FM CF 4529202

CORPORAT FINANCE (4529202) MBA-SEM:-2
Q-1 Goals or Objectives of Financial Management OR Wealth maximization

objective is superior than Profit Maximization objective-Explain.
1) Profit Maximization Objective:-
It is the main objective of any business. It means the company produces maximum output with
minimum inputs. Here, the value of company is measured in terms of profit. It means if the
company earns more profit then its value is high. If the company earns less profit then its value is
low.
 Demerits/Disadvantages:-
1. It is not clear:-
This objective is not clear. This objective not clear means the word maximization does not give
clear idea about how much to maximize the profit.
It is also not clear in the sense that profit maximization means what? Profit before tax or profit
after tax?
2. It ignores time value:-
Money means the value of money today is more than the Value of money tomorrow. But this
objective says that the Value of money is equal to value of money tomorrow. It is Not true.
3. It ignores risk:-
This objective ignores risk. It means this objective says that the profit will be definitely earned but
it is not true. We know that the future is uncertain. The company may face less.
2) Wealth Maximization Objective:-

Wealth means not present value of the company. Here, the company tries to maximize net present
value. The company tries to increase the wealth of its shareholders. This objective is Superiors as
compared to profit maximization objective because of following merits:-
 Merits/Advantage:-
1. It is clear:-
Here the company does not try to increase its profit because the word profit is not clear so. The
company tries to increase Its cash flows. We take that cash inflow means the net income Of the
company. It considers time value.
2. It considers time value:-
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Dr. Mahammadrafique Meman-Associate Prof & Head-MBA-9879199924-rafique_mba_finance@yahoo.co.in
This objective says that the value of money today is more than the value of money tomorrow. We
know that this is true. Here, the company estimates its cash inflows at considering time Value of
money.
3. It considers risk:-
Risk must be calculative risk. Here the company takes all decisions after considering to increase
cash flow and to make profit.
Q-2 Explain Functions or Decision of Financial Management

 Functions or Decisions of financial management
1) Investment or long-term decisions
2) Working capital or short term
3) Dividend or profit allocation decision
4) Capital mix Decision
1) Investment or long term Decision:-
The company earns profit. The finance manager takes the decision about what to do with that
profit. So, he has two options, Long term investment and Short-term investment. Here the finance
manager takes long term investment decisions like to purchase machine, land, start new plant, etc.
Before taking long term decision, the finance manager invests only that part of profit which is not
required in near future. The long-term decision is very risky decision because if the decision is
taken then it cannot be changed.
2) Working capital or short-term Decision: -
Out of the profit the finance manager takes short term investment decision. It means she/he tries to
manage the short-term investments like paying salary on wages, electricity bills, rent, other
expenses, etc… If she/he does not take short term investment decision then it is very difficult to
pay all expenses. The current asset is known as short term investment.
3) Dividend or profit allocation Decision: -
The company earns the profit out of the profit the finance manager has to take decision about how
much to give dividend to its shareholders. If she/he give all profit as a dividend then she/he does
not have money in his hand. If she/he does not give dividend then it will create bad image in the
market. So he has to give some dividend and some parts.
4) Capital Mix Decision: -
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The company requires funds (capital) for running its business. It is the duty of finance manager to
collect the funds from the market. There are various sources for collecting the funds like equity,
preference, debenture, loan, etc. It is very difficult to take the decision for collecting the funds
whether from equity or preference or debenture or loans or combination of all.
Q-3 Discuss briefly the various sources of long-term finance of companies.

(Equity shares, Debentures, Preference shares)
Various sources of long-term finance of companies are as below:
1. Equity shares
2. Debentures
3. Preference shares
1. Equity Shares:
It is also called ordinary share. The company issues equity shares to public. The buyers of equity
shares are called shareholders. The company pays dividend to its share holders from the profit. It
is not from the profit. It is not compulsory for the company to pay dividend. Shareholders are
owners of the company. It is also called VARIABVLE INCOME SECURITY because here the
dividend is not fixed. It means sometimes the company gives dividend and sometimes it does not
give dividend. The dividend is not regular income of the shareholders.
Evaluation of equity shares from the view point of lender/ investor / shareholders:
 Merits / Feature /Rights:
1) Residual claim on income:

The shareholders can claim on the income of the company. It means the company has to pay some
part of its profit to shareholders, because shareholders also the owner of the company.
2) Claim on assets:
The shareholders can also claim on assets of the company. It means if for any reason the company
is closed down then in that case the shareholders can get their investment by selling the assets of
the company.
3) Right to control:
Shareholders have right to control on the activity of the company. It means if any director does
not work properly then shareholders have right to replace that director and select the new director.
4)Voting rights:
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Shareholders have voting rights. In the election of directors, shareholders can give their vote to
any directors and select the directors. The company must invite shareholders for vote. If the
company does not invite then shareholders can claim on the company.
If the company invites the shareholders but for any reason the shareholder cannot able to attend in
that case the shareholders can send another person on his behalf and this is called PROXY.
5) Pro-emotive rights:
When the, company issues new equity shares at that time the company should inform to its current
shareholders. It means the company should give first opportunity to its current shareholders for
purchasing new shares. If the company does not give first opportunity to its current shareholders
and directly gives that opportunity to the other outside persons, in this case the shareholders have
right to claim on the company and this right is called pre-emptive right.
6) Limited liability:
If for any reason the company faces loss or the liability of the company is increased, in that case
the loss of the shareholders is limited to its investment amount only. It means the shareholders
should not sell their personal properties.
2. Debentures / Term Loan:

If the company requires long term funds then the company issues debentures to the company
issues debentures to the public. A debenture is a liability of the company. The buyer of debenture
is called debenture holders. Debenture holders are the creditor of company. The company pays
interest on debentures. It is compulsory to pay interest.
Debentures are issued by private company and bonds are issued by public company (government).
 Features of Debenture / bonds:
1) Trust deed or Indenture:

It is on agreement between the company & trustee. Trustee is any bank or financial institution
which project the debenture holders trust deed includes the duty of company, rights of debenture
holders etc… The company has to sign on trust deed and is submitted to the trusty with the help
of trust deed, the trustee protects the debenture holders.
2) Interest rate:
The company has to pay interest on debentures to the investors. The interest rate is fixed and
compulsory. The interest is paid quarterly (3 months). Half yearly (6 months) or a year, it depends
on the company.
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3) Maturity:
Maturity is the time period for which the company issue debentures the time period is decided by
the company general debentures are issued for 7 to 10 years.
4) Redemption:
All the time of maturity the debentures are redeemed (transaction closed). It means the company
will return the principle ampler and the interest to the investor and, the investors will return the
debentures to the company.
5) Security:
Debentures are secure or unsecure. If the company issues secured debentures, it means the
company has to put its security on mortgage with the trustee.
If the company issues unsecured debentures, it means the company does not put any security on
mortgage with the trustee.
6) Claim on assets and income:

If the company close down, in that case the investors can get their investment by selling the assets
of company.
If the company earns profit, then the investors can get the interest from the profit.
7) Call and put features:

