2. mba 202 financial management assignment 2nd semester

1. MBA 202 FINANCIAL MANAGEMENT Page 1
SPRING 2017
MBA
SEMESTER - II
SUBJECT CODE & NAME-MBA202 & FINANCIAL MANAGEMENT
SET- 1
Q.1 Explain the differences between wealth maximization and profit maximization. Explain
relation between finance and accounting
Answer:
Wealth maximisation vs. profit maximisation:
 Wealth maximisation is based on cash flow. It is not based on the accounting profit as in
the case of profit maximisation.
 Through the process of discounting, wealth maximisation takes care of the quality of
cash flow. Converting uncertain distant cash flow into comparable values at base period
facilitates better comparison of projects.
 Corporate play a key role in today’s competitive business scenario. In an organisation,
shareholders typically own the company, but the management of the company rests
with the board of directors.
 When a firm follows wealth maximisation goal, it achieves maximisation of market value
of share. A firm can practise wealth maximisation goal only when it produces quality
goods at low cost.

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 Another notable feature of the firms that are committed to the maximisation of wealth
is that, to achieve this goal they are forced to render efficient service to their customers
with courtesy. This enhances consumer welfare and benefit to the society.
 From the point of evaluation of performance of listed firms, the most remarkable
measure is that of performance of the company in the share market.
 Since listing ensures liquidity to the shares held by the investors, shareholders can reap
the benefits arising from the performance of company only when they sell their shares.
Relation between Finance and accounting:
In the hierarchy of the finance function of an organisation, the controller reports to the CFO.
Accounting is one of the functions that a controller discharges. Accounting is a part of Finance.
For computation of return on investment, earnings per share and for various ratios of financial
analysis, the data base will be accounting information. Without a proper accounting system, an
organisation cannot administer the effective function of financial management.
The purpose of accounting is to report the financial performance of the business for the period
under consideration. All the financial decisions are futuristic based on cash flow analysis. All the
financial decisions consider quality of cash flow as an important element of decisions. Since
financial decisions are futuristic, they are taken and put into effect under conditions of
uncertainty. Assuming the condition of uncertainty and incorporating the effect on decision
making results in use of various statistical models. In the selection of the statistical models,
element of subjectivity creeps in. The relationship between finance and accounting has two
dimensions:
(a) They are closely associated to the extent that accounting is an important input in financial
decision making
(b) There are definite differences between them

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Q.2 Explain about the doubling period and future value. Solve the below given problem:
Under the ABC Bank’s Cash Multiplier Scheme, deposits can be made for periods ranging from
3 months to 5 years and for every quarter, interest is added to the principal. The applicable
rate of interest is 9% for deposits less than 23 months and 10% for periods more than 24
months. What will be the amount of Rs. 1000 after 2 years?
Answer:
Doubling period:
Doubling period is the period which makes the investment as "Doubled", that is the amount
invested fetches 100% return.
1. Rule of 72
The initial amount of investment gets Doubled within which 72/I
Where, I = Interest Rate of the investment.
2. Rule of 69
The amount method is found to crude logic in determining the doubling period which has its
own limitations. The rule of 69 eliminates the bottleneck associated with the rule of 72 method.
The rule of 69 is originate to be a scientific and rational method in determining the doubling
period of the investment made As per rule of 69 method the doubling period is calculated as
0.35+ 69/I
Future Value
The process of calculating future value will become very cumbersome if it has to be calculated
over long maturity periods of 10 or 20 years. A generalised procedure of calculating the future
value of a single cash flow compounded annually is as follows:
Where, FVn = future value of the initial flow in n years hence,
PV = initial cash flow
i = annual rate of interest

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n = life of investment
of n number of years at a rate of interest ‘i’ referred to as the Future Value Interest Factor
(FVIF). To help ease the calculations, this expression has been evaluated for various
combinations of “i” and “n”. To calculate the future value of any investment, the corresponding
is multiplied with the initial investment.
m = 12/3 = 4 (quarterly compounding)
1000 (1+0.10/4)^4*2
1000 (1+0.10/4)^8
Rs. 1218
The amount of Rs. 1000 after 2 years would be Rs. 1218.
Q.3 Write short notes on:
a) Irredeemable bonds
b) Zero coupon bonds
c) Valuation of Shares
Answer:
 Irredeemable bonds or perpetual bonds:
Bonds which will never mature are known as irredeemable or perpetual bonds. Indian
Companies Act restricts the issue of such bonds and therefore, these are very rarely issued by
corporates these days. In case of these bonds, the terminal value or maturity value does not
exist because they are not redeemable. The face value is known, and the interest received on

