Financial Management – 2 Marks

1. Wealth Maximization.

Wealth maximization is the concept of increasing a firm's worth to increase the value of stockholders' shares.
Wealth maximization is also known as net worth maximization. A stockholder's wealth increases when a
company's net worth maximizes

1. Commercial paper.

Commercial paper represents short-term unsecured promissory notes issued by firms which enjoy a fairly high
credit rating. Generally, large firms with considerable financial strength are able to issue commercial paper. The
important features of commercial paper are as follows:

i. The maturity period of commercial paper usually ranges from 90 days to 360 days.
ii. Commercial paper is sold at a discount from its face value and redeemed at its face value. Hence the
implicit interest rate is a function of the size of the discount and the period of maturity.
iii. Commercial paper is directly placed with investors who intend holding it till its maturity. Hence there is no
well developed secondary market for commercial paper

1. Convertible debentures.

A debenture is a document issued by a company as an evidence of a debt due from the company with or without
a charge on the assets of the company. Convertible Debenture: These debentures can be converted into equity
shares of the company according to the terms specified.

1. Discount factor.

a factor which, when multiplied by a predicted future cash flow from a loan or some other form of debt, gives its
present value.

1. Cash outflow

Cash outflow refers to all of the expenses paid out by your business. Cash outflow includes any debts, liabilities, and
operating costs– any amount of funds leaving your business. A healthy business maintains a positive cash flow by
keeping flows from operating low, and minimizing long-term debts.

1. Borrowed capital.
 1. Return on equity.

Return on equity (ROE) is a measure of financial performance calculated by dividing net income by
shareholders' equity. Because shareholders' equity is equal to a company’s assets minus its debt, ROE is
considered the return on net assets.

1. NOI approach.

h. According to this approach the market value of firm is not at all affected by the capital structure changes .The
market value of the firm is ascertained by the capitalizing the net operating income at the overall cost of capital
(k), which is considered to be constant .The market value of equity is ascertained by deducting the market value
of the debt from the market value of the firm.

According to the NOI approach, the value of a firm can be determined by the following equation:

V = EBIT/k

Where V = value of the firm,

K = overall cost of capital, EBIT = earnings before interest and tax

1. Homemade leverage.

Homemade leverage is when an investment in a company with no leverage is recreated into the effect of
leverage on investment by personal borrowing.

1. Trade credit.

Trade credit represents the credit extended by the supplier of goods and services. It is spontaneous source of
finance in the sense that it arises in the normal transactions of the firm without specific negotiations, provided
the firm is considered creditworthy by its supplier. It is an important source of finance representing 25% to 50%
of short-term financing

1. . Working capital cycle.

The time gap between the sales and their actual realization in cash is technically termed as operating cycle of
the business. In case of a manufacturing company, cycle is the length of time necessary to complete the
following cycle of events:

(1) Conversion of cash into raw materials;

(2) Conversion of raw materials into work-in-progress

(3) Conversion of work-in-process into finished goods;

(4) Conversion of finished goods into accounts receivable, and

(5) Conversion of accounts receivable into cash.

The operation cycle of manufacturing business can be shown as in the following chart.
 1. Lock box system.

A lockbox is a bank-operated mailing address to which a company directs its customers to send their
payments. The bank opens the incoming mail, deposits all received funds in the company's bank account,
and scans the payments and any remittance information. The scanned images are posted to a secure
website, where the company's accounting staff can access the images to apply payments to outstanding
accounts receivable.

1. What do you mean by Liquidity?

Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash
without affecting its market price. The most liquid asset of all is cash itself.

1. What do you mean by private equity?

the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and
restructure financially weak companies that produce goods and provide services. A private-equity fund is both
a type of ownership of assets (financial equity) and is a class of assets (debt securities and equity securities),
which function as modes of financial management for operating private companies that are not publicly traded
in a stock exchange

1. What is meant by valuation of firms?

A business valuation, also known as a company valuation, is the process of determining the economic value of a
business. During the valuation process, all areas of a business are analyzed to determine its worth and the
worth of its departments or units.

1. Define ARR.

According to this method, the capital investment outlays are judged on the basis of their relative profitability.
This method measures the increase in profit expected to result from investment. It is based on accounting
profits and not cash flows.

ARR = (Average income or return/Average investment) 100

Average investment = (Original investment + Salvage value) / 2

 1. Give the meaning of term D.E.ratio.

Debt-to-equity (D/E) ratio is used to evaluate a company’s financial leverage and is calculated by dividing a
company’s total liabilities by its shareholder equity. D/E ratio is an important metric in corporate finance.

1. What is overall cost of Capital?

Overall cost of capital means the weighted average of the cost of each component of capital. It represents the
combined cost of capital of various sources such as debt, preference, equity and retained earnings.

1. What do you mean by capital structure?

Capital structure refers to the specific mix of debt and equity used to finance a company’s assets and
operations. From a corporate perspective, equity represents a more expensive, permanent source of capital
with greater financial flexibility

Capital structure is the permanent financing of the company represented primarily by long-term debt and
shareholder’s funds but excluding all short-term credit.

