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MBA 2nd SEM Subject Code MB0044 Book ID B1133 PRODUCTION & OPERATIONS MANAGEMENT Set 2 Q1. Explain Logical Process Modelling and Physical Process Modelling. What are the ingredients of business process? Ans. Logical Process Modelling Logical Process Modeling is the representation of putting together all the activities of business process in details and making a representation of them. The initial data collected need to be arrange in a logical manner so that, links are made between nodes for making for the workflow smooth. The steps to be followed to make the work smoother are given below: 1. Capture relevant data in detail to be acted upon. 2. Establish controls and limit access to the data during processes execution 3. Determine which task in the process is to be done and also the subsequent task in that process. 4. Make sure that all the relevant data is available for all the tasks. 5. Make the relevant and appropriate data available for that task. 6. Establish a mechanism to indicate acceptance of the results after every task or process. This is to have an assurance that flow is going ahead with accomplishments in the desired path. Some of these activities may occur in a sequential order whereas, some of them run parallel. There may even be circular paths, like re-work loops. Complexities arise when the processes activities are not connected together. Logical processes model consists of only the business activities and shows the connectivity among them. The process model is a representation of the business activities different from the technology dependent ones. Thus, we have a model that is singularly structured only for business activities. Computer programmes are also present in the total system. This allows the business oriented executives to be in control of the inputs, processes and outputs. The logical process model improves, control on the access to data. It also indentifies, who is in possession of data at different nodes in the dataflow network that has been structured. A few of the logical modeling formats are given below. 1. Process Descriptions with task sequences and data addresses. 2. Flow chart with various activities and relationships 3. Flow diagrams 4. Function hierarchies 5. Function dependency diagram Every business activity, when considered as a logical process model, can be represented by a diagram, it can be decomposed and meaningful names can be given to the details. Verb and noun form combinations can be used to describe at each level. Nouns give the name of the activity uniquely and are used for the entire model meaning the same activity. PHYSICAL PROCESS MODELLING

Physical process modeling is concerned with the actual design of data base meeting the requirement of the business. Physical modeling deals with the conversion of the logical model into a relation model. Object gets defined at the schema level. The objects here are tables created on the basis of entities and attributes. A database is defined for the business. All the information is put together to make the database software specific. This means that the objects during physical modeling vary on the database software being used. The outcomes are server model diagrams showing tables and relationships with a database. BELOW ARE THE INGREDIENTS OF BUSINESS PROCESS. The ingredients that might be used in a business process can be briefly outlined as shown below. The data which accomplishes the desired business objective. Acquisition, storage, distribution, and control of data which undertakes the process across tasks. Persons, teams, and organizational units which helps to perform and achieve the tasks. Decision which enhances the value of data during the process. Q.2 Explain Project Management Knowledge Areas. With an example explain work breakdown structure. Ans. The knowledge areas of project management are the following: Project integration management, cost management, communications management. Project scope management, quality management, risk management. Project time management, human management, procurement management. For a project to be successful, it is necessary to understand its relationship with other management disciplines. Other management supporting disciplines are business legal issues, strategic planning, logistics, human resource management, and domain knowledge. WORK BREAK DOWN STRUCTURE. The entire process of a project may be considered to be made up on number of sub process placed in different stage called the work breakdown structure (WBS). WBS is the technique to analysis the content of work and cost by breaking it down into its component parts. Projects key stages from the highest level of the WBS, which is then used to show the details at the lower levels of the project. Each key stage comprises many tasks identified at the start of planning and later this list will have to be validated.


WBS is produced by indentifying the key elements, breaking each element down into component parts and continuing to breakdown until manageable work packages have indentified. These can then be allocated to the appropriate person. The WBS does not shown dependencies other than a grouping under the key stages. It is not time based- there is no timescale on the drawing. Chart showing the example of work break down structure.
A Work Breakdown Structure is a results-oriented family tree that captures all the work of a project in an organized way. It is often portrayed graphically as a hierarchical tree, however, it can also be a tabular list of "element" categories and tasks or the indented task list that appears in your Gantt chart schedule. As a very simple example, Figure 1 shows a WBS for a hypothetical banquet.

