Financial Management Descriptive Model Question Papers with answers.

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Financial Management Descriptive Model Question Papers.

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Financial Management

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Q1. When a firm follows wealth maximization goal, it achieves maximization of the 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 the time value of money. Time value of money translates cash flows occurring at different periods into a comparable value at zero periods. 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:

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

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

  • When a firm follows wealth maximisation goal, it achieves the maximisation of the market value of the 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 society.
  • Since listing ensures liquidity to the shares held by the investors, shareholders can reap the benefits arising from the performance of the company only when they sell their shares.

Therefore, we can conclude that the 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 period1 month2 months3 months
Increase in sales by10 %30 %
Bad debts on sales1 %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.


 1 month2 month3 month
Bad debt to sales4000088000260000
Net sales396000043120004940000
Net incremental sales (A)352000980000
Cost of sales
Variable cost @rs.1224000026400003120000
Fixed cost500000500000575000
Cost of sales290000031400003695000
Net incremental cost (B)240000795000
Average debtors at cost241667523333923750
Increase in average debtors281667682083
Cost of incremental debtors @20% (C)56333136417
Total incremental cost (B+C)269333931417
Net increase in profit {A-(B+C)}5566748593

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. Hence, the firm may change its credit policy from the present credit period of 1 month to 2 months.


Alternative 1 should be considered.


Q3. The concept of financial leverage is significant, as it has a 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 charge 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 number 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 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 until 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 the table

Table: Cash Inflows

YearCash inflows

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.

Cost of goods56,00031.03.079,000
Accounts Receivables
Accounts Payable

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 Walter’s model assumptions in this context.

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


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

YearCash inflowsCertainty equivalent

 Q11. Annual demand for a company is 30,000 units. The ordering cost per order is Rs 20 (fixed) along with a carrying cost of Rs 10 per unit per anum. The purchase cost per unit i.e., the price per unit is Rs 32 per unit. Determine EOQ, the 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?


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?


a) How do you think the trend of capital structure across the Indian corporates affects 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.

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 organisation so that any capital investment proposal from any operating location in the country can be routed to relevant reviewers and approving authorities. With the implementation of the new online system, the total cost savings as a result of reduced man-hours amounts to about Rs 25 lakh per annum.

  1. What do you think would have been the complexities involved in implementing this new project at HPCL?
  2. What are the various phases in the capital budgeting process? To what extent do you believe that automation can ease out the process?


a) Indicate whether the operating cycle in the following industries is short (less than 30 days), medium (less than 6 months) or long (more than 6 months)

Steel, rice, vegetables, fruits, jewellery, processed food, furniture, mining, flowers and textiles

b) Companies with the shortest working capital cycles have current ratios much lower than the firms with longer cycles. What is your view on this statement? How do you think the operating cycle affects operating profit margins?

c) Discuss the relationship between working capital management and market performance of a company? Do you think the kind of relationship varies depending on the type of industry?

Q18. Nirma acquired Core Healthcare Ltd. in FY 2007. To bring about improvement in terms of liquidity in the script of the Company, it has gone for a stock split because it hasn’t had any buyback in the recent past. Nirma paid Interim dividend in 2007 to avoid the higher dividend tax announced in that year’s budget.

Henkel, on the other hand, has a very weak Dividend Policy. The major reason being that the company has weak operations and low margins. There is no record of Stock Splits and Buybacks by Henkel India in the past. Discuss the dividend polices of these two companies.

a) Analyse the dividend policies of the two companies for the last 10 years

b) Explain stock split and buyback of shares

Q19. What are the goals of financial management?

Q20. Calculate the PV of an annuity of Rs. 500 received annually for four years when the discounting factor is 10%.

Q21. Suraj Metals are expected to declare a dividend of Rs. 5 per share and the growth rate in dividends is expected to grow @ 10% p.a. The price of one share is currently at Rs. 110 in the market. What is the cost of equity capital to the company?

Q22. What are the assumptions of the MM approach?

Q23. An investment will have an initial outlay of Rs 100,000. It is expected to generate cash inflows. Table 1.2 highlights the cash inflow for four years.

Table 1.2: Cash inflow

YearCash inflow

If the risk-free rate and the risk premium is 10%,

a) Compute the NPV using the risk-free rate

b) Compute NPV using the risk-adjusted discount rate

Q24. What are the features of optimum credit policy?

Q25. Explain the liquidity decisions and its important elements. Write complete information on dividend decisions.

Q26. Explain about the doubling period and present value. Solve the below-given problem:

Under the ABC Bank’s Cash Multiplier Scheme, deposits can be made for periods ranging from 3 months to 5 years and for every quarter, interest is added to the principal. The applicable rate of interest is 9% for deposits of less than 23 months and 10% for periods for more than 24 months. What will be the number of Rs. 1000 after 2 years?

Q27. Write short notes on:

a) Operating Leverage

b) Financial leverage

c) Combined leverage

Q28. Explain the factors affecting Capital Structure. Solve the below-given problem:

Given below are two firms, A and B, which are identical in all aspects except the degree of leverage employed by them. What is the average cost of capital of both firms?

Details of Firms A and B

Firm AFirm B
Net operating income EBITRs. 1, 00, 000Rs. 1, 00, 000
Interest on debentures INilRs. 25, 000
Equity earnings ERs. 1, 00, 000Rs. 75, 000
Cost of equity Ke15%15%
Cost of debentures Kd10%10%
The market value of equity S = E/KeRs. 6, 66, 667Rs. 5,00, 000
The market value of debt BNilRs. 2, 50, 000
The total value of firm V66, 667Rs. 7, 50, 000

Q29. Explain all the sources of risk in capital budgeting with examples.

