FINANCE MANAGEMENT

1- Scope of financial management?

Ans - The scope of financial management includes:
1. Financial Planning: It involves the determination of financial objectives and developing a
comprehensive plan to achieve these objectives.
2. Capital Budgeting: It involves the process of evaluating and selecting long-term investment
projects that contribute to the growth and profitability of the organization.
3. Risk Management: It involves identifying, assessing, and managing various types of risks
that may affect the financial performance of the organization.
4. Financial Analysis: It involves analysing the financial statements of the organization to
assess its financial health and performance.
5. Working Capital Management: It involves managing the day-to-day financial operations of
the organization, including cash management, inventory management, and accounts
receivable and payable management.
6. Investment Management: It involves managing the organization's investment portfolio,
selecting suitable investment options, and monitoring the performance of investments.
7. Financial Reporting: It involves preparing financial reports that provide information on the
organization's financial performance, liquidity, and solvency.
8. Tax Planning: It involves planning and managing the organization's tax liabilities,
minimizing tax liabilities, and complying with tax laws and regulations.

2- Objectives of financial management?

 Wealth Maximization- One of the main objectives of Financial Management is to maximize

shareholder’s wealth, for which achievement of optimum capital structure and proper utilization
of funds is very necessary. Be mindful that wealth maximization is different than profit
maximization. Wealth maximization is a more holistic approach, aimed at the growth of the
organization
 To Ensure Availability of Funds- The sound financial condition of business is a must for any
business to survive. The availability of funds at the proper time of need is an important objective
of business. The organization will not be able to function without funds, and activities will come
to a halt.
 Attain Optimum Capital Structure- To maintain the optimum capital structure, a perfect
combination of debentures and shares is a requirement. The organization will not want to give
away too much equity, and also control the cost of capital. It is a delicate balance.
 Effective Utilisation of Funds- Business not only needs a large number of funds but also skills
to handle such large amounts. To cut down unnecessary costs and to save funds from wasting in
useless assets is crucial for business. An example of such misuse of funds would be investing in
extra raw material, in quantities not required.
 Ensuring the Safety of Funds-The vital objective of financial management is to ensure the
security of its funds through the creation of reserves. The chances of risk in investment should be
minimum possible. Some of the reserves created for this purpose are Sinking Funds, General
Reserves etc

3- Briefly discuss the wealth maximisation concept of financial

management?

It simply means the maximization of shareholders’ wealth. It is a combination of two words,

viz. wealth and maximization. A shareholder’s wealth maximizes when the net worth of a
 company maximizes. To be even more meticulous, a shareholder holds a share in the
company/business, and his wealth will improve if the share price in the market increases,
which is a function of net worth. This is because another name for wealth maximization is net
worth maximization.
Finance managers are the agents of shareholders, and their job is to look after the interest of the
shareholders. The objective of any shareholder or investor would be a good return on their capital and
the safety of their capital. Wealth maximization serves both these objectives very well as a decision
criterion for business.

Advantages of Wealth Maximization Model- The wealth maximization model is superior because it
obviates all the drawbacks of profit maximization as a goal of a financial decision.

 Firstly, wealth maximization is based on cash flows and not on profits. Unlike the profits,
cash flows are exact and definite and therefore avoid any ambiguity associated with
accounting profits. Profit can easily be manipulative, and if there is a change in accounting
assumption/policy, there is a change in profit. There is a change in the depreciation method;
there is a change in profit. It is not the case in the case of Cash flows.
 Secondly, profit maximization presents a shorter-term view as compared to wealth
maximization. Short-term profit maximization can be achieved by the managers at the cost of
the long-term sustainability of the business.
 Thirdly, wealth maximization considers the time value of money. It is important as we know
that a dollar today and a dollar one year later will not have the same value. In wealth
maximization, the future cash flows are discounted at an appropriate discounted rate to
represent their present value. Suppose there are two projects, A and B. Project A is more
profitable; however, it will generate profit over a long period of time, while project B is less
profitable however it can generate a return in a shorter period. In a situation of uncertainty,
project B may be preferable. So, profit maximization ignores the timing of returns and
considers wealth maximization.