1. What is the significance of Financial leverage?

The financial leverage may be defined as the tendency of the net income to very disproportionately with the
operating profit. It indicates the change that takes place in the taxable income as a result of change in the
operating income.

1. Define Accounts receivables.

Accounts receivable (AR) are the balance of money due to a firm for goods or services delivered or used but
not yet paid for by customers. Accounts receivable are listed on the balance sheet as a current asset. Any
amount of money owed by customers for purchases made on credit is AR.

1. Mention any two factors that influence the credit sales(might get better answer – check )

Payment history, debt-to-credit ratio, length of credit history, new credit, and the amount of credit you have
all play a role in your credit report and credit score.
 Landlords may request a copy of your credit history or credit score before renting you an apartment.

1. Define Venture capital

Venture capital (VC) is a form of private equity and a type of financing that investors provide
to startup companies and small businesses that are believed to have long-term growth potential. Venture
capital generally comes from well-off investors, investment banks, and any other financial institutions.

1. What do you mean by EPS?

EPS is defined as the percentage change in Earning per share

EPS = Earning per share = (EBIT – I)(1-T)-Dp/N

Where EBIT = Earnings before interest and tax

I = Interest paid on debt

T = Tax rate

Dp = Preference dividend

N = Number of equity shares

1. Finance Functions

The finance function refers to practices and activities directed to manage business finances. The functions are
oriented toward acquiring and managing financial resources to generate profit. The financial resources and
information optimized by these functions contribute to the productivity of other business functions, planning,
and decision-making activities.

1. Non convertible debentures

A debenture is a document issued by a company as an evidence of a debt due from the company with or without
a charge on the assets of the company.

Non - convertible Debenture: These debentures cannot be converted into equity shares.

1. Cash inflow

Cash inflow is the amount of cash coming into your business. In the case where the cash inflow is greater than
cash outflow, the cash flow is positive. Cash inflow includes gains you receive from an investment you made. It
includes the cash your customers pay immediately for the products or services you sell.

1. Cash outflow

Cash outflow is when cash is moving out of your business. In the case of operations, cash outflow occurs when
you are paying salaries to your employees and when you pay for rent.When cash outflow is higher than cash
inflow, it leads to negative cash flow which isn’t an ideal situation to be in.
 1. Scrap value

Scrap value is the worth of a physical asset's individual components when the asset itself is deemed no longer
usable. The individual components, known as scrap, are worth something if they can be put to other uses.
Sometimes scrap materials can be used as-is and other times they must be processed before they can be
reused

1. Fixed cost

Fixed cost refers to the cost of a business expense that doesn’t change even with an increase or decrease in
the number of goods and services produced or sold. Fixed costs are commonly related to recurring expenses
not directly related to production, such as rent, interest payments, and insurance.

1. Capital intensive firms.

The term "capital intensive" refers to business processes or industries that require large amounts of
investment to produce a good or service and thus have a high percentage of fixed assets, such as property,
plant, and equipment (PP&E). Companies in capital-intensive industries are often marked by high levels of
depreciation

Or

Capital-intensive industries include automotive, airline, oil and gas, mining, manufacturing, and real estate.
These companies all have to spend money on assets that are expensive, such as a factory or an airplane

1. NPV

It is the best method for evaluating the capital investment proposal. NPV= [Total Present value of cash inflows
at different time periods - initial Investment] Accept or Reject criterion: NPV > zero accept the proposal NPV <
zero reject the proposal Present value Index method (Or) Benefits Cost Ratio This is a refinement of the net
present value method. It is computed by

1. Market value of its equity

Market value of equity is the total dollar value of a company's equity and is also known as market capitalization.
This measure of a company's value is calculated by multiplying the current stock price by the total number of
outstanding shares

1. Trade cycle
 1. Accounts receivable stage

If a company has Receivables, then they’ve made a sale, but have not yet collected the money from the
purchaser. Most companies operate by allowing a portion of their sales to be on credit, offering their clients the
ability to pay after receiving the service.

There are 4 steps in Accounts receivable stage

Establishing credit practices

Invoicing customers
Tracking accounts receivable
Accounting for accounts receivable

1. What is Investment decisions?

An investment decision is a well-planned action that allocates financial resources to obtain the highest possible
return. The decision is made based on investment objectives, risk appetites, and the nature of the investor, i.e.,
whether they are an individual or a firm

1. Give the meaning of the term Business Finance

An investment decision is a well-planned action that allocates financial resources to obtain the highest possible
return. The decision is made based on investment objectives, risk appetites, and the nature of the investor, i.e.,
whether they are an individual or a firm

1. What do you mean by preferred stock?

A preferred stock is a class of stock that is granted certain rights that differ from common stock. Namely,
preferred stock often possesses higher dividend payments, and a higher claim to assets in the event of
liquidation
 1. Mention the most disadvantages of pay back period?

Ignores the returns generated by the project after payback period.

Does not consider time value of money.