EXAMPLE 1. EXAMPLE -2 Q.3 Take an example of any product or project and explain project management life cycle. Ans. A life cycle of a project consists of the following steps. Understanding the scope of the project. Establishing objectives of the projects Formulating and planning various activities. Executing the project Monitoring and controlling the project resources. Closing and post completion analysis Phases of Project Management Life Cylce. Project management life cycle has six phases: 1. Analysis and evaluation phase. 2. Marketing phase 3. Design phase 4. Execution phase 5. Control-inspecting, testing, and delivery phase 6. Closure and post completion analysis phase. 1. Analysis And Evaluation Phase: Analysis and evaluation phase is the initial phase of any project. In this phase, information is collected from the customer pertaining to the project. From the collected information, the requirements of the project are analyzed. According to the customer requirement, the entire project is planned in a strategic manner. The project manager conducts the analysis of the problem and submits a detailed report to the top management. 2. Marketing Phase: A project proposal is prepared by a group of people including the project

manager. This proposal has to contain the strategic adopted to market the product to the customer. 3. Design Phase: Design phase involves the study of inputs and outputs of the various project stages. a. Inputs received consist of project feasibility study, preliminary project evaluation details, project proposal, and customer interviews. b. Outputs produced consist of system design specifications, functional specifications of the project, design specifications of the project and project plan. 4. Execution Phase: In execution phase, the project manager and the term members work on the project objectives as per the plan. At every stage during the execution, reports are prepared. 5. Control- Inspecting Testing and Delivery Phase: During this phase, the project teams works under the guidance of the project manager. The project manager has to ensure that the team working under him is implementing the project designs accurately. The project has to be tracked or monitored through its cost, manpower, and schedule. The project manager has to ensure ways of managing the customer and marketing the future work, as well as ways to perform quality control work 6. Closure and Post Completion Analysis Phase: Upon satisfactory completion and delivery of the intended product or service the staff performance has to be evaluated. The project manager has to document the lessons from the project. Reports on project feedback are to be prepared and analyzed. A project execution report is to be prepared. Let us have a quick recap of what is involved in the above phases a. Analysis and evaluation phase: The preparation stage involves the preparation and approval of project outline, project plan, and project budget. b. Assigning task to the team members: The next stage involves selecting and briefing the project team about the proposals, followed by discussions on the roles and responsibilities of the project member and the organization. c. Feasibility study: The feasibility or research stage establishes whether the project is feasible or not and establishes the risk factors likely to be faced during the course of the project execution and the related key factors to overcome the problem d. Execution phase: A detailed definition and plan for the project and its execution is prepared by the team and coordinated by the project manager. e. Implementation stage: The implementation stage involves the execution of the project as per the plan, this also involves careful monitoring of the project progress and managing the changes, if any, within the scope of the project framework. 7. Closure and post completion analysis phase: The final stage involves satisfactory delivery of the product/service to the customers. Upon completion, a project review is to be conducted by the project manager along with team member, sponsors, and customer. A project review process involves discussions about the progress, performance, hurdles that were overcome and problems faced, so that, such instances could be avoided in future projects. Example No.1 Example No.2 Example No.3 Q.4 Explain PMIS. What Is Difference Between Key Success Factor (Ksf) And Knowledge (K) Factor ? Explain With Examples.

Ans. PMIS (Project Management Information System) An information system is mainly aimed at providing the management at different levels with information related to the system of the organization. It helps in maintaining discipline in the system. An information system dealing with project management tasks is the project management information system. It helps in decision making in arriving at optimum allocation of resources. The information system is based on a database of the organization. A project management information system also holds schedule, scope changes, risk assessment and actual results. The information is communicated to managers at different levels of the organization depending upon the need. Let us find how a project management information system is used by different stakeholders. WHO NEEDS INFORMATION AND WHY? Upper managers To know information on all project regarding progress, problem, resource usage, costs and project goals. This information helps them take decisions on the projects. They should review the projects at each milestone and arrive at appropriate decision. Project manager and department managers To see each project schedule, priority and use of resources to determine the most efficient use across the organization. Project team members To see schedule, task lists and specification so that they know what needs to be done next. The four majors aspects of a PMIS are: 1. Providing information to the major stakeholder. 2. Assisting the team members, stakeholders, managers with necessary information and summary of the information shared to the higher level managers. 3. Assisting the manager in doing what if analysis about project staffing, proposed staffing changes and total allocation of resources. 4. Helping organizational learning by helping the members of the organizations lean about project management. Usually, the team members, and not the systems administrators of the company, develop a good PMIS. Organisations tend to allocate such responsibility by rotation among members with a well designed and structured data entry and analytical format. Different Between Key Success Factors (KSF) And Knowledge (K) Factor Key success factors (KSF) Knowledge (k) factor The KSF should be evolved based on a basic consensus document (BCD) Knowledge is the most powerful mover of the wheels of progress KSF will also provide an input to effective exit strategy (EES)

