1. Assumptions of Net Income approach?

A. The Net Income (NI) approach to valuation makes some simplifying assumptions to arrive at a
firm's value. While these assumptions can be unrealistic, they provide a baseline for understanding
how capital structure can affect value:

• Constant Capital Requirement: The total amount of capital a firm needs is fixed and doesn't
change regardless of how it's financed (debt vs. equity).

• Perpetual Capital: The firm can access debt and equity forever without any maturities or
limitations.

• Cost of Debt (Kd) Less Than Cost of Equity (Ke): Debt financing is cheaper than equity
financing. This is because debt has a contractual interest rate, while equity returns are variable.

• Constant Costs of Capital: Both the cost of debt and cost of equity remain constant
irrespective of the amount of debt used. In reality, as a firm takes on more debt, the risk for
equity investors increases, potentially raising Ke.

• No Taxes: Corporate taxes are not considered, which can significantly impact a firm's value and
capital structure decisions.

These assumptions lead the Net Income approach to conclude that a higher proportion of debt
financing increases firm value by lowering the weighted average cost of capital (WACC). However, this
ignores the concept of financial risk and potential tax benefits of debt.

For a more realistic assessment, financial valuation methods often consider the Net Operating Income
(NOI) approach, which acknowledges the impact of capital structure on risk and value.

2. Walter’s Model?
A. Walter's Model, developed by James E. Walter in 1956, dives into the relationship between a
company's dividend policy and its overall value. It challenges the traditional notion that dividends
directly impact stock price.

Here's the gist of Walter's Model:

• Focuses on Internal Rate of Return (IRR): This refers to the return a company generates on its
invested capital.
• Compares IRR to Cost of Capital (K): The cost of capital is the minimum return investors expect
for taking on the risk of investing in the company.
• Dividend Policy and Share Value: Walter's Model proposes that dividend policy itself doesn't
necessarily impact share value. Instead, it's the investment opportunities funded by retained
earnings that influence value.
3. Preference Shares?
A. Preference shares, also known as preferred stock, are a special type of company ownership that
combines features of both debt and equity. Here's a breakdown of key aspects of preference
shares:
A. Higher Priority for Dividends: Preference shareholders get their dividends before common
shareholders.
B. Asset Priority in Case of Trouble: If the company goes bankrupt, preference shareholders get paid
back before common shareholders.
C. No Voting Rights: Typically, preference shareholders don't get to vote on company decisions like
common shareholders do.
D. Fixed Dividends: They often receive a fixed amount of dividends, which is agreed upon when they
buy the shares.
E. Non-Cumulative vs. Cumulative: Some preference shares might add up unpaid dividends if the
company can't pay, while others don't.
F. Possibility of Being Redeemed: The company might choose to buy back preference shares after a
certain time.
G. No Maturity Date: Some preference shares don't have a specific end date; they can last
indefinitely.
H. Convertibility: Some preference shares can be exchanged for common shares after a certain
period or under certain conditions.
I. Stability: They offer investors a stable income, similar to bonds, because of their fixed dividends.
J. Less Risky Than Common Shares: They're generally safer than common shares because they're
paid before common shareholders, but they also don't usually have the potential for as much
growth.

4. State the different investment criteria adopted by a firm in accepting a project proposal?
A. Firms typically evaluate project proposals using various investment criteria to ensure that the
proposed projects align with their strategic objectives and financial goals. Here are some of the
common investment criteria adopted by firms:

