[Bhalotia Classes (9883034569): FM theory 6" Semester Pass (for 2024)] 4. Define Financial Management. [B.com 2018 Pass] [30%] Financial management is that managerial activity which is concerned with planning and controlling of the firm’s financial resources. In other words itis concemed with acquiring, financing and managing assets to accomplish the overall goal of a business enterprise (mainly to maximise the shareholder's wealth). Financial Management comprises of forecasting, planning, organising, directing, coordinating and controlling of all ting to acquisition and application of the financial resources of an undertaking in keeping with its financial objective. Financial Management is concemed with the managerial decisions that result in the acquisition and financing of short term and long term credits for the firm. Howard and Uptron define Financial Management “as an application of general managerial principles to the area of financial decision-making” Weston and Brighem define Financial Management “as an area of financial decision making, harmonizing individual motives and enterprise goal”. tivities n 2. Discuss the importance of Financial Management. [15P] [10%] | ‘Some of the importance of the financial management is as follow: (a) Financial Planning: Financial management helps fo determine the financial requirement of the business concern and leads to take financial planning of the concem. Financial planning is an important part of the business concem, which helps to promotion of an enterprise (b) Acquisition of Funds: Financial management involves the acquisition of required finance to the business concer, Acquiring needed funds play a major part of the financial management, which involve possible souree of finance at minimum cost (©) Proper Use of Funds: Proper use and allocation of funds leads to improve the operational efficiency of the business concem. When the finange manager uses the funds properly, they can reduce the cost of capital and increase the value of the firm. (@) Financial Decision: Financial management helps to take sound financial decision in the business concern. Financial decision will affect the entire business operation of the concern, Because there is a direct relationship with various department functions such as marketing, production personnel, etc. (© Improve Profitability: Profitability of the concem purely depends on the effectiveness and proper utilization of funds by the business concern, Financial management helps to improve the profitability position of the concern with the help of strong financial control devices such as budgetary control, ratio analysis and cost volume profit analy: () Increase the Value of the Firm: Financial management is very important in the field of increasing the wealth of the investors and the business concem. Ultimate aim of any business concem will achieve the maximum, profit and higher profitability leads to maximize the wealth of the investors as well as the nation (g) Promoting Savings: Savings are possible only when the business concer ears higher profitability and maximizing wealth. Effective financial management helps to promoting and mobilizing individual and corporate savings.Bhalotia Classes (9883034569): FM theory 6' Semester Pass (for 2024) 3. What are the functions of Financ’ Manager? [2014 H, 2016 H] [BHALOTIA] [90%] Function of financial management means functional activities that an enterprise undertakes in achieving its desired objectives. These functions may be classified on the basis of its operational activities, 1. Purchase Function In this fimetion Finance Manager plays a key role in providing finance. In order to minimize cost and exercise ‘maximum control, various material management techniques such as economic order quantity (OQ), determination of stock level, perpetual inventory system ete. are applied. The task of the Finance Manager is to arrange the availability of cash when the bills for purchase become due. 2. Production Function Production function involves heavy investment in fixed assets and in working capital. Naturally, a tighter control by the Finance Manager on the investment in productive assets becomes necessary. It must be seen that there is neither over-capitalisation nor under-capitalisation, 3. Distribution Function The objective of distribution function is making available the goods to the end customer. As every aspect of distributor function involves cash outflow and every distributing activity is aimed at bringing about inflow of cash, both the functions are closely inter-related and hence should be carried out in close union, 4. Accounting Function The efficiency of the whole organization can.be greatly improved with correct recording of financial data, All the ‘ounting tools and control GeViEES. necessary for appraisal of finance policy can be correctly formulated if the accounting data are\properly recorded 5. Human Resource Function A sound HR policy includes proper wage strtiture, ihceffivessschemes, promotional opportunity, human resource developiieritaiid Other fringe befits pRovided fosthe efffployg8S. All these matters affect finance. But the finance ‘manager should know that organization can afford fO.pay only’ What it can bear. It means that expenditure incurred on HR Managenient and the expected return on such iftvestifient through labour productivity should be considered in framing a sound HR’ polieyiTherefore, the relation between the finance and HR department should be intimate, a 6. Research and Development Function In the world of innovations a constant endeavour for improvement and sophistication of an existing produet and introduction of newer varieties, the firm is bound to be gradually out marketed and out of existence - 2~-Admission Going on for B.com, M.com, CA, CMA, CS XI, XI Contact.4. The activi important deci Ss of finan ns. Briefly explain these de: OR Describe the three broad areas of financial decision making. [2018 