FINANCIAL MANAGEMENT MBA II SEMESTER

FINANCIAL
MANAGEMENT
D.NAGENDRA REDDY MBA II SEMESTER
(Examtree.in)
FINANCIAL MANAGEMENT MBA II SEMESTER

Unit- I: Nature, Scope and Objectives of Financial Management, Goals

of FM-Profit Maximization Vs Wealth Maximization – Finance
Functions – Financial Planning and Forecasting - Role of Financial
Manager – Funds Flow Analysis – Cash Flow Analysis. - Ratio Analysis.

Unit-II: Financing Decision: Financial Leverage – EPS-EBIT Analysis –

Cost of Capital – Weighted Average Cost Capital – Capital Structure –
Factors Affecting Capital Structure Theories of Capital Structure.

Unit – III: Investment Decision: Nature and Significance of Investment

Decision- Estimation of Cash Flows – Capital Budgeting Process –
Techniques of Investment Appraisal: Pay Back Period; Accounting Rate
of Return, Time Value of Money- DCF Techniques –Net Present Value,
Profitability Index and Internal Rate of Return.

Unit-IV: Dividend Decision: Meaning and Significance – Theories of

Dividend – Determinants of Dividend – Dividend policy – Bonus
Shares – Stock Splits.

Unit – V: Working Capital Decision: Meaning – Classification and

Significance of Working Capital – Component of Working Capital -
Cash Management Models – Cash Budgeting – Accounts Receivables –
Credit Policies – Inventory Management.

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NAGENDRA REDDY DWARAMPUDI
FINANCIAL MANAGEMENT MBA II SEMESTER

UNIT- I
What is financial management explain the role nature scope
Functions and objectives of financial management? (OR) Role of
Financial Manager
ANS) Meaning of Financial Management
Financial Management means planning, organizing, directing and controlling the
financial activities such as procurement and utilization of funds of the
enterprise. It means applying general management principles to financial
resources of the enterprise.
Roles/ nature of Financial Management
Financial management governs all the financial activities of a company. A few key
roles are mentioned below:
 Bookkeeping and Accounting: It is essential to identify, take
appropriate measures and record all the financial details of a company.
Whatever funds are debited or credited from a company’s account; the
financial management efficient accounting system gives an overview. Also,
the bookkeeping records the everyday transaction of a company and
forms a base for the accounting system.
 Reporting: Most of the stakeholders depend on the organisation’s
financial statement before making any decision. The finance team shares a
financial report to its shareholders regularly. Depending on the report,
the shareholder forecast on when to buy or sell the stock. So, the
accuracy of the financial data is essential to make a decision.
 Receivables and Payables: Managing what your company owes to the
vendors, and what the customer owes to the company is essential. It
gives a clear view of how much liquid cash a company should have in all
time.
 Investment Opportunities: The Financial report gives the opportunity
to invest in the right stock and at the right time. Only after seeing the
financial status, an organisation can leverage the correct openings.
 Risk: A robust financial management system is mandatory to maximise
the profit and minimise the risk and liabilities. An efficient financial team
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should incorporate sufficient insurance to all the essential elements of a

company.

Scope/Elements of Financial Management

1. Investment decisions includes investment in fixed assets (called as
capital budgeting). Investment in current assets are also a part of
investment decisions called as working capital decisions.
2. Financial decisions- They relate to the raising of finance from various
resources which will depend upon decision on type of source, period of
financing, cost of financing and the returns thereby.
3. Dividend decision- The finance manager has to take decision with
regards to the net profit distribution. Net profits are generally divided
into two:
a. Dividend for shareholders- Dividend and the rate of it has to
be decided.
b. Retained profits- Amount of retained profits has to be finalized
which will depend upon expansion and diversification plans of the
enterprise.
Objectives of Financial Management
A financial manager is responsible for making
the decisions to bring effective financial management to the organization.
His/her decisions should be gainful for the shareholders as well as the company.
So, the decisions which increase the value of the share in the market are
considered to be good and fruitful. Increased value of shares fulfills many other
objectives also but it does not means that the manager should use manipulative
activities to raise the prices of the shares.
1.Maximisation of profit and wealth
Profit is the centre of business. Business administration establishes a team of
finance and revenue managers to enhance profitability. The associated board is
given the responsibility to manage to provide a positive rate of profit for both
longer and shorter tenures. Further, the profit builds the wealth for business,
and a retained profit can again be contributed into business to develop all
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aspects. Both these objects of financial management can be said as ‘scaling the
business.’
2.Establish a capital structure
The main objective of financial management is to create a capital structure. The
arrangement of all different types of funds is strategically made, and this
structure helps determine which capital fund should be raised for the
operations and development of business.
3.Keeping a healthy financial flow
Financial management accounts for all the income and expenses of a business,
and though, it also governs responsibility to manage the cash flow. A balanced
inflow and outflow of liquidity are one of the primary goals of financial
management. This objective can also be described as prohibiting cash overflow
and underflow.
4.Developing Financial Scenarios
With the help of financial management, financial scenarios can be developed.
It can be done by forecasts and the current state of the company. But for this
purpose, the financial manager has to assume a wide range of possible
outcomes as per the current and future market conditions.
5.Meeting Financial Commitments with Creditors
Financial management is helpful in the timely payment of dues to the
creditors. The financial manager can list out the creditors, their due amount,
and due date from the financial accounts and can make their payments on
time. This will increase the goodwill of the company in the market and creditors
will also provide the goods to the company on credit without having any
problem. So, if there will be strong management of finance then the company
will be able to meet the financial commitments with creditors easily.
Functions of Financial Management
1. Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and
policies of a concern. Estimations have to be made in an adequate
manner which increases earning capacity of enterprise.

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2. Choice of sources of funds: For additional funds to be procured, a

company has many choices like-
1. Issue of shares and debentures
2. Loans to be taken from banks and financial institutions
3. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each

source and period of financing.
3. Investment of funds: The finance manager has to decide to allocate
funds into profitable ventures so that there is safety on investment and
regular returns is possible.

4. Management of cash: Finance manager has to make decisions with

regards to cash management. Cash is required for many purposes like
payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintenance of enough
stock, purchase of raw materials, etc.
5. Financial controls: The finance manager has not only to plan, procure
and utilize the funds but he also has to exercise control over finances. This
can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.

2.Difference between Profit Maximization Vs Wealth Maximization?

ANS) Profit Maximization vs. Wealth Maximization

What is Profit Maximization

Profit maximization is the process by which a business arranges its prices and
cost structure to achieve the highest possible profit. The central goal of the
organization is to increase its profits.

What is Wealth Maximization?

Wealth maximization is the concept of increasing the value of a business in

order to enhance the value of the shares held by its stockholders. This may
involve additional investments in intellectual property and strategic positioning,
as well as attention to managing the risk profile of a business.

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BASIS FOR
PROFIT MAXIMIZATION WEALTH MAXIMIZATION
COMPARISON

Concept The main objective of a The ultimate goal of the

concern is to earn a larger concern is to improve the
amount of profit. market value of its shares.

Emphasizes on Achieving short term Achieving long term

objectives. objectives.

Consideration of No Yes
Risks and
Uncertainty

Advantage Acts as a yardstick for Gaining a large market share.

computing the operational
efficiency of the entity.

Recognition of Time No Yes

Pattern of Returns

3. Financial Forecasting?

ANS) Financial forecasting is defined as the process by which any company

thinks about and prepares for its future. Forecasting involves the process of
determining the expectations for future results. When any company decides to
conduct its financial forecasts, it then seeks to provide a means for the
expression of its priorities to ensure that they are consistent internally. The
forecasts can also help the company identify any assets or debt that is needed to
achieve the goals and priorities of the organisation.

A common example of a financial forecast is the forecasting of the sales of a

company. Since most of the financial statements are related to sales or
forecasting, it can help the company make any other financial decisions that will

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support in achieving the goals of an organisation. However, if the sales increase,

then the resulting expenses that will help to produce additional sales will also
increase. Each of the forecasts also results in an impact on the overall financial
position of a company.

One of the main advantages of forecasting is that it helps the management

determine where the company is headed.

4.Difference Between Cash Flow and Fund Flow?

ANS) Meaning of Cash Flow

Cash flow refers to the outflow and inflow of cash or cash equivalents in an
organization in a specific period. Cash flow is recorded in the cash flow
statement, which is one of the most important financial statements in
accounting.

There are many sources of cash flow in an organisation which may be

categorized as:

1. Cash Flows from Operating activities: It represents the movement of cash

from the core operations of a business
2. Cash Flows from Investment Activities: It represents the flow of cash due
to purchase or sale of an asset or any other investment activities for the
business
3. Cash flow from financing activities: It involves changes in the flow of
cash involving selling or paying off financial instruments such as the
issuance of debt, issuing shares and debentures or repayment of debt

Meaning of Fund Flow

Fund flow refers to the working capital of the company, and a fund flow
statement is prepared to visualize the changes in working capital of the company
over a period of time. Investors use the fund flow information to determine
where capital needs to be invested.

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There are two types of inflow of funds in a business

1. Funds generated by the business operations

2. Long term funds raised by issuing shares or sale of fixed assets.

Cash Flow Fund Flow

Definition

Cash flow is based on the concept Fund flow is based on the concept
of outflow and inflow of cash and of changes in working capital over
cash equivalents during a particular a period of time
period
What is calculated?

