Financial Management

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Amity CampusUttar PradeshIndia 201303

ASSIGNMENTSPROGRAM: BFIA

SEMESTER-II

Subject Name: Financial ManagementStudy COUNTRY: SOMALIARoll Number (Reg. No.): BFIA01512010-2013019Student Name: MOHAMED ABDULLAHI KHALAF

INSTRUCTIONS

a) Students are required to submit all three assignment sets.ASSIGNMENT DETAILS MARKSAssignment A Five Subjective Questions 10Assignment B Three Subjective Questions + Case Study 10Assignment C Objective or one line Questions 10

b) Total weight-age given to these assignments is 30%. OR 30 Marksc) All assignments are to be completed as typed in word/pdf.d) All questions are required to be attempted.e) All the three assignments are to be completed by due dates and

need to be submitted for evaluation by Amity University.f) The students have to attach a scanned signature in the form.

Signature : __________________________ Date: 27 – June – 2011

( √ ) Tick mark in front of the assignments submitted

Assignment A’ Assignment ‘B’ Assignment ‘C’

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SECTION A:

Q: 1). In what ways is the wealth maximization objectivesuperior to the profit maximization objective? Explain.

ANSWER:

Wealth Maximization is the primary goal for management decisions;it considers the risk and timing associated with expected earningsper share in order to maximize the price of the firm’s common stock.

Its objective is a widely recognized criterion with which theperformance of business enterprise is evaluated. The word wealthrefers to the net present worth of the firm. Therefore, wealthmaximization is also stated as net present worth.

Wealth maximization objective as decisional criterion suggests thatany financial action, which creates wealth or which has a netpresent value above zero is desirable one and should be acceptedand any financial actions that do not satisfy this test should berejected.

The wealth maximization objective when used as decisional criterionserves is a very useful guideline in taking investment decisions. Thisis because the concept of wealth is very clear. It represents presentvalue of the benefits minus the cost of the investment. The conceptof cash flow is more precise in connotation than that of accountingprofit. Thus, measuring benefit in terms of cash flows generatedavoids ambiguity.

The wealth maximization objective considers time value of money. Adollar in hand today is worth more than a dollar to be received in thefuture because, if you had it now, you could invest it, earn interest,and end up with more than one dollar in the future. It recognizesthat cash benefits emerging from a project in different years are notidentical in value. This is why annual cash benefits of a project arediscounted at a discount rate to calculate total value of these cashbenefits.

At the same time, wealth maximization objective also gives dueweight-age to risk factor by making necessary adjustments in thediscount rate. Thus, cash benefits of a project with higher riskexposure is discounted at a higher discount rate (cost of capital),while lower discount rate applied to discount expected cash benefitsof a less risky project. In this way, discount rate used to determine

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present value of future streams of cash earnings reflect on both thetime and the risk.

For those above mentioned reasons, wealth maximization objective isconsidered superior to profit maximization objective.

Q: 2). What is capital budgeting? Why is it significant for afirm?

ANSWER:

The term capital refers to long-term assets used in production, whilea budget is a plan that details projected inflows and outflows duringsome future period. Thus, the capital budget is an outline of plannedinvestments in fixed assets, and capital budgeting is the wholeprocess of analyzing projects and deciding which ones to include inthe capital budget.

Capital budgeting is the firm’s decision to invest its current fundsmost efficiently in the long-term assets in the anticipation of anexpected flow of benefits over a series of years.

Capital budgeting is investment decision-making as to whether aproject is worth undertaking or not. It is basically concerned withthe justification of capital expenditures.

It is the process of planning expenditures on assets whose cashflows are expected to extend beyond one year.

A number of factors combined together make capital budgeting,perhaps the most important function financial managers and theirstaffs must perform. First, since the results of capital budgetingdecisions continue for many years, the firm loses some of itsflexibility. For example, the purchase of an asset with an economiclife of 10 years “locks in” the firm for a 10-year period. Further,because asset expansion is based on expected future sales, adecision to buy an asset that is expected to last 10 years requires a10-year sales forecast. Finally, a firm’s capital budgeting decisionsdefine its strategic direction, because moves into new products,services, or markets must be preceded by capital expenditures.

An erroneous forecast of asset requirements can have seriousconsequences. If the firm invests too much, it will incurunnecessarily high depreciation and other expenses. On the otherhand, if it does not invest enough, two problems may arise. First, itsequipment may not be sufficiently modern to enable it to produce

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competitively. Second, if it has inadequate capacity, it may losemarket share to rival firms, and regaining lost customers requiresheavy selling expenses, price reductions, or product improvements,all of which are costly.

Timing is also important; capital assets must be available when theyare needed.