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such bonds is constant and received at regular intervals and hence, the interest receipt
resembles perpetuity. The present value is calculated as:
Where Vo is the present value; ‘I’ is the annual interest payable on the bond and ‘’ is the
required rate of interest.
If a company offers to pay Rs. 70 as interest on a bond of Rs. 1000 per value and the current
yield is 8%, the value of the bond is 70/0.08 which is equal to Rs. 875.
 Zero coupon bonds:
In India, zero coupon bonds are alternatively known as Deep Discount Bonds (DDBs). These
bonds became very popular in India for over a decade because of issuance of such bonds at
regular intervals by IDBI and ICICI. Zero coupon bonds have no coupon rate, that is, there is no
interest to be paid out. Instead, these bonds are issued at a discount to their face value, and the
face value is the amount payable to the holder of the instrument on maturity. Thus, no interest
or any other type of payment is available to the holder before maturity. Since there is no
intermediate payment between the date of issue and the maturity date, these DDBs are also
called zero coupon bonds. The valuation of DDBs is similar to the ordinary bonds valuation.
Since DDB at the time of maturity generates only one future cash flow, the value of this may be
taken as equal to the present value of this future cash flow discounted at the required rate of
return of the investor for the number of years of the life of DDBs. The value of DDB is calculated
as:
= Value of the DDB
FV= Face value of DDB payable at maturity
r= The required rate of return
n= Life of the DDB

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 Valuation of Shares:
A company’s shares can be categorised into:
 Ordinary or equity shares
 Preference shares
The returns the shareholders receive in return are called dividends. Preference shareholders
get a preferential treatment as to the payment of dividend and repayment of capital in the
event of winding up. Such holders are eligible for a fixed rate of dividends. The following are
some important features of preference and equity shares:
 Dividends – Rate is fixed for preference shareholders. They can be given cumulative
rights, that is, the dividend can be paid off after accumulation. The dividend rate is not
fixed for equity shareholders.
 Claims – In the event of the business closing down, the preference shareholders have a
prior claimon the assets of the company.
 Redemption – Preference shares have a maturity date on which the company pays off
the face value of the shares to the holders. Preference shares can be of two types –
redeemable and irredeemable. Irredeemable preference shares are perpetual. Equity
shareholders have no maturity date.
 Conversion – A company can issue convertible preference shares. After a particular
period, as mentioned in the share certificate, the preference shares can be converted
into ordinary shares.
SET- 2
Q.1 Explain the factors affecting Capital Structure. Solve the below given problem:
Given below are two firms, A and B, which are identical in all aspects except the degree of
leverage, employed by them. What is the average cost of capital of both firms?

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Details of Firms A and B
Firm A Firm B
Net operating income EBIT Rs. 1, 00, 000 Rs. 1, 00, 000
Interest on debentures I Nil Rs.25,000
Equity earnings E Rs.1,00,000 Rs.75,000
Cost of equity Ke 15% 15%
Cost of debentures Kd 10% 10%
Market value of equity S = E/Ke Rs. 6, 66, 667 Rs.5,00,000
Market value of debt B Nil Rs.2,50,000
Total value of firm V Rs. 6, 66, 667 Rs,7,50,000
Answer:
Factors Affecting Capital Structure:
Leverage:
The use of sources of funds that have a fixed cost attached to them, such as preference shares,
loans from banks and financial institutions, and debentures in the capital structure, is known as
“trading on equity” or “financial leverage”. If the assets financed by debt yield a return greater
than the cost of the debt, the EPS will increase without an increase in the owner’s investment.
Similarly, the EPS will also increase if preference share capital is used to acquire assets.
Cost of capital – High cost funds should be avoided. However attractive an investment
proposition may look like, the profits earned may be eaten away by interest repayments.
Cash flow projections of the company – Decisions should be taken in the light of cash flow
projected for the next 3-5 years. The company officials should not get carried away at the
immediate results expected. Consistent lesser profits are any way preferable than high profits
in the beginning and not being able to get any profits after 2 years.

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Dilution of control – The top management should have the flexibility to take appropriate
decisions at the right time. Fear of having to share control and thus being interfered by others
often delays the decision of the closely held companies to go public.
Floatation costs – Floatation costs are incurred when the funds are raised. Generally, the cost
of floating a debt is less than the cost of floating an equity issue. A company desiring to increase
its capital by way of debt or equity will definitely incur floatation costs.
Average cost of capital of firm A is:
10% * 0/Rs. 666667 + 15% * 666667/666667
= 0 + 15
= 15%
Average cost of capital of firm B is:
10% * 25000/750000 + 15% * 533333/750000
= 3.34 + 10
= 13.4%
Interpretation:
The use of debt has caused the total value of the firm to increase and the overall cost of capital
to decrease.
Q.2 Explain the capital Budgeting process and its appraisals .Solve the below given problem:
Given below are the details on the cash flows of two projects A and B. Compute payback
period for A and B.
Cash flows of A and B
Year Project A cash flows (Rs.) Project B cash flows (Rs.)
0 (4,00,000) (5,00,000)

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1 2,00,000 1,00,000
2 1,75,000 2,00,000
3 25,000 3,00,000
4 2,00,000 4,00,000
5 1,50,000 2,00,000
Answer:
Capital budgeting process:
After the screening of proposals for potential involvement is over, the company should take up
the following aspects of capital budgeting process:
 A proposal should be commercially viable. The following aspects are examined to
ascertain the commercial viability of any investment proposal:
 Market for the product
 Availability of raw materials
 Sources of raw materials
 The elements that influence the location of a plant, i.e., the factors to be
considered in the site selection
 Infrastructural facilities such as roads, communication facilities, financial services such
as banking and public transport services
Ascertaining the demand for the product or services is crucial. It is done by market appraisal. In
appraisal of market for the new product, the following details are compiled and analysed:
 Consumption trends
 Competition and players in the market
 Availability of substitutes
 Purchasing power of consumers
 Regulations stipulated by government on pricing the proposed products or services
 Production constraints.