1. Net Present Value (NPV):

• NPV calculates the present value of all expected cash flows generated by the project,
discounted at the firm's cost of capital.
• If the NPV is positive, the project is expected to generate value for the firm, and it is
generally accepted.
• NPV is a widely used investment criterion as it considers the time value of money and
accounts for all cash flows over the project's life.
2. Internal Rate of Return (IRR):
• IRR is the discount rate at which the NPV of the project equals zero.
• Projects with an IRR higher than the firm's cost of capital are generally accepted.
• IRR is useful for comparing different investment options, but it may lead to ambiguous
decisions when cash flows change over time or when there are multiple IRRs.
3. Payback Period:
• Payback period represents the time it takes for the project to recover its initial
investment.
• Projects with shorter payback periods are preferred as they offer faster returns of
investment.
 • Payback period is a simple metric but does not consider the time value of money and
ignores cash flows beyond the payback period.
4. Profitability Index (PI):
• PI measures the ratio of the present value of cash inflows to the initial investment.
• Projects with PI greater than 1 are considered acceptable; the higher the PI, the more
attractive the investment.
• PI helps in ranking projects based on their efficiency in generating value relative to
their cost.
5. Accounting Rate of Return (ARR):
• ARR calculates the average annual accounting profit generated by the project as a
percentage of the initial investment.
• Projects with ARR higher than the firm's required rate of return are accepted.
• ARR is easy to calculate but does not consider the time value of money and relies on
accounting profits rather than cash flows.
6. Risk-adjusted Return Metrics:
• Some firms incorporate risk-adjusted return metrics such as the risk-adjusted NPV or
the risk-adjusted IRR.
• These metrics account for the project's risk by adjusting the discount rate or cash flows
to reflect the project's riskiness.
• Risk-adjusted metrics help in making decisions considering both return and risk
factors.
7. Strategic Alignment and Qualitative Factors:
• Firms also consider qualitative factors such as strategic alignment, market potential,
competitive advantage, and environmental or social impact when evaluating project
proposals.
• These factors may not be quantifiable but are crucial for ensuring that the project fits
with the firm's long-term objectives and values.

By employing a combination of these investment criteria, firms can make informed decisions regarding
project selection and allocation of resources to maximize shareholder value and achieve strategic
goals.

5. What are the factors effecting finance decision?

A. Finance decisions in a firm are influenced by various internal and external factors. Here's
an overview of some of the key factors affecting finance decisions:

1. Cost of Capital: The cost of capital, which includes the cost of debt and the cost of
equity, influences finance decisions such as capital budgeting, capital structure, and
dividend policy.
2. Business Risk: The level of risk associated with the firm's operations affects financing
decisions. Higher business risk may lead to a more conservative financing approach to
minimize financial distress.
3. Market Conditions: External market conditions, including interest rates, inflation, and
overall economic conditions, impact financing decisions such as borrowing costs,
investor sentiment, and access to capital markets.
4. Legal and Regulatory Environment: Legal and regulatory factors, such as tax laws,
securities regulations, and accounting standards, shape finance decisions and
determine the choice of financing instruments and structures.
5. Company Size and Life Cycle: The size and stage of development of the firm influence
finance decisions. Start-ups and small firms may rely more on equity financing, while
larger firms may have more access to debt markets.
6. Investment Opportunities: The availability of profitable investment opportunities
affects financing decisions. Firms with attractive investment prospects may choose to
raise additional funds to finance growth initiatives.
7. Ownership Structure and Corporate Governance: The ownership structure and
corporate governance practices of the firm impact finance decisions, including
dividend policy, capital structure, and transparency in financial reporting.
8. Liquidity Needs: The firm's short-term and long-term liquidity needs influence
financing decisions, such as the choice between short-term and long-term financing
options and the level of cash reserves to maintain.
9. Tax Considerations: Tax implications play a significant role in finance decisions,
including capital structure choices, dividend policy, and investment decisions. Firms
aim to optimize tax efficiency while complying with tax laws.
10. Social and Environmental Factors: Increasingly, social and environmental
considerations influence finance decisions, including sustainable finance initiatives,
corporate social responsibility (CSR), and environmental, social, and governance (ESG)
criteria in investment decisions.
11. Competitive Positioning: The competitive landscape and industry dynamics impact
finance decisions, such as pricing strategies, investment in innovation, and capital
expenditure to maintain or enhance competitive positioning.
12. Investor Preferences and Market Expectations: Investor preferences, market
expectations, and shareholder activism influence finance decisions, including dividend
policy, capital allocation, and communication with investors.
6. Assumptions of Net Income approach?