Effective capital budgeting can improve both the timing and thequality of asset acquisitions. If a firm forecasts its needs for capitalassets in advance, it can purchase and install the assets before theyare needed. Note, though, that if a firm forecasts an increase indemand and then expands to meet the anticipated demand, butsales do not increase, it will be saddled with excess capacity andhigh costs, which can lead to losses or even bankruptcy. Thus, anaccurate sales forecast is critical.

Capital budgeting typically involves substantial expenditures, andbefore a firm can spend a large amount of money, it must have thefunds lined up, due to that large amounts of money are not availableautomatically. Therefore, a firm contemplating a major capitalexpenditure program should plan its financing far enough inadvance to be sure funds are available.

For conclusion, capital budgeting is highly significant to the firm,because of the flowing reasons;

It influences the firm’s growth in the long run; decision toinvest in long-term assets has a decisive influence on the rate anddirection of its growth. A wrong decision can prove disastrous forthe continued survival of the firm; unwanted or unprofitableexpansion of assets will result in heavy operating costs to thefirm. On the other hand, inadequate investment in assets wouldmake it difficult for the firm to compete successfully and maintainits market share.

It affects the risk of the firm; long-term commitment of fundsmay also change the risk complexity of the firm. If the adoption ofinvestment increases average gain but causes frequentfluctuations in its earnings, the firm will become more risky.

It involves commitment of large amount of funds; Investmentdecisions generally involve large amount of funds, which make itimperative for the firm to plan its investment programs verycarefully and make an advance arrangement for procuringfinances internally or externally.

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It is irreversible, and if reversible it is at substantial loss;most investment decisions are irreversible. It is difficult to find amarket for such capital items once they have been acquired. Thefirm will incur heavy losses if such assets are scrapped.

It is among the most difficult decisions to make; Investmentsdecisions are the most complex ones. They are an assessment offuture events, which are difficult to predict. It is really a complexproblem to correctly estimate the future cash flow of aninvestment. Economic, social, & technological forces cause theuncertainty in cash flow.

Q: 3). Explain the factors influencing working capital policyof a firm.

ANSWER:

Working Capital Policy refers to the firm’s basic policy decisionsregarding target levels for each category of current assets and howcurrent assets will be financed.

Working capital policy involves two basic questions:

1) What is the appropriate amount of current assets for the firm tocarry, both in total and for each specific account? And

2) How should current assets be financed?

The working capital policy of a firm is influenced by numerousfactors. The important ones are:

1) Nature of business: The working capital requirement of a firm isclosely related to the nature of its business. A service firm, likeelectricity and water supply or a transport corporation, which hasa short operating cycle and which sells predominantly on cashbasis, has a modest working capital requirement. On the otherhand, a manufacturing concern like a machine tools unit, whichhas a long operating cycle and which sells largely on credit, has avery substantial working capital requirement.

2) Terms of sales and purchases: Credit sales granted by theconcerns to its customers as well as credit terms granted by thesuppliers also affect the working capital. If the credit terms of thepurchases are more favorable and at the same time those of salesless liberal, less cash will be invested in the inventory. With more

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favorable credit terms, working capital requirements can bereduced.

3) Manufacturing cycle: The length of manufacturing cycleinfluences the quantum of working capital needed. Manufacturingprocess always involves a time. The length of manufacturingperiod depends on the nature of product as well as the technologyused. Shorter the manufacturing cycle; lesser the working capitalrequired.

4) Rapidity of turnover: If the inventory turnover is high, theworking capital requirements will be low. With a better inventorycontrol, a firm is able to reduce its working capital requirements.When a firm has to carry on a large slow moving stock, it needs alarger working capital as against another whose turnover is rapid.A firm should determine the minimum level of stock, which it willhave to maintain throughout the period of its operation.

5) Business cycle: Cyclical changes in the economy also influencequantum of working capital. In a period of boom, when thebusiness is prosperous, there is need of larger amount of workingcapital due to increases in sales, rise in price etc and vice-versa.

6) Changes in technology: Changes in technology may lead toimprovements in processing of raw materials, savings in wastage,greater productivity, and more speedy production. All theseimprovements may enable the firm to reduce investments ininventory.

7) Seasonal variation: The inventory of raw materials, spares andstores depends on the condition of supply. If the supply is promptand adequate the firm can manage with small inventory.However, if the supply were unpredictable and scant then thefirm, to ensure the continuity of production, would have toacquire stocks as and when they are available and carry largerinventory on an average.

8) Production Policy: A firm marketed by pronounced seasonalfluctuations in its sales may pursue a production policy whichmay reduce the sharp variations in working capital requirements.For example, a manufacturer of ceiling fans may maintain asteady production throughout the year rather than intensify theproduction activity during the peak business season. Such aproduction policy may dampen the fluctuations in working capitalrequirements.