Cash from the operations is Fund from the operation is

calculated calculated.

What it shows

It shows the short term position of It shows the position of the

the business business in the long term

Purpose

To show the movement of cash To show the changes in the

during the beginning and end of an financial position of business
accounting period between previous and current
accounting periods

Discloses

Inflows and Outflows of cash Source and application of the

available funds

Accounting Basis

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FINANCIAL MANAGEMENT MBA II SEMESTER

Cash Basis of accounting Accrual basis of accounting

Part of Financial Statement

Yes No

Used for

Cash Budgeting Capital Budgeting

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NAGENDRA REDDY DWARAMPUDI
FINANCIAL MANAGEMENT MBA II SEMESTER

UNIT-II
1.What is financial planning? Explain the significance of financial
planning in corporate financial management.
ANS) Financial Planning includes all the activities that apply general management
standards to the financial resources of a firm such as planning, directing,
organizing, procurement of funds, investment, and return of the funds. In this
article, students will learn about the meaning, objectives, and features of
financial planning. Financial Planning is one of the major planning that is required
to be conducted by the management. Financial Planning includes all the activities
which are related to the procurement of funds, investing those funds, and the
return expected from the investment done. Financial Planning also ranges from
tax planning which is an important activity.
Definition
Financial planning is defined as a document that has records of a business
owner or firm's financial situation along with planning on the spending of money
to achieve a certain goal by working by a well-devised plan. Financial planning
may be made independently or by an experienced planner.
Objectives
There two main objectives of financial planning which are given below:
 Ensuring Availability of Funds When Required: The foremost and
most important objective of financial planning is to keep in check that
funds are available in cases of emergency or whenever it is required for
use. Sufficient funds should be available with the firms for various
purposes.
 Check Unnecessary Fundraising by the Firms: Insufficient funds
are just as bad as surplus funds. Idle money will only result in a loss for a
firm as against investment. Therefore, proper allocation of funds is a very
important part of financial planning.

The Objectives of Financial Planning are Enumerated as Follows -

 To Ensure Availability of Funds Whenever Required:

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FINANCIAL MANAGEMENT MBA II SEMESTER

The foremost objective of financial planning is assuring that sufficient fund is

available with the company for different purposes.
 To Check if the Firm Raises the Resources Unnecessarily:
Excess funding is as bad as inadequate funds. If there is a surplus amount of
money, then the financial planning is to invest it in the best possible manner as
keeping financial resources idle is a great loss for an organization as it will be in
vain.
Features
There are a number of features of financial planning that are important for firms
and individuals. These are listed below:
 Foresight: A plan made without foresight will only result in a disaster.
Foresight is needed in planning for estimating risks and the need for
liquid and other assets. It may not be 100% accurate but it should be able
to give an estimate of the future risks.
 Flexibility: A plan made should be flexible as it will help in the future to
make adjustments according to the needs.
 Optimal Usage of Funds: A financial plan should be able to utilize idle
money and assets so that they can prove to be fruitful in the future. It
does not involve funds kept aside for unforeseen circumstances but the
assets that could be otherwise utilized.
 Simplicity: Financial planning should be simple in terms of structure and
should be able to provide a sound allocation of resources that can be
easily understood even by a layman.
 Liquidity: It is also a very important aspect of financial planning which
involves keeping current assets in the form of money. This will help in
easy allocation and payment of various kinds like salary, fees, and other
kinds.
Features of Financial Planning is Enumerated as below -
 Simplicity: A sound financial structure must provide a simple financial
structure that could be managed easily and understandable even to a
layman.

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FINANCIAL MANAGEMENT MBA II SEMESTER

 Foresight: Foresight must be used in planning to know the estimate and

the need for capital which may be estimated as accurately as possible. A
plan visualized without any foresight will outcast disaster for the
company.
 Flexibility: Repeating the financial adjustments becomes necessary
hence its flexibility is required so that it is easily adaptable
 Optimum use of Funds: Capital should not only be adequate but
should also employ productive effects. A financial plan should prevent
wasteful use of the capital, thus avoiding idle capacity to ensure proper
utilization of funds to earn the capacity in an enterprise.
 Liquidity: Current assets are to be kept in the form of liquid cash. Cash
is also required to finance purchases, to pay the daily needs like paying
salaries, wages, and other incidental expenses.
2.Average cost of capital using?
A) Book values
B) Salvage Value
OR
Difference between Book Value and Salvage Value
ANS) Book Value
The book value (also called the net book value) is defined as the total estimated
value that shareholders of a company would receive if the management decides
to sell or liquidate it at any given point in time. It aims to calculate the total
assets of a company minus the intangible assets and liabilities. The book value is
an important accounting measure that helps the analysts as well as investors to
evaluate whether the company stock is under-priced or overpriced compared to
its actual and fair market value.

Salvage Value
The salvage value is an accounting tool that is helpful in providing an estimation
of a tangible asset’s value at the end of its useful life. It aims to determine what
the asset can be salvaged for, when it is not possible to use it any further for

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FINANCIAL MANAGEMENT MBA II SEMESTER

company operations. The main use of salvage value is to find out the annual
amount of depreciation which can be recorded in the accounting books. The
salvage value is also used for the purpose of calculating the depreciation
expense on the tax returns.
Difference between Book Value and Salvage Value

Book Value Salvage Value

Definition

The book value is defined as the total The salvage value is defined as
value at which an asset is carried on the the total estimated resale value of
company’s balance sheet. any asset at the end of its useful
life for the company.

Cash Flow

In the case of the book value of an asset, In the case of the salvage value,
the cash amount that is the same as the the cash amount will be received
value, is received when the asset gets upon the end of the useful life of
sold in the market. an asset, which will be the same
as the total amount of the salvage
value.

Depreciation

The book value is the resulting value The total depreciation is

that is arrived at after accounting for the calculated only after deducting
depreciation. the actual salvage value.

Calculation

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FINANCIAL MANAGEMENT MBA II SEMESTER

The book value is calculated by the The salvage value gets deducted
process of subtracting the accumulated from the total purchase price
depreciation (it is the total depreciation (cost) of a company’s fixed asset
amount that is incurred up to a point of to help arrive at the actual asset
calculation of the book value) from the cost that will be depreciated.
total cost of an asset.

Market value
Market value is the term used to describe how much an asset or a company is
worth on the financial market, according to market participants. It is commonly
used to refer to the market capitalization of a company, which is calculated by
multiplying the number of shares in circulation by the current market price.
Difference between market value and book value
While the market value reflects what a business is worth according to market
participants, book value reflects what a business is worth according to its
financials (its books). The calculation for the book value of a company is its
total tangible assets minus its liabilities.

3.Cost of capital?
Ans) Cost of capital is the minimum rate of return or profit a company must
earn before generating value. It’s calculated by a business’s accounting
department to determine financial risk and whether an investment is justified.
Company leaders use cost of capital to gauge how much money new endeavours
need to generate to offset upfront costs and achieve profit. They also use it to
analyse the potential risk of future business decisions.
Cost of capital is extremely important to investors and analysts. These groups
use it to determine stock prices and potential returns from acquired shares. For
example, if a company’s financial statements or cost of capital are volatile, cost
of shares may plummet; as a result, investors may not provide financial backing.

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FINANCIAL MANAGEMENT MBA II SEMESTER

HOW TO CALCULATE COST OF CAPITAL

To determine cost of capital, business leaders, accounting departments, and
investors must consider three factors: cost of debt, cost of equity, and weighted
average cost of capital (WACC).
1. Cost of Debt
While debt can be detrimental to a business’s success, it’s essential to its capital
structure. Cost of debt refers to the pre-tax interest rate a company pays on its
debts, such as loans, credit cards, or invoice financing. When this kind of debt is
kept at a manageable level, a company can retain more of its profits through
additional tax savings.
Companies typically calculate cost of debt to better understand cost of capital.
This information is crucial in helping investors determine if a business is too
risky. Cost of debt also helps identify the overall rate being paid to use funds
acquired from financial strategies, such as debt financing, which is selling a
company’s debt to individuals or institutions who, in turn, become creditors of
that debt.
There are many ways to calculate cost of debt. One common method is adding
your company’s total interest expense for each debt for the year, then dividing it
by the total amount of debt.

Cost of Debt = (Risk-Free Rate of Return + Credit Spread) × (1 – Tax Rate)

4. EBIT‐EPS Analysis? Advantages, And Difference of EBIT‐EPS Analysis.

ANS) The EBIT‐EBT analysis is the method that studies the leverage, i.e.,
comparing alternative methods of financing at different levels of EBIT. Simply
put, EBIT‐ EPS analysis examines the effect of financial leverage on the EPS
with varying levels of EBIT or under alternative financial plans.
Advantages of EBIT-EPS Analysis:
We have seen that EBIT-EPS analysis examines the effect of financial leverage
on the behaviour of EPS under various financing plans with varying levels of
EBIT. It helps a firm in determining optimum financial planning having highest
EPS.

