalf. The two parties have different interests and the principal's asymmetric knowledge does not
directly guarantee that the agents always behave in their best interests , particularly when activities that
are beneficial to the principal are costly to the agent and when elements of what the agent does are
expensive for the principal to observe.
The more money managers make in salaries and benefits, the less stockholders see in net bottom-line
profits. Obviously, stockholders want the best managers for the job, but they don't want to pay more than
they have to.
Solution- As long as there is an a person or agency/agent who is not the 100 percent true owner of the
firm, the agency issue will not be eliminated. Regulators have acknowledged this issue and sought to
safeguard listed companies Instead of depending on accordance with regulatory legislation, corporations
need to find more efficient ways to minimise agency costs and optimise shareholder benefits.
Many new compensation plans can be made together, such as ESOP which will be beneficial for both,
profit sharing model, management based and participation incentives, are some of the ways to minimise
shareholder and management agency problems so that conflict doesn’t arise
Answer 4-
(a) Risk vs. Return
Usually there is a direct relationship between the risk and return in finance ,i.e. for a higher return in
future the risk involve will be higher but there is no guarantee that the return will be high, only the
probability of return is high with higher risk involve and vice versa. Like if we invest in the stocks, the
risk we take is higher but the probability of higher return is also there as compared to investing in fixed
deposit, where there is low risk and low return.
(b) Retention of Profits vs. Distribution of Dividends
The proportion of the profit earned by the business when distributed among its shareholders is called
dividends (dividend distribution) and when the profits is kept in the company or retained for the future
and growth of business it is called retention of profits.

(c) Present Value vs. Future Value

Present value is the amount one has to invest to find out the future value. Keeping the interest rate and
number of period constant, Present Value and Future Value vary directly: when one increases, the other
increases. Suppose a person invests a amount of Rs 1000 in a fixed deposit for one year and collects
interest at a rate of 10% for the same duration. So Rs 1100, which is Rs1000 Principal plus Rs100
interest, will be received at the end of the year. So we can assume that the future value of today's money
is Rs 1100, which is Rs 1000.  

 (d) Accounting vs. Financial Management

The profit / loss of the corporation is shown by accounting, it  keeps a record of all business transactions
of an organisation. ,whereas. Financial management uses the financial information that accounting
generates in order to monitor the financial wellbeing of the organization.

(e) Share Capital vs. Borrowed Capital (Loans)

Share capital is the capital owned by the company and shareholders and is the opposite of the borrowed
capital which is the capital borrowed from outside which is to be paid back to its owner for example, the
debentures of a company is borrowed capital whereas the equity shares of a company is the share capital.
5. (a) When rate = 5%
Present Value = Future Value (1+r)^1
Present Value = 1000/ (1+0.05)^1
= 1000/ (1.05) = 952.38
= Rs.952.38

When rate = 20%

Present Value = 1000 / (1+0.20)^1
= 1000/ (1.20) = 833.33
= Rs.833.33
Therefore, when rate is 5%, the present value is Rs.119.04 more than the other.
B)

Years Pattern 1 of Cash Pattern 2 of Cash

inflows inflows
1 10000 50000
2 20000 40000
3 30000 30000
4 40000 20000
5 50000 10000
Total inflow 150000 150000

Years Pattern 1 of Cash Pattern 2 of Cash

inflows inflows
1 9090.909 45454.55
2 16528.93 33057.85
3 22539.44 22539.44
4 27320.54 13660.27
5 31046.07 6209.213
Total inflow 106525.9 120921.3

I would prefer cash flow pattern 2 as a financial manager because the net present value of pattern 2 is
more than pattern 1 if we discount @ 10 percent, so we would have more in pattern 2 even though they
both pay out the same by traditional approach
c) Assuming Present Value as Rs.1,000
Future Value = PV/ (1+r)^1
When rate = 10% and period = 5 yrs.
= 1000 (1+ 0.10)^5
= 1000 (1.10)^5
= 1000 (1.61051)
= Rs.1610.51
When rate = 5% and period = 10 yrs
= 1000 (1+0.05)^10
= 1000 (1.05)^10
= 1000 (1.628)
= Rs.1628
As a marketer, since the latter offers Rs.17.49 more than the former, I would prefer the one in which
investment capital grows at 5% for 10 years.
d)Compared to the initial investment expense, the accounting rate of return shows the percentage rate of
return expected on an investment or asset. To calculate the estimated rate of return of each project or to
help decide on an investment, companies use ARR to compare different projects. The estimated ARR
here is 18 percent, so the 25 percent ARR project would likely have a higher annual rate compared to the
20 percent ARR project.