Knowledge (k) factor is an index of the extent to which one can manager today with yesterdays knowledge content and also the extent to which todays knowledge will be used tomorrow. Broad level of KSF should be available at the conceptual stage and should be firmed up and detailed out during the planning stage. The easiest way would be for the team to evaluate each step for chances of success on a scale of ten. K factor would render the development process more productive. The k factor of course, undergoes correction through obsolescence, since changes are now phenomenal. KSF should be available to the management, duly approved by the project manager before execution and control stages. Leaders should recognize the knowledge potential of the younger managers. Seniority is no more an automate scale for knowledge. It is equally important for younger member not suppress their knowledge potential from its application. KSF rides normal consideration of time and cost- at the levels encompassing client expectation and management perceptiontime and cost come into play as subservient to these major goal. Here time and cost does not matter, knowledge is to be updated time to time to get better results. In order to provide complete stability to fulfillment of goals, a project manager needs to constantly evaluate the key success factor from time to time. As age and experience advance wisdom gains, but knowledge should always be updated and utilized. It is the task of every team members to maximize the k factor in all directions.

Example of Key success factor

According to, a turnkey project is "a project in which a builder/developer contracts to construct a completed facility that includes all items necessary for use and occupancy." Unfortunately, many turnkey businesses never capture the interest of the buyers. Whether you're building in brick and mortar or building in computer code, there are several factors critical to the success of your turnkey project.

Know the Business Several businesses can be set up as turnkey businesses, from food service to copy management to telemarketing and sales. Whichever you decide, it is important to have an intimate knowledge of the business you are building. One key factor in a successful turnkey business is being able to anticipate the needs and desires of the potential owners before they are brought on board. A salesman, for example, looking to purchase a turnkey sales business will need an office as a base of operations; but since so much of the sales process is done through phones, computers and other electronic devices, the turnkey developer may want to include additional power outlets in the construction of the building, or desks with onboard power strips and surge protectors. These small additions can make a turnkey project a success. Know the Area Internet businesses often have nationwide access to clientele, but brick-and-mortar turnkey operations sometimes run into trouble in areas poorly suited to the service they offer. For example, an outdoor food service stand opening in Wilkes-Barre, Pennsylvania, will not do as much business (at least during the winter months) as one opening in an Orlando, Florida, theme park. Knowing the area where you are constructing your turnkey business includes knowing the weather conditions, the dominant demographic, the current popularity and number of businesses like the one you are creating and the average income of the public. Planning a turnkey business that uses these factors to its advantage will make the business more readily sellable. Make Connections Turnkey businesses are designed to be ready to operate as soon as the buyer takes ownership. Still, once they are sold, many businesses of this type run into problems when it comes to resupplying, logistics and advertising. Because of this, many buyers are wary of turnkey operations. One way to quell any "down the road" fears is to have this part of the infrastructure accounted for. Make contact with businesses which help advertise businesses, ship products, supply copy paper and any other stock the owner might require. Obtain discounts from as many as possible Example of Knowledge (k) factor ABSTRACT Most organisations are aware that in todays highly competitive environment managing effectively their knowledge is the only way to achieve a sustainable competitive advantage. One of the primary areas to which knowledge management can be applied is the field of project management. An increasing number of business sectors are adopting a project approach to carry out