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FINANCIAL MANAGEMENT MBA II SEMESTER

Financial Planning:
Use of EBIT-EPS analysis is indispensable for determining sources of funds. In
case of financial planning the objective of the firm lies in maximizing EPS.
EBIT-EPS analysis evaluates the alternatives and finds the level of EBIT that
maximizes EPS.
Comparative Analysis: EBIT-EPS analysis is useful in evaluating the relative
efficiency of departments, product lines and markets. It identifies the EBIT
earned by these different departments, product lines and from various markets,
which helps financial planners rank them according to profitability and also
assess the risk associated with each.
Performance Evaluation:
This analysis is useful in comparative evaluation of performances of various
sources of funds. It evaluates whether a fund obtained from a source is used in a
project that produces a rate of return higher than its cost.
Difference Between EBIT & EPS
ANS) EBIT
EBIT is usually listed on a company’s income statement. It is near the bottom of
the statement and indicates the company’s profit before it pays interest and
taxes. It represents the company’s actual operating profit and its ability to
produce income. To calculate a company’s EBIT, subtract the company’s
expenses from its revenues. This indicates the actual amount of money a
company earned before paying required expenses, which are taxes and interest.
EPS
EPS is also often found on a company’s income statement. To calculate it, divide
the company’s net profit, minus dividends, by the average number of shares of
stock outstanding. It is very difficult to find the actual outstanding number of
shares of stock outstanding; therefore, companies use an average number. A
trailing EPS is the total of a company’s EPS for four consecutive quarters, or
one year. A company calculates a rolling EPS by using the previous two quarters'
EPS amounts and the estimated future EPS numbers for the next two quarters.

5.Financial leverage? (OR) Leverage Ratio

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ANS) For any business, securing funding is a tall order. When it comes to doling
out money friends, families, venture capitalists, banks, etc. all have their own
standards and scepticisms involved. If you are in business and need financing,
you would need to understand a few key metrics that determine your financing
situation, one of them being leverage ratio. For businesses and banks, leverage
ratios are a useful indicator to gauge how their assets are financed. One can
gauge how much capital is coming from debts (loans) or equity. How well a
company can meet its financial obligations can be understood by looking at its
leverage ratio,
What is Leverage Ratio
The proportion of debt or loan to equity or capital gives the financial leverage
ratio of any company. Banking institutions often use the capital leverage ratio to
track finances. Businesses also use this metric to show the level of debt
compared to their accounts, for instance, cash flow statements, income
statements, or balance sheets.
Leverage ratios are a set of ratios that showcase a company’s financial
leverage with respect to assets, liabilities, and equity. It is the proportion
of debt to cash and assets.

Leverage ratios are a set of ratios that showcase a company’s financial

leverage with respect to assets, liabilities, and equity. It is the proportion
of debt to cash and assets.

A high leverage ratio also shows that the earnings of the entity could be
inconsistent. Shareholders will have to wait for a while before they can
get a return on their investments.

Another possibility of a high leverage ratio is the company soon

becoming insolvent.

Creditors use the leverage ratio to decide if they could extend their credit
to the firm or not.

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NAGENDRA REDDY DWARAMPUDI
FINANCIAL MANAGEMENT MBA II SEMESTER

A financially responsible organization with a steady flow of revenue

would have a lower leverage ratio. This shows credit agencies and
shareholders that the firm poses minimal risks and is worth an investment

*IMPORTANT PROBLAM*
A Ltd. Has a share capital of Rs .1,00,000 divided into share of Rs. 10
each. It
has a major expansion program requiring an investment of another
Rs. 50,000.
The Management is considering the following alternatives for raising
this amount:
Issue of 5,000 equity shares of Rs. 10 each
Issue of 5000, 12% preference shares of Rs. 10 each
Issue of 10% debentures of Rs. 50,000
The company’s present Earnings Before Interest and Tax (EBIT) are
Rs. 40,000
per annum subject to tax @ 50%. You are required to calculate the
effect of
the above financial plan on the earnings per share presming:
(a) EBIT continues to be the same even after expansion
(b) EBIT increases by Rs. 10,000

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NAGENDRA REDDY DWARAMPUDI
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Solution:
(a) When EBIT is Rs. 40,000 Per Annum

PARTICULARS ALL
DEBENTURES ALLEQUITY PREFERENCE
EBIT 40,000 40,000 40,000
(-)INTEREST _ _
RATE10% 5000
EBT 35,000 40,000 40,000
(-) TAX50% 17,500 20,000 20,000
EAT 17,500 20,000 20,000
PREFE Shares _ _ 6,000
EAESH 17,500 20,000 14,000
NO Equity Shares 10,000 15,000 10,000

EPS 1.75 1.33 1.40

PARTICULARS ALL PREFERENCE

DEBENTURES ALLEQUITY
EBIT 50,000 50,000 50,000
(-) INTEREST _ _
RATE10% 5,000
EBT 45,000 50,000 50,000
(-) TAX50% 22,500 25,000 25,000
EAT 22,500 25,000 25,000
PREFE Shares _ _ 6,000
EAESH 22,500 25,000 19,000

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FINANCIAL MANAGEMENT MBA II SEMESTER

NO Equity 10,000 15,000 10,000

Shares

EPS 2.25 1.67 1.90

EBT= Earning before tax

EAT= Earning after tax
EAESH= Earning average equity shareholders
EPS= Earning for share

6.Financial decisions?
ANS) Financial decisions are the decisions that managers take with regard to the
finances of a company. These are crucial decisions for the financial well-being
of the company. These decisions can be in terms of acquisition of assets,
financing and raising funds, day-to-day capital and expenditure management,
etc. Financial decisions, therefore, affect both the assets and liabilities of a
company. They can lead to profits, revenue generation, and receipt of funds and
assets for the company. They can also be in terms of expenditure, the creation of
liabilities, and an exodus of funds for a company.

The types of financial decisions can classified under: -

1. Long-Term Finance Decisions
2. Short-Term Finance Decisions
1. Long-Term Finance Decisions
Long-term financial decisions are decisions that are taken for a period of more
than a year or more. These may include capital budgeting and investment
decisions, as well as the raising of long-term capital and loans, which may run
for 5-10 years.
2. Short-Term Finance Decisions
Short-term financial decisions are decisions that are taken for a short period of
time, usually less than a year. These decisions pertain to working capital

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management, arranging short-term funds and credits, the provision of dividends,

etc.
There are THREE main financial decisions: -
1. Investment Decisions
2. Financing Decisions
3.Dividend Decisions
1.Investment Decisions:
Investment decisions are decisions that relate to the investment in different types
of assets, instruments, securities, etc. Managers decide how to invest the
company’s funds in different asset classes, depending on the needs of the
organization. Assets can be both short-term and long-term. As each company has
scarce financial resources, it is crucial to decide which asset to invest in first.
Managers must make the tough call of postponing investing in some assets that
are not strictly necessary at present, or that may not give the desired return.
2.Financing Decisions
Financing decisions are decisions that are made to ensure the financing of the
company. They relate to the raising of equity as well as debt for the company to
fund its investment decisions. It is a continuous and ongoing process, as each
company regularly needs funding. Because a growing company’s needs do not
cease, instead go on increasing to keep pace with the growth.
3.Dividend Decisions
Under dividend decisions, whenever a company makes a profit, it decides to
reward its shareholders in return for their investment, trust, and confidence in
the company. This reward is called a dividend. At the same time, managers must
decide to retain part of the profit for the future needs of the company. This is
known as retained earnings.

7.Explain the factors affecting the capital structure?

ANS) Definition
The capital structure combines financial instruments like shares (equity and
preference), debentures, long-term loans, bonds, and retained earnings. These

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instruments help the company generate funds for its operations with the help of
individuals and institutions.
Factors affecting the Capital Structure
Several factors affect a company’s capital structure, and it also determines the
composition of debt and equity portions within this structure. Some of these
factors are as follows:
 Business Size: The size and scale of a business affect its ability to raise
finance. Small-sized companies face difficulty in raising long-term
borrowings. Creditors are hesitant to give them loans because of the scale
of their business operations. Even if they do get these loans, they have to
accept high-interest rates and stringent repayment conditions. It limits
their ability to grow their business.
 Earnings: Firms with relatively stable revenues can afford a more
significant amount of debt in their capital structure. Since debt repayment
is periodical with fixed interest rates, businesses with higher income
prospects can bear these fixed financial charges. On the other hand,
companies that face higher fluctuations in their sales, like consumer
goods, rely more on equity shares to finance their operations.
 Competition: If a company operates in a business environment with more
competition, it should have more equity shares in its capital structure.
Their earnings are prone to more fluctuation compared to businesses
facing lesser competition.
 Stage of the life cycle: A business in the early stage of its life cycle is
more susceptible to failure. In that case, they should use a more
significant proportion of ordinary share capital to finance their operations.
Debt comes with a fixed interest rate, and it is more suitable for
companies with stable growth prospects.
 Creditworthiness: Any company that has a reputation for paying back its
loans on time will be able to raise funds on less stringent terms and at
lower interest rates. It allows them to pay back their loans on time. The
opposite is true for firms that don’t have a good credit standing in the
market.