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9) Market conditions: The degree of competition prevailing in themarket-place has an important bearing on working capital needs.When competition is intense, a larger inventory of finished goodsis required to promptly serve customers who may be inclined towait because other manufacturers are ready to meet their needs.Further, generous credit terms may have to be offered to attractcustomers in a highly competitive market. Thus, working capitalneeds tend it be high because of greater investment in finishedgoods inventory and accounts receivable.

If the market is strong and competition is weak, a firm can managewith smaller inventory of finished goods, because customers can besupplied with some delay. Further, in such a situation the firm caninsist on cash payment and avoid lock-up of funds in accountsreceivable – it can even ask for advance, partial or total.

Q: 4). A- How Finance function is related to investmentfunction? B- Explain different functions performed by afinance manager.

ANSWER:

A- Finance function is mainly concerned with the determination ofoptimum capital structure of the company keeping in mind cost,control and risk. It is also known as Procurement of Fund. AndInvestment Function, also known as Effective Utilization of Fund. Inthis respect finance department has to identify the investmentopportunities and to choice the best one, after a proper evaluation.

Investment function and Finance function are inter-related andinter-connected. They are inter-related because the goal of thosefunctions is one and the same. Their ultimate objective is only one;achievement of maximization of shareholders’ wealth or maximizingthe market value of the shares. All the decisions are also inter-connected or inter-dependent also. Let us illustrate this aspect withan example. If a firm wants to undertake a project requiring funds,this investment decision cannot be taken, in isolation, withoutconsidering the availability of finances, which is a finance decision.So both decisions are inter-connected.

So far the objective of these two functions is the same; maximizingshareholders wealth. As their objectives are same the decisions areinterrelated. A company, having profitable investment opportunities

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generally prepares a good financing, and good investment meansprofit of the company would be more.

Finance function and investment functions are also highlycorrelated. Cost of capital plays a major role whether to accept or notinvestment opportunities. Financing decisions also dependent onamount of to be retained in the profit.

So, we can conclude that investment and finance functions areinterrelated and are to be taken jointly keeping in view their jointeffect on the shareholders wealth.

B- Financial Managers perform several functions including;

1) Estimation of capital requirements: A finance manager has tomake estimation with regards to capital requirements of thecompany. This will depend upon expected costs and profits andfuture programs and policies of a concern. Estimations have to bemade in an adequate manner which increases earning capacity ofenterprise.

2) Determination of capital composition: Once the estimation hasbeen made, the capital structure have to be decided. This involvesshort- term and long- term debt equity analysis. This will dependupon the proportion of equity capital a company is possessingand additional funds which have to be raised from outsideparties.

3) Choice of sources of funds: For additional funds to be procured,a company has many choices like;

a) Issue of shares and debentures.b) Loans to be taken from banks and financial institutions.c) Public deposits to be drawn like in form of bonds.d) Choice of factor will depend on relative merits and demerits of

each source and period of financing.

4) Investment of funds: The finance manager has to decide toallocate funds into profitable ventures so that there is safety oninvestment and regular returns is possible.

5) Disposal of surplus: The net profits’ decisions have to be madeby the finance manager. This can be done in two ways:

6) Dividend declaration: It includes identifying the rate ofdividends and other benefits like bonus.

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7) Retained profits: The volume has to be decided which willdepend upon expansional, innovational, diversification plans ofthe company.

8) Management of cash: Finance manager has to make decisionswith regards to cash management. Cash is required for manypurposes like payment of wages and salaries, payment ofelectricity and water bills, payment to creditors, meeting currentliabilities, maintenance of enough stock, purchase of rawmaterials, etc.

9) Financial controls: The finance manager has not only to plan,procure and utilize the funds but he also has to exercise controlover finances. This can be done through many techniques likeratio analysis, financial forecasting, cost and profit control, etc

Q: 5). ‘Generally individuals show a time preference formoney.’ Give reasons for such a preference.

ANSWER:

Generally individuals show a time preference for money, becauseIndividuals prefer possession of a given amount of cash now, ratherthan the same at some time in the future.

The main reason for the time preference or time value of money is:

1) Risk: There is uncertainty about the receipt of the money infuture.

2) Preference for present consumption: Most persons andcompanies have a preference for present consumption of goods,commodities and services.

3) Investment opportunities: Most persons and companies have apreference for present money because of the availability ofopportunities of investment for earning additional cash flows.

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SECTION B:

Q: 1). A- What is the importance of working capital for amanufacturing firm? B- What shall be the repercussion if afirm has (a) paucity of working capital, (b) Excess workingcapital?

ANSWER:

A- Working capital is very important concept in finance. It representsthe funds available with the company for day to day operations.Working capital finances the cash conversion cycle. Companycannot survive with negative working capital which represents thatthe company has no funds for day to day operations

Essentially working capital is the answer to the question: "Howmuch short term funding do you need to operate this business?”Short term funding is important because, with long term fundingalready in place, the business still needs short term funding tooperate. Without the short term funding, the business will gobankrupt.