If the company wants to redeem the debentures before maturity then the company can do than by
using call feature.
If the investor wants to redeem the debentures then the investors can do that by using put features,
fixed interest only they demand more interest.
3. Preference Shares:
Meaning:
It is also called HYBRID SECURITY since it has many features of both equity shares and
debentures.
Preference & equity share both are similar. It means the dividend is paid on preference and
equity shares. Preference & debentures both are similar. It means the dividend is fixed on
preference shares and the interest is fixed and debentures
So, we can say that the preference share is the combination of equity shares & debentures.
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Features :( preference shares)
1) Claim on income & assets:
Preference share holders can get fixed dividend from the income of company. If the company is
closed down, in that case preference share holders can get their investments by selling the assets
of company. Here, debenture holders have first right, preference share holders have second right
and equity share holder have third right on the assets of company.
2) Fixed assets:
Preference share holders get the fixed dividend from the income of company.
3) Cumulative dividend:
In the company does not pay dividend in first year but if the company wants the dividend in
second year then the company has to pay dividend of first year also and this is called cumulative
dividend.
4) Redemption:
Preference shares are of two types:
1. Redeemable preference share: Here time period is fixed.
2. Irredeemable preference share: Here time period is not fixed.
5) Participation feature:
The company can give more than fixed dividend to the preference shareholders. It depends on
company. It means preference share holders can participate in extra income of the company.
6) Voting rights:
Preference share holders do not get voting rights, but in following two cases, they get voting
rights.
1- If preference share holders have not received dividend for last two years continues then they
get voting rights.
2 -If preference share holders have not received dividend for more than three years in last six
years then they get voting rights.
7) Convertibility:
Preference shares are of two types
1) Convertible preference share, here preference shares can be converted into equity shares of the
end of period.
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2) Non-convertible preference share, here preference shares cannot be converted into equity
shares at the end of period.
Q-4 What is the Venture Capital (Private Equity)? Discuss its features.
Venture capitalist is the institute which provides capital to the company Which is new in the
market.
 Features:
1. Investment in equity.
2. Participation in management.
3. Investment in new product.
4. Investment is illiquid.
5. High risk & High growth potential.
6. Make money by selling shareholding.
7. Investment in small & medium sized organization.
8. No finance to trading & financial service sectors.
1. Investment in equity: It purchases the equity share of the company which is new
and give funds to the company.
2. Participation in management: Venture capitalist is also the owner of company

because it has equity shares of that company so. If the company wants to take any
business decision that the company has to invite venture capitalist in decision
making process.
3. Investment in new product: The venture capitalist invests only in new

company. It does not invest in old companies because old companies are already
set.
4. Investment is illiquid: If venture capitalist requires its investment in short time

then it cannot get the funds from the company. The venture capitalist invest in new
company for long time. So it cannot ask the company to return its investment in
short time.
5. High Risk & High growth potential: The venture Capitalist like to invest in
new company which has higher growth (return) in future higher risk. It means the
venture capitalist does not like to invest in new company which has low growth and
low risk.
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6. Make money by selling shareholding: When the new company will be set and
will achieve the growth, at that time the venture capitalist will sell the equity shares
to the company and gets its investment back.
7. Investment in small & medium sized organizations: The venture capitalist

likes to invest in small size and medium size companies. It does not like to invest in
large companies.
8. No finance to trading & financial service sectors: The venture capitalist does
not invest in trading financial and service sectors. It only invests in manufacturing
company which produces the product.
Q-5 What is Shares Buyback? Explain its merits and demerits.

It can be described as a procedure which enables a company to go back to the holders of its shares
and offer to purchase the shares held by them buyback helps a company by giving a better use for
its funds than reinvesting these funds in the same business at below average rates of return or
going in for unnecessary diversification or buying growth through costly acquisition when a
company has substantial cash resources, may like to buy its own shares from the market
particularly when the prevailing in the market is much lower than the market book value or what
the company perceivers to be its true value this mode of purchase is also called „shares
repurchase ,„ A company can utilize its reserves to buy back equity shares for the purpose of
extinguishing these or treasury operation. Naturally, the market price of equity goes up.
The reduction in share capital strengthens the promoter „s control and enhances the equity value
for shareholders .in the latter option companies buy their shares from open market and keep these
as „ireasury stock‟ this enables the promoters to strengthen their control over the shares bought
back, without any investment of their own.
In case of treasury operation .there is a diversion of company„s funds to buy shares and reduction
in the value of equity for the shareholders .the main aim of shares repurchase might return the
number of shares in circulation in order to improve the shares repurchase may be by way of
purchase from the open market or by general tender offer to all shareholders made by the
company to repurchase a fixed amount of its securities at pre-started price.
Benefits of buyback (merits)

The benefits derived from share repurchase program are as follows;
1. Firms whose profitability was below their industry average enjoy greater share price growth
after shares are repurchased than firms whose profitability was above their industry average.
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2. Firms whose sales growth was below their industry average enjoy greater share price growth
after shares are repurchased than firms whose sales growth was above their industry average.
3. Profitable and growing firms that repurchase shares provide a clear indication to the investors
about the strengths of the company.
4. Repurchasing firms with debt rations below but sales growth rates above their industry
average experience substantially higher share price growth after repurchasing than firms with
debt rations above but sales growth roles below their industry average
5. Repurchasing firms with profitability and debt ratio below their industry average demon
striate higher share price growth after repurchasing thane firms with profitability and debt
ratio above their industry average
Demerits (Disadvantages)
The shares repurchase is criticized for the following reasons;
1. This could enable unscrupulous promoters to use company‟s money to raise their personnel
stakes
2. It opens up possibilities for shares price manipulation.
3. It could divert away the company‟s funds from productive investment.
4. Evidence shows that post buyback situation results in company good earnings and shares price
performance in which only the remaining shareholders can benefit.
5. Evidence shows that repurchase are initiated only when the stocks are underpriced and note
when the stocks perform better.
6. The gain for the stakeholder depends on the type of repurchase.
7. In the open market route the investors may note gain at all due to competitive sellers.
Q-6 Explain Importance or Significance of Capital Budgeting or Investment

Decision.
The capital Budgeting decision very important. So before taking this decision the company must
consider the following factors:-
1) Long Term Effect :-
At the time of making long term investment then the company must consider that it will get the
return after long time. If that decision is correct it means the company get good return from
company gets good return from the investment then it will have positive effect on the company
and it will remain for long time. If the company faces loss from the investment then it will have
negative effect on the company and this effect will be continue for long time.
2) Investment of huge Amount :-
If the company want to make investment then it requires huge capital. So the company should take
care at the time of making investment. The company should collect all details properly before the
investment.
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3) Decision not Reversible :-
Once the capital budgeting decision is taken then it cannot be changed then the company will have
to face loss. So proper care should be taken at the time of taking capital budgeting decision.
4) Difficult Decision :-
We know that it is very difficult for taking capital budgeting decision because the company will
get the return in future. We know that future is uncertain.
5) Fear of under or over production capacity :-
At the time of taking capital budgeting decision the company will have fear about under or over
production capacity. It means if the company forecast more returns and the actual return will be
less than it become under production capacity situation.
If the company forecast less return and the actual return is more that it become over production
capacity situation. The company has to take such decision in which forecast and actual return are
equal and we know that it is very difficult.
6) Future Expansion Depends on sale :-
Before taking capital budgeting decision the company should check weather its sales are
increasing or not. If it is increasing then only the company should buy the machine otherwise not.
Q-7 Methods of Capital Budgeting: -

A) Traditional or Non-Discount Method: -
- PBP (Pay Back Period)
-ARR (Average or Accounting rate of return)
B) Modern or Discounting Method: -
-NPV (Net Present Value)
-PI (Profitability Index) or Benefit Cost Ratio
-IRR (Internal Rate of Return)
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PBP: -
It is the time period in which the company recovers its investment from the project.
 Evaluation of PBP:
 Merits:-
1. Simple and Easy:-This Method Is Simple to Understand Easy to calculation.

