Lawpoint’s Solutions FINANCIAL | MANAGEMENT [WITH NOTES AND ILLUSTRATIONS] e ee Re Cn eee al eet e Additional Solved Illustrations e Unsolved Exercises for Practice B.Com(CBCS) Honours & General 3rd Year e Sem VI fm Murli M Chandak ra Roshan Lodhapital Expenditure Decisions (I) *| oisiderd Decisions | 2019 examination Question Papor (H&G)eal INTRODUCTION PTER’S OVERVIEW EAST TRACK REFERENCER > Financial Management i concemed wih th activiies.o the fanc:al managers i rising funds ‘and proper utlzatan ofthese funds for meen the needs and goals of a busine fern. => Traditional approach, the fnance function was considered in a nartow sense of procuring funds by Corporate houses te finance only hat expansion o* dversiation + Modem approach towards the francil management emphasis bath cn conceptual and ana- Iyiea aspects of facil decision making in business fms. _ | "Rapects of Financiar |“ Management Ta] Profit Maximisation {b) Value or Wealth Maximisation Siving fair wages, er. (2) Maintaining and improving Objectives of Financial markersnare Management (6) Market teadership in logical balance, etc. (Survival and growth5. Financial Analysis / Performance Evaluation '& Dividend Decisions "7. Finaneial Negatstons / Liaison with lenders '8._Market Impact Analysis. u 5 8.Com Sofutions ~ Financial Management 14 }] = Distinguish between prot maximizabon and value maximization objectives of a firm. ‘of these objectives should be pursued by atten ? (5 +1 = 6 marks) 3H] ~ Distinguish between profit maximisaGon and weaRh maximisation objectrres of 2 Warimisaten of prof means =| itignores tne value ofmaney “The Problem of handing uncer- teinly of expected benelits are Benween E-Elsboratve. P-Prestical Multiple Choice Questions [No Questions have been asked from this category. Wilktetak +: a ee MAICOs, F-FR in the Blanks, TIF-Trut and False, SN-Short notes, C-Comment, D-Dstinguish No Questions nave been asked trom this category. ‘True and False/Correct and Incorrect _ —— ee ee Ne Questions rove Ban aed ro hs caegoxy ——— eee Short Notes cer No Quesions have been tka hom Wi eatepary ececea hei Menasedhim me emapory Comment == Ne Quevions Rave bees athed om Tia SGOT Distinguish betwee Distingulah between Duin einwale Bane os Pee eS Re, {2008} - Oistngussn beteeen Profi Maximisation and Vvealth Mstrisation objectives othe Fm. t [2011] — vats value maximisation objective os th? How ee 7 Hom does iter thm prot (S marks) wealth, Give an idea about the ‘wealth maximisation’ objective of nancial management. (Smarts) “The financial goal of a firm should be to maximize value or wesith’ Explsin. (5 uarks} ns wpan (a) Uk rata of earings of me ‘luo of firm = Earning (EB!) + Qverall Capitalisation Rate (WAGE ar Kol‘Masimizaton of he aval Vue of Ey Shave | Financial decision 7 ject ee ne eee | Retum—_——» Trade off ¢ Risk ‘Advantages:= ‘G). tts a lang range and wider approach (vi Starehotsrs prefer an increase inthe firm's wealth 2s against mere crea in ow af prot (villyA firm to use its fund eficienty, has 10 take help of wealth management. Disadvantages ~ : (0) Fatsto provide a dear rwtatonship between financial decison and steck price, (Gil tis 2 iengtny and time consuming process. Gi) The timing cr curation of expected retum is not specified. (Ww) The isk factor of project can not be consider property © (I The dividend potcy cant infivence the market price of shaves soldly ‘Stale two functons of financial management - (2 marks) (2O1G{G I] ~ Explain tne tree msjor decision-making funetons of financial management. Franek Manajerert i a managerial cbt tat deals with planning and cantoliag ola fs ‘nancial resources. The functions of Financial Management are discussed Below. 4. Estimating ‘Capital Required: This 's the foremost function of the financial mix of equity and dabt ane shert term and done to achiewe minimum enst of eaptal and masimite share: is: Before the setual procurement of funds, the finance manager from which the funds are ta be raised. The management can raise ‘udgetary cool, cos cota, ts! nd ratio analysis. The financial manager must lay emphasisaa ef - a = | terpauation 8 Ss lnwestrent decision and divi. * [2011] ~ Expl tne nels between Snancng of'sion (Smarks) ‘The financial goal of a firm should be to maximise value or wealth. So, "Wealth Maximisation’ is ‘dend decision dca preferred over ‘Profit Maximisation’ tenelatonghip between francing decision, investment decision Weath Maximizaton is preferred aver Prt Maximization forte folowing reasons: [201SCH)] ~ Esuciste te nt - (5 marks) (0. Wealth Macimization isa long range end wider approach See ee . () Weatn Maxcmization takes: into account the Risk and Uncertintes involved in business A sce: Te energie cil ne biness dao a. nvesiment Fnacig ad whereas Profit Maximizaton does not. *'" pikdend Oecians is “maimisaion of sharehotsers oe ie paste tices flit) Wealth staximization takes ino account the time pattern of retums whereas Profit Maximiza- eg fntargt of ase bee corso Uv markt { meeincl 2. Linkage: . ee ‘co, a company may have to expand 'de- | __(m) Wah Mariizaton emphasizes on sharholersexpacadretun and rfc ints shares (be prope vein noes er hrostrant denon ie beved ot ho ake price whereas Profi Maximization dos not i sop 8 erate ch recut nd a {(v) Wealth maximisation objective takes info account, all fuure cash flows, dividends, EPS ett. nancing decison bt Pratt Maximization has any objective of profit earning. cing decision is influenced by/ and inflences the dividend decision, since retained Oa eee Mi in didends paid to shareholders. (4) A fim with wealth maximisation objective ey pay reguar dividend to shareholders, however, {gS the tar ralasoatip betweenihe tie types of decision should be analysed joint, ene re ae inorder to matimise the shayehalger’s wealth. router for he earpon's growth prospects {b) Financing Decisions: Propet Blanding betwesn long ffm and shert Ler funds, 28 well ‘3s oem fnds ara Inn fre, il ep the fr fo rie ks vera cost of eaptal and n= (5 marks) (2marks) (8 marks} ‘a member of top management, discharge __ anf derbuted to shareholders, wealth maximisation can be achieved by retaining the funds, ater than declaration of dividend [2012]— wry is Wear Masimisaion’ prelerted over ‘Profit Manimisation’ a the goal of a frm? F (5 marks} [2013(H)] ~ Why is it inappropriate to seek profit maximization as the goal of financial decision making ? (Smacks) {2018(H} ~ What do you mean by valve maxénisaton objective of a fim? How does it ater on eee ener * (5 marks} luehwalth of a. erm i eects vet mrss rete ma niet cs the firm Sato unarne aioe e forecasting all physical activities of the organisation and translating ther in- ofa parc i Wh eral of» om "eeptsemne bythe market pce ets 29) terms. Profit méiezation is one of the basic objectives of financial management. Profit maximization {implies thatthe fnancial managers have 13 make their ina manner eucl ¢ i decisions in a fh that the weallh ‘of funds (eweslment in fed ovtats er working captl) ond timing of unas should be determined, using techniques lke buagelay contol cisions: ine the prope mic / combination of precuring