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 Risk Aptitude of the Management: The attitude of a company’s

management also affects the proportion of debt and equity in the capital
structure. Some managers prefer to follow a low-risk strategy and opt for
equity shares to raise finances. Other managers are confident of the
company’s ability to repay big loans, and they prefer to undertake a higher
proportion of long term debt instruments.
 Control: A management that wants outside interference in its operations
may not raise funds through equity shares. Equity shareholders have the
right to appoint directors, and they also dilute the stake of owners in the
company. Some companies may prefer debt instruments to raise funds. If
the creditors get their instalments on loans and interest on time, they will
not be able to interfere in the workings of the business. But if the
company defaults on their credit, the creditors can remove the present
management and take control of the business.
 State of Capital Market: The tendencies of investors and creditors
determine whether a company uses more debt or equity to finance their
operations. Sometimes a company wants to issue ordinary shares, but no
one is willing to invest due to the high-risk nature of their business. In that
case, the management has to raise funds from other sources like debt
markets.
 Taxation Policy: The government’s monetary policies in terms of
taxation on debt and equity instruments are also crucial. If a government
levies more tax on gains from investing in the share market, investors may
move out of equities. Similarly, if the interest rate on bonds and other
long-term instruments is affected due to the government’s policy, it will
also influence companies’ decisions.
 Cost of Capital: The cost of raising funds depends on the expected rate
of return for the suppliers. This rate depends on the risk borne by
investors. Ordinary shareholders face the maximum risk as they don’t get
a fixed rate of dividend. They get paid after preference shareholders
receive their dividends. The company has to pay interest on debentures
under all circumstances. It attracts more investors to opt for debentures
and bonds.

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8.Dicuss the functions of the cash Management models?

ANS) The cash manager is the person in a business who is responsible for the
control and execution of all the payments, such as salaries, tax authorities and
supplier payments. These must be made under the strict regulations of company
procedure and policies. The cash manager looks after the flow of many
customers.
Examples of cash management
Different types of companies have their own ways of cash management. For
example:
 Companies that have multiple subsidiaries mostly have a fragmented and
complicated account system, and because of this, the cash flow is divided
into several accounts. Some of the corporate banking systems, for
example, cash pooling, make the cash flow into other small accounts, so
that it is easy to make the internal funding through the main account or
concentration account. Hence cash pooling helps the organisation simplify
cash flow, which results in not taking any help from the external source
which ultimately turns out to be more costly.
 Companies like tax authorities or telecom companies have to deal with
many small payments in the market. Thus, sending out bills or generating
bank statements must be automated. In such situations, the cash manager
has a vital role in their operation.
 Companies that work internationally or are aiming to work internationally
have to make payments worldwide. Because of this, such companies
should possess multiple accounts in different banks, and it will be the duty
of the cash manager to look after these international payments.
 International e-commerce companies focus on customers worldwide and
offer easy payment methods. This helps them to gain more customers
because of easy payment methods.
Types of cash management

Cash management in India is mainly done through paper-based systems, such as

cheques. The electronic movement of money is also widely used, but cheques

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are still the primary way of transferring money in India. Here are a few ways of
cash management done in India.

 Upcountry own branches location cheques

 Transfer cheques
 Cash collection
 Ad hoc location cheques
 Upcountry correspondent bank branch location cheques
 ESC direct debit
 Capital market IPO collection
 Local high-value cheques
 Pay orders
 ESC credit
 Capital market IPO payment
 Own branch location demand drafts
 Cheques
 Intra bank payments
The basic principles (OR)models of cash management

Inventory management :A higher quantity of raw materials or huge stocks

means less liquidity because of trapped sales. Thus, an organisation must find
better ways to take out the stock to make the cash flow constant.

Receivable management: After raising an invoice, the credit period or the time
taken to receive the payment is between 30 to 90 days. The organisation has
completed the sale in such cases but still has not received the cash transaction.

Payables management: Payables management is also equally crucial. It is the

situation when the organisation or a company has purchased materials on credit
and has to make the payment within a fixed period. Organisations are also
eligible to take credit from banks and financial institutions for a short period. To
do this, the organisation has to make sure that the payment is done in due time

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and maintains a good liquidity position, which ultimately helps them in timely
payments of debts.

Causes of problems with cash management: Many organisations have poor

cash management, and many factors affect good cash management flow.

Poor understanding of the cash flow cycle: Organisations should have a clear
understanding of the timing of cash outflows and inflows, such as knowing
when to buy raw materials and when to complete the due payments. When an
organisation has good and rapid growth, it might run out of money due to
purchasing more raw materials or inventory.

Lack of understanding of profit vs cash: For organisations that are fast-

growing and generating revenue, it doesn’t mean that they have received the
cash payment. So, an organisation that requires a lot of inventory or raw
materials may generate good revenue but not receive the necessary amount of
cash flow.

Lack of cash management skills: An organisation needs to have skilled cash

managers to tackle all the aforementioned issues. The manager should have the
ability to manage and optimise the working capital, which includes discipline
and having proper frameworks to make sure that the receivables are received on
time. The due is paid before the scheduled time.

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UNIT- III
1.Make a comparison between NPV and IRR methods ?
ANS)

NPV or otherwise known as Net Present Value method, reckons the present
value of the flow of cash, of an investment project, that uses the cost of capital
as a discounting rate. On the other hand, IRR, i.e. internal rate of return is a rate
of interest which matches present value of future cash flows with the initial
capital outflow.
In the lifespan of every company, there comes a situation of a dilemma, where it
has to make a choice between different projects. NPV and IRR are the two most
common parameters used by the companies to decide, which investment
proposal is best. However, in a certain project, both the two criterion give
contradictory results, i.e. one project is acceptable if we consider the NPV
method, but at the same time, IRR method favors another project.
Comparison Chart
BASIS FOR NPV IRR
COMPARISON
Meaning The total of all the present IRR is described as a rate
values of cash flows (both at which the sum of
positive and negative) of a discounted cash inflows
project is known as Net equates discounted cash
Present Value or NPV. outflows.
Expressed in Absolute terms Percentage terms
What it represents? Surplus from the project Point of no profit no loss
(Break even point)

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Decision Making It makes decision making It does not help in decision

easy. making
Rate for Cost of capital rate Internal rate of return
reinvestment of
intermediate cash
flows
Variation in the cash Will not affect NPV Will show negative or
outflow timing multiple IRR

2.Cash flow analysis? Describe the importance and process of preparing

cash flows in detail
ANS) This is particularly the case when it comes to accounting. Successful
business owners know that to drive revenue and increase cash flow, the numbers
must be watched and carefully analysed.
This is what optimizes data-driven decision-making and leads to intelligent
forecasting. Cash flow is so important that among failed SMEs, 60% cited poor
cash flow management as a cause.
One of the most effective strategies to stay on top of accounting and “out of the
red” is known as cash flow analysis

Cash Flow Analysis

A cash flow analysis is the examination of the cash inflows and outflows of a
business to determine a company’s working capital. It looks at a certain period
of time for different activities, including operations, investment, and financing.
Cash flow analysis is calculated by subtracting current liabilities (during a
specific accounting period) from current assets.
Preparing a Cash Flow Statement
A cash flow statement is one of the most important financial statements a
business can create. That’s because it includes all cash inflows from ongoing
operations and external investment sources, as well as cash outflows for
business activities and investments in a given time period.

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Operating Cash Flow

The line items typically factored into your net income, and included in the
operating cash flow statement, include:
 Cash from goods/services sold
 Purchase of inventory or supplies
 Staff wages and cash bonuses
 Payments to contractors
 Utilities, rent, and/or lease payments
 Interest on loans and other long-term debt
 Fines or cash settlements from lawsuits
There are two common methods used to calculate the operating activities section
of cash flow statements: the Direct Method and the Indirect Method.
 Direct Method – Takes all cash collections from operating activities and
subtracts all cash disbursements to reach net income.
 Indirect Method – This starts with net income and adds/deducts from the
amount for non-cash revenue and expenses.
Importance of Cash Flow Analysis
Cash flow analysis is important for many reasons. Reports demonstrate that
small businesses consider cash flow one of their top 5 challenges. Engaging in
an ongoing analysis helps to quickly identify any problems with incoming and
outgoing cash. For example, if a company has revenue streams that aren’t
producing as much as they should, cash flow analysis will show that.

Analysing cash flow helps to understand if a company is capable of paying the

bills and generating enough cash to keep operating—or better yet, grow. Long-
term negative cash flow can lead to potential bankruptcy, while a continuous
stream of positive cash flow is a good indicator of success.

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3.What is profitability index which is a superior rank criterion Profitability

index or net present value?
ANS) The profitability index (PI), also known as the profit investment ratio (PIR)
or value investment ratio (VIR), is a capital budgeting tool that gauges the
potential profitability of an investment or project. It can be used as an appraisal
technique or applied to potential capital outlays, and functions as a useful
formula for ranking a project's financial outlook alongside other investments.
The profitability index allows investors to quantify the amount of value created
per unit of investment.
The Formula
The profitability index is calculated by dividing the present value of future cash
flows by the initial cost (or initial investment) of the project. The initial costs
include the cash flow required to get the team and project off the ground. The
calculation of future cash flows does not include the initial investment amount.
Profitability Index = Present Value of Future Cash Flows ÷ Initial Investment in
the Project.
The profitability index is often used to rank a firm's investments and/or projects
alongside others. For the sake of maximizing limited financial resources and
profits for shareholders, investors naturally want to spend money on projects
with high short-term growth potential. When there are a multitude of investment
projects available, would-be investors can use the profitability index (alongside
other formulas) to rank the projects from high to low before deciding which is
the best opportunity. Even when a project offers a high net present value, it may
still be passed over based on the use of other financial calculations.