2. Reduce: - The company selects that project which has minimum PBP.so that company can
recover its investment past by this way the company tries to reduce the risk.
3. Saves time money & energy: -this method is less costly. It‟s saved timeMoney and energy.
4. Fast returns:-with the help of this method the company can recover its invest post so that the
company can start to earn return past
5. Size of investment:-the company does not consider the size of investment. It only considers
the project which has minimum PBP.
6. Fast changing technology:-we know that the technology changes very past so the company
will try to recover its investment as fast as possible so if the technology changes. Then also the
company will not pace only loss.
 Demerits:-
1. Not consider profit:-this method does not consider the profit of the project. It means the
company does not focus on the project but it only project focuses on the original investment.
2. Doesn‟t consider time value of money:-this method doesn‟t consider time value of money. It
means this method says that the value of money today is same as the value of money
tomorrow, but it is wrong.
3. Not consider size of investment:-this method doesn‟t consider about how much investment
will be required for the investment .it only consider the time period.
4. Comparison of two projects:-this method compares two projects which have different different
investment. It is not logical.
5. Not consider all years:-this method only considers the time period in which it will recover its
investment. It doesn‟t consider the remaining years.
ARR:-
It is the rate of return which the company earns on its investment.
 Evaluation of ARR:
 Merits:-
1. Simple and easy:-this method is simple to understand and easy to calculate.
2. It considers profit:-this method gives the importance to the profit. It helps the company to find
the profit rate of the investment.
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3. It all considers all years and all cash inflows:-this method gives the rate of return by
considering all years and all cash flows.
4. All information available:-to find out ARR, all information like net profit. Investment etc are
easily available from p&l a/c. and balance sheet.
 Demerits:-
1. Not consider time value of money:- This method that the value of money today is same as
value of money tomorrow. But it is wrong.
2. Not consider time period:-This method doesn‟t consider time period. It means if the company
has two projects. The company will select that project which has maximum ARR. But if that
selected project has more number of years then it may be risky. The company doesn‟t
consider this.
3. Wrong information:- If the information in profit & loss a/c and then the calculate of ARR is
also wrong. As a result the wrong decision will be taken.
NPV :-( Net Present Value)
This is the best method of capital budgeting. NPV means the value of future in present time with
the help of NPV the company can know the value of future cash flow in present.
 Evaluation of NPV:-
 Merits:-
1. If the company has so many projects then the company will select that project which has
maximum NVP we know it is considers time value of money:-
2. This method says that the value of money today is more than the value of money tomorrow.
3. It considers all cash inflows:- This method considers all cash inflow. It means on the basis of
NVP the company takes decision by considering all cash inflows of all years.
4. It considers profit maximization objective: - The company tries to maximize its profit with the
help of NVP method. It means if the company that NVP is nothing but the profit.
5. Superior:- This method is superior (good) as compared to PBP, ARR, PT and TRR.
6. It considers risk:- This method is calculated with the help of discount factor is nothing but the
factor. It means the company takes decision by considering risk.
 Demerits:-
1. Discount factor:- The NPV is calculated with the help of discount factor if the company
doesn‟t have discount factor it can‟t find NPV it is very difficult to find discount factor in real
life.
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2. Difficult to calculation:- The calculation of NPV is very difficult as compared to PBP and
ARR.
PI :- (Profitability Index)
This method provides the ratio between cash inflow and cash outflow. If PI is greater than 1 then
accept the project and if PI is less than 1 then reject the project.
 Evaluation of PI:-
 Merits:-
1. It Consider time value of money.
2. It Consider all cash inflows.
3. It consider profit maximization objective
4. Superior
5. It considers risk.
 Demerits:-
1. Discount factor
2. Difficult calculation
3. Ratio:-
This method gives the ratio. The company can‟t get any idea from this ratio.
IRR (Internal Rate of Return)

IRR is the rate return on which the company earns from its investment. It is the rate of which NPV
becomes zero. It means it is the rate where cash inflows and cash outflows both are equal.
IRR = A + C/C-D * (B-A)
Where A = Lower Rate of Discount
B = Higher rate of discount
C = Excess of present value at lower rate
D = Shortfall (less) of present value at higher rate
If IRR > Cost of Capital then accept the project.
If IRR < Cost of capital then reject the project.
 Evaluation of IRR:-
 Merits:-
1. It considers time value of money.
2. It considers all cash inflows.
3. It considers profit maximization objective.
4. It is superior to ARR, PI, and PBP.
5. It considers risk.
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 Demerits:-
1. Discount factor.
2. Difficult calculation
3. NVP is zero:- We know that IRR is the rate where NVP becomes zero. But it is very
difficult to find the rate where NPV can be zero. It requires more to calculate IRR.
Q-8 Discuss the CAPM (Capital Asset Pricing Model) in detail.

