NAME : AMIT PATHAK ROLL NO : 1302016570 Q1. What are the goals of financial management? Ans.

Financial management is the art and the science of managing money. Traditionally, financial management was
considered as a branch of knowledge that focused on the procurement of funds. The modern approach transformed the field of study from the traditional, narrow approach to a dynamic and extensive approach .

Goals of Financial Management

Financial management means maximisation of economic welfare of its shareholders. Maximisation of economic welfare means maximisation of wealth of its shareholders. Shareholder's wealth maximisation is reflected in the market value of the firm's shares. Experts believe that, the goal of financial management is attained when it maximises the market value of shares. There are two versions of the goals of financial management of the firm- Profit Maximisation and Wealth Maximisation.

Profit maximisation
Profit maximisation is based on the cardinal rule of efficiency. Its goal is to maximise the returns with the best output and price levels. A firm's performance is evaluated in terms of profitability. Profit maximisation is the traditional and narrow approach, which aims at maximising the profit of the concern. The concept of profit lacks clarity. What does profit mean? i.Is it profit after tax or before tax? ii.Is it operating profit or net profit available to shareholders? In this sense, profit is neither defined precisely nor correctly. It creates unnecessary conflicts regarding the earning habits of the business concern. Differences in interpretation of the concept of profit thus expose the weakness of profit maximisation. Profit maximisation neither considers the time value of money nor the net present value of the cash inflow. It does differentiate between profits of current year with the profits to be earned in later years. The concept of profit maximisation fails to consider the fluctuations in profits earned from year to year. Fluctuations may be attributed to the business risk of the firm. Risks may be internal or external which will affect the overall operation of the business concern. The concept of profit maximisation apprehends to be either accounting profit or economic normal profit or economic supernormal profit.

Wealth maximisation
The term wealth means shareholder's wealth or the wealth of the persons those who are involved in the business concern. Wealth maximisation is also known as value maximisation or net present worth maximisation. This objective is an universally accepted concept in the field of business.

Q2. Calculate the PV of an annuity of Rs. 500 received annually for four years when discounting factor is 10%. Ans. Computation of PV of Annuity

End of year 1 2 3 4

Cash inflows Rs.500 Rs.500 Rs.500 Rs.500

PV factor 0.909 0.827 0.751 0.683 3.170

PV in Rs. 454.5 412.5 375.5 341.5 1585.0

Present value of an annuity is Rs. 1585. OR By directly looking at the table we can calculate: =500*PVIFA (10%.4y) =500*3.170 =Rs. 1585 The present value of annuity is Rs. 1585.

Q3. Suraj Metals are expected to declare a dividend of Rs. 5 per share and the growth rate in dividends is expected to grow @ 10% p.a. The price of one share is currently at Rs. 110 in the market. What is the cost of equity capital to the company? Ans.Ke= (D1/Pe)+g = (5/110) + 0.10 =0.1454 or 14.54% Cost of equity capital is 14.54%. Q4. What are the assumptions of MM approach? Ans. Equity and debt are the two important sources of long term sources of finance of a firm. The proportion of debt and
equity in a firms capital structure has to be independently decided case to case. A proposal, though not being favourable to lenders, may be taken up if they are convinced with the earning potential and long-term benefits.

Assumptions:
The following are some common assumptions made: The firm has only two sources of funds, debt and ordinary shares There are no taxes, both corporate and personal The firms dividend payout ratio is 100%, that is, the firm pays off the entire earnings to its equity holders and retained earnings are zero The investment decisions of a company are constant, that is, the firm does not invest any further in its assets The operating profits/EBIT are not expected to increase or decrease All investors shall have identical subjective probability distribution on the future expected EBIT A firm can change its capital structure at a short notice without the incurrence of transaction costs

 The life of the firm is indefinite

Miller and modigliani approach:

Miller and modigliani criticise traditional approach that the cost of equity remains unaffected by leverage up to a reasonable limit and K0 remains constant at all degrees of leverage. They state the relationship between leverage and cost of capital is elucidated as in NOI approach.