NPV
NPV calculates the present value of each cash flow (converting future cash
flows to today’s rupees) and adds them up—including both income and
outflows. With that information, you know how much a series of payments is
worth, and you can compare that value to other options available to you today.
For example, NPV can be useful when deciding if it makes sense to purchase a
new piece of equipment for your business (an additional delivery vehicle, for
example). If the NPV of future revenues exceeds the cost to pay for the
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equipment, it may be a good strategy. Likewise, in the oversimplified lottery

example above, you can use NPV to help you decide if you want to take a lump
sum or a series of payments.
Predicting the Future
NPV relies on assumptions about the future, such as how much you can earn on
your money. Everything gets boiled down to a single number, but that number
might summarize many years’ worth of cash flows in a complicated world.
Changing the rate slightly can alter the results dramatically, so it’s crucial to
acknowledge that your assumptions might be off.
Unintended Consequences
Your assumptions might not capture all of the unintended consequences or
second-order effects of a decision. For example, when deciding whether or not
to take a lump-sum payment or a series of income payments, various outcomes
can unfold after you make your decision. What if tax rates change in the future?
What if you get sued shortly after taking the lump sum?
4.Discuss the nature and significance of investment decision?
ANS) An investment is an asset or item accrued with the goal of generating
income or recognition. In an economic outlook, an investment is the purchase of
goods that are not consumed today but are used in the future to generate wealth.
In finance, an investment is a financial asset bought with the idea that the asset
will provide income further or will later be sold at a higher cost price for a
profit.
Importance
Before we begin to describe the various types of investment models in existence,
one must understand the basic definition of investment and the factors that
govern it.
In simpler terms investment means exchange of money for a profit yielding
asset. The same profit earned is used to invest in other assets as well. As far as
the economic wellbeing of the country is concerned, investment is important as
it contributes to growth and development.
When the government invests in business, agriculture, manufacturing or
supporting industries it can generate employment opportunities for its

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population. But a robust investment scenario is when the government and the
private sector join hands to create investment opportunities.
Also keep in mind that the following factors come into play when making an
investment and by proxy, choosing an investment model:
 Savings Rate.
 Tax Rate in the country. (Net income available after tax).
 Inflation.
 Rate of Interest in Banks.
 Possible Rate of Return on Capital.
 Availability of other factors of production – cheap land, labour etc and
supporting infrastructure – transport, energy and com
Types of Investment Models
The following are the major investment models
1. Public Investment Model: In a Public Investment Model, investment in
specific goods, services is made by the government through the central or
state government or with the help of the public sector by using the
revenue earned through it.
2. Private Investment Model: As is the case with India, there are times
when the earnings from the public sector is not enough to make up for
certain shortfalls that may come about. Thus the government invites
private players to invest in some of its ventures. This investment can be
domestic or foreign in nature. A foreign direct investment (FDI) can
improve the current infrastructure and generate employment in the
process. This model is one of the most sought after when it comes to
external investment.
3. Public Private Partnership Model: A public-private partnership (PPP,
3P, or P3) is a cooperative arrangement between two or more public and
private sectors, typically of a long-term nature. The following sectors in
India have been have projects based on the PPP model:
 Health Sector
 Power Sector

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 Railways
 Urban Housing
There are additional investment models as well. They are as follows:
1. Domestic Investment Model: Can be Public or a Private-Public
Partnership venture
2. Foreign Investment Model: It can be majority foreign or foreign-
domestic mix
3. Sector Specific Investment Models: Where investments are made
in Special Economic Zones or other allied sectors
4. Cluster Investment Models: Investment in Manufacturing Industries
5.Time value of money?
ANS) Introduction
Money is the most important element in the whole world. Both at the macro and
micro levels, money plays the most important role in business, finance, and
economics. Therefore, a better study of the value and nature of money is very
crucial. The time value of money is therefore a concept that explores the nature
of the value of money.
What is the time value of money?
The time value of money indicates that a certain amount of money will hold a
greater value in the current time rather than the value it will have in the future. It
happens due to the reduction of money earning potential over time. This concept
is a primary and core principle of business which states that a sum of money has
greater value now than it may have in the future.
More about the time value of money
As the time value of money indicates that the value of money will decrease in
the future, investors always want to receive money on the current date rather
than in the future. They do so because once they invest a certain sum of money,
it will grow gradually over time. A good example will be a savings account. A
certain amount of money when deposited in a savings account earns interest.
Eventually, the interest which is earned adds up to the principal and thus earns
even more interest. That is how compound interest works.

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The formula for Time Value of Money

The formula of calculating the time value of money may experience minor
changes according to the situation. For instance, in some cases of perpetuity or
annuity payments, the generally used formula has more or lesser factors.
However, generally, the time value of the money calculator considers the
following variables.
FV = Future value of money
PV = Present value of money
I = interest rate
N = number of compounding periods per year
T = number of years
Based on these variables, the formula for TVM is:
FV = PV x [ 1 + (I / n)] (n x t)
Use of time value of money in finance
Time value of money is such an important concept in finance, that it is difficult
to find even one single topic in finance where the time value of money does not
play a role. It plays a crucial role in almost every decision-making process. In
the analysis of discounted cash flow (DCF), the time value of money plays as
the primary and the most important concept. DCF is also the most influential
and most popularly used procedure for evaluating investment opportunities.
Similarly, DCF also plays a very important role in various financial activities,
like financial planning and risk management.
6.Payback period?
ANS) The Payback Period measures the amount of time required to recoup the
cost of an initial investment via the cash flows generated by the investment.
 Payback Period = Initial Investment / Cash Flow Per Year
Shorter Duration: As a general rule of thumb, the shorter the payback period,
the more attractive the investment, and the better off the company would be –
which is because the sooner the break-even point has been met, the more likely
additional profits are to follow (or at the very least, the risk of losing capital on
the project is significantly reduced).

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Longer Duration: A longer payback time, on the other hand, suggests that the
invested capital is going to be tied up for a long period – thus, the project is
illiquid and the probability of there being comparatively more profitable projects
with quicker recoveries of the initial outflow is far greater.
Here, the “Years Before Break-Even” refers to the number of full years until the
break-even point is met. In other words, it is the number of years the project
remains unprofitable.
Next, the “Unrecovered Amount” represents the negative balance in the year
preceding the year in which the cumulative net cash flow of the company
exceeds zero.
And this amount is divided by the “Cash Flow in Recovery Year”, which is the
amount of cash produced by the company in the year that the initial investment
cost has been recovered and is now turning a profit.

7.Net operating income approach?

ANS) Operating profit is the benefit or profit acquired from the standard
business exercises of the undertaking. After the organization arrives at the gross
profit while working costs (backhanded costs) like devaluation, compensation,
and salaries to employees, rent, telephone expenses, and electricity bills, are
deducted from it, then, at that point, operating profit emerges. It is likewise
named earnings before interest and taxes (EBIT) when there is no non-operating
Income.
Operating profit is the income of the organization that is left in the wake
of taking care of all working costs or operating costs.

Accommodating in controlling abundance costs

A rough approximation of the organization’s productivity.

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9.Funds from operations?

ANS) Funds from operations is the cash flows generated by the operations of a
business, usually a real estate investment trust (REIT). This measure is
commonly used to judge the operational performance of REITs, especially in
regard to investing in them.
Understanding Funds from Operations
The funds from operations concept is needed, especially for the analysis of an
REIT, because depreciation should not be factored into the results of operations
when the underlying assets are appreciating in value, rather than depreciating;
this is a common situation when dealing with real estate assets.
The funds from operations concept is considered to be a better indicator of the
operational results of a business than net income, but keep in mind that
accounting chicanery can impact a variety of aspects of the financial statements.
Thus, it is always better to rely upon a mix of measurements, rather than a single
measure that can potentially be twiste
10. Internal rate of return?
ANS) The internal rate of return or IRR is the return at which the company
determines the project break even. As per the Knight's, IRR is commonly used
by financial analysts along with the Net Present Value or NPV. Both the methods
are quite similar but use different variables. With NPV, the analyst assumes the
discount rate and then calculates the present value of the investment. However,
with IRR, the analyst calculates the actual return provided by project cash flows,
then compares the rate of return with the company's hurdle rate (expected rate of
return). If the IRR return is higher, it is worthwhile to invest in the project.
Internal Rate of Return: The internal rate of return is a method used to
estimate the profitability of the potential investment. It is the discount rate that
makes the net present value of an investment equals zero. The Internal rate of
return method is widely used in discounting cash flow analysis, and also used
for analyzing capital budgeting method. While calculating the IRR, the present
value of future cash flows equals the initial investment of the project, and thus
makes the NPV = 0. After calculating the IRR, it should be compared with the
minimum required rate of return or cost of capital of the project. For example, If
the calculated IRR is found greater than the minimum required rate of return,

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then the project should be accepted whereas If the calculated IRR is found lesser
than the minimum required rate of return, then the project should be rejected.
How to Calculate Internal Rate of Return?
For the calculation of the internal rate of return, we use a similar formula as
NPV. To calculate IRR, analysts have to depend on trial-and-error methods and
cannot use analytical methods. Analysts also calculate IRR using different
software like Microsoft Excel. In MS-Excel, there is a financial function that
calculates IRR using cash flows at regular intervals.