The capital asset pricing model was developed in mid-1960s by three researchers William Sharpe,
John Lintner and Jan Mossin independently. Consequently, the model is often referred to as
Sharpe-Lintner-Mossin Capital Asset Pricing Model.
The capital asset pricing model or CAPM is really an extension of the portfolio theory of
Markowitz. The portfolio theory is a description of how rational investors should build efficient
portfolios and select the optimal portfolio. The capital asset pricing model derives the relationship
between the expected return and risk of individual securities and portfolios in the capital markets
if everyone behaved in the way the portfolio theory suggested.
ASSUMPTIONS OF CAPM
The capital asset pricing model is based on certain explicit assumptions regarding the behaviour
of investors. The assumptions are listed below:
1. Investors make their investment decisions on the basis of risk-return assessments measured in
terms of expected returns and standard deviation of returns
2. The purchase or sale of a security can be undertaken in infinitely divisible units.
3. Purchases and sales by a single investor cannot affect prices. This means that there is perfect
competition where investors in total determine prices by their actions.
4. There are no transaction costs. Given the fact that transaction costs are small, they are
probably of minor importance in investment decision-making, and hence they are ignored
5. There are no personal income taxes. Alternatively, the tax rates on dividend income and
capital gains are the same, thereby making the investor indifferent to the form in which the return
on the investment is received (dividends or capital gains).
6. The investor can lend or borrow any amount of funds desired at a rate of interest equal to the
rate for riskless securities.
7. The investor can sell short any amount of any shares.
8. Investors share homogeneity of expectations. This implies that investors have identical
expectations with regard to the decision period and decision inputs. Investors are presumed to
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have identical holding periods and also identical expectations regarding expected
returns, variances of expected returns and covariances of all pairs of securities.
Q-9 Discuss the significance and factor affecting cost of capital (weighted
average Cost of capital)
The company requires capital for its business. At the capital from the market whatever cost the
company incurs this cost called cost of capital.
Significance / Important / factors / advantage of cost of capital :
1.Capital Budgeting Decision:
If a company wants to invest in one project then it has to find NPV (net present value). If NPV is
positive then the company want to invest in project & if NPV is negative then the company will
not invest in project but for finding NPV. The company requires rate which called cost of capital.
It means the company cannot find NPV without cost of capital.
2.Maintaining Market value of share :
If the company wants to increase or maintain its market value then the company must know about
its cost of capital the company can decide whether to increase or to maintain the market value of
share.
3. It helps in designing capital structure:
Capital structure means the combination of long term source of fund (equity, preference,
debenture, bank loan,etc. The cost of capital helps a company to decide how much to) collect from
equity, preference share, from debenture, loan, etc.....
4.Issue of new securities:
If a company wants more funds then it will select the source which has minimum cost for that the
company should have cost of capital all source.
5.To evaluate performance of top management:
Cost of capital helps to evaluate the performance of top management. It means whatever the cost
is assumed by top management, it is company with actual cost. If actual cost is more than assumed
cost. It means top management is not performing well.
6.Financial Decision:
The cost of capital also help a company to take all financial decision like working capital decision,
dividend decision etc.....
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Q-10 Discuss the factor affecting (determining) Dividend Decision or Dividend
Payout Ratio.
The dividend is paid by the company to its shareholders. It is paid on equity share. It is not
compulsory to pay but still the company has to give some dividend from its profit. But, how much
to give whether high or low. It depends on the following factors
 Factor affecting dividend decision policy :-
1) Type of business:- If the company is in the business of luxurious items in this case the profit
is not fixed so the company should decide low dividend rate. But if the company is in the
business of regular items, in this case the profit is almost fixed, so the company can decide
high dividend rate.
2) Current year’s earnings:- If current year‟s profit of company is low then the company
should decide low dividend rate. If the current year‟s profit of company is high then the
company should decide high dividend rate.
3) Past dividend:- Before deciding the dividend rate the company has to consider the past
dividend. According to the past dividend, the company should decide present and future
dividend.
4) Estimate of future earnings:- Before deciding the dividend the company should predict its
future earnings. If the company thinks that its earnings may decrease in near future then the
company should decide low dividend rate and vice-versa.
5) Future needs of capital:- If company will require more capital in near future then the
company should decide low dividend rate and vice-versa.
6) Fluctuation in business:- If there is a boom period in the market then the company can give
more dividend but, if there is a recession in the market then the company should give less
dividend.
7) Present amount of reserve:- If the company has more reserve in its balance sheet then the
company can give more dividend and vice-versa.
8) Distribution of shareholding:- If the company has majority of shareholders who belong to
middle class or lower class then the company can give more dividend but, if they belong to
upper class the company can give less dividend.
9) Age of company:- If the company is old then the company can give more dividend but if the
company is new to set its business so the company should give less dividend.
10) Government policy:- If the government policy like monetary policy, tax policy, etc…. are
very strict then the company should decide less dividend and vice-versa.
11) Taxation:- If the company pays tax on its profit then company should give less dividend and
vice- versa.
12) Attitude of management:- If the attitude of top management is conservative then the
company decide low dividend rate but if the attitude of top management is liberal then the
company decides high dividend rate.
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Q-11 Critically examine the assumption underlying the irrelevance hypothesis of
MM regarding dividend distribution (MM model).
M-M approach:-
This approach is similar to NOI approach. This approach says that if a company increases or
decreases the debenture n its capital structure then there will be no change in the value of
company and cost of capital.
Example: suppose there are 2 company X &Y. Firm X has debenture & equity. Firm Y has only
equity. This approach says that the value of both firm X and Y is equal and this is called &
equilibrium value.
Assumptions:-
1. Perfect capital market: It is assumed that the investor has full knowledge about each and
every detail of the market and the company in which he wants to investor.
2. Homogeneous risk classes: It is assumed that all companies are having the same level of risk
for investment.
3. Risk: It is assumed that all investor are having that same risk taking ability the investment.
4. No taxes: It is assumed that all the companies do not pay income tax on their profit.
5. Full pay out: It is assumed that all companies distribute their total profits as a dividend to
their shareholder. It means dividend payout ratio is low.
Q-12 Traditional approach is neutral to NOI and NI approach”. Discuss with

diagram. Or Explain the capital structure theory with the help of diagram.
Traditional approach says that increase in debenture will lead to increase the value of company
but up to some level than increase in debenture will lead to no increase and no decrease in value
and cost of company now beyond that point increase in debenture will to decrease the value and
increase the cost.
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It is the intermediary or the combination of NI & NOI approach says that when the debenture
increase the value of firm increase and cost of capital decrease (NI approach).it isup tosome point
beyond increase then also value of firm and cost of capital do not (NOI APPROCH).
After this point where the debenture increase then the value of firm decrease and cost of capital
increase
In above the diagram of three stages which are explain as below:
1. Stage: 1. increasing Value

When the debenture increase then cost of capital (K0) decrease cost of debt (K d) increase
constant and cost of equity (k e) increase.
2. Stage: 2. Optimum Value

When the debenture increase then cost of capital (k o) and cost of debt (k d) both remain constant
whereas cost equity (k e) increase.
3. Stage: 3. Decreasing Value

When the debenture increase then cost of debt (k d) cost of capital (k o) and cost of equity (k e) all
three will increase.
Q-13 Explain the concept of leverage (financial Leverage, Operating Leverage,

