Centre for Distance and Online Education
Name- ABHISHEK SINGH
ROLL Number- 2314515260
ASSIGNMENT
SESSION FEBRUARY - MARCH 2024
PROGRAM MASTER OF BUSINESS ADMINISTRATION
(MBA)
SEMESTER II
COURSE CODE & NAME DMBA202 FINANCIAL MANAGEMENT
CREDITS 04
NUMBER OF ASSIGNMENTS 02
& MARKS 30 MARKS EACH
Note: Answer all questions. Kindly note that answers for 10 marks questions should be
approximately 400 - 450 words. Each question is followed by an evaluation scheme.
Q.No Assignment Set – 1 Marks Total
Questions Marks
1. The consequences of “over-capitalization” are far more 5+5 10
serious than “under capitalization”. Discuss the statement
by elaborating on the causes and effects of over-
capitalization and Undercapitalization.
2. Zubi wants to invest in bonds in given alternative 3+3+3+1 10
situations, as stated below. You are required to advise her
in selecting the best option:
Bond Price =Rs.500
Coupon rate= 8%
Life of bond = 5 Years
Redemption value = Rs.500
Rate of return = 10%
Options:
1. Interest accrued Annually
2. Interest accrued Bi-Annually
3. Interest accrued Quarterly
3. a) Differentiate between Operating and Financial 5+5 10
Leverage.
b) If you contribute Rs. 2,400 every year to a
retirement account. Calculate what will be the future value
of this annuity in 30 years if 7% is the annual rate of return.
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Q.No Assignment Set – 2 Marks Total
Questions Marks
4. Do you think that different factors affecting capital 10 10
structure decisions will be viewed differently by different
companies? Support your answer with suitable examples.
5. You are required to prepare a statement showing the 10
working capital required to finance the level of activity
of 18000 units per year from the following information: -
Particulars Rs.
Raw material per unit 12
Direct Labor per Unit 3
Overheads per unit 9
Total Cost per unit 24
Profit per unit 6
Selling price per unit 30
Additional Information:
1. Raw material is in stock on average for 2 months
2. Materials are in process on an average for half a
month
3. Finished goods are in stock on an average for two
months
4. Credit allowed by creditors is two months in
respect of raw materials supplied.
5. Credit allowed to debtors is three months.
Debtors are calculated on the selling price.
6. Lag in payment of wages in half a month. Cash
on hand and at the bank is expected to be Rs.7000
7. You are informed that all activities are evenly
spread out during the year.
6. a) A manufacturing company places a semi-annual order 2.5+2.5+5 10
of 24,000 units at a price of Rs.20 per unit. Its carrying
cost is 15% and the order cost is Rs.12 per order. What is
the most economical order quantity? And how many
orders need to be placed?
b) Differentiate between hard and soft capital rationing.
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Assignment Set – 1
Questions
1. The consequences of “over-capitalization” are far more serious than “under capitalization”. Discuss the
statement by elaborating on the causes and effects of over-capitalization and Undercapitalization.
Causes and Effects of Over-capitalization and Under-capitalization
Over-capitalization: Over-capitalization occurs when a company raises more capital than it
can effectively utilize. This can be caused by overestimating the company's capital needs,
excessive borrowing, or overvaluation of assets. The effects of over-capitalization include
reduced return on investment, lower stock prices, and potential bankruptcy due to the burden
of servicing excessive debt. It can also lead to reduced competitiveness and hinder the
company's ability to invest in growth opportunities.
Under-capitalization: Under-capitalization happens when a company lacks the necessary
capital to operate effectively. This can result from underestimating capital needs, inadequate
borrowing, or undervaluation of assets. The effects of under-capitalization include financial
instability, inability to seize growth opportunities, and potential insolvency due to the
inability to meet financial obligations. It can also lead to reduced investor confidence and
hinder the company's ability to attract financing for expansion.
In conclusion, while both over-capitalization and under-capitalization have negative
consequences, over-capitalization can lead to more severe and long-term issues such as
bankruptcy and reduced competitiveness, whereas under-capitalization may result in missed
growth opportunities and financial instability. It is essential for companies to strike a balance
in their capital structure to avoid these detrimental effects.
2. Solution:- Calculating Yield to Maturity (YTM) for Each Option:
Interest accrued Annually:
YTM = ?