Another concept is net working capital which means surplus ofcurrent assets over current liabilities. A positive NWC is good for acompany.

Some time, if creditors demand their money from company, at thistime company's high working capital saves company from thissituation. You know that selling of current assets is easy in smallperiod of time but Company cannot sell their fixed assets with insmall period of time. So, if Company has sufficient working capital,Company can easily pay off the creditors and create his reputationin market. But if a company has zero working capital and thencompany cannot pay creditors in emergency time and eithercompany becomes bankrupt or takes loan at higher rate of Interest.In both condition, it is very dangerous and always Company'sAccount Manager tries to keep some amount of working capital forcreating goodwill in market.

Positive working capital enables also to pay day to day expenses likewages, salaries, overheads and other operating expenses. Becausesufficient working capital can not only pay maturity liabilities butalso outstanding liabilities without any more delay.

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One of advantages of positive working capital is that Company cando every risky work without any tension of self security.

B- The paucity or shortage of working capital leads to a company’sbankruptcy. Working capital is a good measure of liquidity becauseit looks at debts that must be paid within one year or less.

A firm must have adequate working capital as much as needed. Itshould be neither excessive nor inadequate. Both situations aredangerous. Excessive working capital means the firm has idle fundswhich earn no profits for the firm. Inadequate working capital meansthe firm does not have sufficient funds for running its operations. Itwill be interesting to understand the relationship between workingcapital, risk and return. The basic objective of working capitalmanagement is to manage firm’s current assets and currentliabilities in such a way that the satisfactory level of working capitalis maintained; neither inadequate nor excessive.

Positive working capital generally indicates that a company is able topay off its short-term liabilities almost immediately. Negativeworking capital generally indicates a company is unable to do so.This is why analysts are sensitive to decreases in working capital;they suggest a company is becoming overleveraged, is struggling tomaintain or grow sales, is paying bills too quickly, or is collectingreceivables too slowly. Increases in working capital, on the otherhand, suggest the opposite.

When not managed carefully, businesses can grow themselves out ofcash by needing more working capital to fulfill expansion plans thanthey can generate in their current state. This usually occurs when acompany has used cash to pay for everything, rather than seekingfinancing that would smooth out the payments and make cashavailable for other uses. As a result, working capital shortages causemany businesses to fail. The most efficient companies invest wiselyto avoid these situations.

Q: 2). A- Why should inventory be held? B- Why is inventorymanagement important? C- Explain the objectives ofinventory management?

ANSWER:

A- Inventory means the raw materials, work-in-processgoods and completely finished goods that are considered to be the

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portion of a business's assets those are ready or will be ready forsale.

Inventory represents one of the most important assets that mostbusinesses possess, because the turnover ofinventory represents one of the primary sourcesof revenue generation and subsequent earnings for the company.

The Inventories are held for the following reasons.

1) Smooth production: to ensure smooth production as per therequirements of marketing department, inventories are procuredand sold.

2) To achieve Competitive edge: Most of the retail and industrialorganizations carry inventory to ensure prompt delivery tocustomers. No firm likes to lose customers on account of the itembeing out of stock.

3) Gaining Quantity Discount: Sometimes buying in large volumesmay give the firm quantity discounts. This quantity discountsmay be substantial that the firm will take benefit of it.

4) Hedge against uncertain lead times: Lead time is the timerequired to procure fresh supplies of inventory. Uncertainty dueto supplier taking more than the normal lead time will affect theproduction schedule and the execution of the orders of customersas per the orders received from customers. To avoid all theseproblems arising from uncertainty in procurement of freshsupplies of inventories, the firms maintain higher levels ofinventories for certain items of inventory.

B- Inventories are the most significant part of current aspects ofmost of the firms. Since they constitute an important element oftotal current assets held by a firm the need to manage inventoriesefficiently and effectively for ensuring optimal investment ininventory cannot be ignored. Any lapse on the part of managementof a firm in managing inventories may cause the failure of the firm.

Inventory management is an important part of a business becauseinventories are usually the largest expense incurred from businessoperations.

C- The major objectives of inventory management are to:

1) Maximize the satisfaction of customers.2) Minimize the investment in inventory.3) Achieve low cost plant operation.

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These objectives conflict each other. Therefore, a scientific approachis required to arrive at an optimal solution for earning maximumprofit on investment in inventories.

Q: 3). Explain the assumptions & implications of NI approach& the NOI approach. Illustrate your answer with hypotheticalexamples.