and Combined Leverage).
Lever means instrument used for lifting heavy weight. Leverage means power gained by the use
of lever. In the field of financial management leverage is used for the upliftment of the economic
welfare of the shareholders who are the owners of the company. In other words leverage is a
means to increase the ability of the business firm to magnify the return to its owners by using
fixed cost assets or fixed cost funds. Here the fixed cost assets or fixed cost funds serve the
purpose of a lever. Their use for magnifying the return or earnings per share is known as
leverage.
“James Horne has defined leverage as the employment of an asset or funds for which the firm, pay
fixed cost or fixed return” (e.g. fixed rate of return on bonds). According to him leverage results
as a result of employment of assets with fixed operating cost or funds with fixed cost. The former
is known as fixed operating cost and the latter is known as fixed financial cost. If a firm is not
required to pay fixed operating cost or fixed financial cost there will be no leverage.
As the fixed cost or return on funds employed has to be paid irrespective of the volume of output
or sales, the size of such cost or return has considerable influence over the amount of profit
available for shareholders. Under normal circumstances profit responds to changes in the volume
of output and sales. How profit will respond to changes in the volume of sales that we can
understand with the help of leverages. Therefore, study of leverages is very important for the
students of financial management.
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TYPES OF LEVERAGES:
There are three types of leverages:
[1] Operating leverage
[2] Financial leverage and
[3] Combined or total leverage
1) Operating Leverage:
Operating Leverage comes into existence as a result of no employment of fixed operating cost
assets. If there is no fixed operating cost. Operating leverage does not comesinto existence
Operating leverage is a measure of sensitivity of operating profit (EBIT) to changes in the sales.
It is a ratio between sales income after variable cost (i.e. contribution) and earnings before
interest and tax(EBIT). Earnings before interest and tax is the operating profit (i.e. sales revenue
less variable cost and fixed cost) Because of the existence of fixed operating cost changes in the
quantity of sales have magnifying effects on the operating profit (EBIT).
That or is, increase or decrease in sales results into faster increase decrease in operating
profit. Thus changes in the level of sales influence operating profit. But how much that is
indicated by operating leverage. It indicates the sensitivity of operating profit to changes in
production and sales. If we know this sensitivity we can predict the change in operating profit in
response to changes in sales.
If there is only variable cost in the business certain percentage change in sales results into equal
percentage change in sales results into equal percentage change in operating profit. i.e. 50 p.c.
increase in sales results into 50 p.c. increase in operating profit. It means linear relationship
between the two will exist. Decrease in sales will result into equal percentage of decrease in
operating profit.
But in the business there is not only variable cost. Fixed cost is also there. Because of fixed
operating cost operating leverage comes into existence. Because of fixed cost changes in
operating profit are greater than changes in sales. It means operating profit increases or decreases
greater than increase or decrease in sales. This situation indicates the existence of operating
leverage. The reason is that fixed cost remains fixed even if the production and sales increase or
decrease. When the production and sales increase per unit fixed cost decreases and operating
profit increases. Contrary to this when production and sales decrease per unit fixed cost increases
because it is divided among smaller number of units. As a result operating profit decreases.
In fact operating leverage is concerned with fixed cost. The higher the fixed cost, the higher is the
operating leverage and vice a versa. Higher leverage indicates higher fixed cost and higher return
and risk for the shareholders.
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Utilities of Operating leverage:
Operating leverage is useful in the following ways:
1. We can know the impact of changes in volume of sales on operating profit (EBIT)
Because of the presence of fixed cost the operating profit will not increase or decrease at the same
rate at which sales increase or decrease. What will be the impact of changes in sales on operating
profit that we can understand with the help of operating leverage. e.g. operating leverage is 3 and
sales increase by 10 p.c. the operating profit will increase by 3*10 = 30 p.c. at a particular level
of sales
2. Useful in measuring business risk:
The higher the fixed cost the higher is the operating leverage and more benifits of increase in
sales. Conversely, the higher the fixed cost the higher is the risk of decrease in profit as a result of
decline in sales. If the income is not sufficient to meet the fixed cost the business firm is put into
trouble. Very high operating leverage is a very risky situation wherein a small drop in sales can
be excessively damaging to the firm's efforts to achieve profitability.
2) Financial Leverage:
Operating leverage has a linkage with fixed cost while financial leverage has a linkage with capital
structure. Financial leverage tells us what will be the impact of changes in operating profit on
earnings per share. It is of much importance in making financial mix or capital structure decision.
Use of means with fixed charges like debentures, bonds, term loans, preference share etc. for
raising long term capital along with equity shares in the capital structure is known as financial
leverage.
We know that debentures, bonds etc. bear fixed rate of interest and preference shares bear fixed
rate of dividend. Presence of fixed charges in the cash outflow indicates existence of financial
leverage.
It is also known as trading on equity or capital gearing. It is known as trading on equity because
by using the equity base an attempt is made to increase the earnings per share.
Utilities of Financial Leverage:
The practical uses of the financial leverage can be stated as under:

1. Management can predict the changes in EPS as a result of changes in operating profit.
2. Degree of financial leverage indicates the financial risk. Use of debt capital involves financial
risk. The higher the DFL, the higher is the risk.
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 Advantages of Financial Leverage:
1. Favourable leverage increases earnings per share without increasing operating profit.
2. Increase in EPS increases the prestige and value of the firm and makes it easy to issue further
capital.
3. Additional capital can be raised without affecting total voting rights and stability of control.
4. Use of debentures or redeemable preference shares makes the capital structure flexible.
5. When the market conditions do not permit issue of equity shares, required capital can be raised
by debt securities.
6. Business on large scale is possible even with a small amount of ownership capital.
 Limitations of Financial Leverage:

1. Only the companies with stable income can use financial leverage
2. Financial leverage increases the burden of interest payments and repayment of principal. This
burden increase financial risk
3. When income declines and company is not in a position to pay interest, it ereates financial
crisis.
4. Debt capital is subject to certain conditions imposed by creditors, suchcondition may pertain to
mortgage of property, its sale etc.
5. It may happen that for the redemption of cheap debt dear debt may be used.
6. Use of leverage depends upon the certainty of income, regularity of income and attitude of
directors towards risk. If these three conditions are favourable financial leverage can be used.
3) Combined Leverage or Total Leverage:
Combined leverage indicates the fixed operating cost and fixed cost of capital borne by the
company. Combined leverage = Operating leverage x Financial leverage.
Utilities of Combined Leverage:
Combined or total leverage is useful in the following ways:
1. We can predict the changes in EPS in response to changes in sales volume.

2. It measures the total risk:
3. Helpful in reconciling between financial risk and business risk:
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Q-14 Discuss the factors affecting / determining working capital requirements.
Factors ( Determinants ) affecting Working Capital Requirements : -

1. Nature of Business : -
If the company is engaged in manufacturing business then it will require more working capital and
if the company is engaged in service business then it will require less working capital.
2. Size of Business : -
If the company is large size company then it will require more working capital.
If the company is small size company then it will require less working capital.
3. Length of Manufacturing Cycle : -
If the length of manufacturing cycle is long , it means it takes more time produce the product then
it will require more working capital.
If the length of manufacturing cycle is short , it means it takes less time to produce the product
then it will require less working capital.
4. Purchase & Sales Terms : -
If the company purchases raw materials from suppliers on cash bases and sales the product to the
customers on credit bases then it will require more working capital.
If the company purchases raw materials from suppliers on credit bases and sales the product to the
customer on cash bases, it will require less working capital.
5. Collection or Credit Policies : -
If the collection policy of company is very tight (strict) it means the company can able to collect
the funds from debtors on time, then it will require less working capital.
If the collection policy of company is liberal, it means the company takes more time to collect
funds from debtors then it will require more working capital.
6. Price Level : -
If the price of raw material increases then it will require more working capital.
If the price of raw material decreases, then it will require less working capital.
7. Operating Efficiency : -
If the efficiency of company is high, it means the company can utilize its resources very well with
minimum wastages, then it will require less working capital.
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If the efficiency of company is law it means the company cannot utilize its resources well and the
wastages are more then it will require more working capital.
8. Seasonal Demand : -
If the company is engaged in seasonal business, then it will require more working capital. In the
season and less working capital in off season.
9. Turnover of working capital : -
If the turnover of working capital is high it means the company can purchase raw material & sell
the product very fast then it will require less working capital.
If the turnover of working capital is low, it means the company cannot purchase the raw material
& sell the product very fast, then it will require more working capital.
10. Dividend Payout Ratio : -
If dividend payout ratio of company is high, it means the company pays more dividend from its
profit, then it will require more working capital.
If dividend payout ratio of company is low, it means the company pays less dividend from its
profit, then it will require less working capital.
Q-15 Sources of Working Capital Finance :-

For meeting the regular expenses, the company require working capital. Following are the sources
from which the company can collect the working capital:-
(1) Accruals
(2) Trade Credit
(a) Open Credit
(b) Promissory Note
(c) Bills
(3) Commercial paper
(4) Public Deposits
(5) Inter corporate Deposits
(6) Factoring
(7) Bank Finance
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(1) Accruals:-
Accruals means outstanding liabilities such as salary and wages, rent, other expenses, etc.
So, if the company will delay in paying salary and wages then the company can use that amount
for paying rent or other expenses.
By this way the company can manage its short term requirement (working capital).
(2) Trade Credit:-
The company purchases raw materials from the supplier. The company tries to purchase on credit
basis.
If the company has good relation with the supplier then the supplier can give more credit to the
company.
So, the company can use that fund for other purchase.
Types of Trade credit:-
(a) Open Credit

