Rajasthan Technical University MBA Third Semester Examination, Jan.

2010 Finance for Strategic Decision Time: 3 Hours Note: 1) 2) The question paper is divided into two section- A and B. Section A contain 6 questions, out of which the candidate is required to attempt any 4 questions. Section- B contains 1 question which is compulsory. 3) All questions carry equal marks. Section A Ques 1) What do you understand by Strategic Financial Decisions Why these are decisions so Crucial and Complex? Give briefly the Principles and Parameters which may offer guidance to your decision process? Strategy is a comprehensive plan to achieve organizational goals. Such a plan is prepared keeping in view: - Internal strengths of company & - Challenges of external environment Such strategic plan is formed after the determination of long term goals and objectives of the organization and to make plans for allocation of resources and implementation of projects for achieving set goals.The process of strategic decision making involves the process of deciding long term: - Mission - Objective - Swot analysis - Identification of thrust areas Strategic decision making helps managers in identifying the sources of funds from where they can procure funds at lowest cost and employ them in areas which provide best return. It is a decision regarding management of Max Marks: 70

funds and resources and finding out best activities which can generate profit and value addition to the organization. In today highly technologically advanced business world, advanced statistical techniques such as regression analysis is used to verify and refine financial information for decision taking rather than mere financial depending on financial ratios. The key tasks associated with the decisions related to strategic finance decision are. 1. Analysis of financial problems in individual firm 2. Analyzing the sources of low cost of funds. 3. Analyzing profitable business activities The key objectives of strategic decisions pertaining to finance are: - Maximizing profit - Maximizing share holders wealth - Minimizing risk - Maintaining control to rationalize costs - Proper forecasting and measuring results Main tools and techniques of strategic financial decision making are: - Ratio analysis - Portfolio analysis - Valuation of firm - Trend analysis Ques 2) (a) Describe briefly the key-elements of a well-functioning Financial System present in any economy. Ans : The basic elements of a well-functioning financial system are (i) a strong legal and regulatory environment, (ii) stable money, (iii) sound public finances and public debt management, (iv) a central bank, (v) a sound banking system, (vi) an information system, and (vii) a well-functioning securities market. Since finance is based on contracts, strong legal and regulatory systems that produce and strictly enforce laws alone can protect the rights and interests of investors. Hence, a strong legal system is the most fundamental element of a sound financial system.

Stable money is an important constituent as it serves as a medium of exchange, a store of value (a reserve of future purchasing power), and a standard of value (unit of account) for all the goods and services we might wish to trade in. Large fluctuations and depreciation in the value of money lead to financial crises and impede the growth of the economy. Sound public finance includes setting and controlling public expenditure priorities and raising revenues adequate to fund them efficiently. Historically, these financing needs of the governments world over led to the creation of financial systems. Developed countries have sound public finances and public debt management practices, which result in the development of a good financial system. A central bank supervises and regulates the operations of the banking system. It acts as a banker to the banks, banker to the government, manager of public debt and foreign exchange, and lender of the last resort. The monetary policy of the central bank influences the pace of economic growth. An autonomous central bank paves the way for the development of a sound financial system. A good financial system must also have a variety of banks both with domestic and international operations together with an ability to withstand adverse shocks without failing. Banks are the core financial intermediaries in all countries. They perform diverse key functions such as operating the clearing and payments system, and the foreign exchange market. The banking system is the main fulcrum for transmitting the monetary policy actions. Banks also undertake credit risk analysis, assessing the expected risk and return on the projects. The financial soundness of the banking system depends on how effectively banks perform these diverse functions. Another foundational element is information. All the participants in a financial system require information. A sound financial system can develop only when proper disclosure practices and networking of information systems are adopted. Securities markets facilitate the issue and trading of securities, both equity and debt. Efficient securities markets promote economic growth by mobilising and deploying funds into productive uses, lowering the cost of capital for firms, enhancing liquidity, and attracting foreign

investment. An efficient securities market strengthens market discipline by exerting corporate control through the threat of hostile takeovers for underperforming firms. Financial System Designs

Bank-based Market-based

2 (b)

What have been the aims and objectives of Financial Reforms in this regards in India and if with any results thereof?