funds. Funcs ca Peecon r9g2% structure {called financing decisions) should be taken to: 0 ese ee pment acter inc udaiaemnness Lowknd (0) Long lem hota routed t ran xed asc on lem vesmens 20d prove for permanent needs of working capital. Short term funds are for working capital purposes, 2. Cash Management Deitons: (a) Tee CFO has ensure fata econ ranches faces partments and uns of the tm hve aces nds (cs. 1 facia sco flow of business operators, (2) Ha shou to ensue tat ate sm exesve cash (funds) n any dion at any (b) There are various tools of financial analysis te budgetary control ratio analysis, cash flow ad fund flow analysis, commen size statement analysis, inter frm comparison at 2. Investment Decisions: {0} Funds procured should be invested / utiiced efiectively. The finance Manager should Introduction % i BEA =—s Prescribe the asset management policies, for fed assets and current assets. porte! ne. [2014(G)] —-wnatis meant by prost maxiisation of fm? (2 marks) (c) Foe this purpose, cash management and cash disbursement / transier policies should be [2044(H)) ~-Wearn maximization i dependention profit maximization” —Discuss. ($ marks) (eid down. [2016(G)) - Why snouts a fier maximize its profits ? (2 marks} 4. Capital Budgeting / Investment Decisions: (a) Funds procured should be invested / uilised effectively. The finance Manager should (0) Franc ona hes Fr esas how each funds have been tied anh | * identtying method of improvement. So, the finance manager has to evaluate financial | Performance of vanaus units of the firm. i (2 Thar are varios tos of rail nats ke Budge col, ab analy, cash Sow nd it ow ana conmon se alt ana, en compute &. Dividend Decisions: ex. is “(Te toance manager shia abst hep manogemet in acing th ee 2 ng he dona payout ‘25 stron a mouth Shou be palo shrehloe oe pak Sows bo tines Buses ea it negate wn ancl rss, tone, a cr ep. ent, and te CoparsNeqoleane ay wer ouside francietsrequie specialieed sits, = a: Untclinpes aoe 1) The Cronus mire techy a ba ater or of sharps. Ths ahs BeeeS o™IRC ends in the stack mare and judging Har mpact onthe share pce ot (©) Vale massa cbc ane gh he ara and acon [2013(H)) - How do financial 4 Fina oe ss React manager tae nang ad vest decions? (8 mark) nagement. ° 2 marks) a westmént Decislens are taken by a fnancial manager can be elaborate aia an calla aoa : oe i Financial Management one nana anal beos in 1g = Delon ‘ancl Monageren “Soya tewitesmaenty — enel—newroenencemey | a ee Unio eigen Sm MaNCe monager has to evalua financial Sa Ferien to manne weal oft owner fa cone Intahy twos te concep hal ar ‘managermentis concerned with arranging the shart tarm e¢fang orm fund forte organisabon ~Wle, 7Sone eas: Lowpoint's 8.Cam Solutions - Financia Management ¥ “Financia! management is conoamed with the manageris! decisions tnatresuits in the acquisition ‘and inaneing of short term anc long term credit fee frm™ Phiippats “Procurement af fund and their elfective utiization is known as Financia! Management” = S, Kuehnal “Finance Management is concemed with the efficient use of an important economic resources, named as copia! fund.” Solomon [2015{G}] - State reo important functions of financial management, (marks) ‘Ans. Financial Manogement is a manaperial actvty that deals with planning and controling of a firs financial resources, Financial management deals wih two basie aspects as follows: (a Procurement of Funds” () fective tization ef Funds [2015{6)] - Oiscuss me imponance of Financial Management. (6marks) Ans. The importance offnancial management can be discussed under the fllowing heads:- Intreduction 2.13 ‘performance of the firm can be measured by its financial two major factors whe ‘crease the volue al the firm and on the ether hand, financial profeailty wil Increase value of the firm, Risk and prottabity are two ensontial ingredients (S marks) 114 upon the earring capac, ost imer, Le, funds should be invested in sale ventures so that adé- achieved, should be sound and fair composition of capital x ‘and equity capital be regarded as the primary goal of financial man (Smarts) rolit as the abjactve of a fern (S marks} ‘ef financial management, Profit maxima n objective ft maximization can be a pat of weath max of Maximization of rofts ae: sk OF Uncertainty and emphasizes only profit abil er the higher ine ie rt by profitability, Higher the profs. 2. It'does net take into account he time pattem of returns. 3. istoonartoa an objective; it fis to take inin account the social considerations ‘4 Quality ofthe products fal in satisfying goal in the shot period5. Itignores social and moral otigations of the business. 6 ‘The tem ‘pros vague. [2016{G}] ~ What is financing decision? Ans. The Financing Deesion ts yet ansther cruciat decision made by the financial manager relat- ing tothe francing-mix ofan organzation I& cancémnéd wih the Borreving and sieation of funds required tor the mvestment decisions. {[2046(G}] — The actvibes of financial managers evolve taking tiree important decisions, Briefly ‘explain these decisions, (6 marks) ROB(HI] - Deterbe me tee toad areas of nancial decision making, Gr 3) a nts 4. Capital Structure / Financing Decisions: Ia) The CFO has te setermine the proper mix J combination of uring funds. Funds can be ‘poearecram vaneussoures fr shor tem along tem purpeese, (Proper balance between long term & short term funds and also loan funds Bown fund, (6) Lars tem tds ave reqared io fiage fd asses & long term ivesteny sd provide tot pernent needs of wong eaptal Shar es funds are for wosangeaphal parece 2 Gath Maragenent Onion: fe far have adequate funds (cash), to facliate smooth flow of business operations, (0) He shauta aiso ensure that mere is no meena nena (exbesaive cash (le funds) in any division at any F : mar se (6 Forti purpose cash agEmeN Bnd cash disceement ante poles should be 3. Capital Budgeting / investment Decisions: Managemert is a manageralactty that (Smarks) with planning and cial eseroas. Fiigcial mansgpmeat eens ing and controing ota iy Saascocrpat eas wth a bas ceca hows em ane Faas or ts le Ea, Peta Cop, eta Memo ik coe ana comol MOUS SOUERS Rave dierent characteris in (4) Thus, procurement of finde icles efor < * Identiicston of sources of nance Drvison of profs between cidends snd retenion of pees (ern and seneration) Introduction 1.18 2. Effective Utilization ef Funds (a) Funds are procufed ata cost. Hence, itis crucial to employ thom property and peastably. {b) The finance: manager identifies the areas whave funds remain ile and why they are not Used propery. (c) The finance manager analyses the financial impSeatons of each decision te invest in fixed assets, the need for adequate working capital te r 1201746] - wnatis “investment decision"? (2 marks) ‘Ans, The Investment Oecision relates to the decision made by the investors or the top level management with respect fo the amount of funds to Be deployed in the investment apperturities. ‘Simply, selecting the type of assets in which the funds wil be invested by the frm is termed 38 {he investment decision, These assets 1a into two categories: ) Long-Term Assets (i) Short-Torm Assets ‘The decision of investing funds in the lang term assets is known as Capital Budgeting. Thus. Capital Budgeting is the process of selecting the asset of an Investment proposal that wil yield ‘The first stop involved in Capital Budgeting isto select the asset, whether exising or new on the basis of benefits that willbe desived from fin the future ‘The neat stop is to analyze the proposal's uncertainty and risk involved in it Since the benefits fore to be accrued in the future, the unceriainy Is high with respect tots returns. Fioaly, he minimum rate of raturn ts to be set against which the performance of the long-term Droject can be evaluated. ‘The investment made in the current assets or short term assets is termed as Working Capital Management, The working capital management deals with the management of current assets Wat are highly lui in nature, : ‘The Investment decision in shor-term assets is crucial for an organization as.a short term surval is necessary for the long-te”ny success. Through working capital management, a firm tries to ‘case Ine firm has. more current assets than required, it can have an advarse atfect on the peefit- ‘abilty ofthe firm, ‘Thus, a tm must have dn optimum working capital that is necessary for the smooth functioning of Its day to day operation, [2017(H)] — Discuss the nature and objectives of financial Management. Ans. Nature of fi (smarks) H management could be spotighted with reference to the following #3 ' specialized branch of general management, in the present day- tonal times, the fiance function was coupled, eltnar wits producti being assigned a separate status. times, Lang back, ‘or wth marketing: without =Introduction Lar ‘career in management, underga specialard courses in Financial Management. offered by Objectives: universtis, management instues ee; aod take up the profession ol nancial management The financial management is gereray eaneemed with procurement, allocation and coil ol fe {ty Despite a separate status fnancisl management, i intermingled wih other aspects of man fancial resources of concern. The objectives can be- agement. Te some extent. financial management Is the responsibilty af every functional 1. Totensuse regular and adequate suppiy of funds:to the concern. manager. For example, the production manager proposing tht installation ef a New plant to 2. Toensure adequate returns to the sharchoicers which will depend upon the earning capacity, be operated with modem technology, i also involved in a financial dée:si0n. market price of the share, expectatons of the shareholders. 3. To ensure optimum funds utizaton, Gnce the funds are procured, they should be wt in Ukesise, the Advertsing Manager thinking, in terms of launching an aggressive: advertising 2 ea (programme, & too, considering a financial decision: and 86 on for other functional managers, invested in safe ventures SO Thang nate tel marepee als eats neaeng a ote Tenant oe rani ete Aevkt bs ened fete Seen 2 {financial system tor the whole enterprise: F ee se ¢. To pans sour! copal scare, Tere shoul be sour and ft composton of toa! 42 (Fancast sien i proche ar cas, See ena ene te Economies conte fora beter portent and leaton of ances leo For exami, mac enanic ees tnencal manajenert = beng and facil nt- ST 0 geneienten ei ie Pelee ‘tutions, eapfal market, monetary and fiscal policies to enable the finance manager decide ‘about the best sources of finances, under the ecenemic conditions, the economy is (a (G)] - Sete four advantages of value masinhization* cbjoctive ofthe firm. Who is a "Chief essing Brough. Financial Officer"? (¢o2=¢ mans) Micro-ecanomics points out to the finance manager techniques for profit maximisation, with ‘Ans. The fundamental differences between profit maximization and weaith masimization is ex- the imted finances: at the disposal af the enterprise. Accounting, again, prevides data to the plained in points below. france manager for better and improved financial decision making in future. ‘The process through which the company is eapeble of increasing eaming capacity known as Prot- (v) The finance manager is often called the Control 1. Maximization. On the other hand, the sity of the company in increasing the value of its stock en tame ef contotersip inca inthe market snow as wealth maximization ‘9nd implementation of pians-thraugnot 1, Profit maxenization ts a short term objective of the fim while the long-term objective is Wealth The france manager, very often, is a hig Monmizaten, ‘Team. He pertorms & trinity of roles-that of. * or 2, Proft Maximization ignores risk and uncertainty, Uniixe Wealth Maximization, which considers bath. cal deans unending subordinates twoughou! the enterpise in mates requiring nan 3. Profit Maximization avoids time value ol money. but Wealth Maximization recognises it Tae ae ana tac, suageaing Be best nancial plans, pics and rovedures 4, Profi Maximizaton is necessary for the sundial an growin-of the enterprise. Conversaly. bc edreaiaed ‘Wath Maxmizatonacclorates the growth rte of he enterprise and aims at ataring the Management, viet ot eae i tenty of the fnanen manages is defined by the Top ‘maximum market share of the economy, \¥erw of the role desired of him- depending on his financial expertise and the For a business, iis not thi system of ogeizatanal cloning For pearees RS re reoeasar a specs tke nereaeing ‘Caspase nd ry abot decentaation of authori: nance ater tbe foun st prottabilty. So, we-can say Mal prof rasimizaton sa subset of wrath and being 9 subeel,& mney being cee rDraes whieh are 80 called highly decenraised. The reason fo a wil focitate weath creation, comaie ie pineal meters npc, a8 every Tom, Dick ond Harry man- ‘Giving protty to value creation, managers have now ehitied from tracitinal approach to modern poopferespaioy er finances, the way halshe likes. Finance is both-a crucial ‘ppraach of financial management thal focuses on wealth maximization. ee rege arey# bl amt en sng wn cna Derg bea ett Na preducton, purchases er 08 the emeging ole tthe che financial manage i the pagan bus isos lly Peeted atthe top of nance department of an organisation. He acts Hk finances. Hone, Fnanil Manspemerteore a era dy supported by requite nance. He has fo function in co-ordiaahan with chet acounant and assistant ional areas of genet manager ae higher satus vs-mvi all other fune- manager Al dei inking management nds come unde te pure of Farce Meand ting of ines rarpose of funds (resent in fed asst oF working capt) (Le. when itis required) should be determined, using techniques ke budgetary control ‘anda range planing ‘ (e) Tis cal for forecasting all physica! acts ef th organisation and ranting them in te monetary tons. ‘2. Capital Structure / Financing Decisions: (a) The GFO has todetarnice te proper mic combination of procung finds Funds en be procure from various sources fr shat em along te purposes. (@) Decisions regaring cops (calcd frarcig decisions) should be taken to prove ‘roperbalance beeen fng ean & shart term fnds and also lean funds own fund, (6) Lang term fonds ate require to france fued assets & long tm ivestnls and provide for permanant neess of working capa Short term finds ar for working capal purposes. 