4- Drawbacks of profit maximisation concept?

Profit maximization objective consists of certain drawback also:

 It is vague: In this objective, profit is not defined precisely or correctly. It creates
some unnecessary opinion regarding earning habits of the business concern.
 It ignores the time value of money: Profit maximization does not consider the
time value of money or the net present value of the cash inflow. It leads certain
differences between the actual cash inflow and net present cash flow during a
particular period.
 It ignores risk: Profit maximization does not consider risk of the business
concern. Risks may be internal or external which will affect the overall operation
of the business concern.
5- What are the preferential right that a preference shareholder can enjoy?
The following preferential rights are enjoyed by preference shareholders-

 Receiving a fixed rate of dividend, out of the net profits of the company, before any dividend
is declared for equity shareholders.
 Preference over equity shareholders in receiving their capital after the claims of the
company's creditors have been settled, at the time of liquidation.
 In case of dissolution of the company, preference share capital is refunded prior to the refund
of equity share capital.

6- What do you mean by participative preference shares?

Participative preference shares refer to a type of shares that give the shareholders the right to
participate in the company’s profits and assets in excess of the stated rate of dividend. Simply
put, the holders of such shares receive their regular dividends in addition to a share in the
company’s profits after the payments of ordinary shareholders, usually proportional to their
investment. Participative preference shares also give the holders voting rights in significant
company decisions and are often issued to long-term investors or stakeholder groups.
7- Difference between convertible and Warrant?
Warrants
Warrants are a type of security that gives the holder the right, but not the obligation, to buy
shares of stock at a set price within a certain period of time. Warrants are typically issued by
companies as a way to raise capital. For example, a company might issue warrants to
investors in exchange for an investment in the company. Warrants are similar to options, but
there are some key differences. First, warrants are typically issued by the company itself,
while options are typically issued by investors. Second, warrants are often attached to debt,
meaning that if the company goes bankrupt, the warrants will still be valid. Options, on the
other hand, are not typically attached to debt and will become worthless if the company goes
bankrupt.

Convertible Debt
Convertible debt is a type of security that gives the holder the right, but not the obligation, to
convert the debt into shares of stock at a set price within a certain period of time. Convertible
debt is usually issued by investors as a way to hedge their investment. For example, an
investor might buy a bond that is convertible into shares of stock. If the stock price goes up,
the investor can convert the bond into shares and make a profit. If the stock price goes down,
the investor can hold on to the bond and wait for the price to rebound. Convertible debt is
similar to warrants, but there are some key differences. First, convertible debt is typically
issued by investors, while warrants are typically issued by companies. Second, convertible
debt is often attached to equity, meaning that if the company goes bankrupt, the debt will be
converted into shares of stock. Warrants, on the other hand, are not typically attached to
equity and will become worthless if the company goes bankrupt.

8- Short note on ADR, GDR?

GDR
A global depositary receipt is one type of depositary receipt. Like its name, it can be offered
in several foreign countries globally. Global depositary receipts are typically part of a
program that a company builds to issue its shares in foreign markets of more than one
country. For example, a Chinese company could create a GDR program that issues its shares
through a depositary bank intermediary into the London market and the United States market.
Each issuance must comply with all relevant laws in both the home country and foreign
markets individually.

American Depositary Receipts (ADRs)

American depositary receipts are shares issued in the U.S. from a foreign company through a
depositary bank intermediary. ADRs are only available in the United States. In general, a
 foreign company will work with a U.S. depositary bank as the intermediary for issuing and
managing the shares.