ANSWER:

The Net Income Approach (NI-approach) has been suggested by Durand.According to this approach a firm can increase its value or lower theoverall cost of capital by increasing the proportion of debt in the capitalstructure. In other words, if the degree of financial leverage increases theweighted average cost of capital will decline with every increase in thedebt content in total funds employed, while the value of firm willincrease. Reverse will happen in a converse situation.

Net income approach is based on the following three assumptions &implications:

1) There are no corporate taxes.2) The cost of debt is less than cost of equity or equity capitalization

rate.3) The use of debt content does not change at risk perception of

investors as a result both the kd (debt capitalization rate) and kc

(equity-capitalization rate) remains constant.

Example: A company expects its annual EBIT to be $50,000. Thecompany has $200,000 in 10% bonds and the cost of equity is 12.5 %(ke).

Calculation of the Value of the firm:

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According to the net operating income (NOI) approach the market valueof the firm is not affected by the capital structure changes. The marketvalue of the firm is found out by capitalizing the net operating income atthe overall or the weighted average cost of capital, which is constant.

The overall capitalization rate depends on the business risk of the firm. Itis independent of financial mix. If NOI and average cost of capital areindependent of financial mix, market value of firm will be a constant areindependent of capital structure changes. The critical assumptions of theNOI approach are:

1) The market capitalizes the value of the firm as a whole. Thus thesplit between debt and equity is not important.

2) The market uses an overall capitalization rate, to capitalize the netoperating income. Overall cost of capital depends on the businessrisk. If the business risk is assumed to remain unchanged, overallcost of capital is a constant.

3) The use of less costly debt funds increases the risk to shareholder.This causes the equity capitalization rate to increase. Thus, theadvantage of debt is offset exactly by the increase in the equity-capitalization rate.

4) The debt capitalization rate is constant.5) The corporate income taxes do not exist.

Thus, we find that the weighted cost of capital is constant and the costequity increase as debt is substituted for equity capital.

Example: Let us assume that a firm has an EBIT level of $50,000, cost ofdebt 10%, the total value of debt $200,000 and the WACC is 12.5%. Letus find out the total value of the firm and the cost of equity capital (theequity capitalization rate).

Solution:EBIT = $50,000WACC (overall capitalization rate) = 12.5%Therefore, total market value of the firm = EBIT/Ko $50,000/12.5% $400,000Total value of debt =$200,000Therefore, total value of equity = Total market value - Value of debt

$400,000 - $200,000 $200,000Cost of equity capital = Earnings available to equity holders/Total market value ofequity sharesEarnings available to equity holders = EBIT - Interest on debt

$50,000 - (10% on $200,000) $30,000Therefore, cost of equity capital = $30,000/$200,000 15%Verification of WACC:10% x ($200,000/$400,000) + 15% x ($200,000/$400,000) 12.5%

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CASE STUDY

Just-in-Time Inventory Creates VolatilityJust-in-time (JIT) delivery systems have had a dramatic impact onefficiency and profitability. Firms can reduce inventory to bare boneslevels. Lead time, the time between ordering and shipping, is downsubstantially. One manufacturer indicates lead time is now one to threedays, less than half what is was five years ago.

Lantech, a manufacturer of machines used to wrap plastic aroundpallets, is an example of a company that has taken substantialadvantage of JIT techniques. Lantech can now build a special ordermachine in ten hours. The same machine took five weeks to build tenyears ago. All companies have been forced to adapt to the instantaneousnature of orders. A customer will call in the morning wanting goods forthe next day, or even that afternoon. Gone are the days of ordering weeksin advance.

Even those companies that can't speed up the manufacturing processare reluctant to stockpile inventory. Worthington Industries, a steelproducer, indicated that it will pass on some orders needing quickdelivery rather than build up inventory. Many firms no longer attempt toforecast demand for their products; they merely react to new orders asrapidly as possible. The economic result is increased volatility. Excludingdefense orders, capital goods orders were up 4.6% in February, down3.1% in March, and up 1.9% in April.

TALKING IT OVER AND THINKING IT THROUGH!Q: 1). How does JIT increase profits?

ANSWER:

Just-in-time (JIT) is a system used to minimize inventory investment.The idea of JIT is to have zero inventories or as near zero as possiblewithout adversely affecting production or sales. The goal of this strategyis to cut down on inventory costs;

1) Holding less inventory, so that there are lower storage costs, lowerlevels of spoilage, and less risk of obsolescence.

2) Coordinating with suppliers to minimize the cost of reorderinginventory.

The goal of the JIT is to minimize the costs of holding and orderinginventory.

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In addition to reducing the holding and ordering costs of inventory, thereare other considerations in determining the appropriate level ofinventory. One consideration is taxes on inventory. There may be a statetax based on the value of inventory held as of a specified date, in thatcase, you would hold on the smallest amount of inventory that would notcause a shortage of goods for your customers.