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IMP Problems

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UNIT-IV
1.The major determinant of dividend decision? VVIMP
ANS) Factors Affecting Dividend Decision:
The finance manager analyses following factors before dividing the net earnings
between dividend and retained earnings:
1. Earning:
Dividends are paid out of current and previous year’s earnings. If there are more
earnings then company declares high rate of dividend whereas during low
earning period the rate of dividend is also low.

2. Stability of Earnings:
Companies having stable or smooth earnings prefer to give high rate of dividend
whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position:

Paying dividend means outflow of cash. Companies declare high rate of
dividend only when they have surplus cash. In situation of shortage of cash
companies declare no or very low dividend.

4. Growth Opportunities:
If a company has a number of investment plans then it should reinvest the
earnings of the company. As to invest in investment projects, company has two
options: one to raise additional capital or invest its retained earnings. The
retained earnings are cheaper source as they do not involve floatation cost and
any legal formalities.

5. Stability of Dividend:
Some companies follow a stable dividend policy as it has better impact on
shareholder and improves the reputation of company in the share market. The
stable dividend policy satisfies the investor. Even big companies and financial

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institutions prefer to invest in a company with regular and stable dividend

policy.

2.Dividend policy of the firm?explain VVIMP

ANS) A company’s dividend policy dictates the amount of dividends paid out by
the company to its shareholders and the frequency with which the dividends are
paid out. When a company makes a profit, they need to make a decision on what
to do with it. They can either retain the profits in the company (retained earnings
on the balance sheet), or they can distribute the money to shareholders in the
form of dividends.

What is a Dividend?
A dividend is the share of profits that is distributed to shareholders in the
company and the return that shareholders receive for their investment in the
company. The company’s management must use the profits to satisfy its various
stakeholders, but equity shareholders are given first preference as they face the
highest amount of risk in the company. A few examples of dividends include:
1. Cash dividend
A dividend that is paid out in cash and will reduce the cash reserves of a
company.
2. Bonus shares
Bonus shares refer to shares in the company are distributed to shareholders at no
cost. It is usually done in addition to a cash dividend, not in place of it.
Examples of Dividend Policies

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1. Regular dividend policy

Under the regular dividend policy, the company pays out dividends to its
shareholders every year. If the company makes abnormal profits (very high
profits), the excess profits will not be distributed to the shareholders but are
withheld by the company as retained earnings. If the company makes a loss, the
shareholders will still be paid a dividend under the policy.
The regular dividend policy is used by companies with a steady cash flow and
stable earnings. Companies that pay out dividends this way are considered low-
risk investments because while the dividend payments are regular, they may not
be very high.
2. Stable dividend policy
Under the stable dividend policy, the percentage of profits paid out as dividends
is fixed. For example, if a company sets the payout rate at 6%, it is the
percentage of profits that will be paid out regardless of the amount of profits
earned for the financial year.
Whether a company makes $1 million or $100,000, a fixed dividend will be paid
out. Investing in a company that follows such a policy is risky for investors as
the amount of dividends fluctuates with the level of profits. Shareholders face a
lot of uncertainty as they are not sure of the exact dividend they will receive.
3. Irregular dividend policy
Under the irregular dividend policy, the company is under no obligation to pay
its shareholders and the board of directors can decide what to do with the profits.
If they a make an abnormal profit in a certain year, they can decide to distribute
it to the shareholders or not pay out any dividends at all and instead keep the
profits for business expansion and future projects.
The irregular dividend policy is used by companies that do not enjoy a steady
cash flow or lack liquidity. Investors who invest in a company that follows the
policy face very high risks as there is a possibility of not receiving any dividends
during the financial year.
4.No dividend policy
Under the no dividend policy, the company doesn’t distribute dividends to
shareholders. It is because any profits earned is retained and reinvested into the

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business for future growth. Companies that don’t give out dividends are
constantly growing and expanding, and shareholders invest in them because the
value of the company stock appreciates. For the investor, the share price
appreciation is more valuable than a dividend payout.
4.Final Word
The dividends and dividend policy of a company are important factors that many
investors consider when deciding what stocks to invest in. Dividends can help
investors earn a high return on their investment, and a company’s dividend
payment policy is a reflection of its financial performance.

3.Bonus shares?
ANS) Bonus shares are the additional shares that a company gives to its existing
shareholders on the basis of shares owned by them. Bonus shares are issued to
the shareholders without any additional cost.
WHY COMPANIES ISSUE BONUS SHARES
Bonus shares are issued by a company when it is not able to pay a dividend to its
shareholders due to shortage of funds in spite of earning good profits for that
quarter. In such a situation, the company issues bonus shares to its existing
shareholders instead of paying dividend. These shares are given to the current
shareholders on the basis of their existing holding in the company. Issuing bonus
shares to the existing shareholders is also called capitalization of profits because
it is given out of the profits or reserves of the company.
BONUS SHARES CALCULATION
The bonus shares are given to the existing shareholders according to their
existing stake in the company. Like for example, a company declaring one for
two bonus shares would mean that an existing shareholder would get one bonus
share of the company for every two shares held. Suppose a shareholder holds
1,000 shares of the company. Now when the company issues bonus shares, he
will receive 500 bonus shares (1,000 *1/2 = 500).
When the company issues bonus shares, the term “record date” is used along
with it. Let us now learn about the term record date.

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ADVANTAGES OF BONUS SHARES

 There is no need for investors to pay any tax on receiving bonus shares.
 It is beneficial for the long-term shareholders of the company who want to
increase their investment.
 Bonus shares enhance the faith of the investors in the operations of the
company because the cash is used by the company for business growth.
 When the company declares a dividend in the future, the investor will
receive higher dividend because now he holds larger number of shares in
the company due to bonus shares.
 Bonus shares give positive sign to the market that the company is
committed towards long term growth story.
 Bonus shares increase the outstanding shares which in turn enhances the
liquidity of the stock.
 The perception of the company's size increases with the increase in the
issued share capital.
Since there are many advantages of bonus shares, let us now learn the conditions
for the issue of bonus shares
CONDITIONS FOR ISSUE OF BONUS SHARES
o The issue of bonus shares must be authorized by the Articles of the
company.
o The issue of bonus shares must be recommended by the resolution
of the Board of Directors. Also this recommendation must be later
approved by the shareholders of the company in the general
meeting.
o The Controller of Capital Issues must give permission to the issue.

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4.Stock spit?
ANS) stock split is when a company’s board of directors’ issues more shares of
stock to its current shareholders without diluting the value of their stakes. A
stock split increases the number of shares outstanding and lowers the individual
value of each share. While the number of shares outstanding change, the overall
market capitalization of the company and the value of each shareholder’s stake
remains the same.
Say you have one share of a company’s stock. If the company opts for a 2-for-1
stock split, the company would grant you an additional share, but each share
would be valued at half the amount of the original. After the split, your two
shares would be worth the same as the one share you started with.
What Is a 2 for 1 Stock Split
A 2-for-1 stock split grants you two shares for every one share of a company you
own. If you had 100 shares of a company that has decided to split its stock,
you’d end up with 200 shares after the split.
A 2 for 1 stock split doubles the number of shares you own instantly. Two-for-
one and 3-for-1 stock splits are relatively common, says Holden. While Apple
(AAPL) and Tesla (TSLA) have gotten a lot of publicity for their 2020 stock
splits, their 5-for-1 or 4-for-1 stock splits were uncommon choices.

5.Walter’s dividend model?

ANS) Walter’s Model is based on the model of dividend. Organizations give
dividends, which is a percentage of earnings, to their shareholders as a reward
for their investment in the venture. The dividend model also determines the
proportion of money that will be reinvested in the organization to facilitate
growth and platform expansion. The primary aim of financial management is to
facilitate growth and development in the organization.
Walter’s Model
Walter’s Model, as the name suggests, was introduced by Prof. James E. Walter.
The model is based on share valuation and postulates that both prices of share
and dividends are interdependent. On the other hand, this model is based on the

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statement that investment and dividend are interrelated. Many organisations use
the model for maintaining the share prices in the market.
Walter’s Model Description
Walter’s Model demonstrates the relationship between the internal rate of return
(r) or returns on investment with the capital cost (k). So, the decision made on
the dividend affects the operation of all other financial domains of the
organisation. In simple words,
Walter’s Model provides insight into how dividends affect the organisation’s
overall return:
 Suppose the rate of return is greater than the cost of capital (r > k). In that
case, the organisation must hold their earnings to increase investment
opportunities. The organisation will earn more compared to the
reinvestment made by shareholders. Organisations that earn or gain more
returns than costs incurred are known as growth firms. The payout of such
firms is zero.
 If the rate of return is equal to the cost of capital (r = k), then the
organisation’s dividend will not impact its value. In such conditions, the
organisation has to decide how much they will keep and how much they
will distribute among shareholders. The payout ratio changes with
different circumstances in the case. It would either be zero or 100%.
 Suppose the rate of return is less than the cost of return (r < k), then the
organisation should have distributed all its return or earnings among the
shareholders through dividends. It will give rise to more investment
opportunities for the future. The payout ratio, in this case, remains 100%.
Limitations of Walter’s Model
 It is assumed that no external earning or investment is used in this model.
In this case, the value of investment policy and dividend policy comes
below standard.
 The scope of Walter’s Model is limited to equity-based organisations. In
this model, it is assumed that the rate of return never changes, but its
value decreases as investment increases.