ADRs can be found on many exchanges in the U.S. including the New York Stock Exchange
and Nasdaq as well as over-the-counter (OTC). Foreign companies and their depositary bank
intermediaries must comply with all U.S. laws for issuing ADRs. This makes ADRs subject to
U.S. securities laws as well as the rules of exchanges. ADRs are alternative investments that
include additional risks that should be thoroughly analysed by American investors.
Hypothetically, an investor could choose to broaden their investing universe by choosing to
consider ADRs. ADRs ultimately increase the investment options for U.S. investors. They
can also simplify international investing by providing the offering to U.S. investors through
U.S. market exchanges. For U.S. investors, ADRs can have some unique risks. Primarily the
risk of currency found in conversion with the payment of dividends. Otherwise, ADRs are
denominated in U.S. dollars but their initial offering value is based on a valuation that is
created in terms of their home currency.
9- Concept of present value, Future Value, Time Value?
Present value (PV) is the concept that states an amount of money today is worth more than
that same amount in the future. In other words, money received in the future is not worth as
much as an equal amount received today.

Receiving $1,000 today is worth more than $1,000 five years from now.

Future value (FV) is a financial concept that assigns a value to an asset based on estimated
variables such as future interest rates or cash-flows. It may be useful for an investor to know
how much their investment may be in five years given an expected rate of return. This
concept of taking the investment value today, applying expected growth, and calculating
what the investment will be in the future is future value.

The time value of money is a basic financial concept that holds that money in the present is
worth more than the same sum of money to be received in the future. This is true because
money that you have right now can be invested and earn a return, thus creating a larger
amount of money in the future. (Also, with future money, there is the additional risk that the
money may never actually be received, for one reason or another). The time value of money
is sometimes referred to as the net present value (NPV) of money.
 10- Difference between present value and Future Value?

11- Capital budgeting?

 Capital budgeting is a process that businesses use to evaluate potential major projects or
investments. Building a new plant or taking a large stake in an outside venture are examples
of initiatives that typically require capital budgeting before they are approved or rejected by
management.

As part of capital budgeting, a company might assess a prospective project's lifetime cash
inflows and outflows to determine whether the potential returns it would generate meet a sufficient
target benchmark. The capital budgeting process is also known as investment appraisal.
12- NPV, IRR, Annual rate of Return, payback period?
The internal rate of return (IRR) is a metric used in financial analysis to estimate the
profitability of potential investments. IRR is a discount rate that makes the net present value
(NPV) of all cash flows equal to zero in a discounted cash flow analysis.

IRR calculations rely on the same formula as NPV does. Keep in mind that IRR is not the
actual dollar value of the project. It is the annual return that makes the NPV equal to zero.
Generally speaking, the higher an internal rate of return, the more desirable an investment is
to undertake. IRR is uniform for investments of varying types and, as such, can be used to
rank multiple prospective investments or projects on a relatively even basis. In general, when
comparing investment options with other similar characteristics, the investment with the
highest IRR probably would be considered the best.

Net present value (NPV) is a financial metric that seeks to capture the total value of an
investment opportunity. The idea behind NPV is to project all of the future cash inflows and
outflows associated with an investment, discount all those future cash flows to the present
day, and then add them together. The resulting number after adding all the positive and
negative cash flows together is the investment’s NPV. A positive NPV means that, after
accounting for the time value of money, you will make money if you proceed with the
investment.

An annualized rate of return is evaluated as an equivalent amount of annual return an

investor is entitled to receive over a stipulated period. It is computed depending on time
weight and scales down to 12 months, allowing investors to compare the return on assets over
a particular time.

For example, assume that an asset returned 50% in three years and another has returned 85%
in 5 years. With this data, it can be complex to understand which asset yielded better returns
until we scale and determine which asset delivered a higher rate of return.

Payback period is defined as the number of years required to recover the original cash
investment. In other words, it is the period of time at the end of which a machine, facility, or
other investment has produced sufficient net revenue to recover its investment costs .
13- Why capital budgeting is used?
Capital budgeting is used for the following reasons:

 To evaluate potential long-term investment opportunities: Capital budgeting helps

businesses determine whether they should invest their resources in a long-term project or not.
It helps them identify and evaluate the available investment opportunities and make decisions
based on their investment objectives.