2. Cash Management Decisions: * } The CFO'has to ensure tat al sections / branche ovine fepartmants and uns of the fim have adequate funds (cash), face smicch ow f business operations i (@) He should also ensore tnt tece i no encessine cash (tle funds nary vision at any point of me (6) For Bis pupose, cash management and cash sebureemént | Vansler policies should be isi down | 4, Capital Budgeting I investment Decisions: (8) Funds pocared shoul be iovestedF used atectvaly. The faaace Manoger should PresoBe te asset management ples, fared assets apd eure sels, {0} Lang teem fans shoud be invesied in hed aeets | projets areata taxiing and ! in permanent wartng copa ater estinatngrequcurents cael. | & Fhanclat Analysis 1 Perfermante Evaluation: | (3) Faecal anayss helps i assessing how eflecvey the funds have been lized and in ening metod of eproverient So, the france manager has Wo evslite teres performance of various Units of the flan, (P) Theve ave various tools of financial analysis Ike budgetary contr, rato onal cath flow and fund flow analysis, ‘common site stslement analysis, inter tiem com shy , & Divkfend Decisions: ae tee (x) The foonce manager shoul xu the tp management indeciding the dhidend fs eteton rato Le. wet snout ol @veund vou be pls boar er amount shouldbe vetaines nb business sel (paca cactions depend wpon tats le rend of args. equement of nds ter Aa pro: ‘atin, Wed of shore pies ard tax babi ef fem 1 share. introduction 19 SO 4 Market impact Analysis: {0} The CFO has to monitor the siock exchange and behaviour of share prices. This inrlves analysis of major irends in the stock market and judging ther impact on the share price of Whe fern. {201@(H — Do you think tat the profit maximization goal is an Operatianslly feasible criterion? Crtieady expioin your view, é (5 marks} Ans. The basic motive of a business is profit @arning, So, the finance manager has fo take his decisions in oder to: maximise the profs of the business. Profit maximisation is a basic and long tem objecttre. Hence, profil maximisation is essential but not sufficient. [201816] ~ State ovo detects of prof maximization abjectve ofa fem, (2 marks) ‘Ans. The detects ol profit maximieaton objective of a firms as follows: (8) Hancre Risk or uncertainty and emphasizes only proft ability. Higher the prefl higher the risk (19M ignres socist and moral obligations of ne business. Practical ae, tg Soe pee ee I ee ty Se Ne Questions Fave bean ated fam ts alegaryCHAPTER Basic ECE TS {important Notes & Formulae) ‘Time Value of Monev (YM) |. Basis ef Time Value of ttoney Concept: The present worth of a ruoee received Piles thereby eaming income Moreover in'an nfatonary period. a rupee today purchasing power than a rupee in the future. Again, since Kure ‘9 characterized by Uncet- tainty, individuals peefer current consumption to future consumption. 2. Compounding and Discounting: terest is paid in a year 1s Rate of interest per annum(a) Future Vale of Single Cosh a Future Vaive of an Anni R= » dear crate ol rotum n estan (0) Present Valve of a Single (8) Present Value of an Annuity Where, A= Amount, a =:n0. of years, R= rate of retum on investment Perpetulty Formulae: PY ol 8 Constant Perpatuty «C1 R. where, C= Cash Le. Interest, Dividend, ote. Per period te per payment period PV ola Growing Perpetu where, terest, Dividend, ete for the fest period payment period = Rote of growth in Gash Flows Note: A stream of cash flow at a constant rate forever ie known as Growing Perpetulty M-MACOs, FFI iv hie Blanks, TIF-True and False, SN-Shon notes, G-Comment, D-Distnguish Between, €-Elaterative, P-Practical ‘Multiple Cholee Questions No Questions nave been asked from this category Fill in the Blanks No Guestions have been asked from this ealegory. ‘True and Palse/ Correct and Incorrect have been asked tom this category ee — ——— ‘No Questions have been asked trom nis Category. SS Distinguish between oe Ee No Questions have been atxod ftom this calegory ‘Plain wih example the compounding technique and tha decounting technique in res- e valve of maney. ‘Szarks} £2010] - State ne compouncing and scouring techniques oftima valve of money. (Sars)Eee Bia Basie Concepts 25 [2049(G)) =Wnat do you mean by ‘ime value of money” (2 marks) 'Ans. Meaning; Time Value of Monay (TVM) is defined as “the vabue dived from the use of mon ‘gy over lime as resull of investment and recivestment TVM is a concept which states Mat. worth TrOtai inure crac res utd with va of Rony? nor i . _ Loree ested ys cate mw warn ope tbe econ ore’. The pre [ZO16(C —Citerenike beneeen creaming and cacsuing wchiges, | ENS tron ter nrey ton at angared one Maney, xo o Tene Preece of More ‘ins, The cancent of TVM Reps in ving atthe comparable value of he diferent rupee amount Reasons for Time Preferonce of Monoy: ae ot pet ns ecu aes on pee pt ine Sh (Rak Tow wre arcana qatar kev over ee. Furtar, ere wc f = ‘ ea tainly about the receip! of monay in future, The longer the time period af tums, tne greater ra eye pcset money fe 8 hare date ie Trdg out ue ae of presen Sion he aan lon: Mest person f companies profer present consumptan jweto Urgency of noed (say. consumer durable) or ctherwise: {€} inflaton: Infation erodes the value of money. in an lnflaonary situation, 2 rupee today money, oF {op Diseeunting future money ta the present date ie. finting out present vakse of future meney. revious eamed intorest and as well a8 0n portunities for eaening siitional cash fo. Mothods of Analysis: The concept of TVA helps in arrting at the comparable value of the dit erent gupee amount arising ot dferent points of ime into equivalent aes ot a parculer point of time (Present or Future). This can be done by either — . [Note: The Future Value Table can also be used for calculation [ab Compounding tie present money to a fuure este Le: finding out future value of present Bample: mor fe) Me. Shankar Lal makes posit of ¥ £0,000 wan Super Fund Bank Lid. Interest is 1e money to the present date Lo. finding out present value of future money, (O) Ur. Desai enters into an agreement to deposit ® ‘iar who wil asow 8% interest per aar 0 per annum for four yeers, to-a finan ‘and repay the amount af the end of four years. 