a range of essential activities where valuable knowledge is gained. Knowledge from projects is an important resource for further projects, because projects solve innovative and interdisciplinary tasks. However, the majority of organisations do not manage the information gained through past projects. Failure to transfer knowledge from past to future projects leads to wasted activity and unnecessary expenses by reinventing the wheel. Therefore, knowledge management is a critical success factor for many projects. The purpose of this Management Report is to approach knowledge management from the perspective of project management. The main objective is to define how knowledge management can be enhanced within a project by analysing suitable tools and relevant theories. The research is based on the high-speed train project XY of the company XXX. This project is an important milestone for XXX to improve its market position in Spain. The knowledge gained through the XY project will be the key factor for the success of the further high-speed train projects. The main finding of the case study highlights that there is a lack of formal knowledge management activities at the project. The project team focuses mainly on personal interaction for transferring knowledge and information technology is not used to its full potential. A hybrid approach to knowledge management for project environments is suggested, taking into account technical as well as human-specific aspects. The main recommendation is to determine a knowledge management strategy, which preferably focuses on transferring tacit knowledge and gives information technology a support function. Other areas of improvement are creating an open and constructive project culture, including knowledge initiatives in reward systems and fostering documented project review sessions. Finally, general conclusions are provided to answer the main research question of this management report. Q.5 Explain the seven principal of supply chain management. Take an example of any product in the market and explain the scenario of Bullwhip effect. Ans: Seven Principles Of SCM are: 1. Group customer by needs: Effective SCM groups customers by distinct service needs, regardless of industry and then tailors services to those particular segments. 2. Customize the logistics networks: In designing their logistic network, companies need to focus on the service requirement and profit potential of the customer segments identified. 3. Listen to signals of market demand and plan accordingly: sales and operations planners must monitor the entire supply chain to detect early warning signals of changing customers demand and needs. This demand driven approach leads to more consistent forecast and optimal resource allocation. 4. Differentiate the product closer to the customer: companies today no longer can afford to stockpile inventory to compensate for possible forecasting errors. Instead, they need to postpone product differentiation in the manufacturing process closer to actual consumer demand. This strategy allows the supply chain to respond quickly and cost effectively to changes in customer needs. 5. Strategically manage the sources of supply: By working closely with their key suppliers to reduce the overall costs of owning materials and services, SCM maximizes profit margins

both for themselves and their suppliers. 6. Develop a supply chain wide technology strategy: As one of the cornerstones of successful SCM, information technology must be able to support multiple levels of decisions making. It also should afford a clear view and ability to measure the flow of products, services and information. 7. Adopt channel spanning performance measures: Excellent supply chain performance measurement systems do more than just monitor internal functions. They apply performance criteria to every link in the supply chain-criteria that both service and financial metrics. BULLWHIP EFFECT IN SCM An organization will always have up and downs. It is necessary that the managers of the organization keep track of the market conditions and analyze the changes. They must take decisions on the resources and make necessary changes within the organization to meet the market demands. Failing to do so may results in wild swings in the orders. This may adversely affect the functioning of the organization resulting in lack of coordination and trust among supply chain members. The changes may affect the information and may led to demand amplification in the supply chain. The Bullwhip effect is the uncertainty caused from distorted information flowing up and down the supply chain. This has its affect on almost all the industries, poses a risk to firms that experience large variations in demand, and also those firm which are dependent on suppliers, distributors and retailers. A bullwhip effect may arise because of: Increase in the lead time of the project due to increase in variability of demand Increase in the stocks to accommodate the increase demand arising out of complicated demand models and forecasting techniques. Reduced service levels in the organization. Inefficient allocation of resources. Increased transportation cost. How to prevent it ? Bullwhip effect may be avoided by one or more of the following measures: Avoid multiple demand forecasting. Breaking the single order into number of batches of orders. Stabilize the prices, avoid the risk involved in overstocking by maintaining a proper stock Reduce the variability and uncertainty in point of sale (POS) and sharing information Reduce the lead time in the stages of the project Always keep analyzing the past figures and track current and future levels of requirement. Enhance the operational efficiency and outsourcing logistics to a capable and efficient agency Example of one product the effect Bullwhip theory. The beer game was developed at MIT by the Systems Dynamic Group in the 1960s. The game involves a simple production/distribution system for a single brand of beer. There are three players in the game including a retailer, a wholesaler, and a marketing director at the brewery.