 To estimate the future cash flows: Capital budgeting helps businesses to estimate the future
cash flows associated with an investment opportunity. By forecasting the future cash inflows
and outflows, businesses can calculate the expected return on investment, payback period,
and other financial metrics.
  To reduce risk: Capital budgeting also helps businesses to identify and reduce risks
associated with a particular project. By evaluating the potential risks, businesses can adopt
strategies to mitigate them, which in turn, reduces the overall risk exposure.

 To allocate resources efficiently: Capital budgeting helps businesses in identifying the most
profitable investment opportunities. It allows them to allocate limited resources efficiently
and maximize their returns.

 To facilitate long-term planning: Capital budgeting also facilitates long-term planning by

helping the businesses to identify their long-term investment priorities. It also helps the
management to identify the resources needed for future investments and make necessary
arrangements for the same.
14- Concept and objectives of Capital Budgeting?

Capital budgeting is the process of allocating and investing resources to long-term

investments that will provide future benefits to the organization. The main objectives of
capital budgeting are:

Identifying Profitable Investment Opportunities: The primary objective of capital

budgeting is to identify and evaluate profitable investment opportunities that will generate
high returns.

Maximizing Shareholder's Wealth: The goal of capital budgeting is to maximize

shareholder's wealth by investing in projects that will increase the value of the firm.

Minimizing Risk: Capital budgeting helps to minimize the risk associated with investing in
long-term projects by analysing the potential risks and uncertainties.

Alleviating Capital Constraints: Capital budgeting helps an organization to allocate its

resources effectively and efficiently, thereby alleviating capital constraints and giving rise to
new investment opportunities.

Maintaining Market Share: Capital budgeting helps an organization to maintain its market
share by investing in new projects that will help it to compete effectively with its rivals.

Ensuring Long-term Sustainable Growth: The objective of capital budgeting is to ensure

long-term sustainable growth for the organization by investing in projects that will generate
significant cash flows over a prolonged period.

15- Discounting methods, Non-Discounting methods?

Discounting is the process of determining the present value of a payment or a stream of payments that
is to be received in the future. Given the time value of money, a dollar is worth more today than it
would be worth tomorrow. Discounting is the primary factor used in pricing a stream of tomorrow's
cash flows.
How Discounting Works
For example, the coupon payments found in a regular bond are discounted by a certain interest rate
and added together with the discounted par value to determine the bond's current value.
From a business perspective, an asset has no value unless it can produce cash flows in the future.
Stocks pay dividends. Bonds pay interest, and projects provide investors with incremental future cash
flows. The value of those future cash flows in today's terms is calculated by applying a discount factor
to future cash flows.
A non-discount method of capital budgeting is one that does not consider the time value of money.
In other words, all dollars earned in the future are assumed to have the same value as today's dollars.
Examples of Non-discount Methods of Capital Budgeting
One example of a non-discount method is the payback method, since it does not consider the time
value of money. The payback method simply computes the number of years it will take for an
investment to return cash that is equal to the amount invested. The computed number of years is
referred to as the payback period.

LEVERAGE
1- Meaning of leverage and its types?
The term ‘leverage’ is used to describe the ability of a firm to use fixed cost assets or
funds to increase the return to its equity shareholders. In other words, leverage is the
employment of fixed assets or funds for which a firm has to meet fixed costs or fixed
rate of interest obligation—irrespective of the level of activities attained, or the level
of operating profit earned. Leverage occurs in varying degrees. The higher the degree
of leverage, the higher is the risk involved in meeting fixed payment obligations i.e.,
operating fixed costs and cost of debt capital. But, at the same time, higher risk
profile increases the possibility of higher rate of return to the shareholders.

Types of Leverage:

Leverage are the three types:

(i) Operating leverage (ii) Financial leverage and (iii) Combined leverage

 Operating Leverage: Operating leverage refers to the use of fixed operating costs such as

depreciation, insurance of assets, repairs and maintenance, property taxes etc. in the

operations of a firm. But it does not include interest on debt capital. Higher the proportion of

fixed operating cost as compared to variable cost, higher is the operating leverage, and vice

versa. Operating leverage may be defined as the “firm’s ability to use fixed operating cost to

magnify effects of changes in sales on its earnings before interest and taxes.”