Companies using JIT inventory management system increase their profit,through cutting down inventory costs without affecting productionprocess or sales.

Q: 2). What impact does JIT have on inventory obsolescence?

ANSWER:

Inventory obsolescence is when inventory is no longer salable. Possiblydue to too much inventory on hand, out of fashion or out of demand.

Implementing JIT inventory management system prevents the companyfrom been under such circumstances.

Q: 3). What is the danger of not holding product in inventory?

ANSWER:

There are many dangers and risks faced by a company which doesn’thold products in inventory, including:

1) Risk of non-smooth sale operations: The Company may notpossibly be able to produce the goods immediately after they aredemanded by the customers. Hence it is needed to hold somefinished goods in inventory to attain customer satisfaction.

2) In addition to the requirement to hold the inventory for routinetransactions, the company may like hold them to guard againstrisk of unpredictable changes in demand. For example; the demandfor finished goods may suddenly increase (especially in case ofseasonal type of products) and if the company is unable to supplythem, it may mean gain of competition and loss of profitableopportunity. Hence, company will like to maintain sufficient supplyof finished goods.

3) Price rise: The price of raw materials involved in the production myrise, lifting the cost of production. To get rid of that it’s better tohave some finished goods in inventory.

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SECTION C40 MULTIPLE CHOICE QUESTIONS

Q: 1). Which of the following statements is true with respectto the mobilization of funds by a finance manager?

a) Analysis of variance between the targeted costs and actual costsincurred and reporting on the same.

b) Assessing the costs and benefits of a project underconsideration.

c) Interacting with banking agencies for procuring funds. (√)d) Appraisal of investment proposals given by various departments.e) Deciding the optimum quantity of raw materials to be ordered

for procurement.

Q: 2). Which of the following is not a source of long-termfinance?

a) Equity capital.b) Preference capital.c) Debenture capital.d) Commercial paper.e) Reserves and surplus. (√)

Q: 3). Which of the following approaches advocates that theoverall capitalization rate remains constant for all degrees ofleverage and that there is no optimal capital structure?I. Traditional approach.

II. Miller and Modigliani approach.III. Net operating income approach.IV. Net income approach.

a) Only (I) aboveb) Only (II) abovec) Both (II) and (III) above.d) Both (III) and (IV) abovee) (II), (III) and (IV) above. (√)

Q: 4). For Jayalakshmi Sarees Ltd. the face value of theirredeemable preference share is Rs.500, dividend is equal to15% and the applicable tax rate is 30%, then the cost of thepreference share is

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a) 15.0%b) 10.5%c) 8.5%d) 4.5%e) Data is insufficient. (√)

Q: 5). Which of the following would cause a firm’s EOQ toincrease, other things held constant?

a) Carrying cost as a percentage of unit price increases.b) Fixed ordering costs per order doubles.c) Purchase price of inventory items doubles.d) Safety level stock increases.e) Decrease in annual usage of materials. (√)

Q: 6). Which of the following is a technique for monitoringthe status of the receivables?

a) Ageing schedule. (√)b) Outstanding creditors.c) Selection matrix.d) Funds flow analysis.e) Credit evaluation.

Q: 7). Which of the following is not a relevant factor in anefficient cash management system for a business entity?

a) Billing promptly and thereafter mailing the same to thecustomers.

b) Payment of interest on term loans whenever it is due. (√)c) Collection of receivables from the branch.d) Depositing the cheque immediately to the bank on receiving the

same from the customers.e) Making a centralized payment system for the suppliers.

Q: 8). Which of the following changes in credit policy is/arelikely to reduce the investment in receivables?

I. Liberalizing credit standards.II. Hastening the collection process.

III. Extending the credit period.IV. Reducing the cash discount.

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a) Only (I) aboveb) Only (II) abovec) Both (II) and (III) aboved) Both (III) and (IV) abovee) (II), (III) and (IV) above.

N.B: the correct answer is (I), (II) and (IV) above. (√)

Q: 9). Which of the following types of factoring does notcarry the service elements of factoring?

a) Recourse Factoringb) Full Factoringc) Maturity Factoringd) Invoice Discounting. (√)e) Non-Recourse Factoring.

Q: 10). Which of the following is not a reason to make capitalexpenditure decisions very important in corporate finance?

a) Once the decision is taken, it has far reaching consequencesextending over a considerably long period, which influences therisk complexion of the firm

b) These decisions involve huge amount of moneyc) These decisions once taken are irreversibled) These are among the most difficult to make when the company

is faced with various potentially viable investment opportunitiese) The liquidity position of a firm is very much dependent on

its investment in fixed assets. (√)

Q: 11). Which of the following statements is/are correct for aproject with a positive NPV?