Each player's goal is to maximize profit. A truck driver delivers beer once each week to the retailer. Then the retailer places an order with the trucker who returns the order to the wholesaler. There's a four week lag between ordering and receiving the beer. The retailer and wholesaler do not communicate directly. The retailer sells hundreds of products and the wholesaler distributes many products to a large number of customers. The following represents the results of a typical beer game:3.1 The Retailer Week 1: Lover's Beer is not very popular but the retailer sells four cases per week on average. Because the lead time is four weeks, the retailer attempts to keep twelve cases in the store by ordering four cases each Monday when the trucker makes a delivery. Week 2: The retailer's sales of Lover's beer doubles to eight cases, so on Monday, he orders 8 cases. Week 3: The retailer sells 8 cases. The trucker delivers four cases. To be safe, the retailer decides to order 12 cases of Lover's beer. Week 4: The retailer learns from some of his younger customers that a music video appearing on TV shows a group singing "I'll take on last sip of Lover's beer and run into the sun." The retailer assumes that this explains the increased demand for the product. The trucker delivers 5 cases. The retailer is nearly sold out, so he orders 16 cases. Week 5: The retailer sells the last case, but receives 7 cases. All 7 cases are sold by the end of the week. So again on Monday the retailer orders 16 cases. Week 6: Customers are looking for Lover's beer. Some put their names on a list to be called when the beer comes in. The trucker delivers only 6 cases and all are sold by the weekend. The retailer orders another 16 cases. Week 7: The trucker delivers 7 cases. The retailer is frustrated, but orders another 16 cases. Week 8: The trucker delivers 5 cases and tells the retailer the beer is backlogged. The retailer is really getting irritated with the wholesaler, but orders 24 cases. 3.2 The Wholesaler The wholesaler distributes many brands of beer to a large number of retailers, but he is the only distributor of Lover's beer. The wholesaler orders 4 truckloads from the brewery truck driver each week and receives the beer after a 4 week lag. The wholesaler's policy is to keep 12 truckloads in inventory on a continuous basis. Week 6: By week 6 the wholesaler is out of Lover's beer and responds by ordering 30 truckloads from the brewery. Week 8: By the 8th week most stores are ordering 3 or 4 times more Lovers' beer than their regular amounts. Week 9: The wholesaler orders more Lover's beer, but gets only 6 truckloads. Week 10: Only 8 truckloads are delivered, so the wholesaler orders 40.

Week 11: Only 12 truckloads are received, and there are 77 truckloads in backlog, so the wholesaler orders 40 more truckloads. Week 12: The wholesaler orders 60 more truckloads of Lover's beer. It appears that the beer is becoming more popular from week to week. Week 13: There is still a huge backlog. Weeks 14-15: The wholesaler receives larger shipments from the brewery, but orders from retailers begin to drop off. Week 16: The trucker delivers 55 truckloads from the brewery, but the wholesaler gets zero orders from retailers. So he stops ordering from the brewery. Week 17: The wholesaler receives another 60 truckloads. Retailers order zero. The wholesaler orders zero. The brewery keeps sending beer. 3.3 The Brewery The brewery is small but has a reputation for producing high quality beer. Lover's beer is only one of several products produced at the brewery. Week 6: New orders come in for 40 gross. It takes two weeks to brew the beer. Week 14: Orders continue to come in and the brewery has not been able to catch up on the backlogged orders. The marketing manager begins to wonder how much bonus he will get for increasing sales so dramatically. Week 16: The brewery catches up on the backlog, but orders begin to drop off. Week 18: By week 18 there are no new orders for Lover's beer. Week 19: The brewery has 100 gross of Lover's beer in stock, but no orders. So the brewery stops producing Lover's beer. Weeks 20-23. No orders. At this point all the players blame each other for the excess inventory. Conversations with wholesale and retailer reveal an inventory of 93 cases at the retailer and 220 truckloads at the wholesaler. The marketing manager figures it will take the wholesaler a year to sell the Lover's beer he has in stock. The retailers must be the problem. The retailer explains that demand increased from 4 cases per week to 8 cases. The wholesaler and marketing manager think demand mushroomed after that, and then fell off, but the retailer explains that didn't happen. Demand stayed at 8 cases per week. Since he didn't get the beer he ordered, he kept ordering more in an attempt to keep up with the demand. The marketing manager plans his resignation. 3.4 Lessons from the Beer Game 1. The structure of a system influences behavior. Systems cause their own problems, not external forces or individual errors. 2. Human systems include the way in which people make decisions. 3. People tend to focus on their own decisions and ignore how these decisions affect others. 3.5 Lessons Related to the Learning Disabilities 1. People do not understand how their actions affect others. 2. So they tend to blame each other for problems.