(b) Promissory Note
(c) Bills
(A) Open Credit:-
Here, the supplier open the account of company. when the company purchase raw material then
the supplier debits its account, when the company make payment then the supplier credit its
account. Here, there is no any written document is made between supplier and the company.
(B) Promissory Note:-
Here, when the company purchase raw material then the company writes one promissory note
that is the company will pay the amount on one particular date and it includes value a good.
The company send this promissory note to the supplier.
(C) Bills
Here, when the company purchases raw material, then the supplier writes one bill and the bill
includes the name of company. Value of goods and date of payment. The supplier sends this
bill to the company. The company accepts the bill with signature and sends it back to the
supplier. This bill is a legal document.
It is bills receivable for the supplier and bills payables for the company.
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(3) Commercial Paper:-
If the company requires working capital then, it will issue commercial paper to the public. It is
issued at discount and it is redeemed at face value.
(4) Public Deposites:-
If the company requires working capital, then it can collect by using public deposites. Here, the
public will deposites their savings in the company and the company will use that deposites and
give interest to the public.
(5) Inter Corporate Deposites:-
If the company requires working capital then the company will collect it from the other company.
The company will pay interest to the other company.
(6) Factoring:-
If the company requires working capital then it can collect it by selling its debtors to the bank.
Here, the bank is called factor.
(7) Bank Finance:-
If the company requires working capital, then it can collect it from the bank as a loan. There are
various norms, regulation and rules, of bank for giving the loan, the norms are as below:-
According to Tandon committee before giving loan to the company, the bank will check the
current assets and current liabilities of the company and bank will find working capital gap
(current assets – current liabilities). The basis of this gap the bank will give loan to the company.
These norms are called MPBF (Maximum Permissible Bank Finance).
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Q-16 Discuss the Factoring and Bank Finance (Tandon Committee).
If thecompany requires working capital then it can collect it by selling its debtors to the bank.
Here the bank is called factor. There are three parties which are as below:
Company (seller)
(Sales Debtor) ( Selling of goods)

( Payment)
Factor (Bank) Buyer (Debtor)

( Collect fr Collect from debtor)
Features:
1) Selection of Account or Client: Before giving the funds to the company. The bank will check
the credit or debtors in the market whether the image of debtor is good or bad, whether he will
able to pay or not, etc. if the bank thinks the debtor is good then only bank will give fund to the
company.
2) Setting Credit Limit : The limit of funds is set by the bank and not by the company. It means
the amount is decided by the bank. If the company is agree then only this deal will be completed.
3) Collection of Debts : At the end of time period. Either the bank or the company will collect the
funds from the debtor.
4) Payment to the company: If the book will collect the funds from the debtor then the bank will
give that fund to the company
5) Advances against Debt: Generally the bank provides 70% to 80% of total amount of debtor. it
means the bank does not give total amount to the company.
6) Recourse or Non recourse : Recourse means, it is the responsibility of company to collect the
funds from debtors. Non – recoursemeans, the responsibility of bank to collect the funds from
debtors.
7) Charging of Commission : The company has to pay commission or interest to the bank.
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 Bank Finance : (Tandon committee)
If the company requires working capital. Then it can collect it from the bank as a loan.
There are various norms , regulation and rules , of bank for giving the loan . the norms are as
below : this norms are decided by TANDON committee. This norms are called MPBF
(Maximum Permissible Bank Finance.)
According to TANDON committee, Before giving loan to the company , the bank will check
current assets and liabilities of the company and bank will find working capital gap (current assets
– current liabilities ). On the basis of this gap the bank will give loan to the company.
Methods of MPBF (Tandon Committee):-
 Method-1
In this method, out of total amount of working capital gap, 25% should be contributed by the
company and 75% should be contributed by the bank as a loan. it means the bank should give
maximum 75% of total amount.
MPBF = 0.75(current Assets – Current liabilities )
In current liabilities, the bank loan is not included.
Example:
BALANCE SHEET
LIABILITIES AMOUNT ASSETS AMOUNT
C.L. C.A.
Creditors 15 00000 R.M. 20 00000
Bills payable 10 00000 W|P 10 00000
Bank loan 30 00000 F.G. 25 00000
Debtors 20 00000
55 00000 75 00000
CL = 5500000 – Bank loan
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= 5500000 – 3000000
= 2500000
CA = 7500000
MPBF = 0.75 ( CA –CL )
= 0.75 (7500000 – 2500000)
MPBF = 3750000 Rs
Here, the bank can give maximum of Rs 3750000 to the company. here, the company has already
taken a loan of Rs 3000000. So now the bank can give only Rs 750000 (3750000 – 3000000).
 Method-2
In this method, the company should contribute 25% of working capital gap and the bank should
contribute 75%. Here, the company must manage 25% from long term sources of funds only. like
from equity shares, debentures, etc.
MPBF = 0.75 (CA)-CL
Taking above example
= 0.75 (7500000) – 2500000
MPBF = Rs 3125000
Here the bank can give maximum of Rs. 3125000.
Here the company has already taken a loan of Rs. 3000000. So now the bank can give only Rs.
125000 (3125000 – 3000000).
 Method-3
In this method the company should contribute 100% core current assets and 25% of current assets
and the bank should contributed remaining 75%. The core current asset means the minimum
amount which is required for the company at any point of time.
MPBF = 0.75 (CA – core CA) – CL
Taking above example
The core CA are 3000000
MPBF = 0.75 (7500000 – 3000000) - 2500000
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MPBF = Rs. 875000
Here the bank can give maximum of Rs. 875000.
But the bank has already given a loan of Rs 3000000 which is more than Rs. 875000. So bank
should not give more loan to the company.
Q-17 Discuss the Credit Policy Variables for Receivable Management Policy.
Receivable Management
Receivable includes debtors and bills receivable. When company sales the goods to the customer
on credit basis, the company will receive the payment from the customer in future and the
customer become debtors.
The company has to manage its debtors. Receivable management means the management of
receivable in such a way that the company can able to collect cash from debtors on time,so that it
will not disturb the operation of company.
Credit Policy Variables/ Factor affecting Receivable Management /Ingredients:-
Every company has to sell goods on credit basis so it has to make credit policy, which may be
different for different customer. The main variables of credit policy are as below.
(1) Credit Standard :-
It is the criteria on which company gives credit to its customer. Before giving credit the company
should check the customer according to 5 „c‟ s which are as the blow.
I. Character:-
It includes the willingness of customers to make a payment. Before giving payment on credit the
company should check the character(image) the customers. If the character of the customer is
good in the market then the company can give more credit to this type of customer. If the
character of the customer is not good in the market then the company should not to give credit.
II. Capacity:-
It is the capacity of the customer to make a payment. Before giving credit, the company should
check the business of customer whether the customer does any business or not whether he earns
good profit or not. If it is good than the company can give credit.
If the business of customer is facing loss or if the customer is not doing any business then
company should not give credit.
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III. Collateral:-
If the company keeps one security as a mortgage from the customer then company should check
the security properly. If the security is valid then only company should give credit otherwise it
should not give credit. That mortgage security is called collateral security.
IV. Condition :-
If the financial condition of customer is strong it means the customer is financially good, then the
company can give credit otherwise it should not give credit.
V. Capital:-
If the customer is having more capital,it means he has more assets and properties then the
company can give credit otherwise not or it should not give credit.
(2) Credit Period:-
It means the time limit in which the customer will have to pay generally the credit period is
between 15 to 60 days. It is written as below.
2/15 net 60
Here, it means if the customer will pay in 15 days then he will get 2% of cash discount. If he does
not want discount then he can pay in 60 days. If the company decides strict credit period then the
sales will not be increased, but the bad debt will also not be increased.
If the company decides the liberal credit period then sales will be increased but the bad debt will
also be increased. So the company should decide credit period which is not very strict and not
very liberal.
(3) Cash Discount:-
If the company wants past payment from the customer then it should offer a cash discount to the
customer .it is written as below.
2/15 net 60
If the customer will pay in 15 days then he will get cash discount of 2%. If the customer does not
want to take discount then he can pay in 60 days. If the company offers more discounts then the
customer will pay fast, but the profit will be decrease. If the company offers less discount then the
customer may not pay fast but the profit may be increased.
(4) Collection Policy:-
If the collection policy of company is very strict then it may create bad image of company. If the
collection policy of company is very liberal then it may increase bad debt so, the company should
decide not to be very strict and not to be very liberal collection policy.
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The company should Write a reminder letter to the customer. If the customer does not reply then
the company should write a strong letter and if still the customer does not reply then only the
company should send legal letter (notice) to the customer.
Q-18 Expanding on the Baumol Model , Miller and Orr consider a stochastic
generating process for periodic changes in cash balance “In light of the above
statement explain Miller and Or model for cash management.
 OPTIMUM CASH BALANCE: A FEW MODEL
Which budget for a firm may indicate the period when it is budgeted to have a shortage or surplus
of funds .it a shortage selected ways and means of over coming it must be and in case of expected
surplus ,its profitable in marketable securities should be explored .However he converting cash
into marketable securities and piece the financial manager must determine and assess the him cash
balance for the firm .he should also find out and how much cash is to be converted the problem of
planning optimum cash balance for a firm between risk and return of maintaining cash balance
several models have been suggested to deal with the firm of optimum cash balance .two important
models has been discussed here.
 BAUMOL‟S MODEL
Tested by W.J BAUMOL (1952) this model is the same as economic order quantity model of the
inventory manage. This model attempts to balance the income foregone or held by the firm
against the transaction cost of convert into marketable securities or vice versa this model be
presented as follows.
 Assumption : The Baumol‟s model assumes that the firm uses at an already known rate per
period and that‟s this rate of is constant.
 Holding cost : There is always a cost of holding cash by a firm cost may be the interest one the
investment of this cash.
 Transaction cost : whenever cash is to be converted into available securities or vice versa there
is always a cost in the form of brokerage ,commission etc.
This model is based on the proposition that in order to reduce the holding cost. A firm keeps the
least amount of cash in hand. However, as the cash level depletes. The firm can acquire cash by
selling some of its marketable securities each time the firm transaction as occasionally as possible
this could be done by maintaining a higher cash level involving a high holding cost. Thus, the firm
has to deal with the holding cost as well as the transaction cost. The optimum cash balance is
found by controlling the holding cost and transaction cost so as to minimize the total cost of
holding cash in other words. The case is recovered by selling marketable securities in such a way
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that the transaction cost is optimally balance with the holding cost of cash.this model is almost the
same as EOQ model of the inventory management and can be presented follows
C = √2FT/r
Where,
c = cash required each time to restore balance to minimum cash
F= total cash required during the year
T= cost of each transaction between cash and marketable securities
R= Rate of interest on marketable securities
As Per Baumol's model, the firm should start each period with the cash balance „C' and spend
gradually until its balance comes to zero. At this time, the firm should replenish the cash equalling
„C‟ from the sale of marketable securities the model can be presented in a graphical from also
figure shows the determination of optimum cash balance at a level at which the holding cost and
the transaction cost are optimized.
Q-19 Operating cycle:
Meaning:- Operating cycle means the time period required to convert cash into raw materials. Into
work in process into finish goods, into debtors into cash debtors receivable Cash Row Material
work in process Finished goods
Phase:1  Conversion of cash into raw materials
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Phase:2  Conversion of raw material in work in process
Phase:3  Conversion of work in process into finished goods
Phase:4  Conversion of finished goods into debtors
Phase:5  Conversion debtors into cash
Q-20 Discuss the difference between Leasing and Hire purchase

