NAME MOHAMMED FARHAN
ROLL NO 2414506697
PROGRAM BACHELOR OF BUSINESS
ADMINISTRATION {BBA]
SEMESTER 2
COURSE NAME FINANCIAL MANAGEMENT
COURSE CODE DBB1208
SET – 1
Q-1 A company issued bonds with a face value of $100, sold at a 10%
discount, and are redeemable at a 10% premium. Calculate the effective
cost of these bonds for the company considering :
a} A 5 - year maturity period
b] perpetual bonds [ no maturity]
The company’s tax rate is 40% .
Ans. F= 100 – 10% = 90
R = 100+10% = 110
Tc = 40% = 0.4
N = 5 years
I = 10%
Kd = I (1- tc ) + R – F/n/R+F/2
= 10[1-0.4] + 110 – 90 / 5/110 +90/2
= 6+ 4/100 = 10%
Kd = 1/F [ 1 – tc ]
= 10/90 [ 1 – 0.4 ] = 6.67%
Q-2 a} If an amount of ₹50,000 is invested at an annual interest rate of
12%, calculate the future value of the investment after 3 years.
b} Determine the present value of ₹ 50,000 to be received in the
future, assuming a suitable discount rate and considering the concept of
time value of money.
Ans. a} FV = P * [ 1 + 0.12 ]3
= 50,000 * [ 1 + 0.12 ]3
= 50,000 [ 1.405 ]
= 70, 250
b] PV = A [ 1 – 1/[1+ I]n/I ]
= 50,000/0.12 [ 1 – 1/ [ 1+ 0.12]5 ]
= 4,16,666 [ 1 – 0.5674 ]
= 4,16,666 [ 0.4326 ]
= 1,80,249
Q- 3 a} What is leverage in financial management? Explain how it
contributes to maximizing shareholder’s wealth
b) Explain the concept of wealth maximization and distinguish it
from profit maximization, highlighting their key differences and
implications for financial decision- making.
Ans. a) leverage in this context, is to take maximum advantage by
focusing on the key strength. In finance, it is defined as using the
influence of one variable over the other to maximise the return on
investment. In other words, it is the ratio of relative change in another.
SET- 2
Q-4 Briefly explain and compare the following instruments, highlighting
their key features and differences :
a) Financial lease
b) Hire- purchase Financing
Ans.
FINANCIAL LEASE HIRE- PURCHASE FINANCING
The financial lease is the outcome Hire purchase is a financing
of a contract between the lessor method involving three parties :
and lessee whereby the lessor the manufacturer, the hirer and the
tenders the right to use the asset hiree.
owned by him to the lessee for
which the lessee agrees to pay the
periodical rent for lease period.
Depreciation is charged by the The hirer is entitled to charge
lessor. depreciation on hired assets and
claim tax benefits on depreciation.
The ownership of the assets The ownership of the assets gets
remains with the lessor throughout transferred to the hirer once all
the agreement. installments are paid.
The whole of the lease rental can From installment paid, only the
be claimed for availing tax interest portion can be claimed as
benefits. tax benefits.
Provides the means to use the The possession of asset is
asset with small amount of capital. transferred by the owner of the
asset.
No- Risk of obsolescence . The ownership of the assets
remains with the hiree till the final
installment is paid.
Q-5 Critically analyze the major theories of capital structure, highlighting
their key assumptions, implications and relevance with appropriate
examples?
Ans. Capital structure is defined as the mix of debt and equity that a firm
uses its operations. the major theories of capital structure are –
1. Net income approach : According to this theory, the value of a firm can
be increased if the firm decreases the overall cost of capital measured in
terms of the weighted average cost of capital. This is possible by choosing
a higher proportion of debt in financing is cheaper than equity finance.
Weighted average cost of capital [WACC] is the weighted average costs of
equity and debts where the weights are the amount of capital raised
from each source.
WACC = [ E/V × Re ] + [ D/V ×Rd × ( 1 – Tc )]
Where:
E = Market value of the firm’s equity
D = Market value of the firm’s debt V= E + D
Re = Cost of equity
Rd = Cost of debt
Tc = Corporate tax rate
Example for Net Income Approach :
Suppose a firm has equity- debt ratio of 50:50. If it changes this ratio to
20:80, it will bring a positive change in the business as the value per
share of firm will increase.
Assumptions of net income approach :
a} Investors will not change their mind with increase in debt proportion.
b] Only two sources of finances are there debt and equity. Other sources
like preference.
c} Share capital and retained earnings are not there.
d] All companies have a uniform dividend payout ratio; it is 1.
2. Net operating Income Approach : According to the net operating income
approach, value of firm is unaffected by any change in debt proportion in
the capital structure of the firm.
Assumptions of net operating income approach :
a) The overall capitalization rate remains irrespective of the degree of
leverage.
b) Value of equity is the difference between the total firm Value of debt.
c) WACC [ Weightage average cost of capital] remains constant; and with
increase in debt, the cost of equity also increases.
3. Traditional Theory of Capital Structure : According to this theory, an
optimal capital structure corresponds to an ideal debt – to- equity ratio.
4. Modigliani and Miller Approach : This theory is considered to be the
most important theory in corporate finance. It was developed by the
economist, Modigliani and Miller in 1958. The main idea behind this theory
is that overall value of a company is unaffected by its capital structure.
Assumptions of Modigliani and Miller approach :
a) there are no taxes.
b) transaction cost for buying and selling securities as well as the
bankruptcy cost is nil.
c) there is symmetry of information.
Q-6 ABC Corp is evaluating a potential investment project involving an
initial outlay of $200,000. The expected annual cash inflows are $50,000
for the next 3 years. Given a discount rate of 15%. Calculate the Net
Present Value (NPV) of the project and provide an assessment of its
financial viability?
Ans. NPV = Cn/[I + 1]n – I0
= 50,000/[0.12 + 1]3 – 200,000
= 50,000/[1.404928] – 200,000
= 35,479 – 200,000
= 164,521