I. IRR exceeds the cost of capital.II. Payback period will be more than the cut-off rate.

III. BCR is greater than 1.IV. NBCR is more than zero.

a) Only (I) aboveb) Only (II) above.c) Both (I) and (III) aboved) Both (III) and (IV) abovee) (I), (III) and (IV) above. (√)

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Q: 12). The price-earnings ratio approach is used forestimating the cost of

a) Debenture capitalb) Preference capitalc) Equity capital (√)d) Term loane) Fixed deposits.

Q: 13). Consider the following projects.

I. Project B which has a Net Benefit Cost Ratio less than one butmore than zero.

II. Project C whose present value of inflows is less than the presentvalue of outflows.

III. Project D which has a cost of capital less than the internal rateof return.

IV. Project E which has the highest annual capital charge comparedto all other projects.

Which of the project(s) mentioned above can be accepted?

a) Only (I) aboveb) Both (I) and (III) above (√)c) Both (III) and (IV) aboved) (II), (III) and (IV) abovee) (I), (III), and (IV) above

Q: 14). If the net benefit cost ratio is 0.3, the net presentvalue is Rs. 60,000, the present value of the cash inflowsassociated with the project is

a) Rs. 78,000b) Rs.2,00,000 (√)c) Rs.2,60,000d) Rs.2,78,000e) Rs.2,80,000

Q: 15). The letter of credit is

a) A letter sent by the bank to its client which confirms that a loanhas been sanctioned

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b) An arrangement in which a bank undertakes to pay asupplier of the client of the bank, if its client fails to pay forthe goods purchased from the supplier. (√)

c) An arrangement between a firm and its bank which facilitatestimely collection of receivables of the firm

d) A letter sent by a firm to its customer which states that thecredit period has been extended

e) A letter sent by a supplier to a firm which states that thesupplier has agreed to supply goods on credit to the firm.

Q: 16). Which of the following factors does not influence theworking capital management policies of a firm?

a) Excise duties on the capital equipments.b) Sudden increase in the demand for the product of the company.c) Adoption of better technology leading to the reduction in

production time.d) Sudden stoppage of the supply of a major raw material.e) Increase in the short term interest rate. (√)

Q: 17). Which of the following assets is least liquid?

a) Work in process. (√)b) Cash and bank balancec) Debtorsd) Bills receivablee) Certificates of deposits.

Q: 18). As a general rule, the capital structure that maximizesthe market value of a company

a) Maximizes its average cost of capitalb) Maximizes its earnings per share. (√)c) Maximizes the chance of bankruptcyd) Minimizes the cost of capital of the companye) Minimizes the cost of debt capital of the company.

Q: 19). Which of the following is not a type of bank finance forworking capital?

a) Cash creditb) Overdraftc) Commercial paper

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d) Purchasing and discounting of billse) Packing credit. (√)

Q: 20). Which of the following statements is/are trueregarding difference between fixed assets and current assets?

I. In comparison to management of fixed assets, the time value ofmoney is less significant in management of current assets.

II. The liquidity position of a firm is mainly dependent on theinvestment in current assets, whereas fixed assets have only alimited role in the matter of liquidity.

III. In any short run, immediate need of the company foradjustments to fluctuations in sales can be made only throughadjustments with fixed assets.

a) Only (I) aboveb) Only (II) abovec) Both (I) and (II) above. (√)d) Both (II) and (III) abovee) All (I), (II) and (III) above.

Q: 21). If the cost of an investment is Rs. 2 lakh and it paysRs.17,500 in perpetuity at an interest rate of 8% p.a., thebenefit cost ratio of the investment is

a) –1.29b) –0.09c) 0.70d) 1.09 (√)e) 1.22.

Q: 22). Which of the following are the quantitative measuresto prove the creditworthiness in order to enjoy trade creditfrom the suppliers?

I. Good track record of profitability and liquidity.II. A free and frank discussion with the suppliers.

III. A record of prompt payments by the company to other suppliers.IV. Negotiation with suppliers for payments to synchronize with the

company’s cash inflows.

a) Both (I) and (III) above. (√)b) Both (II) and (IV) above

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c) Both (III) and (IV) aboved) (I), (II) and (III) abovee) (II), (III) and (IV) above.

Q: 23). Which of the following is not a cost incurred formaintaining receivables?

a) Collection costb) Financing cost. (√)c) Cash discountd) Administrative coste) Defaulting cost.

Q: 24). Which of the following is not a motive for thecompanies to hold cash?

a) Transaction motive.b) Precautionary motive.c) Speculative motive.d) Lack of proper synchronization between cash inflows and

outflows. (√)e) Capital investments.

Q: 25). The surplus cash available with a firm can be identifiedas cash

I. Available for meeting unforeseen disbursements.II. Available on certain definite dates for making specific payments

such as account of tax, dividends, capital expenditure, etc.III. Not required to meet any specific payments and is a sort of

general reserve.

a) Only (II) aboveb) Only (III) above. (√)c) Both (I) and (II) aboved) Both (I) and (III) abovee) All (I), (II) and (III) above.