3. Becoming proactive causes more problems. 4. The problems build gradually, so people don't realize there is a problem until its too late. 5. People don't learn from their experience because the effects of their actions occur somewhere else in the system. Stock variability amplification in a supply chain due to Bullwhip Effect Q6. Time taken by three machines on five jobs in a factory is tabulated below in table below. Find out the optimal sequence to be followed to minimize the idle time taken by the jobs on the machines. Ans. Consider M1 and M3 Job Machine 1 (M1) Machine 3 (M3) A67 B43 C57 D36 E44 JOB = D E C A B

MBA 2nd SEM Subject Code MB0045 Book ID B1134 FINANCIAL MANAGEMENT Set 2 Q.1 Discuss the objective of Profit Maximization vs Wealth Maximization. Ans. The financial management comes a long way by shifting its focus from traditional approach to modern approach. The modern approach focuses on wealth maximization rather than maximization. This gives a longer term horizon for assessment, making way for sustainable performance by businesses. A myopic person or business is mostly concerned about short term benefits. A short term horizon can fulfill objective of earning profit but may not help in creating wealth. It is because wealth creation needs a longer term horizon Therefore, Finance Management or Financial Management emphasizes on wealth maximization rather than maximization. For a business, it is not necessary that profit should be the only objective; it may concentrate on various other aspects like increasing sales, capturing more market share etc, which will take care of profitability. So, we can say that maximization is a subset of wealth and being a subset, it will facilitate wealth creation. Giving priority to value creation, and managers has now shifted from traditional approach to modern approach of financial management that focuses on wealth maximization. This leads to better and true evaluation of business. For e.g., under wealth maximization, more importance is given to cash flows rather than profitability. As it is said that profit is a relative term, it can be a figure in some currency, it can be in percentage etc. For e.g. a profit of say $10,000 cannot be judged as good or bad for a business, till it is compared with investment, sales etc. Similarly, duration of earning the profit is also important i.e. whether it is earned in short term or long term.

In wealth maximization, major emphasizes is on cash flows rather than profit. So, to evaluate various alternatives for decision making, cash flows are taken under consideration. For e.g. to measure the worth of a project, criteria like: Present Value Of Its Cash Inflow present value of cash outflows (net present value) is taken. This approach considers cash flows rather than profits into consideration and also use discounting technique to find out worth of a project. Thus, maximization of wealth approach believes that money has time value. An obvious question that arises now is that how can we measure wealth. Well, a basic principle is that ultimately wealth maximization should be discovered in increased net worth or value of business. So, to measure the same, value of business is said to be a function of two factors - earnings per share and capitalization rate. And it can be measured by adopting following relation: Value of business = EPS / Capitalization rate At times, wealth maximization may create conflict, known as agency problem. This describes conflict between the owners and managers of firm. As, managers are the agents appointed by owners, a strategic investor or the owner of the firm would be majorly concerned about the longer term performance of the business that can lead to maximization of shareholders wealth. Whereas, a manager might focus on taking such decisions that can bring quick result, so that he/she can get credit for good performance. However, in course of fulfilling the same, a manager might opt for risky decisions which can put-on stake the owners objectives. Hence, a manager should align his/her objective to broad objective of organization and achieve a tradeoff between risk and return while making decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth of its current shareholder she objections are:(i) Profit cannot be ascertained well in advance to express the probability of return as future is uncertain. It is not at possible to maximize what cannot be known. (ii) The executive or the decision maker may not have enough confidence in the estimates of future returns so that he does not attempt future to maximize. It is argued that firm's goal cannot be to maximize profits but to attain a certain level or rate of profit holding certain share of the market or certain level of sales. Firms should try to 'satisfy' rather than to 'maximize' (iii) There must be a balance between expected return and risk. The possibilities of higher expectedyields are associated with greater risk to recognise such a balance and wealth Maximization is brought in to the analysis. In such cases, higher capitalization rate involves. Such combination of expected returns with risk variations and related capitalization rate cannot be considered in the concept of profit maximization. (iv) The goal of Maximization of profits is considered to be a narrow outlook. Evidently when profit maximization becomes the basis of financial decisions of the concern, it ignores the interests of the community on the one hand and that of the government, workers and other