Perfect capital markets Dividend Payout

Rational Apporach

M and M Approach

Taxes

Homogenity

Year 1 2

Cash inflow 40000 50000

Above Table depicts the assumptions regarding Miller and Modigliani (MM) approach: perfect capital markets, rational behaviour, homogeneity, taxes, and dividend payout.

Let us discuss these assumptions in detail.

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 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 the same perception of business risk and returns. Taxes There is no corporate or personal income tax.

 Dividend payout is 100% - The activities.

3 4

15000 30000

firms do not retain earnings for future

Q5. An investment will have an initial outlay of Rs 100,000. It is expected to generate cash inflows. Table 1.2 highlights the cash inflow for four years.
Table 1.2: Cash inflow

If the risk free rate and the risk premium is 10%, a) Compute the NPV using the risk free rate b) Compute NPV using risk-adjusted discount rate Ans. A) NPV can be computed using risk free rate. Below Table shows NPV calculation using the risk free rate. PV Using Risk Free Rate Cash flows(inflow) PV factor at 10% Rs. 40000 0.909 50000 0.826 15000 0.751 30000 0.683 PV of cash inflows PV of cash outflows (1,00,000) NPV

Year 1 2 3 4

PV of cash flows (inflows) 36,360 41,300 11,265 20,490 1,09,415 9,415

b) NPV can be computed using risk-adjusted discount. Above Table shows NPV calculation using the riskadjusted discount. NPV Using Risk-adjusted Discount Rate Cash inflows Rs. PV factor at 20% PV of cash inflows 0.833 33,320 40000 50000 0.694 34,700 15000 0.579 8,685 30000 0.482 14,460 PV of cash inflows 91,165 PV of cash outflows (1,00,000) NPV (8,835)

Year 1 2 3 4

The project would be acceptable when no allowance is made for risk. However, it will not be acceptable if risk premium is added to the risk free rate. By doing so, it moves from positive NPV to negative NPV. If the firm were to use the internal rate of return (IRR), then the project would be accepted, when IRR is

greater than the risk-adjusted discount rate.

Q6. What are the features of optimum credit policy? Ans.The credit policy of a firm can be termed as a trade-off between increased credit sales leading to increase in profit and
the cost of having larger amount of cash locked up in the form of receivables along with the loss due to the incidence of bad debts. The term credit policy compromise the policy of a company with respect to the credit standards adopted; the period over which the credit is extended to customers; any incentives in the form of cash discount offered; as also the period over which the discount can be used by the customers; and the collection efforts made by the company. Credit Standards The term credit standards refer to the criteria for extending credit to customers. The basis for setting credit standards are: o Credit ratings o References o Averages payment period o Ratio analysis There is always a benefit to the company with the extension of credit to its customers, but with the associated risks of delayed payments or non-payment and of getting funds blocked in receivables. The firm may have light credit standards. The firm may sell goods on cash basis and extend credit only to financially strong customers. Such strict credit standards will bring down bad debt losses and reduce the cost of credit administration. Credit period Credit period refers to the length of time allowed by a firm, for its customers to make payment, for their purchases. Credit period is generally expressed in days like 15 days or 20 days. Generally, firms give cash discount if payments are made within the specified period. Cash discount Firms offer cash discounts to induce their customers to make prompt payments. Cash discounts have implications on sales volume, average collection period, investment in receivables, incidence of bad debts and profits. A cash discount of 2/10 net 20 means that a cash discount of 2% is offered if the payment is made by the tenth day; th otherwise full payment will have to be made by 20 day. Collection programme The success of a collection programme depends on the collection policy pursued by the firm. The objective of a collection policy is to achieve a timely collection of receivables. Releasing funds locked in receivables and minimising the incidence of bad debts are the other objectives of the collection policy.