What does the DFL of 3 times imply?

The degree of financial leverage (DFL) is a leverage ratio that measures the sensitivity of a
company's earnings per share to fluctuations in its operating income, as a result of changes in its
capital structure. This ratio indicates that the higher the degree of financial leverage, the more
volatile earnings will be.DFL of 3 times means that for every 1% change in EBIT or operating income,
EPS would change by 3%.

1. State the proposition 1 of MM Approach.

Proposition I states that the market value of any firm is independent of the amount of debt or
equity in capital structure.

Proposition II states that the cost of equity is directly related and incremental to the percentage of
debt in capital structure.

2. How does a firm make its dividend more stable?

The company distributes a fixed amount of cash dividends. It creates a reserve that allows them
to pay a fixed dividend even when earnings are low or there are losses. The constant dividend
policy is more suited for companies whose earnings remain stable over a number of years.

3. Preferred stock is hybrid form of long term financing. Explain.

Preferred stock is referred to a hybrid security because it has similarities to both common stock
and bonds. Common stocks aren't paid regularly, and their value is dependent on the growth
rate of their dividends. Preferred stock is paid regularly, and their value is fixed.

4. List out some sources and uses of cash.

three sources and uses of cash – Operating, Investing, and Financing

The five primary categories of a sources and uses of funds statement are beginning cash balances,
cash flows from operating activities, cash flows from investing activities, cash flows from financing
activities, and ending cash balances.

5. Why don’t all firms simply increase their payables periods to shorten their cash cycles?

They would like to! The payables period is a subject of much negotiation, and it is one aspect of the
price a firm pays its suppliers. A firm will generally negotiate the best possible combination of
payables period and price. Typically, suppliers provide strong financial incentives for rapid payment.
This issue is discussed in detail in a later chapter on credit policy.
 6. How the cash conversion cycle is calculated?

Cash Conversion Cycle = days inventory outstanding + days sales outstanding - days payables
outstanding.

7. What do you mean by 2.5/15,net 45 term?

2/5 net 45: 2.5% early payment discount within 15 days, or the total amount of the invoice due in
45 days.

8. Is maximizing disbursement float a sound business practice?

Maximizing disbursement float are debatable on both ethical and economic grounds because
payments terms frequently offer a substantial discount for early payment. The discount is usually
much larger than any possible savings from “playing the float game”. Hence, it is a sound business
practices.

9. How the theoretical value of warrant is calculated?

Warrant value = formula value + time value

The formula value is the difference between the underlying share price
and the warrant’s exercise price, multiplied by the number of new shares
issued on exercise. This value is either positive or zero, but can’t be
negative. 

 Merger

-merger is the fusion of two or more companies that voluntarily come together to form a new
entity. The size of merging companies is more or less the same.

 Acquisition

-an acquisition is the process whereby a company or business entity acquires another one but
no new company is formed. The acquiring company is larger or bigger than the acquired one.
  Define money market.
-money market is the financial market which deals with trading of short-term securities having
less than one year of maturity. The return on investment is relatively low.

 Define capital market.

-capital market is the financial market for long-term securities whose maturities range above
one year. The return on investment is high.

 Why corporate securities are exposed to default risk but government securities are not ?
-corporate securities are exposed to default risk but government securities are not because
corporation are likely to default on interest payment and repayment of principal but
government securities are backed by national treasury of government.

 Define yield curve.

-Yield curve is the graphic presentation of the term structure of interest rate.it shows the
relationship between interest rate on securities having different maturities.

 Why the rate of interest on corporate bond is higher than t- bond?

-the rate of interest on corporate bond is higher than t-bond because of the default risk inherent in the
corporate bond.

 Nominal rate of return

-nominal rate of return is the amount of money generated by an investment before factoring in
expenses such as taxes, investment fees and inflation.

 Real rate of interest

-real rate of return is the annual percentage of profit earned on an investment, adjusted for
inflation.

 inflation
-inflation is the rate of increase in prices over a given period of time. it represents the rate of
change in general price level in the economy.

 Financial market

-financial market is the market where transaction of financial assets take place. Buyer and seller of
financial assets are brought together in financial market to trade financial assets such as shares,
debenture and others. It types are money market and capital market.
  What is correlation coefficient.
-correlation coefficient is the statistical measure of the strength of the relationship between the
relative movements of two variables.

 Unsystematic risk
-Unsystematic risk is a firm specific and is uncorrelated to the market. this risk is independent of
political or economic factors and unique to each individual firms.

 Systematic risk

-Systematic risk refers to the risk inherent to the entire market or market segment.this type
of risk is dependent of political or economic factor.

 What is opportunity cost?

-oppurtunity cost is the minimum rate of return an investment alternative should earn
consistent to its given level of risk.

 What is beta coefficient.

-beta coefficient is an index of systematic risk associated with an asset.the market beta is always
assumed to be 1.

 What do you mean by non-diversifiable risk?

-non diversifiable risk can also be said as market risk or systematic risk.

 Define Capital Assets Pricing Model(CAPM)

-CAPM shows the relationship between systematic risk and return of an asset.

 Security Market Line (SML)

SML is a line drawn on a chart that serves as a graphical representation of the capital asset
pricing model (CAPM).
Define Amortization.

-amortized loan refers to the loan that is to be repaid in equal periodic installments including both
principal and interest.

 Why the price of zero coupen bond is always less than maturity value?
-a zero coupon bond doesnot pay interest. Instead it is sold at discount. Hence its price is always
less than the maturity value other things held constant.

 Define call provision.

-call provison is a feature attached to bond and preferred stock issue that allows the issuer to
call the bond and preferred stock for redemption prior to the expiry of maturity.

 Bond yields
-bond yields refers to the different measures of bond return.the return on bond can be
measured as rate of return, current yield, capital gain yield, yield to maturity(YTM) and yield to
call(YTC).

 YTM (yield to maturity)

-YTM is an annualized return from a bond investment if it is held until the maturity.

 YTC (yield to call)

-YTC refers to the return a bondholder receives if the bond is held until the call date, which
occurs sometime before it reaches maturity.

 What is a Bond ?
-a bond is a long term security or long term promissory note, promising to pay interest and
principal, on specific date, to the holders of the bond.

Its feature are:

Par value
Coupon interest rate
maturity
call provison
  what is cost of capital?

-Cost of capital is the rate of return the firm expects to earn from investment in order to increase the
value of the firm in the market.

 Define marginal cost of capital.

-marginal cost of capital is the weighted average cost of raising an additional unit of capital.

 Weighted average cost of capital (WACC)

-weighted average cost of capital is the weighted average of the cost of specific component of capital
employed by a firm, where weight being measured by proportion of each component of capital into the
overall capital of the firm.

 Payback period

-payback period is the number of years required to recover a projects initial investment.
  What is financial management?

-it can be defined as the acquisition, financing and management of resources for the business firm with
due regard for prices in external economic market.

 What are bank and financial institution (BFIs)

-Bank and financial institution are the organizations which issue financial claims against themselves for
cash.for eg. They accept cash on different types of deposit account and issue the cerficate of deposit.

 Which goal would you like to recommend to a firm, wealth maximization or profit
maximization?

-wealth maximization because of the following reasons:

-Wealth maximization is based on cash flow rather than accounting profits.

-wealth maximization takes into account the concept of time value of money.

-wealth maximization is consistent to the interest of all stakeholders.

 Responsibilities of financial manager.

-value maximization goal is clear.

-value maximization is based on time value of money concept.

-value maximization recognize the time value of money.

-value maximization represent all stakeholder.

 Function of finance

-investment decision

-financing decision

-dividend decision

-working capital decision