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Technical appraisal
The technical appraisal deals with the technical aspects of the project. The technical aspects of
a project are:
 Selection of process know-how
 Decision on determination of plant capacity
 Selection of plant, equipment and scale of operation
Technical appraisal ensures implementation of all the technical aspects of the project.
Economic appraisal
The economic appraisal deals with economic and social impacts of a project. It examines the
impact of the project on the following:
 Environment
 Income distribution in the society
 Fulfilment of certain social objective like generation of employment and attainment of
self sufficiency
Financial appraisal
Financial appraisal is to examine the financial viability of the project. Financial appraisal
technique examines:
 Cost of the project
 Investment outlay
 Means of financing and the cost of capital
 Expected profitability
Cash Flows and Cumulative Cash Flows of A and B
Year
Project A Project B
Cash flows
(Rs.)
Cumulative
Cash flows
Cash flows
(Rs.)
Cumulative
Cash flows
1 2,00,000 2,00,000 1,00,000 1,00,000
2 1,75,000 3,75,000 2,00,000 3,00,000
3 25,000 4,00,000 3,00,000 6,00,000
4 2,00,000 6,00,000 4,00,000 10,00,000

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5 1,50,000 7,50,000 2,00,000 12,00,000
From the cumulative cash flows column, project A recovers the initial cash outlay of Rs 4,00,000
at the end of the third year. Therefore, payback period of project A is 3 years.
From the cumulative cash flow column the initial cash outlay of Rs. 5,00,000 lies between 2nd
year and 3rd year in case of project B.
Therefore, payback period for project B is: {2 + (500000-300000)}/300000
= 2.67 years
Pay-back period for project B is 2.67 years
Q.3 Explain the concepts of working capital. Explain the determinants of working capital.
Answer:
Concepts of Working Capital:
 Gross working capital:
Gross working capital refers to the amounts invested in various components of current assets.
It basically refers to the current assets. This concept has the following practical relevance:
 Management of current assets is the crucial aspect of working capital management
 Gross working capital helps in the fixation of various areas of financial responsibility
 Gross working capital is an important component of operating capital.
 Net working capital:
Net working capital is the excess of current assets over current liabilities and provisions. Net
working capital is positive when current assets exceed current liabilities and negative when
current liabilities exceed current assets. This concept has the following practical relevance:
 Net working capital indicates the ability of the firm to effectively use the spontaneous
finance in managing the firm’s working capital requirements
 A firm’s short term solvency is measured through the net working capital position, it
commands
 Permanent working capital:
Permanent working capital is the minimum amount of investment required to be made in
current assets at all times to carry on the day-to-day operation of firm’s business.
 Temporary working capital:
Temporary working capital is also known as variable working capital or fluctuating working
capital. The firm’s working capital requirements vary depending upon the seasonal and cyclical
changes in demand for a firm’s products.

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Determinants of Working Capital
 Nature of business – Working capital requirements are basically influenced by the
nature of business of the firm. Trading organisations are forced to carry large stocks of
finished goods, accounts receivables and accounts payables.
 Manufacturing cycle – Capital intensive industries with longer manufacturing process
will have higher requirements of working capital, because of the need of running their
sophisticated and long production process.
 Products policy – Production schedule of a firm influences the investments in
inventories.
 Volume of sales – There is a positive direct correlation between the volume of sales and
the size of working capital of a firm.
 Term of purchase and sales – A firm that allows liberal credit to its customers will need
more working capital than a firm with strict credit policy. A firm, which enjoys liberal
credit facilities from its suppliers requires lower amount of working capital when
compared to a firm, which does not have such a facility.
 Operating efficiency – The firm with high efficiency in operation can bring down the
total investment in working capital to lower levels. Here, effective utilisation of
resources helps the firm in bringing down the investment in working capital.
 Price level changes – Inflation affects the working capital levels in a firm. To maintain
the operating efficiency under an inflationary set up, a firm should examine the
maintenance of working capital position under constant price level.
 Business cycle – During boom, sales rise as business expands. Depression is marked by a
decline in sale. During boom, expansion of business can be achieved only by augmenting
investment in various assets that constitute working capital of a firm.
 Processing technology – Longer the manufacturing cycle, larger is the investment in
working capital. When raw material passes through several stages in the production,
process work in process inventory will increase correspondingly.
 Fluctuations in the supply of raw materials – Companies which use raw materials
available only from one or two sources are forced to maintain buffer stock of raw
materials to meet the requirements of uncertainty in lead time.