Financial management assignments and descriptive model question papers

Financial management assignments and descriptive model question papers

 

Q1. When a firm follows wealth maximization goal, it achieves maximization of market value of a share. Do you agree? Substantiate your arguments.

 

Ans: Wealth maximisation means maximising the net wealth of a company’s shareholders. Wealth maximisation is possible only when the company pursues policies that would increase the market value of shares of the company. It has been accepted by the finance managers as it overcomes the limitations of profit maximisation.

The following arguments are in support of the superiority of wealth maximisation over profit maximization.

  • Wealth maximisation is based on the concept of cash flows. Cash flows are a reality and not based on any subjective interpretation. On the other hand, profit maximisation is based on accounting profit and it also contains many subjective elements.
  • Wealth maximisation considers time value of money. Time value of money translates cash flows occurring at different periods into a comparable value at zero period. In this process, the quality of cash flows is considered critically in all decisions as it incorporates the risk associated with the cash flow stream.

 

Let us now look at some of the key definitions:

  • Time value factor is known as the time preference rate, that is, the sum of risk free rate and risk premium.
  • Risk premium is the consideration for the risk perceived by the investor in investing in that asset or security.
  • Required rate of return is the return that the investors want for making investment in that sector.

 

In the liberalised set up, the society expects corporate to tap the capital markets effectively for their capital requirements. Therefore, to keep the investors happy throughout the performance of value of shares in the market, management of the company must meet the wealth maximisation criterion.

  • When a firm follows wealth maximisation goal, it achieves maximisation of market value of share. A firm can practice wealth maximisation goal only when it produces quality goods at low cost.
  • Another notable feature of the firms committed to the maximisation of wealth is that to achieve this goal, they are forced to render efficient service to their customers with courtesy. This enhances consumer welfare and benefit to the society.
  • Since listing ensures liquidity to the shares held by the investors, shareholders can reap the benefits arising from the performance of company only when they sell their shares.

 

Therefore, we can conclude that maximisation of wealth is the appropriate goal of financial management in today’s context.

 

 

 Q2. Premier Steel Ltd. has a present annual sales turnover of Rs. 40,00,000. The unit sale price is Rs. 20. The variable costs are Rs. 12 per unit and fixed costs amount to Rs. 5,00,000 per annum. The present credit period of 1 month is proposed to be extended to either 2 or 3 months whichever is profitable. The following additional information is available :

 

Credit period 1 month 2 months 3 months
Increase in sales by 10 % 30 %
Bad debts on sales 1 % 2 % 5 %

 Fixed costs will increase by Rs. 75,000 when sales increase by 30 %. The company requires a pre-tax return on investment of 20 %.

 Evaluate the profitability of the proposals and recommend the best credit period for the company.


Solution:

  1 month 2 month 3 month
Sales 4000000 4400000 5200000
Bad debt to sales 40000 88000 260000
Net sales 3960000 4312000 4940000
Net incremental sales (A) 352000 980000
Cost of sales   
Variable cost @rs.12 240000 2640000 3120000
Fixed cost 500000 500000 575000
Cost of sales 2900000 3140000 3695000
Net incremental cost (B) 240000 795000
Average debtors at cost 241667 523333 923750
Increase in average debtors 281667 682083
Cost of incremental debtors @20% (C) 56333 136417
Total incremental cost (B+C) 269333 931417
Net increase in profit {A-(B+C)} 55667 48593

The change of credit period from 1 month to 2 months is expected to increase the profit by rs 55667, which is more than rs 48583. Hance, the firm may changes its credit policy from the present credit period of 1 month to 2 months.

 

Conclusion:

Alternative 1 should be considered.

 

 

Q3. The concept of financial leverage is a significant, as it has direct relation with capital structure. Do you agree? If so, substantiate your arguments.

 

Ans: Financial leverage as opposed to operating leverage relates to the financing activities of a firm and measures the effect of earnings before interest and tax (EBIT) on earnings per share (EPS) of the company.

A company’s sources of funds fall under two categories –

  • Those which carry a fixed financial charges like debentures, bonds and preference shares and
  • Those which do not carry any fixed charges like equity shares

 

Debentures and bonds carry a fixed rate of interest and have to be paid off irrespective of the firm’s revenues. Though dividends are not contractual obligations, dividend on preference shares is a fixed charge and should be paid off before equity shareholders are paid any. The equity holders are entitled to only the residual income of the firm after all prior obligations are met.

Financial leverage refers to the mix of debt and equity in the capital structure of the firm. This results from the presence of fixed financial charges in the company’s income stream. Such expenses have nothing to do with the firm’s performance and earnings and should be paid off regardless of the amount of earnings before income and tax (EBIT).