Hons] [60%] OR Explain the inter-relationship between financing decision, investment decision and dividend decision. [2022 H] [BHALOTIA] Value of a firm will depend on various finance fu decisions, namely 1. Investment Decision I managers involve taking three ions? [60%] clions/decisions. It can be broadly classified into three major These decisions relate to the selection of assets in which funds will be invested by a firm, Funds procured from different sources have to be invested in various kinds of assets. Long term funds are used in a project for various, fixed assets and also for current assets. The investment of funds in a project has to be made after careful assessment of the various projects through capital budgeting. A part of long term funds is also to be kept for financing the working capital requirements. Asset management policies are to be laid down regarding various items of eurrent assets. The inventory policy would be determined by the production manager and the finance manager keeping in view the requirement of production and the future price estimates of raw materials and the availability of funds Financing Decision These decisions relate to acquiring the optimum finance to meet financial objectives and seeing that fixed and working capital are effectively managed. The financial manager needs to possess a good knowledge of the sources of available finds and their respective Costs and feeds to ensure that the company has a sound capital structure, ie. 4 proper balanee between equity capital and debt. Such managers also need to have a very clear understanding as to the difference between profit and cash flow, bearing in mind that profit is of litle avail unless the organisation is adequately supported by cash to pay forassets and sustain'the working capital cycle. Financing decisions also call fora good knowledge of evaluation of risk, g. excessive debt earried high risk for an organization’s equity because rights of the lenders, The dividend decision thus has two elements ~ the amount fo be paid out and the amount to be retained to support, also a the growth of the organisation, the latter b represent a significant factor shares by the stock market. 7 nancing decision; the level and regular growth of dividends determining a profit-making company’s market value, ie. the value placed on its All three types of decisions are interrelated, the first two pertaining to any kind of organisation while the third relates only to profit-making organisations, thus it can be seen that financial management is of vital importance at every level of business activity, from a sole trader to the largest multinational corporation,[ 5. What are the objectives of financial Management? [17H] [30%] | Efficient financial management requires the existence of some objectives or goals because judgment as to whether or nota financial decision is efficient must be made in the light of some objective. Although various objectives are possible but we assume two objectives of financial management for elaborate discussion. These are: 41. Profit Maximisation thas traditionally b financial management is also profit maximisation. This implies that the finance manager has to make his decisions in a manner so that the profits of the concern are maximised. Each alternative, therefore. is to be seen as to whether or not it gives maximum profit. Limitations of ‘Maximisation of Profit’ as the objective of the firm. However, profit maximisation cannot be the sole objective of a company. It is at best a limited objective. If profit is given undue importance, a number of problems can arise. Some of these have been discussed below (a) The term profit is vague. It does not clarify what exactly it means (b) Profit maximisation has fo be attempted with a realisation of risks involved. (©) Profit maximisation as an objective does not take into account the time pattern of returns. (@) Profit maximisation as an objective is too narrow. Arguments in favour of Profit Maximization (a) When profit eaming is the main aim of business the ultimate objective should be profit maximization (b) Future is uncertain, A firm should eam more and more profit to meet the future contingencies (©) The main souree of finance for growth of a business is profit, Henee, profit maximization is required (d) Profit maximization is justified on the grounds of rationality as profits act as a measure of efficiency and en argued that the primary objective of a company is to eam profit; henee the objective of economic prosperity Arguments against Profit Maximization (a) It leads to exploitation of workers and consumers, (b) It Ignores the risk factors associated with profit, (©) Profitiin itself is a vague concept and means differently to different people. (@) Itisnarrow concept at the cost of social and moral obligations. ‘Thus, profit maximization as an objective of Financial Management has been considered inadequate Wealth / Value Ma: ation 1 will first like to define what is Wealth / Value Maximization Model. Shareholders wealth are the result of cost benefit analy'is adjusted with t So, Wealth = Present vah It is important that benefits measured by the finance manager are in terms of cash flow. Finance manager should emphasis on Cash flow for investment of financing decisions not on Accounting profit. The shareholder value ‘maximization mode! holds that the primary goal of the firm is to maximize its market value and implies that business decisions should seek to increase the net present value of the economic profits of the firm. So for measuring and ‘maximising shareholders wealth finance manager should follow (a) Cash Flow approach not Accounting Profit (b) Cost benefit analysis (©) Application of time value of money. ir timing and risk i.e. time value of money of benefits ~ Present Value of CostsArguments in favour of Wealth Maximization, (@) Due to wealth maximization, the short term money lenders get their payments in