Financial sector reforms have long been regarded as an important part of the agenda for policy reform in developing countries. Traditionally, this was because they were expected to increase the efficiency of resource mobilization and allocation in the real economy which in turn was expected to generate higher rates of growth. More recently, they are also seen to be critical for macroeconomic stability. This is especially so in the aftermath of the East Asian crisis, since weaknesses in the financial sector are widely regarded as one of the principal causes of collapse in that region. Following East Asia, soundness of the financial system has been elevated to a position similar to that of fiscal deficit as one of the 'fundamentals' for judging the health of an economy. Developing countries can expect increasing scrutiny on this front by international financial institutions, and rating agencies and countries which fail to come up to the new standards are likely to suffer through lower credit ratings and poorer investor perceptions. In this background it is both relevant and timely to examine how far India's financial sector measures up to what is now expected. Reform of the financial sector was identified, from the very beginning, as an integral part of the economic reforms initiated in 1991. As early as August 1991, the government appointed a high level Committee on the Financial System (the Narasimham Committee) to look into all aspects of the financial system and make comprehensive recommendations for reforms.

3 (a) Define briefly (but clearly, precisely) the following terms: Savings, Investment, Money, Interest and Inflation.

Saving is what households (i.e. participants in the consumption account) do. The level of saving in the economy depends on a number of factors (incomplete list):

A higher real interest rate will give a greater return on saving as banks offer more favourable rates. Poor returns on risky forms of saving, e.g. stocks and bonds, make it more advantageous to hold money savings (in contention between Keynesian and Monetarist views here, mostly because of differences in definitions). Poor expectation for future economic growth, increase households' savings as a precaution for a grim future. More disposable income after fixed expenditures (such as mortgage, heating bill, basic goods purchases) have been made (in contention between Keynesian and Monetarist views here, mostly because of differences in definitions). Perceived likelihood of plunder of the future value of savings, via legal or extralegal means, will make saving less attractive (in contention between Keynesian and Monetarist views here, mostly because of differences in definitions).

These factors affect the marginal propensity to save (MPS) - the greater this MPS, the more saving households will do as a proportion of each additional increment of income Investment

Investment is made into capital (ie. plant and machinery, also 'human capital' - training and education), with intent to increase productivity, efficiency and output of goods and services In national accounting terms, stocks, bonds, mutual funds, and other items whose value is risky, are NOT investments. They fall into the savings account, not the investment account. In monetary terms, the relationship between savings and investment is modeled, rather than being an accounting identity. Stocks and bonds are considered to be important intermediary forms of savings as it gets transformed into a capital investment that produces value. Mutual funds, CDs, BICs, GICs, pension obligations, insurance annuities, and other forms of savings marketed by financial intermediaries, all consist of stocks, bonds, and cash balances, which in turn pay for the capital that increases productivity, efficiency and output of goods and services.

Money Money is something that is widely used and accepted in transactions involving transfer of Goods and services from one person to another. However, it is difficult to define it. Different authors has tried to define money in their own way. Some of the definitions are given below: H. Withers :- The stuff with which we buy and sell things Crowither:- Anything that is generally accepted as a means of exchange (i.e. means of settling debts) and that at the same time acts as a measure and as a store of value

J.M. Keynes :- Money is thing by delivery of which debt contracts and price contracts are discharged and in the shape of which a store of general purchasing power is held A common thing which is there in above definitions is emphasis on functions of money.

Interest Interest- is fee paid on borrowed money/ capital. It can be thought of rent of money. The fee is compensation to lender for forgoing other useful investments that could have been made with the loaned money. The amount lent or the value of asset lent is called the principal. This principal value is held by the borrower on credit. Interest is there fore price of credit. The percentage of principal that is paid as fee over certain period of time is called interest rate.