12008] - Explain the concept of time value of mney with examples. (5 marks) [2009] — wae note on Time value of money (5 marks) [2011, 2043(G)] - wnat is Tne valve of money? (2 marks) I] ~ vinat i time value of money 7 ¥Mat i its importance in fori term Frsneial decision alte imporarc tie ala money? ee ae sp amasie cages een: ner =a Lawpeint’s 8,Com Solutfons — Financial Management 26 ‘A fundamental idea in finance ia the relationship betwoer rsk and retumn. The greater the amoung cof risk that an investor is wailing bo take on. the qreater the potenti ef return. The 1e3e = (this 1s that investors need to be compensated fr taking on addtional Fisk. ‘There are three types of risks associated win financial management foaws: [2018(G}] ~ Name two principal components of finacial environment ‘Ans. The fnanesl envitenment is composed of thee kay components: {) Financial Managers: Financial managers are responsible for deciding how to invest a com- Sarecapo pcs Tus seit onmon fer re tan fact ation i aos he si tonal ines whe anche Shri ston eames 2 he rtermery by conelg tne that Vansters funds to 8 firm that needs financing. . Proceeds Hom selling the stock. Thus Paenet tmnt ei et cn a i eS Basic Concepts 27 [2013(G}] — Explain the torn ‘ise retur trade ot, @ monns) [RO16(HI] — Bviety state me concept of risk and ratum, (Senacks) ‘ns. Rick roles to fucwation Risk is the uncertainties ox Nuciuatons in expected goin or benef. Return isthe gain ot reward. Rik and retum are inked, in a probobilistc way, High risk ray ‘ive you mare return and vice versa. AS Fisk and retum move inthe same direction, instablty ‘aciations in what we cherish io ebiain. Variations in sales, pret, capacity Ulizaban, Rquisty, seh vency, market value and lke are relested 16 sk. Business tisk and Facial risk are prominent ‘among diterent risks. Business rik refers to variaion in proftatilly whte financial risk retars to \oravon in debt eencng capacity. The business cisk alternatively, refers 19 variations in ex pected retums. The tisk-eism tradect bs the principe that potent retusn rises with an increase in ish. Low tevels of uncertanty jowesk) ace assacialed wits low potential returns, whoraas high levels of uncertainty (Oigh-risk) are accociated with high polenilretums. According to Una fse-eturn tradeoff, evvested rmaney an render higher profts only # & is subject to the porsibaty of being lost Beeause of ho risk-eturn wade, you must be aware of you pertonal ek tolerance when cheaaing Investments fr your portiolo, Taking on some Fisk is the prick of achieving rewms; therefore, i you want la make money, you ean" cut out ail isk. The goal instead isto find an ap proptiate belanca -one thal generates Some prof, but stl alas you to sleep at night [2013(H]) —-Give a riot idea fegording nancial environment of a business. (5 marks Ans. ln india, the financial environment of a business is influenced by growth af managerial par ‘considered necassarily only for equiation, liquidation ete 2 ‘considered to meet the days day decision makina requiterents of top level management, lke, fund analysis, fnaneiatplan- In this Phase, Financial Management it. viewed a8 a supportive and tacita- sinesses for financial retums. Markets represent the financial envionment {hal makes this il possible = Histarically. firms were very smal of even no ‘few frm have always baen in existence, the abity for alge numberof ims was ot posse ‘atl markels became mare mature. Mature markets allow for mace access to resources neces"28 _Laupoint’s &.Com Sotutions Financial Managemen, S077 to produce goods and services. As fers bepis 1 grew, ¢xpand, and muti. OME capi, ‘needs lo persist in order for fms to succeed. Capital sourées nett money trom outside pag, such as vemos ‘Many times investors are individuat who have more apa than is necessary 10 provide su cient living standard. Any excess capital can actually make indniduals more money f they invest the funds into. frm hat ofers a francil rir. Ths symbiotic relalionsivo in te Enna er ‘onmer abows both paras ta Increase the captal. Many aiferent factors play a role for na. viduals making Ivasimans. A faw af eee may ietude risk, curent market conditions, ang competion, among otter, “The ast player in he financial envionment isthe marke. Maviats represent any place where se fers and buyers can meet together and exchange lors, la mest eases, Lie excRaNGE IS €Spdal for goods at services. Markets may be local, repional, of international, depending on tne e&sn- ‘emg, Free markets tend to have fewer government repuloions, along lor an increased ex. ‘change ef ge0ds due to lowes Irensacton cass ‘A financial emizorment ean exatanyunere £0 long as he major players exist in the eeanomy Newer meskes lee to nave fewer resources ana tower evel of ecenome acty vet he tac cf resouces. The facial enviar isso wbject to he buaess G8, wre Get the stages of row and decine m tha economy. For exampie, when a new fnaneia! mapal oF en Xo resources, as bw ably o iow and expand as bi players see ft 3 mavket ie satraled wih goods ant earvices eu to 9 ack ef demand 1) — Wat sanity? (2 marks) What is annuity? (2 mares) Wat is ‘anny? amos) . An annuity is 3 contractual financial product sold by financial insitutions that is designed to scoept ang grow funds fom an individual and hen, pen annutizoton, pay out a sticam el pp ‘ents to be incvival at alata pont in ime. The pero f tme when an anny is being furces snd belore payouts begin ks refered tea the aecuriatan phase. Once payments cammence FRO18(HI] ~ Explain the risk coturn rela ine context of modern tusiness envirenment Ans. To iow msi bean fh deny be main epi tay net ae, srr seas tes fo eth a ta Bat cca ee icbaip “ons ecto te" cn, manage’ he meee ae Ou at cas th cna lon wit ppl anon Sas Ae cae sono betien fh ne ns 0 sy the tof exch ober ‘We measures the effect of inctease or decrease fi veneer nee sk en retum of tuestmeat. Felowing fie Main lype at relatianship of risk and ret et ae wil alse decrease,Jon: Mest ofthe persons and the companies Mas a pray faure consumption eer BECAUSE OF UTENCY Of eng 2 Most of the persons and the éarm lables of opportunises of investment (4 mars) broad tem dascrbing any merketplace wher trading of secures e forex markets rade tions of dollars of secustes daly Present value of certain sum of money is mote valuable than the futu ‘the same amount — Expioin with reazens ANS. This is quite practical phenomena that price fet any! incceasing trend of inflation and as a reauit money loses is ef ‘money represents principal senaunt which is exclusive of inlecest Ifyou invested seme a ‘money in any of the investrseat proposal and want io-get back your money a ‘you will have to.requice some axiditana! amount along with your principal se ‘neva ot mane. By comparing e resent value eye retum slong a ‘imecmen ta nominal asf nate retum you may ake Gecian wnetner ts wary c ‘ot Sa fe coetion making purpose i's adit to cna presen ve of money ater bss stu awe as seal. Hence the prosen value ef cen sen al money is more cotati the future valve of the same amount. ee igs ee [2007] - Nava is offered ethor ta receive 75,000 one. 7 Yar fem now ore years ‘ew, Which one Naba will accept and wil accept and why eee 3. fo 3 years. Compute hature v8 (2 marks) (2014) A sum of © 5,000 is invested for 2 years al 10% interest rate compounds Find the maturity amovat. ‘Ans. Maturty Amount after 2 years 10% biennwally — Alvader deposited € 4,00,000 in'a bank @ 8% p.a. compound rs? [Compounded value of € 1 for Syears @ 6% pa = posal, She wanis to get her money doubled est in compounded @ 12% p.a, annually, then how tong she has to wast ofl ner desk? wall for more than yenes then what showid be the 3 imate rte ofMr, Ghattacharya borrows %18,00,000 te buy a bungalow in Riajarhat. He wants to "repay this amount in 15 equal anicual insakmens, The logo has been taken from 9 comenerciat ‘bank which charges interes! @ 10% p.a. Whal is Bie amount of each annual instalment? (Py). FRcaut7 O00) (8 marks) ‘Ans. Amount of annual instaimant = Present Valve / PVIFA et {2018{H] ~-You ae arproacnod by snineuance agent to be r wean gent aby an any ot $9:00for 8 years sting om te tegen of re na. Haw hh ou held be ready py now otis, by you coir a Guzman tot of pt wou? (Sivas) = #231425 (pron [BO1S(H ~ tir. x ovesieg © 50,000 at an ietrestof 12% pa. lor 3 years. Yu are required to earnpule ture value of investment ageing toes 's compou a coor indies quarterty (marks) c) ([2016(G)] ~ Aenal wants to invest compound interest interest accruing at the end ors, He invests the amount af 1 “amount at 12% per annum ofeach querer. Wot amount wit ha receive after : (5 marks) i 233 [2016{H)] — Ne, Chiko is offered the folowing cash inflows: Asnaunt (8) 15,000. 