It is the firm’s ability to use fixed financial charges to increase the effects of changes in EBIT on the EPS. It is the use of funds obtained at fixed costs which increase the returns on shareholders.

A company earning more by the use of assets funded by fixed sources is said to be having a favourable or positive leverage. Unfavourable leverage occurs when the firm is not earning sufficiently to cover the cost of funds. Financial leverage is also referred to as “Trading on Equity”.

Highly leveraged firms are considered very risky and lenders and creditors may refuse to lend them further to fuel their expansion activities. On being forced to continue lending, they may do so with their own conditions like earning a minimum of X% EBIT or stipulating higher interest rates than the market rates or no further mortgage of securities. Financial leverage is considered to be favourable till such time that the rate of return exceeds the rate of return obtained when no debt is used.

 

 

Q4. A project requires an initial outlay of Rs. 1,00,000. It is expected to generate the cash inflows shown in table

Table: Cash Inflows

Year Cash inflows
1 50,000
2 50,000
3 30,000
4 40,000

          What is the IRR of the project?

Q5. Below Table gives the complete details of sales and costs of the goods produced by XYZ ltd for the year 31.03.12.

Table -Sales and Costs Produced by XYZ Ltd.

Sales 80,000 Inventory 
Cost of goods 56,000 31.03.07 9,000
   31.03.08 12,000
   Accounts Receivables 
   31.03.07 12,000
   31.03.08 16,000
   Accounts Payable 
   31.03.07 7,000
   31.03.08 10,000

What is the length of the operating cycle? What is the cash cycle?

Assume 365 days in a year.

Q6. Facebook bought WhatsApp on Feb, 19, 2014 for $19 billion. This was split between $4 billion in cash, $12 billion worth of Facebook shares, and $3 billion in restricted stock units to be paid in four years. Do you think the market capitalization has played a significant role in pricing the valuation. Discuss the Walter’s model assumptions in this context.

Q7. Capitalisation of a firm refers to the composition of its long –term funds debt and equity. Discuss the theories of capitalization.

Q8.  A) The share of Megha Ltd is sold at Rs 500 a share. The dividend likely to be declared by the company after one year is Rs 25 per share. Hence, the price after one year is expected to be Rs 550. What is the return at the end of the year on the basis of likely dividend and price per share?

B) A bond of face value of Rs 1000 and a maturity of 3 years pays 15% interest annually. What is the market price of the bond if YTM is also 15 %.

Q9. Discuss the sources of capital of a company. Analyse the factors that affect the capital structure.

Q10. A project costs Rs 50,000. It is expected to generate cash inflows as shown in table. If the risk free rate is 10%, compute NPV.

Year Cash inflows Certainty equivalent
1 32000 0.9
2 27000 0.6
3 20000 0.5
4 10000 0.3

 

Q11. Annual demand of a company is 30,000 units. The ordering cost per order is Rs 20 (fixed) along with a carrying cost og Rs 10 per unitper anum. The purchase cost per unit i.e., price per unit is Rs 32 per unit. Determine EOQ, total number of orders in a year and the time gap between two orders.

Q12. Discuss the dividend policy of Dabur India Ltd for the last three years.

Q13. TCS has emerged as India’s most admired company ahead of Hindustan Unilever, ITC, and Infosys, says global management consultancy Hay Group. TCS replaced last year’s winner group company Tata Steel by scoring highest on parameters such as corporate governance, financial soundness, and talent management. Two criteria in particular, Leadership, and Creating Shareholder Value separated the winners.

How do you think effective interaction between HR and finance department of a firm helps in achieving its skills?

Do you think that TCS has preferred the profit maximization approach over the wealth maximization approach?

Q14. A) The current price of an Ashok Leyland share is Rs. 30. The company is expected to pay a dividend of Rs. 2.50 per share which goes up annually at 6%. If an investor’s required rate of return is 11%, should he or she buy this share or not?

B) A bond with a face value of Rs. 100 provides an annual return of 8% and pays Rs. 125 at the time of maturity, which is 10 years from now. If the investor’s required rate of return is 12%, what should be the price of the bond?

Q15. a) How do you think the trend of capital structure across the Indian corporates affect the economy as a whole?
b) What proportion of debt and equity should be taken up in the capital structure of a firm?
c) Discuss the theories that are propounded to understand the relationship between financial leverage and value of the firm.

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h5>Q16. HPCL was established in 1952, operates from 500 different locations, including refineries, terminals, LPG plants, aviation service facilities, etc. They developed a Lotus Notes workflow tool and deployed it across the o

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