Inflation Inflation generally refers to rise in prices of specific goods or services. Inflation is usually measured as percentage rate of change of a price index. Two widely known indices for which inflation rates are reported in many countries as a consumer price index (CPI) which measures consumer prices and GDP deflator which measures price variations associated with domestic production of goods and services. Just mention the determinants of Interest.

(b)

Investment is the employment of funds with the aim of getting returns on it. Funds are saved from current consumption with the hope to get benefits from these funds in future. There are two concepts of investment. Economic concept:- in economic term, investment means increase in building, equipments, inventory etc i.e. capital stock of society. It implies formation of new and productive capital. Financial concept:- investment means exchange of financial claims such as shares, bonds, real estate etc. Financial investment means investment in shares, debentures, fixed deposits, NSC, LIC polices, provident funds etc to derive future income in the form of interest, dividend, premium rent, pension benefit leading to appreciation in the value of principal amount invested.

Investment attributes:- Every investor has certain specific objectives to achieve through his short term and long term investments. Such objectives may be: - Monetary/ Financial :- These include Safety and security of funds invested Profitability (through interest, dividend & capital appreciation) & Liquidity (convertibility in to cash as & when required) Besides above, investor would not like to take undue risk about his principal amount even interest rate offered is attractive. - Personal objective which are given due consideration by investor like provision for old age & sickness, provision for house construction, education and marriage of children, provision for dependents like wife and physically handicapped members of family Investment avenue selected should be suitable for achieving both the objectives i.e. financial as well as personal. Two important factors considered are Period of investment which relate to liquidity Risk in investment relate to non-payment of principal or interest there on Factors effecting selection of suitable avenue for investment - Investment objective - Period of investment - Risk in investment - Market standing of borrowing agency - Future marketability - Loan facility - Returns on investments - Tax benefits Investment Avenues - Investments in shares, debentures & bonds of different companies, corporations, and public sector organizations - Postal saving schemes - PF, PPF and other tax saving schemes such as NSC, LIC schemes, infrastmeture bonds etc. - Deposits in banks, public sector organizations, public deposits in companies - LIC policies

- Gold, silver, precious metals and antiques - Investments in real estates - Investments in gild edged securities (securities of Govt. and semi-Govt. organizations) How does the Inflation affects the savings, Investments and interest. The impact inflation has on a portfolio depends on the type of securities held there. Investing only in stocks one may not have to worry about inflation. In the long run, a companys revenue and earnings should increase at the same pace as inflation. But inflation can discourage investors by reducing their confidence in investments that take a long time to mature. The main problem with stocks and inflation is that a company's returns can be overstated. When there is high inflation, a company may look like it's doing a great job, when really inflation is the reason behind the growth. In addition to this, when analyzing the earnings of a firm, inflation can be problematic depending on what technique the company is uses to value its inventory.

(C)

The effect of inflation on investment occurs directly and indirectly.

Inflation increases

transactions and information costs, which directly inhibits economic development. For example, when inflation makes nominal values uncertain, investment planning becomes difficult. Individuals may be reluctant to enter into contracts when inflation cannot be predicted making relative prices uncertain. This reluctance to enter into contracts over time will inhibit investment which will affect economic growth. In this case inflation will inhibit investment and could result in financial recession(Hellerstein, 1997). In an inflationary environment intermediaries will be less eager to provide long-term financing for capital formation and growth. Both lenders and borrowers will also be less willing to enter long-term contracts. High inflation is often

associated with financial repression as governments take actions to protect certain sectors of the economy. For example, interest rate ceilings are common in high inflation environments. Such controls lead to inefficient allocations of capital that inhibit economic growth. 4 What is the significance of Bond Market? Describe and assess the current scenario and present status of the bond market in India.