20,000 32,000 20.000 Calculate the ameunt recolvable by Wr, Chiko ihe wants the whole amour ai the en TApplcabie interest rate bs 10% p.a. compounded annually] ‘Ans, Ameunt receivable atthe end of 4" yeor ofa? yar (marks) [2017(G)) — De Karyotc given ftw tno onions by his ermpoyer ate ane otis retirement ‘Opton | — Aa annual pension of 80.000 a long 9 he lives ‘Option it — A amp sum payment of 3:00,009 Ihe expects to to for 15 years and time preforence for monay i 12%, which option should he senso {Given PVF 88941 1 annual penaion oft 50,000 is = 60,000 . of € 46840 Optin I 0 De. Kania should go for Option |. {2017(t)] - x borrows t 69.36.000 fram Y at a compound interest rato of 42% p.a It is agreed that the foan shal be payable in two equal instalments whieh shail be payadie at the end ofthe spectively, Calculate the amount ef instalments. (marks) [2017(H)] =e. H is oftered either to receive T 10:000 three years from now or € 14,090 tre years from naw, Which aro Mir. H will accept? Assume rate ol discount is 10%. Aen: Petot ae at 10% or 0.78% nd 1621 fer sand Shyer cepa (Emus) 1. Am PY[2018(6)] ~ Mi ¥ has two options Option A: Receive § 40,000 two years from now ‘Option B : Receive € 60,000 seven years trom aow {a} Which one shouts Me. Y choose df the clscount rate is 138? 44256 marks) ‘Computaton of Present Value of money received @% Option A 40000 » 6880 = 35800 Option & 60000 = 01865 = 30900 onctusion: (2) Option A shall be chosen. (b) Option B shat be chosen 7 Comma he dace rm er pra we ie vy eer pe ss. nes Cus obs bare tk ceerrmts a 78 Se aoe esl oa [2018] ~ U4 x retres 1 he age of 60 and Oot on 8 amp sa 0212.00 on ever way mn MBPS 1800 per year tor ret of hi Pe tae oles 9% pa. and Pin Hence there sa es 0 9150 eee one, Sof. X shoulda wih ‘option twa, 215 {¢84,000 and 10,000 at ihe be- (6 marks) Future value a) so.0x2 16.260 2.036 17820 i LR [RO1B(GY — Hf re nominal rate of interest is 12% pa. ond intrest is pai four es in a year, what wil bo te effective rate of intarest? (2emarks) ‘Ana. A= 100{1 + 0.1208)¢= 112.55 Therefore, fective rate of intowct = 112.55—100 = 12.55%. ‘Additional Solved Illustrations {TL Alage 25, how much should one invest each year in-ordes to have & 1,00,000 at age 407 As- g cash flows using a discounting rate of 10%. ei ® tooo, #000 F ‘sisPresont Value (253) 909 820 25 1.388 1.963 654 513. 497 24 3a 350 319 4, An kwestent of & 1,009,000 for 3 years in a bank yids simple interest a SS TERE oS j.00000 for 3 yeas bas yas gsm t 93. Wi be Ans. €27,000 and €1,27,000] E 2. Aninvestmert of €3,00,000 for 9 mono a bank yes an amount of, 16,875: Fie ines ale 3, Anlinvestment of 25,00,000 in a bank yield an amour of Es Soh hen te ne nae ent ot 770000 he ees tas a kr pe lara compte ype. Te ‘quarry rata wn eflocove annua reso wr sme eee oa want oa tery rate, Find the effective annual rete of interest. ‘terest as in ca: fans, 8.26%) 5. Caloutate he compound interest €7,00.000is invesiog [ae aan, (0r 3 years at 5% compounded quarter an7 * Basle Coneapts 6. A porson required to pay four annual payment of 84,000 cach in his Deposit Acrount thot pays 10% intrest per yar. Find out the future value of annuity atthe end of 4 yesrs- 7. Me. Nayak is 38 years old. He had decided ae area yes unl De ie 65, he wil save 810,000 In Retirement Account. fhe account corns 10% per year, Ros? much wi ie have saved atthe age of 857 {Ans £9644,900] [XY Lid has aed Bebentues of € 50 lah 10 be repaid after 7 years. How much shoul recampony nvestino sinking fund anning 12% inorder to beable repay debentures? Ans. 24.5,5831 Ramesh has taken a 20 month car fan of 600,000. Rate of neces 12% per annum ‘rat wabp te amount of moet oan natant? ans. €33,249.10] 40. Find the present value of following cosh flows using a discounting rate of 10%, : 1-4 5 6-10 11-74 7 2,000 500 3000 000 z e[7y*ey]s sai | oses | asia | one7 | cara (Ans. €20,482]>>———_—_—_—_—__ = B.Com Solutions ~ Financial Manageman, eats SOURCES OF FINANCE AND Cost OF CAPITAL (Important Notes. & Formulae) FAST TRACK REFERENCER 4. Abutiness may have long term, meciuen term andlor shart term financial needs. 2. Long term fnancial needs rater to nagd of funds for S or mace years Eg. lavestrent in plant, land ete 3. Medium term financial needs reler to need of funds for ‘expenditure Shor term fmancial needs are required to finance current assets (for less than t yea). . Equity shore capital, preference share capita. retained earnings, debentures, bends, term loans, asset securiization etc. are examples cf long term sources of finance 5 years. Eg. Advertisement Pubic deposits, loans tram commercial banks, lease Brancing, hire purchase. euro-Ssués. fareign eurtency bonds etc. are examples of medium term sources ol finance. es x oe owe cal incrvals. From the lassee's point tion of eliminating iepmediote cash o. "and Bonde: Company can ese funds rom puble by leslig deboriies ying win applicable legal requirements, Debentures are issued on the ta. sia ears Tun Dees aye denn ey coor eof sue. Features: {2} Issue of cebontwes is govemed by Companies Act, SEB! Regulations, and related Ly, {B) Debentures are normally secured against he assets f the company. {c) lnterestrate on debertures i lower, compared to pre. Dividend ale orcost of equity, (6) Debentures can algo be issued with new ivventive schemes lke warrants, options, coy vortbaty, te {6 Cretraing compulsory for pu iesu of ebantures ofa placement bl mutual fire, 1 may be classified into — (1) Fully convertible, Partly convertible, Non-comvertibte, (2) Receemabe, medeemabie, (2) Secured, unsecured, el, Advantages: {@) Coste! Debt Capealie tomer when compared te Equity of Prelerence Capital. (0) Tre gearng or leverage effect ie sovartageous for companies win geod Return on Cap. tal Employed (ROCE). 