time. (>) The long time lenders too get a fixed rate of interest on their investments. (c) The employees share in the wealth gets increased (@) The various resources are put to economical and efficient use. Argument against Wealth Maximization (a) __ Itis socially undesirable. (b) _Itisnota descriptive idea (©) Onlly stock holders wealth maximization does not lead to firm’s wealth maximization (@)_— The objective of wealth maximization is endangered when ownership and management are separated 6. Distinguish Between Profit maximization & wealth maximization [BHALOTIA] [9883034569/9330960172] [50%] Profit Maximisation Wealth Maximisation’ Its traditional approach of the financial management. It is modem approach of the financial ‘management. According to this criterion, the financial activities of a firm are conducted in such a way so that the amount of profit of the firm is maximum, According to this criterion, the financial activities of a firm are conducted in such a way 50 that the net wealth of the firm is The concept of profit is not clear in the profit maximisation ‘The concept of wealth is clear in the wealth ‘maximisation criterion, criterion. maximisation criterion. In this ease wealth refers to the net present value of a project. The aspects of risk and uncertainty are ignored in profit] The aspects of risk and uncertainty are considered in wealth maximisation criterion, In this ease, itis not necessary to know the rate of discount for determining the profit, In this case, it is necessary to know the rate of discount for determining the net wealth, Time value of money is not considered in this etiterion. Time value of money is considered in this criterion It measures the performance of a business firm only on the basis ofits profit. It measures the performance of business firm on the basis of the shareholders’ wealth (Gt the current market price of the equity shares) It is based on the assumption of perfect competition in the product market. It assumes an efficient capital market It does not also consider the impacts of eamings per share. dividend payments and other returns to the shareholders on. shareholder’ s wealth or on the value of the firm. It takes into account the present value of the future cash inflows, dividend payments, eammings per share and their influence on olders’ wealth. A firm may not pay regular dividends to its shareholders and reinvest its retained earning to achieve this goal. ‘A. firm pays regular dividends to its shareholders to achieve this goalBhalotia Classes (9883034569): FM theory 6' Semester Pass (for 2024) 7. Why value maximisation (wealth ma: ation) objective is called better than profit maximisation objectives? [2017 H, 2021H] [BHALOTIA] [9883034569/9330960172] [95%]***** Although Profit and Wealth Maximization sound pretty similar, there are some major differences between them, While profit maximization aims at increasing the profit of a firm, wealth maximization has a larger role to play and it deals with the wellbeing of the stakeholders as a whole. Profit and wealth maximization dealin different subjects and hence they are defined differently. Profit maximization refers to the management of a firm's resources and utilities to maximize profit. On the other hand, wealth maximization refers to managing the financial and managerial resources for the wellbeing of the stakeholder community as a whole, However wealth maximisation objective is held to be superior to the profit maximisation objective, because of the following reasons: (a) Wealth maximization play’ a larger role in business than profit maximization (b) The main focus of profit maximization is on increasing the profit of the company while wealth maximization deals in raising the value of stakeholders in the company. The profit maximization theory is centered around the profit motive while wealth maximization looks at the wellbeing of all stakeholders, (©) Therisk and its effects on financials of the company are a core part of the wealth maximization process, while there is no focus on risk in the. profit:maximization theory. Therefore, in practice, profit maximization is not a complete theoryinitselfwhile wealth maximization is much more cohesive and inclusive in nature (@)_ Profit maximization is actually @ Concept that is basically related to day-to-day business profits, Wealth ‘maxintization i8 a more/complex pedéess of increasifig the overall wealth of the company that is reflected in the inereased price of shitresin the market (©) Profit HHAXIRHIZAtion does not coveF the ri8k.fators A¥Sociated with finance and operations but wealth maximization does (©) Profit maximization 18"aW Glderstheory. and-hence it lacks the modem approaches towards business and profitability. Wealth maximization is a new concept that deals with a larger subject area and includes as many factors as possible, Therefore, wealth maximization is a better approach than profit maximization. (g)_ Profit maximization was a very relevant theory during the early 19th century, while the wealth maximization concept is a newer concept in business. So, wealth maximization is more complex and inclusive in practice in general. (h) Profit maximization is a theory of the past, while wealth maximization is a modem theory - 6 ~Admission Going on for B.com, M.com, CA, CMA, CS XI, XIL Contact.8. Specify the limitations of ‘Ma ation of Profit’ as the objective of the firm. [2016 H, 2020H old] [BHALOTIA] [10%] As the term suggests, Profit Maximization is a philosophy to maximize the profits from a business concern. In the free economy, there is always profitability if the goods and/or services are good. So, firms selling good products, and services increase the prices of goods to generate more revenues and profits. After the market competition for such service providers, however, a point is reached where the maximum profit halts. This is the point of profit maximization Profit maximization was considered an ideal concept in the early 1900s when businesses were owned by one person ‘who usually paid for everything and asked all the staff to work so that the firms could eam as much as possible. The structure of the firms allowed the owners to do so. Profit maximization may seem to be a good idea but it does not fit the modern ideas of entrepreneurship and doing business, 1. The haziness of the concept “profit” The term “Profit” is a vague term. It is because different mindset will have a different perception of profit, For e.g. profits can be the net profit, gross profit, before tax profit, or the rate of profit ete, There is no clearly defined profit ‘maximization rule about the profits. 