concerned persons in the enterprise on the other hand. Keeping the above objections in view, most of the thinkers on the subject have come to the conclusion that the aim of an enterprise should be wealth Maximization and not the profit Maximization. Prof. Soloman of Stanford University has handled the issued very logically. He argues that it is useful to make a distinction between profit and 'profitability'. Maximization of profits with a view to maximising the wealth of shareholders is clearly an unreal motive. On the other hand, profitability Maximization with a view to using resources to yield economic values higher than the joint values of inputs required is a useful goal. Thus the proper goal of financial management is wealth maximization. Q2. Explain the Net Operating Approach to Capital Structure. Ans. Net operating income approach examines the effects of changes in capital structure in terms of net operating income. In the net income approach discussed above net income available to shareholders is obtained by deducting interest on debentures form net operating income. Then overall value of the firm is calculated through capitalization rate of equities obtained on the basis of net operating income, it is called net income approach. In the second approach, on the other hand overall value of the firm is assessed on the basis of net operating income not on the basis of net income. Hence this second approach is known as net operating income approach. The NOI approach implies that : (i) Whatever may be the change in capital structure the overall value of the firm is not affected. Thus the overall value of the firm is independent of the degree of leverage in capital structure. (ii) (ii) Similarly the overall cost of capital is not affected by any change in the degree of leverage in capital structure. The overall cost of capital is independent of leverage. If the cost of debt is less than that of equity capital the overall cost of capital must decrease with the increase in debts whereas it is assumed under this method that overall cost of capital is unaffected and hence it remains constant irrespective of the change in the ratio of debts to equity capital. How can this assumption be justified? The advocates of this method are of the opinion that the degree of risk of business increases with the increase in the amount of debts. Consequently the rate of equity over investment in equity shares thus on the one hand cost of capital decreases with the increase in the volume of debts; on the other hand cost of equity capital increases to the same extent. Hence the benefit of leverage is wiped out and overall cost of capital remains at the same level as before. Let us illustrate this point. If follows that with the increase in debts rate of equity capitalization also increases and consequently the overall cost of capital remains constant; it does not decline. To put the same in other words there are two parts of the cost of capital. One is the explicit cost which is expressed in terms of interest charges on debentures. The other is implicit cost which refers to the increase in the rate of equity capitalization resulting from the increase in risk of business due to higher level of debts.

Optimum capital structure This approach suggests that whatever may be the degree of leverage the market value of the firm remains constant. In spite of the change in the ratio of debts to equity the market value of its equity shares remains constant. This means there does not exist an optimum capital structure. Every capital structure is optimum according to net operating income approach. Q.3 What do you understand by Operating Cycle. Ans. An operating cycle is the length of time between the acquisition of inventory and the sale of that inventory and subsequent generation of a profit. The shorter the operating cycle, the faster a business gets a return on investment (ROI) for the inventory it stocks. As a general rule, companies want to keep their operating cycles short for a number of reasons, but in certain industries, a long operating cycle is actually the norm. Operating cycles are not tied to accounting periods, but are rather calculated in terms of how long goods sit in inventory before sale. When a business buys inventory, it ties up money in the inventory until it can be sold. This money may be borrowed or paid up front, but in either case, once the business has purchased inventory, those funds are not available for other uses. The business views this as an acceptable tradeoff because the inventory is an investment that will hopefully generate returns, but keeping the operating cycle short is still a goal for most businesses so they can keep their liquidity high. Keeping inventory during a long operating cycle does not just tie up funds. Inventory must be stored and this can become costly, especially with items that require special handling, such as humidity controls or security. Furthermore, inventory can depreciate if it is kept in a store too long. In the case of perishable goods, it can even be rendered unsalable. Inventory must also be insured and managed by staff members who need to be paid, and this adds to overall operating expenses. There are cases where a long operating cycle in unavoidable. Wineries and distilleries, for example, keep inventory on hand for years before it is sold, because of the nature of the business. In these industries, the return on investment happens in the long term, rather than the short term. Such companies are usually structured in a way that allows them to borrow against existing inventory or land if funds are needed to finance short-term operations. Operating cycles can fluctuate. During periods of economic stagnation, inventory tends to sit around longer, while periods of growth may be marked by more rapid turnover. Certain products can be consistent sellers that move in and out of inventory quickly. Others, like big ticket items, may be purchased less frequently. All of these issues must be accounted for when making decisions about ordering and pricing items for inventory. Q4. What is the implication of Operating Leverage for a firm. Ans. Operating leverage: Operating leverage is the extent to which a firm uses fixed costs in producing its goods or offering its services. Fixed costs include advertising expenses, administrative