1. What is meant by cost of capital?

The term Cost of Capital refers to the minimum rate of return a firm must earn on its investments so that the
market value of the company’s equity shares does not fall. A firm’s cost of capital may be defined, as “the rate of
return the firm requires from investment in order to increase the value of the firm in the market place”

1. What do you mean by combined leverage?

Combined leverage (OL + FL) represents a company’s total risk related to operating leverage, financial leverage,
and the net effect on the EPS. Operating leverage affects the operating risk (i.e., the percentage change in EBIT
due to the percentage change in sales), and financial leverage impacts the financial risk (i.e., the percentage
change in EPS due to the percentage change in EBIT). Finance managers may calculate combined leverage to
make more precise decisions.

1. What do you mean by EBIT?

EBIT refers to the percentage change in Profits

Where EBIT = Total revenue - Total Variable cost - Fixed cost

=QxP-QxV-F=Q(P-V)-F

Where Q = Quantity produced and Sold

P = Selling price per unit

V = Variable cost per unit

F = Fixed cost
(or)

Earnings before interest and taxes (EBIT) is an indicator of a company's profitability. EBIT can be calculated
as revenue minus expenses excluding tax and interest. EBIT is also referred to as operating earnings,
operating profit, and profit before interest and taxes

1. Mention any two sources of Working Capital.

It reduces risk, since the need to repay loans at frequent intervals in eliminated.

It increases liquidity, since the firm has not to worry about the payment of these funds in the near future.

1. What do you mean ABC Analysis?

ABC Analysis for Inventory Control: ABC analysis is a method of material control according to value. The basic
principle is that high value items are more closely controlled than the low value items. The materials are
grouped according to the value and frequency of replenishment during a Period.

‘A’ Class items: Small percentage of the total items but having higher values.

‘B’ Class items: More percentage of the total items but having medium values.

‘C’ Class items: High percentage of the total items but having low values

1. What are the features of investment in marketable securities?

Marketable securities are investments that can easily be bought, sold, or traded on public exchanges. The
high liquidity of marketable securities makes them very popular among individual and institutional investors.
These types of investments can be debt securities or equity securities.

Stocks, bonds, preferred shares, and ETFs are among the most common examples of marketable securities

Money market instruments, futures, options, and hedge fund investments can also be marketable securities

1. Profit maximization.

Profit maximization refers to a tendency of business firms to maximize profits in the short or long run by using
the most efficient methods and equalizing the marginal cost and revenues. Its main purpose is to increase the
level of production of a firm or business that will grant it the maximum profit on selling goods and services.
 1. Registered debentures

Registered Debentures: These debentures are such debentures within which all details comprising addresses,
names and particulars of holding of the debenture holders are filed in a register kept by the enterprise. Such
debentures can be moved only by performing a normal transfer deed

1. DCF Techniques

Discounted cash flow (DCF) refers to a valuation method that estimates the value of an investment using its
expected future cash flows

DCF analysis attempts to determine the value of an investment today, based on projections of how much
money that investment will generate in the future

1. Post payback profitability

Under this method, the cash inflows after payback period is taken into account for considering the profitability
of the project. It can be calculated in the following manners.

Post Payback Profitability = Annual Cash Inflow (Estimated Life— Payback Period)

The above formula is used if there is even cash inflow. In the case of uneven cash inflows, the following formula
is used.

Post Payback Profitability = Total Annual Cash Flows – Initial Investment

1. Opportunity cost

Opportunity costs represent the potential benefits that an individual, investor, or business misses out on when
choosing one alternative over another. Because opportunity costs are unseen by definition, they can be easily
overlooked. Understanding the potential missed opportunities when a business or individual chooses one
investment over another allows for better decision making.

1. Debt capital

Debt Capital is the money that a company raises through borrowing from individuals or institutions, and they
must repay the entire amount after a specific time interval. They are a cheaper and low-risk alternative for
getting finances when compared to equity capital.

1. Trade-off theory(Explore more on the Ans )

The trade-off theory of capital structure is the idea that a company chooses how much debt finance and how
much equity finance to use by balancing the costs and benefits.

1. Traditional approach

Arrangement of funds from financial Institutions.

Arrangement of funds through financial instruments, viz shares, bonds, etc.

Looking after the legal and accounting relationship between a corporation and its sources of funds.

1. Concentrated banking

A concentration bank is a financial institution that is the primary bank of a specific organization. A
concentration bank may also be where the organization conducts most of its transactions. Several
organizations use multiple banks but generally deal significantly with one bank (the concentration bank).

1. Credit policy

A credit policy is a set of terms that lays out how your company will issue credit to its clients and collect unpaid
debts. It also specifies which team members in your company have the authority to grant credit or change the
terms of credit.

1. EOQ

Economic order quantity (EOQ) is a calculation companies perform that represents their ideal order size,
allowing them to meet demand without overspending. Inventory managers calculate EOQ to minimize holding
costs and excess inventory.

The EOQ is that inventory level that minimizes the total of ordering of carrying cost. EOQ can be calculated with
the help of the mathematical formula:

EOQ =

Where

a = Annual usage of inventories (units)

b = Buying cost per order

c = Carrying cost per unit