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Director of Distance Education Sikkim Manipal University II Floor, Syndicate House Manipal-576 104

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MB 0045 Financial Management (Book ID:B1628)

Q1. What are the goals of financial management?

Ans: Financial Management plays important role in the successful growth of any industry. In order to make financial decisions the management must have a clear understanding of the objective sought to be achieved. Basically the financial management has to take three important decisions viz. (i) Investment decision i.e., where to invest fund and the quantum of amount to be invested, (ii) Financing decision in source of raising the funds and the respective fund amounts for the said sources. i.e. from where to raise funds and in what amount and (iii) Dividend i.e. how much to pay dividend and how much to retain for future expansion. It is generally agreed that the financial objective of the firm should be maximization of owners economic welfare. There are two widely discussed approaches or criterion of maximizing owners welfare (i) Profit maximization, and (ii) Wealth maximization. It should be noted here that objective is used in the sense of goal or goals or decision criterion for the three decisions involved. Profit Maximization: Maximization of profits is very often considered as the main objective of a business enterprise. The shareholders, the owners of the business, invest their funds in the business with the hope of getting higher dividend on their investment. Moreover, the profitability of the business is an indicator of the sound health of the organisation. Profitability of an Industry should be capable of safeguarding the economic interests of various social groups which are directly or indirectly connected with the company e.g. shareholders, creditors and employees. All these parties must get reasonable return for their contributions and it is possible only when company earns higher profits or sufficient profits to discharge the obligations to them. Wealth Maximization: The wealth maximization (also known as value maximization or Net Present worth Maximization) is also universally accepted criterion for financial decision making. The value of an asset should be viewed in terms of benefits it can produce over the cost of capital investment.

Q2. Explain the factors affecting Financial Plan. Ans: We live in a society and interact with people and environment. What happens to us is not always accordance to our wishes. Many things turn out in our live are uncontrollable by us. Many decisions we take are the result of external influences. So do our financial matters. There are many factors that affect our personal financial planning. Economic factors affecting financial plans range from national to global (international factors) influences; that play important role in changing the trends as well as circumstances prevailing. Aware of factors affecting your money matters below will certainly benefit your planning. Factors Affecting Financial Plan 1. Nature of the industry: - Here, we must consider whether Industry is a capital intensive or labour intensive industry. This will have a major impact on the total assets that the firm owns. 2. Size of the company: - The size of the company has greatly and direct influence on the availability of funds from different sources. A small company normally finds it difficult to raise funds from long term sources at competitive terms. On the other hand, large companies like Reliance enjoy the privilege of obtaining funds both short term and long term at attractive rates. 3. Status of the company in the industry:- A well established company enjoying a good market share, for its products normally commands investors confidence. Such a company can tap the capital market for raising funds in competitive term for implementation new projects to exploit the new opportunity emerging from changing business environment. 4. Sources of finance available: - Sources of finance could be group into debt and equity. Debt is cheap but risky whereas equity is costly. A firm should aim at optimum capital structure that would achieve the least cost capital structure. A large firm with a diversified product mix may manage higher quantum of debt because the firm may manage higher financial risk with a lower business risk. Selection of sources of finances us closely linked to the firms capacity to manage the risk exposure. 5. The capital structure of a company: - Capital structure of a company is influenced by the desire of the existing management of the company to maintain control over the affairs of the company. The promoters who do not like to lose their grip over the affairs of the company normally obtain extra funds for growth by issuing preference shares and debentures to outsiders. 6. Matching the sources with utilization: - The product policy of any good financial plan is to match the term of the source with the term of investment. To finance fluctuating working capital needs the firm to resort to short term finance. All fixed assets-investment are to be financed by long term sources. It is a cardinal principal of financial planning. 7. Flexibility:- The financial plan of company should possess flexibility so as to effect changes in the composition of capital structure when ever need arises. If the capital structure of a company is

flexible, it will not face any difficulty in changing the sources of funds. This factor has become a significant one today because of the globalization of capital market. 8. Government Policy:- SEBI guidelines, finance ministry circulars, various clauses of Standard Listing Agreement and regulatory mechanism imposed by FEMA and Department of Corporate Affairs (Govt of India) influence the financial plans of corporate today. Management of public issues of shares demands the companies with much status in India. They are to be compiled with a time constraint.

Q3 Explain the time value of money.

Ans: - Time value of money is the value of a unit of money at different time intervals. The value of the money received today is more than its value received at a later date. In other words, the value of money changes over a period of time. Since a rupee received today has always more value; rational investors would prefer current receipts over future receipts. That is why this phenomenon is referred to as time preference of money. Illustration we intuitively know that Rs.100 in hand now is more valuable than Rs. 100 receivable after a year. In other words, we will not part with Rs. 100 now in return for a firm assurance that the same sum will be repaid after a year. But we might part with the same Rs. 100 now if we are assured that something more than Rs. 100 will be paid at the end of first year. This additional compensation required for parting with Rs. 100 now is called the interest or the time value of money. Some important factors contributing to this nature are: Investment opportunities Preference for consumption Risk These factors remind us of the famous English saying, A bird in hand is worth two in the bush. The question now is: why should money have time value? Some of the reasons are: 1) finished Productivity Money can be employed productively to generate real returns. For example, if we spend Rs. 500 on materials, Rs. 300 on labour, and Rs. 200 on other expenses and the product is sold for Rs. 1100, we can say that the investment of Rs. 1000 has fetched us a return of 10%. 2) Inflation During periods of inflation, a rupee has higher purchasing power than a rupee in the future. 3) Risk and uncertainty We all live under conditions of risk and uncertainty. As the future is characterised by uncertainty, individuals prefer current consumption over future consumption. Most people have subjective preference for present consumption either because of their current references or because of inflationary pressures.

Q4. XYZ India Ltds share is expected to touch Rs. 450 one year from now. The company is expected to declare a dividend of Rs. 25 per share. What is the price at which an investor would be willing to buy if his or her required rate of return is 15%? Ans :P0= D1/ (1+Ke) + P1/(1+Ke) = {25/(1+0.15)} + {450/(1+0.15)} = 21.74 + 391.30 = Rs. 413.04

Q5. Below Table depicts the statistics of a firm and its sales requirements. Compute the DOL according to the values given in the table. Table: Statistics of a Firm Sales in units 2000 Sales revenue Rs. 20000 Variable cost Contribution Fixed cost EBIT Ans :DOL = {Q(S-V)}/{Q(S-V)-F} {2000(10000)}/{2000(10000)-0} =2000000/2000000 =DOL=1 The DOL according to the values given in the table is 1. Q6. What are the assumptions of MM approach? Ans :1) 2) 3) 4) 5) 1) Assumptions of Miller and Modigliani (MM) approach is as follow: Perfect capital markets Rational behaviour Homogeneity Taxes Dividend payout. 10000 6000 0 6000

Perfect capital markets Securities can be freely traded, that is, investors are free to buy and sell securities (both shares and debt instruments), no hindrances on the borrowings, no presence of transaction costs, securities are infinitely divisible, and availability of all required information at all times. Investors behave rationally They choose the combination of risk and return which is most advantageous to them. Homogeneity of investors risk perception All investors have thesame perception of business risk and returns. Taxes There is no corporate or personal income tax. Dividend payout is 100% The firms do not retain earnings for future activities.

2) 3) 4) 5)