46) Debenture Financing does nat result in sivtoa af canto Disadvamages: (2) Ocbenture interest ang repayment of capital are obligatory. (} There maybe restive contions ina Debentute Trust Deed. (eh The cate of interest should be leas than or equal fo the rate of interest on nstitora! loans and interest can be paid only after payment of institutional dues. Distribution of Marks Dajectives Theory Prectiat ] reat aT rl m@ypmype lore e on 7 i _ 2 o 10 = z a 7 o a 70 z z % = = TF Tron ond False, SN-Shor notes, @-Germent, O-Distinguish ibebenan E-Savornin Pree Multiple Choice Questions ‘Multiple Choice Questions 000000 [No Questions have been asked fram tis eategory. Filla the Blanks pela the ani Primary dealers. sue CP to enable them to meet thHence Commercial paper is a sho‘ teim unsecured, promissory note issued By'@ Company, nq. = @atiable by endorsement and delivery, issued at a discount on face value, and redeemable a jy {face value. The difference between the intial lnvesiment and the maturity value, constitutes py. income ofthe investor For example: A campany issues a commercial paper each having matuity of € §,00,000. Thy investor pays (say) & 462.850 at the time of his investment, On matuity, the company pays ¢ '5,00,090 (maturty value) to the investor. The commercial papor If $2id 10 be issued al a discayn, ‘f€ 17,190, which consitutas the interest income of the investor. £2008] — Wwite a note on the popularity of trade credit as source of shortterm finance. (5 marks) ‘Ans. Trade credit represents the cresit exterited by tha supplier of goods and services. It fas {les the purchase of supplies winout immediate payment. This is commonly used by busines, ‘otganisation 3.8 source of shart term financing. It is granted to those customers who: have res. ‘sonable amount of financial standing and goodwill On an average, lade credit accounts fox about 40% of curent labilties £2003} ~ Conwersbie Securitas (2) li may be fut} or party convertible. The non convertible portion wil be redeemed at the tine of conversion of the eanveribla perben, (b) The holder of such secunties shall op fr its eanversion in due time, {€) The conversion price and ratio shallbe disclosed at the time of issue. (6) The conversion price must be fixed and higher ihan market price (Le. at conversion premium) (Cumulative Public Osposits (Maturity value inclusive of total interest onthe initia! depos & paid back by the company aller a speciiod numbers af years.) (i) Fixed Public Deposit iinierest is paid annuaty) [2012] — Finance Lease and Operating Leare (5 avis! Ans. Financial ease i an agreeriento france tho use ef equipment for " ni fora major part of its use! We tis ao cated Capa Leese estate ta een doning Ree ee a7 ‘Sourees of Finance and Cost of Gapltal x rating Lease iit doos not secure forthe lessor the reoa¥ery Of CaP: Joase is classified a8 an Ope eae? a enema tung mesic, cringe less em Te orm of operating ease “shorier than the assets ecanomie Hf mi [2044(G]] = Bator Exchange nen ‘Ans. A Bil of exchange Is a nonntorest-bearng writen over used peimanty © SES aint rig areiunuea bys bane er ‘opm ae ry vmod seston, " Sena gat W toy ae saved Oy mais, ey can 8 TPES ch shareholder remains constant. [2014(G)] = wo a nate-on Lease Financing [2018(G)] - Lease financing (3 marks) 8 marks) sssets and goeds which are used in of finance provided by banking and % Lessor acquires the ttle to the asset by paying full value af the asset, and grant the lessee an ‘exclusive right 15 use the asset 3. Thelessar does nat transfor tite of oumership of the asset to the lessee. ‘4. Tho lease contact mentions the lesze pried, which is lower than the economic le of the asset 2015(6y) - Operating Lease aun {2019(G}] ~ wnat operating ease? ‘nial Ton of oeetta lease Is a conct that allows forthe use of on asst, bu oes st corey of he asset. An cparatng ease i not captalzed, is accounted for as aren rr38 Lawpoint's B.Com Solutions — Financia! Mant tal expense in what i known as “of Balance sheet financing” For the lessor, the-2s80! being leased is accounted for 0s an a3set ond is depreciated as such Operating leases have 12x incen, fives and da not resin assets o ables being reconded on the lessce's BBMINGA ENGEL, which ‘can improve thelesdee's financial ratios [2015(G)] ~ Sweat Equity Share (3 marks) ‘Ans. Sweat Equity Shares means such equity chaves az ae issued by a company to is decors o ‘emplaynes ata discount oor considoraton, ther than cash, fr provi the know-how or mang avaiable rights in the nature of imetiectual propesty nights or value additions, by whatever name cates, ‘The issue of Sweat Equity Shares is subject to the following conditions: (1) The Sweat Equity Shares. should be 188 of shares already issued, [section 54(1}) (2) The issue of Sweat Equity Shares ts authorized by a spacial resolution passed by the com pany in the general meet ‘umber of shares, current market pre, consideration any. ana the class or classes of directors or employees fo whom such equiy shares are ta be issuee {section $¢1,03) (8) One year should nave ola tho date af euen iu, since tne date on which the com pany had commenced business. (Section 5441} (8) The Sweat Equity Shares of a company whose equity shares ate listo cn a recognized stoc) ‘exchange are Issued in accordance with he regulation made by the SEBI in ths Benall, [See von £4(71(4)] [2015(G)1- Debenture (3 marks) ‘Ans. A debenture is atywe of debt insturrent thot is not secuted by physical as ets or eolatera Debentures are backed only by the general credit worthiness and reputation of the issuer. Beth rerperatons end governments frequently iesuo ths type of bond to secure capital. Like other types of tonss, debantures ave documented in an indenture, [2018(6)]- Pioughing back ot prott Iner depandence on funds trom exeal sources order fo france Ml regular Business 202+ ‘Such 9 ovtee of france may ba used by te company fer the oowing pUpeseS For expansion and growth of he business {For strengthening the faancil postion of he company +) For meeting various waring capital requirements of the company + For redemption a ot debs + For replacement of obsolete assets and modernisation 12018(G)] —_Cormutsive and nan-cumviiveproference share. (3 marks) ‘Ans. Cumulolive Preference Shares; When ungoi civiends on preference shaves ore teste? as arrears and are cated forward io subsequent yours, than such prolerence shores ore tne” 39 Ee inininigie crate preference snares Kmoant unpaid dividend on auehaharess ecu 4 eet cram gy a et Taner ternary ean naar weae ataaer sora Rycerceer nee eienatowram ped capta base 0 in case o uty ean here is leveraging oF gearing edvantsge. + To Dertunses to banks fo atocate me funds properly OO Comment Somment No Questions have been asked from this category, errr. Distinguish between Na Questions have been asked trom this category. Elaborative (5 marks) (marks) (Samarks) ‘The ICA has ised the accounting stand: a lessor conveys to the lessee. in retur of time" Under section 324 and 324. tis a contract ot two partes (.0; lessor and lessee) 2. Lessor acguies the ile tothe asset by paying ful value of the asset, and grant the laste a, Lessee usgustbe Case eras oe tmnt re neste tb bio {ear unc ea ona Ita can ca ene [2007] = Win te rts deri of coi sven ‘Ans at) The dobre holler ange ouraray ov ehavickerh Decora (li) Easy way to get voting fight in the campany. (iv) Getting adcttonal benefit (as it eomverte into shores higher than market pete) Demers: Conversion of debenture eo egy shares may ack be benefit ts the debt hades ster conven each debentures requres the neath of the debertveheldess, Ths hagpenn# £2008] — Financial lnsttusons in India play an important role in providing long term finance Yo ne company faising deposits