The environment in which the issuance and trading of debt securities occurs. The bond market primarily includes government-issued securities and corporate debt securities, and facilitates the transfer of capital from savers to the issuers or organizations requiring capital for government projects, business expansions and ongoing operations. Significance and current scenario Governments need to borrow money. They borrow money through selling bonds to the private sector. Usually, investors are quite happy to buy government bonds. They are seen as a safe investment (governments usually don't default) and the investor gets a guaranteed rate of interest in return. Fear of Default

The problem with bond markets comes at the first sign of possible debt default. If the bond market feels the government is borrowing beyond it's capacity. There is a chance that the government will not be able to repay its debt. The government may then create inflation to be able to pay back the debt. This reduces the value of bonds. If there is a greater fear of debt default or default via inflation, then investors will require a higher interest payment to compensate for the risk. Investors will send bonds, causing the price of bonds to fall and therefore the effective interest rate to rise. The greater the chance of default, the higher the interest rate markets will require. This is why credit ratings can be very important. A downgrade in a countries credit rating from AAA to BBB means it is more difficult and more expensive to borrow. This is very important for the government. Through the DMO, the government needs to sell something like 180bn of gilts and bonds this year. At the moment, the government can pay a relatively low interest rate on these gilts, because the bond market has the appetite to buy them. However, if the markets lost confidence, in the governments fiscal position, bond prices would fall and the government would have to pay higher interest rates. When you have a national debt of 800bn, a 0.5% rise in interest rates is still a significant sum. Often the fear of higher interest rates due to borrowing is exaggerated. So far, the government have been able to borrow as much as they need at relatively low interest rates. Japan is borrowing close to 200% of GDP and it hasn't spooked the bond market (yet).

But, the point is the bond market has the capacity to throw the governments best laid plans into confusion. There is no fixed level of debt when bond markets will turn. It doesn't just depend on levels of debt, but, issues such as political stability, expectations of future e.t.c If the bond market froze up, it could force the government into painful choices. - Cut spending, increase taxes. It can be brutal. Current Scenario The Indian debt market, and the government securities market in particular, is at a turning point in India with significant changes taking place in the domestic economic environment along with various proposed legislative changes. Let me briefly touch upon the reasons why I believe we are living in interesting times and why this is an opportune time to reflect on further debt market development. The first such significant change is the prohibition of RBIs subscription to Government securities in the primary market effective April 1, 2006, as mandated by the Fiscal Responsibility and Budget Management (FRBM) Act. This will complete the transition to a fully market based issuance of Government securities, a process that was initiated in the early 1990s with the introduction of auctions. Second, as a consequence of the recommendations of the Twelfth Finance Commission, the role of the Central Government as a financial intermediary for State Governments is effectively ending, although there will be some transitional arrangements. Thus State Governments' borrowing will be more and more market determined. This is perhaps the beginning of the emergence of a vibrant sub-national debt market although it still has a long way to go. Third, the economy is estimated to be growing at 8.1 per cent this year with modest inflation and if similar conditions prevail, we can expect growth and inflation next year to also be on a similar path. If this growth is to be maintained and accelerated in the medium and long run, financial intermediation will have to improve and the debt market, in this context will become even more important. Fourth, the sustenance of such growth will be possible only if investments in both infrastructure and industry accelerate. Again, this will require debt financing with medium to long term maturity to supplement traditional bank financing. Fifth, as Government finances have been improving for both, the Central and State Governments in consonance with the Central and State FRBM Acts, the negative savings rate of public sector that had arisen over the last 5 years has turned positive. We can, therefore, look forward to Gross Domestic Savings touching 30 per cent or more of GDP on a sustained basis. 5 What you do understand by Corporate Financial Models? Briefly give the conceptual features of such models you know about. Section B

7 (a)

What do you understand by Valuation of strategic options? Also illustrate it.

(b) Write an elaborate note on the pricing, timing, planning and procedure for Acquisition of a Business.

The following is the balance sheet of a corporate firm as on March 31, current year. Profit before tax for current year-end amount to Rs. 64 lakh, including rs. 4 lakh as extraordinary income.