The Net Income (NI) approach to valuation makes some simplifying assumptions to arrive at a firm's
value. These assumptions can be unrealistic, but they provide a starting point for understanding how
a company's capital structure (debt vs. equity financing) can affect its value:

1. Constant Capital Requirement: The total amount of capital a firm needs is fixed and doesn't
change regardless of how it's financed (debt vs. equity).
2. Perpetual Capital: The firm can access debt and equity forever without any maturities or
limitations on raising capital.
3. Cost of Debt (Kd) Less Than Cost of Equity (Ke): Debt financing is assumed to be cheaper than
equity financing. This is because debt has a fixed interest rate, while equity returns are variable
and depend on company performance.
4. Constant Costs of Capital: Both the cost of debt and cost of equity remain constant
irrespective of the amount of debt used. In reality, as a firm takes on more debt, the risk for
equity investors increases, potentially raising the cost of equity (Ke).
5. No Taxes: Corporate taxes are not considered, which can significantly impact a firm's value and
capital structure decisions.

These assumptions lead the Net Income approach to conclude that a higher proportion of debt
financing increases firm value by lowering the weighted average cost of capital (WACC). However, this
ignores the concept of financial risk (increased risk for equity holders with more debt) and potential
tax benefits of debt (tax shield effect).

Due to these limitations, the Net Income approach is a simplified model and financial valuation
methods often consider a more realistic approach like the Net Operating Income (NOI) approach,
which acknowledges the impact of capital structure on risk and value.

7. Wealth Maximization?

A. Wealth maximization refers to a strategy focused on increasing the value of a company for the
benefit of its shareholders. It's a long-term approach that considers how decisions today will impact
the company's future worth and, consequently, the share price.

Here's a breakdown of the core aspects of wealth maximization:

Focus on Shareholder Value:

• The primary objective is to increase the value of the company's stock for its shareholders. This
translates to a higher share price or increased dividends over time.

Long-Term Perspective:

• Wealth maximization looks beyond short-term profits. Decisions are evaluated based on their
long-term impact on the company's value and future cash flows.
Strategic Growth:

• It prioritizes sustainable growth strategies that enhance profitability, expand market share, or
improve operational efficiency.

Efficient Resource Allocation:

• Wealth maximization involves making wise investment decisions. It emphasizes allocating

capital towards projects with strong return on investment (ROI) and using a healthy mix of
debt and equity financing.

Considering Stakeholders (to an extent):

• While shareholder wealth is central, wealth maximization acknowledges the importance of

other stakeholders. Building positive relationships with customers, employees, and the
community can indirectly contribute to long-term value creation.

8. Finance Function?

A. The finance function plays a critical role in the smooth operation and financial health of a business.
Here are some of its key aspects:

1. Financial Planning and Analysis:

• This involves creating financial forecasts, budgets, and cash flow projections.

• It also includes analyzing financial data to identify trends, measure performance, and assess
risks.

• Financial planning helps businesses make informed decisions about resource allocation,
investments, and future growth.

2. Capital Budgeting and Investment Decisions:

• The finance function evaluates potential capital expenditures (CapEx) and investment
opportunities.

• This involves techniques like Net Present Value (NPV) and Internal Rate of Return (IRR) to
assess project viability and choose the most profitable options for the company's long-term
goals.

3. Risk Management:

• Financial professionals identify, assess, and mitigate financial risks faced by the business.

• This includes risks like market fluctuations, currency exchange rates, interest rate changes, and
credit risk.

• They implement strategies to minimize potential losses and ensure financial stability.

4. Financing and Capital Acquisition:

• The finance function secures funding for the business through various sources like debt
financing (loans), equity financing (issuing stock), or a combination of both.

• They manage relationships with banks, investors, and other financial institutions to obtain the
most favorable financing terms.
5. Cash Flow Management:

• This involves ensuring the business has sufficient cash flow to meet its ongoing operational
expenses, debt obligations, and investment needs.

• Financial professionals monitor cash inflows and outflows, implement strategies to optimize
cash flow, and manage working capital effectively.

6. Financial Reporting and Compliance:

• The finance function is responsible for maintaining accurate financial records, preparing
financial statements (income statement, balance sheet, cash flow statement), and complying
with accounting standards and tax regulations.

• They ensure timely filing of financial reports with regulatory bodies and stakeholders.

7. Investor Relations (for Public Companies):

• In publicly traded companies, the finance function manages communication with investors.

• This includes providing financial information, responding to investor inquiries, and

participating in investor presentations.