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In Walter’s Model, the value of the cost of capital never changes, which is an
unrealistic approach. This assumption ignores the risk on the organisation and
the impacts of risk on the organisation’s value.
6.Right shares vs bonus shares?
ANS) A company’s capital is usually divided into smaller shares of definite
price and offered to the public for sale in a quest to raise funds from the market.
Through investing in the stock market, investors become shareholders of any
given company through the purchase of specific stocks.
As a result, the investors are updated from time to time about the company’s
decisions and an update on the right shares and bonus shares.
The main difference between Right Shares and Bonus Shares is that the right
shares are issued to the shareholders at a discounted rate. Bonus shares are
issued to the shareholders for free of cost. Right shares are always paid fully or
partly, whereas bonus shares are always paid fully.
Comparison Table Between Right Shares and Bonus Shares
Parameter of Right Shares Bonus Shares
Comparison

Purpose The aim is to raise The aim is to bring the share

additional capital for the price down. Also, issued as
company. alternative dividends payments
to stakeholders.
Price Price is issued at Price is issued to stakeholders
discounted prices. free of cost.

Minimum Requires minimum Does not require a minimum

Subscription subscription. subscription.

Creation and Created from additional Created out of a company’s

Renunciation shares and renounced profit and lack renunciation
either partially or fully. options.

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Share Price Share price affected if the It lowers the share price
shareholders sell the according to the proportion.
shares to the open market.

IMP Problems:

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UNIT– V
1.What is meant by working capital? Explain the classification and
significance of working capital?
OR
Significance of working capital?
ANS) Every company needs working capital to meet its short-term expenses. It
keeps the business going. The following points highlight the need for working
capital:
1. Continuity in Business Operations: Working capital keeps the business
operations going. It is needed to purchase raw materials, to pay the
workers and staff and also to pay for recurring expenses like electricity
and power bills, rent, etc.
2. Dividend Payment: Working capital is needed to pay a dividend to the
shareholders. The payment of dividend takes place on a yearly or half-
yearly basis.
3. Repayment of Long-Term Loans: Working capital is also used to repay
long-term loans and debentures.
4. Increases Creditworthiness: A company that pays its creditors on time
has a positive reputation in the credit market. Such a goodwill helps a
company to obtain raw materials on credit. It can also get loans and
advances from the banks. The dealers will also be willing to give money
to such companies. Hence, working capital increases a company's
creditworthiness.
5. Boosts Efficiency and Productivity: The company that faces no working
capital problems provides better working conditions and welfare facilities
to its workers. It also can maintain its machines in good condition. It can
afford to spend money for training and development of its workers. All
such steps boost the efficiency and productivity of the company.
6. Helps to Fight Competition: Working capital helps the company to fight
its competitors. It can be used to advertise and for sales promotion. The
company can also afford to give longer credit terms to the customers.

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7. Helps to Withstand Seasonal Fluctuations: Working capital is required

throughout the year. But sales may be seasonal in nature. If the sales are
low, the money inflow is less. Therefore, liquid cash is required to pay
wages to workers and to meet other expenses. So, it helps the company
withstand seasonal fluctuations.
8. Increases Goodwill: The company that meets the needs of its working
capital without any difficulty earns a good reputation in the labour and
capital markets. This happens because the company pays wages and
salaries to the employees and the suppliers of raw materials, etc., on time.
Thus, it also helps increase the goodwill of the company.

The working capital, also known as net worth capital is the money that a
company needs for managing it’s short-term expenses. It is calculated as a
difference between an organisation’s current assets and its current liabilities.
Working capital is a measure of the operational efficiency, liquidity and short-
term financial health or solvency of the company.
The worthiness of an organisation’s working capital is subject to the industry in
which it engages, its link with its suppliers and customers. Few other factors to
be considered are:
 Current Assets and how fast it can be liquidated- If the company’s
assets are liquid cash and cash equivalents, a little working capital is
sufficient. But if the current assets have slow-moving items, then a large
amount of working capital is required.
 Type of company’s sales and how customers’ pay- If a company is into
online sales and the customer’s pay with a credit card option. At the time
of payment, only a small amount of working capital is enough. But if a
company has a credit duration of 60 days and the suppliers should be paid
in 30days, then the company requires a large amount of working capital.
 No borrowing and approved credit line- This point helps the company
to utilise a small amount of working capital.
Working Capital Formula:
Working capital = Current Asset – Current Liabilities
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Example of Working Capital

XYZ Company Current Assets:
 Fund in the bank: ₹1,00,000
 Pending accounts receivables: ₹4,00,000
 Inventory: ₹5,00,000
Total current assets = ₹10,00,000
XYZ Company Current Liabilities:
 Pending accounts payable: ₹3,00,000
 Temporary debt due payments for this year: ₹30,000
 A section of expended due debt for this year: ₹25,000
 Other accrued expenses for this year (e.g. rent, permanent salary, etc.):
₹4,00,000
Total current liabilities = ₹7,55,000
Working Capital of XYZ Company= Current Assets – Current Liabilities
= ₹10,00,000 – ₹7,55,000
= ₹2,45,000
2.Briefly explain the Baumol model and miller-orr cash management
models in Working capital?
ANS) The cash budget tells us the estimated levels of cash balances for the
given period on the basis of expected revenues and expenditures. • However, if
there are shortfalls and surplus, how should these be arranged and what should
be done with surplus, are the questions which are not answered by the cash
budget. • For such issues, there are cash management models.
1. Baumol Model
2. Miller And Orr model.
1.Baumol Model
The Baumol model helps in determining the minimum
amount of cash that a manager can obtain by converting securities into cash.

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Baumol model is an approach to establish a firm’s optimum cash balance under

certainty. As such, firms attempt to minimise the sum of the cost of holding cash
and the cost of converting marketable securities to cash.
Baumol model of cash management trades off between opportunity cost or
carrying cost or holding cost and the transaction cost.
The Baumol model is based on the following assumptions:
 The firm is able to forecast its cash requirements in an accurate way.
 The firm’s playouts are uniform over a period of time.
 The opportunity cost of holding cash is known and does not change with
time.
 The firm will incur the same transaction cost for all conversions of
securities into cash.

Miller-Orr Model
It is an improvement over Baumol’s model.
• On the basis of empirical data, Miller and Orr argued that the cash balances
fluctuate randomly. It does not follow a constant consumption rate.
• Baumol modes tells how much to be the optimum transaction size but it does
not talk about treatment of surplus cash balance.
The changes in cash balances are random. This is applicable for cash inflows as
well as for cash outflows.
• There are opportunities for transaction of marketable securities.
• Transaction of marketable securities has transaction cost.
• Holding of cash has opportunity cost as well.
• The firms maintain a minimum level of cash balances

3.Explain the objectives and process of inventory Management?

ANS) Inventory Management is a technique through which stocked goods,
inventories, and non-capitalized assets are kept in a proper manner according to
their specific shape and placement.
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An Inventory can be any item that a business holds to receive the goal of resale
or repair.
Inventory Management is a process of ordering, storing, and using inventories.
This stock management includes generating the lead on raw materials,
components, and finished products, along-side warehousing and processing of
such items in your company.
Inventory accounting is grouped into four separate categories:
 Raw Materials - The raw material is purchased by any company for its
production purpose to transform it into a finished good.
 Work in progress inventory - refers to the process of transformation of
raw material into a finished product.
 Finished goods - these are the complete goods that are now ready to be
available for sale.
 Maintenance, repair, operation (MRO) goods - items used for support
of the production of finished goods as they will be purchased from the
distributor of future resale.
Objectives:
The investment put in inventory is very high, especially for those
businesses that deal in manufacturing, wholesale, and retail trade.
The amount of investment might be sometimes more than the amount
spent on other assets of the company.
Almost 90% of the working capital of a business is invested in
inventories. The management should do proper planning on how to
purchase, handle, store, and account with inventory management
software.
The main aim of an inventory management system is to keep the stock in
such a way that it is neither overstock nor understock.
The overstock condition will reduce the other production processes and
understock will lead to stoppage of work.

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The objectives of inventory management are operational and financial. In

operational, materials and stock should be available in sufficient amount
whereas, in functional, the minimum working capital should be locked in.

1. To ensure a continuous supply of materials and stock so that production

should not suffer at the time of customers demand.
2. To avoid both overstocking and under-stocking of inventory.
3. To maintain the availability of materials whenever and wherever required
in enough quantity.
4. To maintain minimum working capital as required for operational and
sales activities.
5. To optimize various costs indulged with inventories like purchase cost,
carrying a cost, storage cost, etc.
6. To keep material cost under control as they contribute to reducing the cost
of production.
7. To eliminate duplication in ordering stocks.
8. To minimize loss through deterioration, pilferage, wastages, and damages.