Leasing Hire purchase
In leasing, the user gets the In hire purchase, the users gets
assets from the owner, user the assets, users uses the assets
uses the assets and pays rent to and pays installment.
1) Meaning the owner.
In leasing the user is not the In hire purchase,the user is

owner. He uses the assets and owner but he will get the
2) Ownership at the end of period he returns complete ownership when the
the assets. total installment will be paid
by the user.
In leasing the user can not get In hire purchase the user can
the advantage of depriciation get the advantage of
3) Depriciation for tax purpose because he is depriciation for a tax purpose
not the owner. because he is the owner.
In leasing the user can not In hire purchase the user can
4) Accounting Entries show the assets on asset side show the assets on asset side
in balance sheet. in balance sheet.
In leasing the user is not In hire purchase the user is

5) Provision for Finance required to pay any amount at require to pay down payment
initial level. at the initial level.
In leasing the user is not In hire purchase the user is

6) Repair and Maintenance responsible for repair and responsible for repair and
maintenance of assets. maintenance of assets.
In leasing the amount of rent In hire purchase,the amount of

includes that repair and installment includes principal
7) Amount of Installment maintenance cost. amount of assets and intrest
amount.
8) Type of Assets In leasing, the assets are very In hire purchase, the assets are
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costly. which is not possible to not very costly. which is
purchase. possible to purchase.
ex:- Machine ex:- Car, T.V., Bike, A.C.
Q-21 Explain the types of Leasing

1) Operating Lease :-
Operating lease is short term contract and it is cancellable contract. Here lease will use the assets
for short period of time the lease will have to return that assets the lessor. At the end of time if
leasee wants to purchase that assets then he does not have that option. Here lessor is responsible
for the maintain of that assets.
Example:- Giving a car on rent, Giving on office space on rent etc.
2) Financial Lease:-
It is long term contract and it is non- cancellable contract. The leasee will use the assets for long
period of time say 5year, 10 year etc. Both parties cannot cancel the contract. At the end of time
if lease wants to purchase that assets then he has the option. Here, leasee is responsible for the
maintain of that assets.
Example:- Giving machinery, land, building, etc…
3) Sale & Lease Back:-