Q: 26). Which of the following is false with regard to theconcept of cost of capital?

a) It considers the various sources of long term finance.

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b) It is a weighted average of the costs of the various sources oflong term finance used by the firm.

c) It is expressed in post tax terms.d) It assumes that the risk characterizing the new investment

proposals differs significantly from the risk level of theexisting investments of the firm. (√)

e) It assumes that the firm will continue to pursue the samefinancing policies.

Q: 27). Other things remaining the same, which of thefollowing project appraisal criteria will remain unchanged ifthe cost of capital is changed?

a) Net present valueb) Internal rate of return. (√)c) Benefit cost ratiod) Net benefit cost ratioe) Annual capital charge.

Q: 28). Consider the following data:

Raw-material storage period 40 daysConversion period 2 daysFinished goods storage period 20 daysAverage collection period 18 daysAverage payment period 25 daysThe gross operating cycle is

a) 55 days.b) 80 days. (√)c) 87 days.d) 105 days.e) 110 days.

Q: 29). M/s Priya Garments and Exports is considering to buya new piece of equipment, which is expected to costRs.4,00,000 and will produce cash flows of Rs. 100,000 everyyear for the next 6 years (the first cash flow will be exactlyone year from today). If the company is able to invest in anupgrade which would cost Rs. 120,000 in year 3, it wouldincrease the annual cash flows from 4th year onwards to Rs.

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200,000. If the discount rate appropriate for the company is15%, the NPV of the investment is approximately

a) Rs.28,765b) Rs.36,674c) Rs.45,295d) Rs.49,672 (√)e) Rs.52,605

Q: 30). Which of the following is the principal tool in effectivecash management?

a) Capital budget.b) Cash flow statement.c) Funds flow statements.d) Cash budget. (√)e) Financial statement analysis.

Q: 31). Current assets do not include

a) Cash and bankb) Short-term investmentsc) Sundry debtorsd) Outstanding expenses. (√)e) Inventory.

Q: 32). Which of the following is false with regard to theAccounting Rate of Return (ARR) as an appraisal criterion forprojects?

a) It considers the profits over the entire life of the projectb) It gives more weight to the earlier receipts than the later

receipts. (√)c) It considers accounting profits instead of cash flowsd) It serves as a measure of profitability of the investmente) It ignores the time value of money.

Q: 33). Which of the following is not a factor affecting thecomposition of working capital?

a) Nature of businessb) Nature of raw material usedc) Degree of competition in the market

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d) Tax structure of a company. (√)e) Process technology used.

Q: 34). Which of the following is not a merit of using bookvalues as weights for calculating the weighted average cost ofcapital?

a) The book value weights are independent of the fluctuations ofthe market prices.

b) The calculation of weights is simple.c) The book values of the different sources of finance are

approximately related to their present economic values. (√)d) The book value weights are suitable for a firm whose securities

are not traded regularly.e) The book value weights are the most suitable for the unlisted

firms.

Q: 35). Which of the following is not a function of financemanager?

a) Mobilization of funds.b) Deployment of funds.c) Control over the use of funds.d) Risk-return trade off.e) Optimum utilization of stores. (√)

Q: 36). Which of the following is not true about CommercialPapers (CPs)?

a) CPs are issued at a discount to face value.b) The minimum maturity period of CPs is 15 days.c) CPs are unsecured in nature.d) CPs are not negotiable by endorsement and delivery. (√)e) Prior approval of RBI is not needed for CP issues.

Q: 37). The sinking fund factor is the inverse of

a) Capital Recovery Factor. (√)b) Future Value Interest Factor.c) Future Value Interest Factor for Annuity.d) Present Value Interest Factor for Annuity.e) Present Value Interest Factor.

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Q: 38). Ms. Remani has taken a car loan for Rs. 200,000 to berepaid in 60 equal monthly installments at the end of everymonth. If the loan carries an interest rate of 10% p.a.,compounded quarterly, calculate the amount of eachinstallment?

a) Rs.4,150b) Rs.4,240c) Rs.4,465 (√)d) Rs.4,618e) Rs.4,763

Q: 39). The objective of financial management is to increasethe wealth of the shareholders means to

a) Increase the physical assets owned by the firm.b) Increase the market value of the shares of the firm. (√)c) Increase the current assets of the firm.d) Increase the cash balance of the company.e) Increase the total number of outstanding shares of the

company.

Q: 40). Which of the following functions of the Indianfinancial system influences the growth of investment andliving standards in the society?

a) Risk function.b) Liquidity function.c) Payment function.d) Savings function. (√)e) Policy function.