Overall, the finance function plays a vital role in driving a business's financial success. It ensures the
company has the resources it needs to operate, manages financial risks, and helps make strategic
decisions that maximize shareholder value.

9. Growth and Declining Firm?

Firms can be categorized based on their growth stage, which impacts their financial health, strategic
priorities, and risk profile. Here's a breakdown of growth firms and declining firms:

Growth Firms:

• Rapid Revenue and Profit Growth: These companies experience significant increases in sales,
earnings, and market share.

• Focus on Expansion: Growth firms prioritize strategies to expand their market reach, develop
new products or services, and acquire new customers.

• High Investment Needs: To fuel growth, they typically invest heavily in research &
development (R&D), marketing, and operational capacity.

• Financing Needs: Growth firms often rely on external financing sources like venture capital,
equity offerings, or bank loans to fund their expansion plans.

• Lower Profitability (initially): They may prioritize growth over short-term profits, reinvesting
earnings back into the business. As they mature, profitability is expected to increase.

• Higher Risk: Growth firms are inherently riskier due to their dependence on untested markets,
unproven technologies, and intense competition.

Examples: Tech startups, companies in emerging industries, or businesses experiencing rapid market
expansion.

Declining Firms:
 • Stagnant or Decreasing Sales and Profits: These companies experience a slowdown in growth
or a decline in revenue and profitability.

• Market Saturation or Obsolete Products: Declining firms may operate in saturated markets,
offer outdated products, or face new and disruptive competition.

• Cost-Cutting Focus: To survive, they may prioritize cost-cutting measures, workforce

reductions, or asset sales.

• Focus on Cash Flow: Preserving cash flow becomes critical to meet debt obligations and
maintain operations.

• Dividend Payouts (potentially): In some cases, declining firms may distribute a higher
proportion of profits as dividends to attract investors seeking current income.

• Financial Risk: Declining firms face a higher risk of financial distress, bankruptcy, or even
acquisition by competitors.

Examples: Companies in mature industries facing technological disruptions, businesses with outdated
products or services, or firms struggling with high debt burdens.

10) Profit maximization

A) Profit maximization is a core objective for many businesses. It essentially means taking actions to
achieve the highest possible level of profit. This can be achieved through various strategies that
consider both increasing revenue and controlling costs.

Here's a breakdown of the key aspects of profit maximization:

Central Goal:

• Maximize the difference between a company's total revenue and total costs. This translates to
a higher net income on the company's income statement.

Strategies for Profit Maximization:

• Increasing Revenue:

o Raising prices
o Selling more products or services
o Expanding into new markets
o Developing new products or services
o Improving customer satisfaction and loyalty
• Reducing Costs:
o Negotiating lower prices with suppliers
o Implementing cost-efficiency measures
o Reducing waste
o Minimizing operational expenses
11) What are the factors effecting Dividend decision?
Dividend decisions involve determining how much of a company's earnings should be distributed to
shareholders in the form of dividends versus retained within the company for reinvestment. Several
factors influence dividend decisions:
1. Profitability: The company's current and expected future profitability directly impacts its
ability to pay dividends. Higher profits generally allow for larger dividend payouts.
2. Cash Flows: The availability of cash flows is crucial for dividend payments. Even profitable
companies may face liquidity constraints that limit their ability to pay dividends.
3. Investment Opportunities: Companies with promising investment opportunities may choose
to retain earnings for reinvestment rather than distributing them as dividends. Dividend
decisions are influenced by the firm's growth prospects and the potential return on investment
in new projects.
4. Capital Expenditure Needs: Dividend decisions are affected by the company's capital
expenditure requirements for maintaining and expanding its operations. High capital
expenditure needs may result in lower dividend payouts.
5. Debt Obligations: Companies with significant debt obligations may prioritize debt repayment
over dividend payments to maintain financial stability and avoid default risk.
6. Tax Considerations: Tax policies affect dividend decisions, as dividends are typically taxed at
the individual shareholder level. Companies may adjust dividend policies to optimize after-tax
returns for shareholders.
7. Legal and Regulatory Constraints: Legal and regulatory requirements may influence dividend
decisions. Companies must comply with laws and regulations governing dividend distributions,
including restrictions on dividend payments based on retained earnings and capital
maintenance rules.
8. Shareholder Preferences: The preferences of shareholders, particularly institutional investors
and dividend-seeking investors, play a role in dividend decisions. Companies may adjust
dividend policies to attract and retain investors.
9. Market Conditions: Market conditions, including the company's stock price, investor
sentiment, and overall economic environment, can influence dividend decisions. Companies
may adjust dividend policies in response to changes in market conditions to maintain
shareholder confidence.
10. Competitive Pressures: Dividend decisions are influenced by competitive pressures within the
industry. Companies may adjust dividend policies to remain competitive with peer firms and
attract capital from investors.
 11. Dividend Stability and History: Companies often strive to maintain stable dividend payments
over time to signal financial strength and reliability to investors. Dividend history and
consistency may influence future dividend decisions.
12. Corporate Governance Considerations: Dividend decisions are subject to corporate
governance principles and guidelines. Sound corporate governance practices promote
transparency, accountability, and fairness in dividend distributions.