Solve the below-given problem:

An investment will have an initial outlay of Rs 100,000. It is expected to generate cash inflows. Cash inflow for four years.

YearCash inflow

If the risk-free rate and the risk premium is 10%,

  1. a) Compute the NPV using the risk-free rate
  2. b) Compute NPV using the risk-adjusted discount rate

Q30. Explain the objectives of Cash Management. Write about the Baumol model with their assumptions.

Q31. Explain the factors affecting the Financial Plan.

Q32. Explain the time value of money.

Q33. XYZ India Ltd’s share is expected to touch Rs. 450 one year from now. The company is expected to declare a dividend of Rs. 25 per share. What is the price at which an investor would be willing to buy if his or her required rate of return is 15%? 10 marks

Q34. Below Table depicts the statistics of a firm and its sales requirements. Compute the DOL according to the values given in the table.

Table: Statistics of a Firm

Sales in units2000
Sales revenue Rs.20000
Variable cost10000
Fixed cost0


a.) A bond of Rs. 1000 value carries a coupon rate of 10% and has a maturity period of 6 years. Interest is payable semi-annually. If the required rate of return is 12%, calculate the value of the bond. ( 5marks)

b.) A bond whose par value is Rs. 500 bearing a coupon rate of 10% and has a maturity of 3 years. The required rate of return is 8%. What should be the price of the bond? ( 5marks)

Q36. Examine the features & evaluation of decision-tree approaches.

Q37. If the EPS is Rs.5, dividend pay-out ratio is 50%, the cost of equity is 20% and the growth rate in the ROI is 15%. What is the value of the stock as per Gordon’s Dividend Equalisation Model?

Q38. Two companies are identical in all aspects except in the debt-equity profile. Company X has 14% debentures worth Rs. 25,00,000 whereas company Y does not have any debt. Both companies earn 20% before interest and taxes on their total assets of Rs. 50,00,000. Assuming a tax rate of 40% and the cost of equity capital to be 22%, find out the value of the companies X and Y using the NOI approach.

Q39. The following data is available in respect of a company:

Equity Rs.10lakhs, cost of capital 18%

Debt Rs.5lakhs, cost of debt 13%

Calculate the weighted average cost of funds taking market values as weights assuming tax rate as 40%

Hint: Use the equation WACC = We Ke + Wp Kp +Wr Kr + Wd Kd + Wt Kt

Q40. Explain the concepts of working capital

Q41. Discuss the techniques of inventory control

Q42. An employee of a bank deposits Rs. 30000 into his PF A/c at the end of each year for 20 years. What is the amount he will accumulate in his PF at the end of 20 years if the rate of interest given by PF authorities is 9%?                                     Hint Amount= 1534800

Q43. Mr Anant purchases a bond whose face value is Rs.1000, and which has a nominal interest rate of 8%. The maturity period is 5 years. The required rate of return is 10%. What is the price he should be willing to pay now to purchase the bond?

Hint: 924.28

Q44. Briefly examine the significance of the identification of investment opportunities in the capital budgeting process

Q45. What is Financial Management? Explain its importance.

Q46. What is meant by Capital budgeting? Explain the importance of capital budgeting.

Q48.  Critically analyze the four broad areas of strategic financing decision.

Q49. What is FVIFA? Is it different from Sinking fund factor?

A finance company offers to pay Rs. 44,650 after five years to investors who deposit annually Rs. 6,000 for five years. Calculate the rate of interest implicit in this offer.

Q50. A firm owns a machine furnishes the following information :

Book value of the machine1,10,000
Current market value80,000
Expected salvage value after the end of five years of remaining useful lifeNIL
Annual cash operating costs36,000
The firm’s cost of capital15 %
Corporate tax rate35 %

The firm follows straight-line method of depreciation (permitted by the Income-tax authorities).

The management of the company is now considering selling of the machine. If it does so, the total operating costs to perform the work, now done by the machine, will increase by Rs. 40,000 p.a.

Advise management.

Q51. How will you compute the cost of equity capital using CAPM?

The Xavier Corporation, a dynamic growth firm which pays no dividends, anticipates a long-run level of future earnings of Rs. 7 per share. The current market price of Xavier’s share is Rs. 55.45. Floatation costs for the sale of new equity shares would average about 10 % of the price of the shares. What is the cost of new equity capital to Xavier Corporation?

Q52. Jharkhand Mining ltd. has to select one of the two alternative projects whose particulars are furnished below:

Project EProject F
Rajrappa, HazaribaghTatisilwai, Ranchi
Initial Outlay11,87,20010,06,700
Net Cash Inflow :
End of year 110,00,0001,00,000

The company can arrange necessary funds @ 8 %. Compute the NPV and IRR of each project and comment on the results.

Is there any contradiction in the results? If so, state the reason for such contradictions. How would you propose to resolve the contradictions?


A) If you deposit Rs 10000 today in a bank that offers 8% interest, how many years will the amount take to double?

B) What is the future value of a regular annuity of Re 1.00 earning a rate of 12% interest p.a. for 5 years?

Q54. ABC Ltd. provides the information as shown in table 6.21 regarding the cost, sales, interests and selling prices. Calculate the DFL.

Details of ABC Ltd.


Rs.0.05 per unit



Output20,000 units
 Fixed costs
 Variable cost
 Interest on borrowed funds
 Selling price per unit

Hint calculate

Q55. Two companies are identical in all respects except in the debt-equity profile. Company X has 14% debentures worth Rs. 25,00,000 whereas company Y does not have any debt. Both companies earn 20% before interest and taxes on their total assets of Rs. 50,00,000. Assuming a tax rate of 40%, and the cost of equity capital to be 22%, find out the value of the companies X and Y using the NOI approach?

Hint: use the formula K0 = [B/(B+S)]Kd + [S/(B+S)]Ke

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