Here the lessor (owner of the assets) will sell his assets to others (insurance company, bank,) and
he gets the same assets then after he gets the same assets on rent and use the assets and pays rent
now the lessor is become leasee and he is responsible for the maintenance of the assets.
4) Leveraged Lease:-
Here the lessor is not full owner of the assets it means the lessor purchases assets on loan from
the bank and he pays the instalment. Now he gives that assets to the leasee on rent, generally out
of total value of assets the lessor invest 25% and the bank gives 75% as a loan. Here the lease is
responsible for the maintenance.
Here, there are three parties lessor, leasee, and bank.
For example:- Shopping centre, House, etc..
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5) Service Lease:-
Here the lessor not only gives his assets on rent but he also provides his service to the leasee.
Here the lessor is responsible for the maintenance.
Example :- Computers, Machines, etc.
6) Direct Lease:-
Here the lease will directly go to the manufacturing company and he gets the assets from that
company and gives rent to that company. Here the company is lessor.
7) International Lease :-
Here the lessor and leasee both are from different country.
Example :-The lessor is in India and he gives his assets to the lease who is in Japan. This is
called international lease.
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Short Questions (Corporate Finance-4529202 MBA Sem-2)
1. Time Value of Money: The money which is receivable at present has more value than the
money receivable in the future. Hence, the relationship that exists between the value of money
receivable at present and the value of money receivable at future is known as Time Value of
Money.
2. Simple Interest: It is the interest which accrues only on the amount originally borrowed/lent.
3. Compound Interest: It is the interest which accrues not only on the amount originally
borrowed/lent but also on the interest accrued previously but not paid/received.
4. Effective Rate of Interest: It is a rate at which money held at present actually increases in a
year.
5. Present Value: It is today‟s value of tomorrow‟s money. In other words, it is the difference
between future value and interest for the period between present and future. It is future value of
money discounted at a given rate of interest.
6. Annuity: A series of equal amount of cash flows over a certain given years as called an
annuity.
7. Sinking Fund: It is a fund created to accumulate the specified amount of sum in a future by
way of regular periodic payment for some specific purpose.
8. Perpetuity: The stream of regular cash flows for an infinite period is called perpetuity.
9. Growth Rate: The rate by which future cash flows increase is called a growth rate. The growth
rate may be increasing, static or decreasing.
10. Indifference Point: It refers to that level of EBIT at which EPS would be same
irrespective of the method of financing the new funds requirements.
11. Agency Cost: These are the costs that are directed to reduce the impact of agency
problems. These costs may be direct or indirect. Examples are salary, bonuses and perks paid
to employees.
12. Financial Risk: It can be defined as the variability of earnings before tax. It results
because of use of financial leverage.
13. Risk-Return Trade off: Lower the risk, lower the gain and higher the risk, higher the
gain. The finance manager has to strike balance between return he desires and the risk he wants
to take. He has to find that point of return and risk which shall maximize the present value and
that point is called risk-return trade off.
14. Current Yield: it relates the annual coupon interest to the market price. It is calculated
annual interest divided by the price.
15. Yield To Maturity (YTM): it is the interest rate that makes the present value of the cash
flows receivable from owning the bond equal to the price of the bond.
36
16. Yield To Call (YTC): Some bonds carry a call feature that entitles the issuer to call (buy
back) the bond prior to the stated maturity date in accordance with a call schedule. For such
bonds, it is a practice to calculate the yield to call (YTC) as well as the YTM.
17. Floatation Cost: When a firm raises finance by issuing equity and debt, it almost
invariably incurs floatation or issue costs, comprising of items like underwriting costs,
brokerage expenses, fees of merchant bankers, advertising expenses, etc.
18. Right Issue: it is an issue of capital to the existing shareholders of the company through a
“Letter of Offer” made in the first instance to the existing shareholders on a pro-rata basis.
19. Private Placement: it is an issue of securities to a select group of persons not exceeding
49. Private placement of shares and convertible debentures by a listed company can be of two
types: preferential allotment and qualified institutional placement.
20. Walter Model: James Walter has proposed a model of share valuation which supports the
view that the dividend policy of the firm has a bearing on share valuation.
Assumptions of Walter Model:
i. The firm is an all-equity financed equity.
ii. It will rely only on retained earnings to finance its future investments.
iii. The rate of return on investment is constant.
iv. The firm has an infinite life.
21. Gordon Model: Myron Gordon proposed a model of stock valuation using the dividend
capitalization approach.
Assumptions of Gordon Model:
i. Retained earnings represent the only source of financing for the firm.
ii. The rate of return on investment is constant.
iii. The firm has an infinite life.
iv. Tax does not exist.
22. Accruals: the major accrual items are wages and taxes. These are simply what the firm owes
to its employees and to the government.
23. Trade Credit: It represents the credit extended by the suppliers of goods and services. It is a
spontaneous source of finance in the sense that it arises in the normal transactions of the firm
without specific negotiations.
37

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CORPORAT FINANCE (4529202) MBA-SEM:-2

Q-1 Goals or Objectives of Financial Management OR Wealth maximization

2. It ignores time value:-

2) Wealth Maximization Objective:-

2. It considers time value:-

Q-2 Explain Functions or Decision of Financial Management

1) Investment or long term Decision:-

2) Working capital or short-term Decision: -

3) Dividend or profit allocation Decision: -

4) Capital Mix Decision: -

Q-3 Discuss briefly the various sources of long-term finance of companies.

 Merits / Feature /Rights:

1) Residual claim on income:

2. Debentures / Term Loan:

 Features of Debenture / bonds:

1) Trust deed or Indenture:

6) Claim on assets and income:

7) Call and put features:

1. Redeemable preference share: Here time period is fixed.

2. Irredeemable preference share: Here time period is not fixed.

2. Participation in management: Venture capitalist is also the owner of company

3. Investment in new product: The venture capitalist invests only in new

4. Investment is illiquid: If venture capitalist requires its investment in short time

7. Investment in small & medium sized organizations: The venture capitalist

Q-5 What is Shares Buyback? Explain its merits and demerits.

Benefits of buyback (merits)

Q-6 Explain Importance or Significance of Capital Budgeting or Investment

1) Long Term Effect :-

2) Investment of huge Amount :-

5) Fear of under or over production capacity :-

6) Future Expansion Depends on sale :-

Q-7 Methods of Capital Budgeting: -

- PBP (Pay Back Period)

-ARR (Average or Accounting rate of return)

B) Modern or Discounting Method: -

-NPV (Net Present Value)

-PI (Profitability Index) or Benefit Cost Ratio

-IRR (Internal Rate of Return)

1. Simple and Easy:-This Method Is Simple to Understand Easy to calculation.

NPV :-( Net Present Value)

IRR (Internal Rate of Return)

IRR = A + C/C-D * (B-A)

Where A = Lower Rate of Discount

B = Higher rate of discount

C = Excess of present value at lower rate

D = Shortfall (less) of present value at higher rate

If IRR > Cost of Capital then accept the project.

If IRR < Cost of capital then reject the project.

Q-8 Discuss the CAPM (Capital Asset Pricing Model) in detail.

2. The purchase or sale of a security can be undertaken in inﬁnitely divisible units.

7. The investor can sell short any amount of any shares.

Significance / Important / factors / advantage of cost of capital :

1.Capital Budgeting Decision:

2.Maintaining Market value of share :

3. It helps in designing capital structure:

4.Issue of new securities:

5.To evaluate performance of top management:

 Factor affecting dividend decision policy :-

Q-12 Traditional approach is neutral to NOI and NI approach”. Discuss with

In above the diagram of three stages which are explain as below:

1. Stage: 1. increasing Value

2. Stage: 2. Optimum Value

3. Stage: 3. Decreasing Value