Using the formula:
YTM = (C + ((F - P) / n)) / ((F + P) / 2)
Where:
C = Annual coupon payment = 500 * 8% = Rs. 40
F = Redemption value = Rs. 500
P = Bond price = Rs. 500
n = Life of bond = 5 years
Interest accrued Bi-Annually:
YTM = ?
Using the same formula as above, but with n = 10 (twice the compounding frequency).
Interest accrued Quarterly:
YTM = ?
Using the same formula as above, but with n = 20 (four times the compounding frequency).
Advice for Zubi:
Zubi should select the option with the highest YTM, as it represents the highest annualized
return on the bond. After calculating the YTM for each option, Zubi should choose the option
with the highest YTM for the best return on her investment.
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o calculate the future value of an annuity, you can use the formula:
[ FV = P \times \left( \frac{{(1 + r)^n - 1}}{r} \right) ]
3. Differentiate between Operating and Financial Leverage.
b) If you contribute Rs. 2,400 every year to a retirement account. Calculate what will be
the future value of this annuity in 30 years if 7% is the annual rate of return.
Difference between Financial Leverage and Operating Leverage:
OPERATING LEVERAGE FINANCIAL LEVERAGE
Meaning
The utilisation of such resources and assets in the The utilisation of obligation or debt in an
organisation’s tasks for which it needs to pay fixed organisation’s capital design for which it needs to
costs is known as operating leverage. pay interest costs is known as financial leverage.
Formula
DFL = EBIT / EBT DOL = Contribution / EBIT
Risk Involved
It brings about business risk. It leads to a monetary gamble or financial risk.
Recommends
Low. High, just when ROCE is higher.
Deduce by
It ascertains the organisation’s cost structure. It ascertains the organisation’s capital structure.
b. To calculate the future value of an annuity, you can use the formula:
[ FV = P \times \left( \frac{{(1 + r)^n - 1}}{r} \right) ]
Where:
( FV ) = Future Value
( P ) = Payment per period (Rs. 2,400)
( r ) = Interest rate per period (7% or 0.07)
( n ) = Number of periods (30 years)
Substitute these values into the formula to find the future value:
[ FV = 2400 \times \left( \frac{{(1 + 0.07)^{30} - 1}}{0.07} \right) ]
[ FV = 2400 \times \left( \frac{{(1.07)^{30} - 1}}{0.07} \right) ]
[ FV \approx 2400 \times \left( \frac{{7.612255 - 1}}{0.07} \right) ]
[ FV \approx 2400 \times \left( \frac{{6.612255}}{0.07} \right) ]
[ FV \approx 2400 \times 94.4615 ]
[ FV \approx 226,707.6 ]
So, the future value of the annuity in 30 years will be approximately Rs. 226,707.6.
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4. Do you think that different factors affecting capital structure decisions will be viewed
differently by different companies? Support your answer with suitable examples.
1. Cash Flow Position:
The composition of the capital structure is determined by the business’s ability to create cash
flow. It is essential to consider the cash flow in the future to choose the capital structure. The
company must have sufficient funds for funding business operations, investing in fixed
assets, and fulfilling debt obligations, such as interest and capital repayments. The firm must
pay dividends to preferred shareholders, fixed-rate interest to debenture holders, and loan
principal and interest. Sometimes, a company produces sufficient profit but is unable to
produce cash inflow for payments. If the company does not make its financial commitments,
it may become insolvent. Therefore, the expected cash flow must match the obligation to
make payments.
If a company is confident in its ability to generate sufficient cash flow, it should use more
debt securities in its capital structure; however, if there is a cash shortage, it should use more
equity securities since there is no obligation to pay its equity owners.
2. Interest coverage ratio(ICR):
ICR signifies the number of times a company’s earnings before interest taxes (EBIT) meet its
interest payment. The ICR specifies the number of times EBIT can repay the interest
obligation.
ICR=\frac{EBIT}{Interest}
A high ICR shows that companies can have borrowed funds due to the lower risk of making
interest payments whereas a lower ratio shows that the company should use less debt.
3. Return on Investment(ROI):
Return on Investment is a crucial factor in designing an appropriate capital structure.
ROI=\frac{EBIT}{Total Investment}
ROI=\frac{EBIT}{Total Investment}
ROI=\frac{EBIT}{Total Investment}
In case ROI> Rate of interest, then the company must prefer borrowed funds in capital
structure whereas in case ROI <Rate of interest on debt, then the company must avoid debt
and use equity financing.