2. Ignores time value of money The profit maximization formula simply stigzests “higher the profit better is the proposal”. In essence, it is considering the naked profits without considering the timing of them. Another important dictum of finance says dollar today is not equal to a dollar a year later”. So, the time value of money is completely ignored. 3. Ignores the risk A decision solely based on profit maximization model would take a decision in favor of profits. In the pursuit of Profits, the risk involved is ignored which may prove unaffordable at times simply because higher risks directly questions the survival of a business. 4. Ignores quality The most problematic aspect of profit maximization as an objective is that it ignores the intangible benefits such as quality, image, technological advancements etc. ‘The contribution of intangible assets in generating value for a business is not worth ignoring. They indireetly ereate assets for the organization. Conclusion: Profit maximization ruled the traditional business mindset which has gone through drastic changes. In the modem approach of business and financial management, much higher importance is assigned to wealth maximization in comparison of Profit Maximization vs, Wealth Maximization, The losing importance of profit maximization is not baseless and it is not only because it ignores certain important areas such as risk, quality, and the time value of ‘money but also because of the superiority of wealth maximization as an objective of the business or financial management,Bhalotia Classes (9883034569): FM theory 6' Semester Pass (for 2024) 9. Discuss the Role of Chief financial officer (CFO) [21P] [99%]*** The role of the CFO (Chief Financial Officer) has been changing over the past twenty years. Originally, the role of the CFO revolved around producing and analyzing the financial statements. However, because of the computerization of the accounting finetion the need for accounting skills in performing the roles and responsibilities of a CFO diminished. Though the job description of a CFO (Chief Financial Officer) remains broad the tasks comprising that fimetion fall into four distinct roles 1. The Strategist CFO The first role of the CFO is to be a strategist to the CEO. The traditional definition of success for a chief financial officer was reporting the numbers, managing the financial funetion, and being reactive to events as they unfold, But in today’s fast paced business environment, producing financial reports and information is no longer enough CFO's in the twenty-first century must be able to “peak around comers”. Therefore, they must be able to apply critical thinking skills, along with financial acumen, to the long term goals of the organization, 2. The CFO asa Leader The second role of the CFO hand in hand with the first one, That is one of a leader implementing the strategies of the company. As a result, itis no longer sufficient for a CFO to sit back and analyze the effort of others. The chief financial officer (CFO) of today must take ownership of the financial results of both the organization and senior ‘management team. The chief financial officer of today must be responsible for providing leadership to other senior management team. members, including the CEO. The CFO's role can sometimes force them to make the tough calls that others in the organization don’t or can’t make, Occasionally, this can mean the difference between suecess and failure. 3. The CFO asa Team Leader The third role of the CFO is.thatoP a tea Texter to other employees function. Not only will'@/60a6h call plays for a team, but they are also responsible for getting the highest results out of the talent on their team An aspiring afid SueeesSful coach will prodiice Superior results by finding the strengths of their team members and obtaining a higher level of performance than the individuals might achieve on their own, The role of the CFO (Chief Financial OMG) 18 to bring tagethsh a diverse group OF tillented individuals to achieve superior financial performance. both inside and outside of the financial 4. The CRO with Third Parties Last, but not least, the FOle of the.CFO is that of a diplomat to third parties. People outside of the company look to senior management team for inspiratfoW aiid confidence in the company’s ability to perform. In almost every case the financial viability of the company is vouched for by the CFO. The CFO's role becomes that of the “face” of the company’s sustainability fo customers, vendors and bankers. Often these third parties look to the CFO for the unvamnished truth regarding the financial viability of the company to deliver on it’s brand promise Today's Role of the CFO. In today’s fast paced environment the role of the CFO is extremely fluid. One day the CFO might be developing 4 compensation plan for employees. Then the next day taking their bankers on a tour of the facilities. Consequently, tobe a successfull CFO in the future you must be a more multi-functional executive with financial skills - 8-Admission Going on for B.com, M.com, CA, CMA, CS XI, XI Contact.10. Discuss the basic components of the financial environment under which a firm has to operate. [2015 H] [BHALOTIA] [1%] Definition of financial