costs, equipment and technology, depreciation, and taxes, but not interest on debt, which is part of financial leverage. By using fixed production costs, a company can increase its profits. If a company has a large percentage of fixed costs, it has a high degree of operating leverage. Automated and high-tech companies, utility companies, and airlines generally have high degrees of operating leverage. As an illustration of operating leverage, assume two firms, A and B, produce and sell widgets. Firm A uses a highly automated production process with robotic machines, whereas firm B assembles the widgets using primarily semiskilled labor. Table 1 shows both firms operating cost structures. Highly automated firm A has fixed costs of $35,000 per year and variable costs of only $1.00 per unit, whereas labor-intensive firm B has fixed costs of only $15,000 per year, but its variable cost per unit is much higher at $3.00 per unit. Both firms produce and sell 10,000 widgets per year at a price of $5.00 per widget. Firm A has a higher amount of operating leverage because of its higher fixed costs, but firm A also has a higher breakeven pointthe point at which total costs equal total sales. Nevertheless, a change of 1 percent in sales causes more than a 1 percent change in operating profits for firm A, but not for firm B. The degree of operating leverage measures this effect. The following simplified equation demonstrates the type of equation used to compute the degree of operating leverage, although to calculate this figure the equation would require several additional factors such as the quantity produced, variable cost per unit, and the price per unit, which are used to determine changes in profits and sales: Operating leverage is a double-edged sword, however. If firm As sales decrease by 1 percent, its profits will decrease by more than 1 percent, too. Hence, the degree of operating leverage shows the responsiveness of profits to a given change in sales. Implications: Total risk can be divided into two parts: business risk and financial risk. Business risk refers to the stability of a companys assets if it uses no debt or preferred stock financing. Business risk stems from the unpredictable nature of doing business, i.e., the unpredictability of consumer demand for products and services. As a result, it also involves the uncertainty of long-term profitability. When a company uses debt or preferred stock financing, additional riskfinancial riskis placed on the companys common shareholders. They demand a higher expected return for assuming this additional risk, which in turn, raises a companys costs. Consequently, companies with high degrees of business risk tend to be financed with relatively low amounts of debt. The opposite also holds: companies with low amounts of business risk can afford to use more debt financing while keeping total risk at tolerable levels. Moreover, using debt as leverage is a successful tool during periods of inflation. Debt fails, however, to provide leverage during periods

of deflation, such as the period during the late 1990s brought on by the Asian financial crisis. Q5. A company is considering a capital project with the following information: The cost of the project is Rs.200 million, which consists of Rs. 150 million in plant a machinery and Rs.50 million on net working capital. The entire outlay will be incurred in the beginning. The life of the project is expected to be 5 years. At the end of 5 years, the fixed assets will fetch a net salvage value of Rs. 48 million ad the net working capital will be liquidated at par. The project will increase revenues of the firm by Rs. 250 million per year. The increase in costs will be Rs.100 million per year. The depreciation rate applicable will be 25% as per written down value method. The tax rate is 30%. If the cost of capital is 10% what is the net present value of the project. Ans. Total outflow Rs. 150 Million + Rs. 50 Million = Rs. 200 Million Incremental approach Revenue Cost Rs. 250 Million Rs. 100 Million = 150 Million Pr factor @10% for 5 years = 3.790 150 X 3.790 = Rs. 568.62 Calculation of depreciation:

150 25% Year Dep Tax saving PV@10% Tax saving 1 37.5 11.25 0.909 10.226 2 28.125 8.4375 0.826 6.969 3 21.09 6.327 0.751 4.751 4 15.82 4.746 0.683 3.241 5 11.87 3.561 0.621 2.211 27.398
Total inflow: 568.62 + 27.398 = 596.018 + Inflow in 5th year 50+48 = 98 60.858 x 0.621 = 656.876 Net Present Value = 656.876 -200 = 456.876 (Ans) Q.6 Given the following information, what will be the price per share using the Walter model. Earnings per share Rs. 40 Rate of return on investments 18% Rate of return required by shareholders 12% Payout ratio being 40%, 50%, or 60%. Ans. D = 40 % EPS = 40 DPS=16

1. (for40%) = 16 / 12% + (40-16) /12% x 18 % = 169.33 2. (for 50%) = 20 / 12% + (40-20) /12% x 18 % = 196.66 3. (for 60%) = 24 / 12% + (40-24) /12% x 18 % = 224