4. Debt Service Coverage Ratio(DSCR):
Under this, the amount of money needed to pay off debt and the capital for preferred shares is
compared to the profit generated by operations.
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DSCR=\frac{Profit~after~tax+Depreciation+Interest+Non-
cash~Expense~written~off}{Preference~Dividend+Interest+Repayment~obligation}
A higher DSCR indicates a better capacity to meet cash obligations, which implies that the
company can choose more debt. However, in the case of lower DSCR, the company prefers
more equity.
5. Cost of debt:
The cost of debt has a direct impact on how much debt will be used in the capital structure.
The company will prefer higher debt over equity if it can arrange borrowed funds at a
reasonable rate of interest.
6. Tax Rate:
High tax rates reduce the cost of debt because interest paid to debt security holders is
deducted from income before calculating tax, whereas businesses must pay tax on dividends
paid to shareholders. So, a high tax rate implies a preference for debt, whereas a low tax rate
implies a preference for equity in the capital structure.
7. Cost of equity:
The cost of equity is another aspect that influences capital structure. The usage of debt capital
has an impact on the rate of return that shareholders expect from equity. The financial risk
that shareholders must deal with increases as more debt is used. The required rate of return
rises when the risk does as well. As a result, debt should only be used sparingly. Any use
beyond the amount increases the cost of equity, and even though the EPS is higher, the share
price may fall.
5. Solution:- Working Capital Calculation
To calculate the working capital required to finance the activity of 18,000 units per year, we
need to consider various components.
1. Raw Material Holding Period:
Raw material required for 18,000 units = 18,000 units * Rs. 12 = Rs. 216,000
Raw material holding period = 2 months
Raw material holding cost = (Raw material required / 12) * 2 = Rs. 36,000
2. Work in Process:
Work in process cost = (Total cost per unit - Raw material per unit) * 18,000 units / 2 = Rs.
216,000
3. Finished Goods Holding Period:
Finished goods holding cost = Total cost per unit * 18,000 units / 6 = Rs. 108,000
4. Creditors:
Creditors for raw materials = Raw material per unit * 18,000 units / 2 = Rs. 108,000
5. Debtors:
Debtors = Selling price per unit * 18,000 units / 4 = Rs. 135,000
6. Wages:
Lag in payment of wages = Direct labor per unit * 18,000 units / 2 = Rs. 27,000
7. Cash on Hand and at Bank:
Cash on hand and at bank = Rs. 7,000 (given)
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Total Working Capital Required:
Components Amount (Rs.)
Raw Material Holding 36,000
Work in Process 216,000
Finished Goods Holding 108,000
Creditors 108,000
Debtors 135,000
Wages 27,000
Cash on Hand and at Bank 7,000
Total Working Capital 637,000
Therefore, the working capital required to finance the activity of 18,000 units per year is Rs.
637,000.
6. a) A manufacturing company places a semi-annual order of 24,000 units at a price of
Rs.20 per unit. Its carrying cost is 15% and the order cost is Rs.12 per order. What is
the most economical order quantity? And how many orders need to be placed?
We can use the Economic Order Quantity (EOQ) formula:
EOQ = √((2 * D * S) / H)
Where:
D = Annual demand
S = Ordering cost per order
H = Holding cost per unit per year
First, let's calculate the annual demand: Annual demand = 24,000 units
Next, we can calculate the EOQ: EOQ = √((2 * 24,000 * 12) / 0.15) = √(576,000 / 0.15) =
√3,840,000 = 1,959.6
The most economical order quantity is approximately 1,960 units.
To find the number of orders needed: Number of orders = Annual demand / EOQ Number of
orders = 24,000 / 1,960 = 12.24
Since the number of orders must be a whole number, the company would need to place 13
orders to meet the annual demand.
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Question b) Hard Capital Rationing:
In hard capital rationing, the firm faces external constraints on the availability of investment
funds. This could be due to regulatory restrictions, limited access to capital markets, or other
external factors.
Under hard capital rationing, the firm cannot raise additional funds, regardless of the
potential profitability of investment opportunities.
Soft Capital Rationing:
Soft capital rationing occurs when the firm voluntarily imposes limits on its capital budget,
even though it has the ability to raise additional funds from external sources.
This could be due to internal policies, risk aversion, or strategic decisions to maintain a
certain level of financial flexibility.
Unlike hard capital rationing, soft capital rationing is self-imposed and can be adjusted by the
firm based on changing circumstances.
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