12) Assumptions of M.M Theory?

The Modigliani-Miller (MM) Theorem, also referred to as the M&M theory, is a cornerstone of
corporate finance. However, it's important to understand the assumptions it makes to interpret its
conclusions accurately. Here are the key assumptions underlying the M&M theory:
1. Perfect Capital Markets:
o This is a core assumption. It implies investors can freely buy and sell securities without
any transaction costs, fees, or restrictions. Information about the company and its
financial health is perfectly available to all investors.
2. No Taxes:
o The M&M theory disregards corporate and personal income taxes. In reality, taxes can
significantly impact a company's capital structure decisions and overall value.
3. Certainty and No Asymmetries:
o The M&M theory assumes a world of certainty. There's no business risk, financial risk,
or unexpected events. Additionally, there's no information asymmetry, meaning all
investors have the same level of knowledge about the company.
4. Constant Costs of Capital:
o The M&M theory assumes that the cost of debt (Kd) and the cost of equity (Ke) remain
constant regardless of a company's capital structure (debt-to-equity ratio). In reality,
as a company takes on more debt, it becomes riskier for equity investors, potentially
raising the cost of equity.
5. Perpetual Firms with Infinite Life:
o The M&M theory assumes companies can operate forever and continue accessing
debt and equity financing without any limitations or maturities.
13) Goals of financial management?
1. Make Money: Financial management aims to help the company make as much profit as
possible. This involves finding ways to increase revenues and reduce costs.
2. Save Money: It's also about finding ways to save money wherever possible. This could mean
negotiating better deals with suppliers or cutting unnecessary expenses.
3. Invest Smartly: Financial management involves making smart investments that will help the
company grow. This might include investing in new equipment, expanding into new markets,
or launching new products.
4. Stay Stable: Financial management aims to keep the company stable and financially healthy.
This means ensuring that the company has enough cash on hand to cover its expenses and
debts.
5. Follow the Rules: Financial management involves making sure that the company follows all
the rules and regulations set out by the government and other regulatory bodies. This includes
things like paying taxes on time and accurately reporting financial information.

14) Retained earnings

Retained earnings are the amount of profit a company has left over after paying all its direct
costs, indirect costs, income taxes and its dividends to shareholders. This represents the portion of the
company's equity that can be used, for instance, to invest in new equipment, R&D, and marketing.

1. Saved-Up Profits: Retained earnings are like the savings account of a company. It's the money
they've made from selling stuff or doing business, and instead of spending it all, they keep
some for themselves.

2. Not Given to Shareholders (Yet): When a company earns money, they can either share it with
their shareholders (the people who own the company's stock) as dividends or keep it for
themselves. Retained earnings are the part they keep.
3. Used for Company Stuff: The company uses retained earnings to do things like buying new
equipment, expanding their business, paying off loans, or just keeping some cash on hand for
unexpected expenses.
4. Helps the Company Grow: By keeping some of their profits as retained earnings, the company
can invest in itself and become stronger and bigger over time. It's like planting seeds for future
growth.
5. Shown on the Balance Sheet: You can find retained earnings listed on the company's balance
sheet, usually under the "Shareholders' Equity" section. It shows how much money the
company has kept for itself over the years.