 Financial Leverage: Financial leverage is primarily concerned with the financial activities

which involve raising of funds from the sources for which a firm has to bear fixed charges

such as interest expenses, loan fees etc. These sources include long-term debt (i.e.,

debentures, bonds etc.) and preference share capital. Long term debt capital carries a
 contractual fixed rate of interest and its payment is obligatory irrespective of the fact whether

the firm earns a profit or not. As debt providers have prior claim on income and assets of a

firm over equity shareholders, their rate of interest is generally lower than the expected return

in equity shareholders. Further, interest on debt capital is a tax deductible expense. These two

facts lead to the magnification of the rate of return on equity share capital and hence earnings

per share. Thus, the effect of changes in operating profits or EBIT on the earnings per share is

shown by the financial leverage.

 Combined Leverage: Operating leverage shows the operating risk and is measured by the
percentage change in EBIT due to percentage change in sales. The financial leverage shows
the financial risk and is measured by the percentage change in EPS due to percentage change
in EBIT. Both operating and financial leverages are closely concerned with ascertaining the
firm’s ability to cover fixed costs or fixed rate of interest obligation, if we combine them, the
result is total leverage and the risk associated with combined leverage is known as total risk.
It measures the effect of a percentage change in sales on percentage change in EPS.

2- Trading on equity and its application in business?

Trading on equity is a financial management strategy that involves using borrowings
(debt) to acquire assets that will generate income. The basic objective of trading on
equity is to increase the profitability of a business by increasing the return on equity
investment.

In simple terms, trading on equity involves borrowing money at a lower rate of

interest and utilizing it to invest in projects or assets that have a higher rate of return.
The excess return on the investment is used to service the borrowed funds and the
residual profit is retained by the business.

The key to successful application of trading on equity is to ensure that the returns
from the investment are higher than the cost of borrowing. This can be calculated by
comparing the internal rate of return (IRR) on the investment against the cost of
borrowing.

In business, trading on equity can be applied in various ways, such as:

 Expansion of a product line or business operations: A business can use the funds
generated by trading on equity to expand operations, such as launching new products or
expanding into new markets.

 Acquisition of other businesses: A business can use the funds generated from trading on
equity to acquire other businesses, which can help increase its market share or support its
long-term objectives.
  Investment in research and development: Trading on equity can provide a business with
the funds to invest in research and development, which can help it to improve its products
and services, leading to increased revenue and profitability.

 Upgrading technology or infrastructure: A business can use the funds generated by

trading on equity to upgrade its technology or infrastructure, which can help it to be more
competitive and efficient.

3- Discuss different factors that contribute to operating risk, financial risk?

Operating risk refers to the risk of loss resulting from inadequate or failed procedures, systems,
or potential harm to people or property. Factors that contribute to operating risk include:

1. Human factors: These include the actions of employees, suppliers, and contractors.
Employee errors and negligence, supplier disruptions, and safety hazards can all contribute to
operating risk.

2. Natural disasters: Natural disasters such as hurricanes, floods, earthquakes, and wildfires
can disrupt operations, damage equipment, and cause significant loss of property and life.

3. Technological failures: Malfunctioning or defective equipment, data breaches, and other

technological issues can result in operational disruptions and financial losses.

4. Regulatory compliance: Non-compliance with laws and regulations can result in fines,
legal action, and reputational damage.

Financial risk refers to the risk of loss resulting from adverse movements in market prices,
exchange rates, interest rates, credit risk, and liquidity risk. Factors that contribute to financial
risk include:

1. Market risk: This arises from changes in market prices or interest rates and affects
financial assets such as stocks, bonds, and foreign exchange.

2. Credit risk: This refers to the risk of loss arising from the failure of a borrower to repay a
loan or meet their obligations.

3. Liquidity risk: This is the risk that an asset cannot be sold quickly enough to meet financial
obligations.

4. Interest rate risk: This refers to the risk of changes in interest rates affecting the value of
investments, debts, and cash holdings.