has to simply give receipt to each depositor without having huge legal loemalves, 2, Economy: Interest paid on pubic deposits is lower than thal paid on dobantures sit se Gage on aunt: ue depen are inca ahd Bares, orate a7 ‘of marigage on the company's assets erin reac hemi inte companys trancl sirshan R rc na ep a wen eure cee eet tree na enaon of sarki cats Because e pontrs have no vating rights. anceps ny windy epost whee ay eal ss soo Ne et ere tsar vcwrin aurrtaio ture o ance ennai ytound nna of nds can be raed trough pubic copa die lo teplretiona " arrestee: Tee maby ped of pubs gaps shar, 96 pube depts are To pat suc trance rina eae er tin conceme ew crraies lading yuna ct sang eam 3 Pa oats vest ea hao Copost mane with woh compares. s¢ tres Rapa: Pub peat do nt appel an a ode fiver old nvexor tovenentl ge [2012] — What do youmean by Term Financing’? Write dow fs features brief. rem Prenchg aed am sue trance licen gow used fang ot Sos ype al cng eau 08 Be igatery on tha part of the borrower. rate is negotiated between boreners 9 «ts matutly period Hes between 5 to 10 jetted into equity af the option and according to the terms ination. ‘Dicuss the advantages and disadvantages of ploug! isadvantages of ploughing back of proft. (5 marks) Ans, Advantages of ploughing back of profit — r 1. Convenience: Goawenlenca: Retained profs are the most economical and convenient source of fiance. 2 Na CrETsemencx Prospectus hs tobe issued, No expences or egal oats atiohed Coraeiey On Assets: No charge or morigage is created on the company's assets. The any 1s 08 fo use is assets for raising loans in future.3. No Obligations: There is no feed burden of avidend and no abigation of repayment. lained profes are the company’s own money. ‘Soodwil: Retained profs at he fancal seength, credibly and earning capecky o the lwsiess. The company's borrowing capacty is increased, Kan sully face business cing 5. Growth and expansion: Retained pros are very usellfr financing now rejects and ex pansion of business These ore atso necessary for novations and development of new prog. cis which are exsentainindustnes ike phacmaceuteals. Disadvantages of ploughing back of prof 1. Low Divicends: Pughig back of rts veduces the etment rato of ivsends, Ths may res, in ssotstacton amang te sharehoiers 2s hey do not get he expected rate of dnd 2. Speculation: & company having large resarves may prompt ls rectors to induige in spec. laton in te prices of ts shares. The decors may change he Gvdond rate 10 create pce changes in et favour. Such prize futuations may resut in nes forthe shareholders. The Rate of In- | preferable terest on Debt Under DuPont Model, Rotuen on Capital Emptoy Net Proft Margin = Nét Profit Capital Turnover = __Tumover__ Eepital Employed 4aEE (a) When sales changes, remain constant. prosass nage oe ‘wit be applicable and hence, the perce decrease in sale. This Is te adverse effect of operating ace, woes SOhangein EIT _ Contribution “i Changein Sales ESIT _SEBITIESIT , KEBIT | Sales ‘BSalesiSales SSalee EET per, Hence, the lower the DOL. ine > ave the BEP, to avoid the Where, ROCEAT = Retum on Capital Employed After Tax'= ROCE(1C0% ~ Tax Rete) iy above theei 45 age nd gt rar es FINANCIAL LEVERAGE "5 (COMBINED LEVERAGE Financial Leverage is defined as the ably of a firm to use fixed financial charges (Interess,j, risk of a firm, Le, Operating 48 Lawpoints B.Com Solutions = Financ Manayeme,, oft) interest mi cof changes in ‘operating fami's EPS. - measure the total (DOL). Effect of fed interest SER irae eet (ements eco, a ee) me tn coed tos (a) Finandial Leverage occurs when a company has debi content in its capital Struchute and figs chaeges (Hanciol sks) is ome financial ea eres on deberuren, These fed Marcil charges do Mol vary wm _mensuedbycombinedleverage (DOL) saggy the EBIT. 7 and are to be paid respective of level of EBIT ‘The degree of Combiied Leverage ( ae {b) Won ces, the Interest payable en debt remains constant and hence, retiduny a, -_wonangelnEPS ‘earings avalable ta equity sharehoigers willalso netease mae than proporionatly 3 Change mn Sakes (c) Hence, an increase in EBIT wil lead to a higher percentage increase in EPS, This 4 OFL= 2Changein EPS 3% Changein EBIT ‘on EBIT. DFL measures the im- os . wes. ‘impact, i.6., effect of change in i rere ett on EPS DL none . "ifthe eBT ERT a eee ees Wises ala lon wrens heen wind e 20% (0 2 a ‘increase in EPS. InEPS _AEPSIEPS _ AES. EBIT inEBIT OEBITESIT EPS " AEBIT AEPS . EBT 1 1 = » Bre. » seem AEBIT” EPS BEGID@EPS " EBS 1 EBIT sts cor 287 op art ort Here, AEBIT = Change in EBIT and GEPS = Change in EPS. Significance of DFL: a. Effect on EPS: DFL measures the im; (is 4 tres, it implies that 1% change 086, EPS increases by hange in EBIT on EPS. Suppose DFL of lead to 4%5 change in EPS. Hen: 45 40% Also, if EBIT decreases by 544, EPS falls ed financial charges: OF depend on magitade of terest ans eet fino charges. if these costs are higher, DFLis higher and vice-versa rte, (DFL: If BFL is high, it impbes that faced interest charges are high, This means "2 Whather: pt = i sks are higher. lo ich 2 ea, te fim is used in honowingfwlng eb! Bes swords te level of EBIT that results in equal EPS for two. diferent Financing aption i termed ‘only when tis able ta ear ata rate higher than whatithas to pay towards inferest on debt 4. ROGE vs. Interest Rate: DF. is considered 1 be tevcurable or advantageous to the fT nly i ROCE is greater than rte of lteest on Debt In such a ease the woe of debt WA © Jastied, tos megrifying the resid epmings (EPSDistribution of Marks The = (EBIT = intrest) 100% ~ Tay ee Number of Ea eciives Theory — = ‘When ROGE ond E017 are tour > et C 7 high DOL should Be property man. s = 3 aged with low DFL, lewer Barron, 2 t= é 70 | | Any method of fnoncing can | Same EPS under both allematver + bbe chosen + 7 ‘Gption with high Debt and| When ROCE and EBIT are high 5 = 50> vse of Debt fund is justified, ang fe L 7s maximises gain to Equty Shore z z 7m 10. 10 8 z 5 z & 10 (gun 2s bonds, loans, or preferred stock) to acqure asvets on which ican eam 9 retum greater a thoreby increasing ther interest cost of debt. 1 ean be expiain wit the help of folowing consieerable points — |. When ROCE > Interest Rate on Debt, the company earns at a higher rate of retum on tS ings ot Jers. This wil maximise ROE and EPS, creating a gain to the equif funds when Basic Earning Romer (ROCE) of the business is ha °S and ROE, is called “Gearing Effect” or “Trading on Eauly” Hakiple Cholee Questions Se Filia the Diane Test sod Palee/SoerentieadInporiest = 6 Wate Sesh [No Questions have been asked from this eategary, Short = Wie shor notes an EBIT-EPS Analysis tat is “Indifference point"? Explain it in relat analye aos [2010] ~ expan inaiteronce RliaenNanean? Dencenety Point in EBIT-EPS analysis. How is it measured ? (3 2=Smarks) (2016(G))~ wnat is €BIT-EPS analysis 7 ea narks) Ans. Alternative modes of fi e Jes of francing have di : arent tons mse rary Pe eet PST en EPS, ms saa 2 ider both options is the same. This level of E6!T Pt herent incing options, is called EPS Equivalency Point or Inciterence Point.