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9. To ensure everlasting inventory control so that materials shown in stock

ledgers should be physically lying in the warehouse.
10.To ensure the quality of goods at reasonable prices.
11.To facilitate furnishing of data for short and long-term planning with a
controlled inventory.
12.To supply the required material continuously.
13.To maintain a systematic record of inventory.
14.To make stability in price.
4.A sound capital mix is essential for optimum utilization of funds?
(OR)
Modigliani and Miller Approach (MM Approach)
The assets of the company can be financed either by increasing the owner claims
or the creditor claims. The owner claims increase when the firm raises funds by
issuing ordinary shares or by retaining the earnings; the creditors' claims
increase by borrowing. The various means of financing represent the financial
structure of an enterprise.
A sound or appropriate capital structure should have the following features: 1.
Profitability: It should generate maximum returns to the shareholders without
adding additional cost.
2. Solvency: There should not be the use of excessive debt to maintain long term
solvency. Debt should be used till the point where debt does not add significant
risk, otherwise, use of debt should be avoided.
3. Flexibility: The capital structure should be flexible, to provide funds to
finance its profitable activities in future. The financial plan of the company
should be flexible enough to change the composition of capital structure as
warranted by operating needs.
4. Control: The capital structure should involve minimum risk of loss of
control of the company. Use of more equity may lead to a loss of control of the
company.
5. Conservation: The capital structure should be determined within the debt
capacity of a firm & not beyond

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the firm's capacity. The debt capacity of a firm depends on its ability to generate
future cash flows. It should have enough cash to pay its fixed charges &
principal sum. The size of company may influence its capacity and availability
of funds from different sources. A small company finds it difficult to raise long
term debt or long-term loan at acceptable rate of interest and convenient terms.
If small companies are able to approach capital markets, the cost of issuing
shares is generally more than larger companies.
5.Capital Structure and its Theories?
ANS) Capital Structure means a combination of all long-term sources of
finance. It includes Equity Share Capital, Reserves and Surplus, Preference
Share capital, Loan, Debentures, and other such long-term sources of finance. A
company has to decide the proportion in which it should have its finance and
outsider’s finance, particularly debt finance. Based on the ratio of finance,
WACC and Value of a firm are affected. There are four capital structure theories:
net income, net operating income, and traditional and M&M approaches.

Capital structure or
financial leverage deals
with a crucial financial
management question. The
question is – ‘what should
be the ratio of debt and
equity? and what are the
factors that affect a capital
structure‘. Before
scratching our minds to
find the answer to this question, we should know the objective of doing all this.
In the financial management context, any financial decision aims to maximize
the shareholder’s wealth or increase the firm’s value. The other question that hits
the mind in the first place is whether a change in the financing mix would
impact the value of the firm or not. The question is valid as some theories
believe that financial mix impacts the value and others believe it has no

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connection. Sometimes, the management also uses the pecking order theory
concept for their capital structure.
Traditional Approach
This approach does not define hard and fast facts, and it says that the cost of
capital is a function of the capital structure. The unique thing about this
approach is that it believes in an optimal capital structure. Optimal capital
structure implies that the cost of capital is minimum at a particular ratio of debt
and equity, and the firm’s value is maximum.
Modigliani and Miller Approach (MM Approach)
It is a capital structure theory named after Franco Modigliani and Merton Miller.
MM theory proposed two propositions.
 Proposition I: It says that the capital structure is irrelevant to the value of
a firm. The value of two identical firms would remain the same, and value
would not affect the choice of finance adopted to finance the assets. The
value of a firm is dependent on the expected future earnings. It is when
there are no taxes.
 Proposition II: It says that the financial leverage boosts the value of a firm
and reduces WACC. It is when tax information is available

Net Income Approach

Durand suggested this approach, and he favored the financial leverage decision.
According to him, a change in financial leverage would lead to a change in the
cost of capital. In short, if the ratio of debt in the capital structure increases, the
weighted average cost of capital decreases, and hence the value of the firm
increases.
NOTE: It is enough to write this answer to any question asked about capital
structure in exams

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5. Length of the operating cycle is major deter meant of working capital

needs of a business firm explain?
ANS) working capital cycle
Factors will vary between industries, but essentially how long it takes you to sell
your inventory and how long it is before you receive payment will impact the
length of the working capital cycle for your business.
Factors Impacting the Operating Cycle
The following are all factors that influence the duration of the operating cycle:
 The payment terms extended to the company by its suppliers. Longer
payment terms shorten the operating cycle, since the company can delay
paying out cash.
 The order fulfilment policy, since a higher assumed initial fulfilment rate
increases the amount of inventory on hand, which increases the operating
cycle.
 The credit policy and related payment terms, since looser credit equates to
a longer interval before customers pay, which extends the operating cycle.

6.Cash conversion cycle?

ANS) The cash conversion cycle (CCC) is a metric that expresses the time
(measured in days) it takes for a company to convert its investments in inventory
and other resources into cash flows from sales. Also called the net operating
cycle or simply cash cycle, CCC attempts to measure how long each net input
dollar is tied up in the production and sales process before it gets converted into
cash received.
This metric takes into account how much time the company needs to sell its
inventory, how much time it takes to collect receivables, and how much time it
has to pay its bills.
The CCC is one of several quantitative measures that help evaluate the
efficiency of a company's operations and management. A trend of decreasing or
steady CCC values over multiple periods is a good sign, while rising ones
should lead to more investigation and analysis based on other factors. One

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should bear in mind that CCC applies only to select sectors dependent on
inventory management and related operations
7.Venture capital?
ANS) Venture Capital (VC) typically refers to the funding provided by investors
to small or start-up businesses with strong potential for growth. A venture capital
fund is a form of private equity raised from private and institutional investors,
such as investment banks, insurance companies, or pension funds.
Features of Venture Capital
Venture Capitalists focus on the long-term picture rather than the immediate
scope of a business plan. Venture capitalists can expect an equity stake and
capital gains, and usually become limited partners in their portfolio companies.
Innovative projects with a lot of potential are the most common recipients of
venture capital investments. Venture capital financing can take the form of
equity, participating debentures, and conditional loans. Venture capital can also
come in the form of counsel, expertise, contacts, and assistance with
negotiations.
If you’re the kind of entrepreneur who has their hands in multiple projects at
once, it can help to have someone on your team who can help keep the overall
focus on growing the business. You don’t want to have to worry about checking
every single box on your own, and venture capitalists can help you navigate
business development, growth, management, hiring, and more.
Almost every entrepreneur knows that launching a business will rarely be
smooth sailing. To extend that analogy, venture capital simply offers you the
resources and more hands-on deck for when the water gets choppy, and helps
you keep moving forward.
8.Define credit policies?
ANS) A credit policy is a set of terms that lays out how your company will issue
credit to its clients and collect unpaid debts. Anytime you invoice a client for
services and begin working before the client pays you, you’re technically
working on credit, even if you don’t have a formal credit policy. A formal credit
policy helps you protect yourself in the event of non-payment.
A good credit policy achieves the following goals:

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 Qualifies and disqualifies certain clients for credit

 Defines credit payment terms for qualified clients
 Sets maximum credit limits
 Outlines how your company will collect outstanding debts
The importance of credit policies for businesses
Without a credit policy, operating your company on an invoice-based
billing model is inherently risky. That’s because companies without credit
policies have fewer contractual ways to bind clients to timely payments,
and fewer payments mean reduced cash flow. With less cash flow comes
more challenges in paying bills and keeping operations profitable.
More pointedly, credit policies keep clients accountable to you if you
work in an industry known for slow or partial client payments. These
policies leave little room for clients to argue against repaying their debts if
you do ultimately send them to collections or file a lawsuit. The mere
institution of a credit policy at your company can make it clear to clients
that you won’t let your work go unpaid.
Credit policies also decrease the likelihood of unpaid debts because they
allow clients to pay large invoices in small instalments. These instalments
make client payment easier – and they make your life easier too, since
they bolster your cash flow. In short, credit policies are as good for you as
for your clients.

9. What is a cash budget?

ANS) In its simplest form, a cash budget is a plan for expected cash receipts and
disbursements during a given period. A budget should include all cash inflows
and outflows, from revenues collected and expenses incurred to loan receipts
and payments.
Businesses will develop cash budgets after making sales, purchases, and
expenses, using this information to create balance sheets and accurately assess
the amount of cash that comes and goes during a set budget period.
How a cash budget is prepared

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When preparing a budget, you first need to define three key criteria: the period
of time you wish to cover, estimated sales and expenses, and a desired cash
position. This will help you outline the budget scope and get a greater
understanding of your estimated cash balance over the budget period you’re
looking at.
Once you have gathered all the necessary information you need, you can begin
to put together a basic outline of your budget. All cash budgets feature the same
four main items. These are:
 Opening balance: This is the amount of money available in the account
at the beginning of the week, month, or quarter (depending on the length
of time you want the budget to cover). This is the same amount as the
closing balance of the previous period budgeted for.
 Receipts: This is a list of the money coming into the business during the
budget period. Receipts will account for any and all revenue, including
rent revenue or income from cash or credit sales.
 Payments: This is the cash flow out of the business and includes
operating overheads, like rent and utilities, staff salaries, and other
business expenses.
 Closing balance: This is the amount of cash left at the end of the period
after all payments have been made and all receipts have been collected. It
will also be the opening balance of the next period in your budget.

NOTE: All answers have been updated Most of the questions are explained with
diagrams, these diagrams are not required to be included in the exam, just for your
understanding

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