5. Foreign exchange risk: This is the risk of loss resulting from changes in exchange rates
between currencies used in international trade.

4) Important factors that influence the dividend policy of a firm?

Profitability: The level of profitability of a company is one of the important factors that influence
dividend policy. A company needs to have positive cash flows to be able to pay dividends.
Availability of cash: The availability of cash is another important factor that influences dividend
policy. A company needs to have adequate cash reserves to pay dividends.
Investment opportunities: The availability of investment opportunities is another factor that affects
dividend policy. A company may opt to retain earnings to fund future investment opportunities rather
than pay dividends.
Market expectations: The market expectations of a company's dividend policy also play a role in
determining the dividend pay-out. Companies that have a history of high dividend pay-outs are
expected to continue doing so.
Shareholder preferences: Another important factor is the preference of shareholders. The dividend
policy should align with the expectations of the shareholders.
Legal and contractual constraints: There may be legal and contractual constraints that limit a
company's ability to pay dividends. Companies need to be aware of these constraints before setting
their dividend policies.
Financial leverage: The level of financial leverage of a company also impacts dividend policy.
Companies with high levels of debt may opt for lower dividend pay-outs to maintain financial
stability.
Taxation policies: Taxation policies can have a significant impact on a company's dividend policy.
Companies need to consider the tax implications before setting dividend pay-out policies.

5) Different theories of dividend policies?

 Residual Dividend Theory: This theory suggests that the company should retain earnings to
finance profitable investment opportunities because retained earnings can generate higher
returns. After financing all the profitable investments, if there is still some residual earnings
left, the company should distribute the earnings as dividends.
 Signalling theory: This theory stresses that dividend payments can send signals to investors
about a company's financial health and future performance. A company that consistently pays
a dividend demonstrates that it generates stable cash flows and is capable of paying dividends
in the future.
 Tax preference theory: This theory focuses on the fact that dividend income is taxed more
severely than capital gains income, so investors prefer companies that don't pay dividends so
that they can postpone paying taxes on their gains.
 Clientele effect theory: This theory suggests that different shareholders have different
preferences regarding dividend payments. Some prefer high dividends while others prefer low
or no dividends. As a result, a company’s dividend policy can attract or repel certain types of
investors. Over time, a company’s dividend policy may create a loyal group of investors,
creating a clientele effect.

6) What is capital structure? (Combination of debt& equity) Optimum capital

structure?
Capital structure is the particular combination of debt and equity used by a company to finance its
overall operations and growth.
Equity capital arises from ownership shares in a company and claims to its future cash flows and
profits. Debt comes in the form of bond issues or loans, while equity may come in the form of
common stock, preferred stock, or retained earnings. Short-term debt is also considered to be part of
the capital structure.
Optimum capital structure
Companies that use more debt than equity to finance their assets and fund operating activities have a
high leverage ratio and an aggressive capital structure. A company that pays for assets with more
equity than debt has a low leverage ratio and a conservative capital structure. That said, a high
leverage ratio and an aggressive capital structure can also lead to higher growth rates, whereas a
conservative capital structure can lead to lower growth rates.

7) M.M theory; Net income approach in Capital Structure?

The M.M theory, also known as the Modigliani-Miller theory, is a financial theory that suggests that a
company's capital structure does not affect its market value. The theory states that if a company
increases its debt levels, it will see an increase in its weighted average cost of capital (WACC) but it
will also see a reduction in its cost of equity due to the tax deductibility of interest payments.
Therefore, the net effect on the firm's cost of capital will be equal, regardless of the capital structure.

On the other hand, the net income approach in capital structure suggests that the capital structure
affects the company's net income. It maintains that the optimal capital structure is one that maximizes
the company's earnings per share (EPS) and, therefore its stock prices.

Both M.M theory and the net income approach provide a perspective on the impact of capital structure
on firms. Whereas the M.M theory implies that the capital structure is irrelevant, the net income
approach recommends that the capital structure is important and affects the earnings of the company.