environment Financial environment of a company refers to all the financial institutions and financial market around the company that affects the working of the company as a whole, A financial environment is a part of an economy with the major players being firms, investors, and mark Essentially, this sector can represent a large part of a well-developed economy as individuals who retain private property have the ability to grow their capital. Firms are any business that offer goods or services to consumers. sses that place capital into businesses for financial returns. Markets represent the financial environment that makes this all possible. ‘The financial environment has a number of factors. It includes the financial institutions, government, individuals and firms around the business. Firms use their financial markets to keep their savings as property. It is extremely important for the monetary markets. Components of financial environment ‘The financial environment is composed of three key components: (1) financial managers, (2) financial markets, and (3) investors (including creditors). 1) Financial Managers Financial managers are responsible for deciding how to invest a company’s funds to expand its business and how to obtain funds (financing). The actions taken by financial managers to make financial decisions for their respective firms are referred to as financial management (or managerial finance). Financial managers are expected to make financial decisions that will maximize the firm’s value and therefore maximize the value of the firm’s stock price. They are usually: compensated in a manner that encourages them to achieve this objective. The ret Financial markets represent place! market that facilitate the flow of funds among investors and borrowers. In financial markets investors and borrowers trade financial sceurities, commodities and other fungible items at a price determined by demand and supply. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade. Hence, financial markets refer to an organized institutional structure or mechanism for ereating and exchanging financial assets. An important component of these financial markets is financial institutions that act as intermediaries. Financial markets can be a) Capital markets b) Money market, 3) Investor Investors are individuals or financial institutions that provide funds to firms, government agencies, or individuals who need funds. In this book, our focus regarding investors is on their provision of funds to firms. Individual investors commonly provide funds to firms by purchasing their securities (stocks and debt securities). The financial institutions that provide funds are referred to as institutional investors, Some of these institutions focus on providing loans, whereas others commonly purchase11. What do you mean by time value of money? What are its reasons? [2021H] [BHALOTIA] [9883034569] [60%] ime value of money (TVM ‘Money has time value. In simpler terms, the value of a certain amount of money today is more valuable than its value tomorrow. It is not because of the uncertainty involved with time but purely on account of timing. The difference in the value of money today and tomorrow is referred to as the time value of money. term time value of money ean be d of investment and reinvestment. ed as “The Value derived from the use of money over time as a result ‘The time value of money (TVM) is one of the basic concepts of finanee. We know that if we deposit money in a bank account, we will receive interest. Because of this, we prefer to receive money today rather than the same amount in the future, Money, we receive today is more valuable to us than money received in the future by the amount of interest we can eam with the money. This is referred to as the time value of money. Future is always uncertain and risky. Outflow of cash is in our control as payments to parties are made by us. There is no certainty for future cash inflows. Cash inflows are dependent on our Creditor, Bank ete. As an individual or firm is not certain about future cash r. pts, it prefers receiving cash now. 2. Inflation In an inflationary economy. the money f¥éeived foday. has more purchasing power than the money to be received in future. In other words, a rupee today represents a greater real purchasing power than a rupee a year after 3. Consumption: Individuals generally prefer c rent consumption fo future consumption 4. Investment opportunities: An investor can profitably employ a'fupee received today, to or after a certain period of time. Thus, the fundamental principle behind the concept of time value of money is that, a sum of money received today, is worth more than if the same is received after a certain period of time. For example, iff an individual is given an alternative either to receive Rs.10,000 now or after one year, he will prefer Rs. 10,000 now. This is be than what he is going to get for the same amount after one year ve him a higher value to be received tomorrow use, today, he may be in a position to purchase more goods with this money2. Explain the significance of time value of money (TVM) i financial decision making. [2022 H] [BHALOTIA] [65 %] ‘Since the money is worth more now than the same money in the future, TVM is therefore important for financial management. You can always use the funds to make an investment and receive interest. Following are the significance of time value of money (TVM) in financial decision making 1. Opportunity costs_& Time value of money Opportunity costs exist wherever options are available. Opportunity costs are, therefore, the benefit or interest that one forgoes when one prefers one investment over another. Or, to put it simply, opportunity costs are the next best available and preferred investment. Therefore, when deciding on an investment, one should consider its opportunity costs. Opportunity costs are a TVM concept and help in decision-making, 2. Capital Budgeting And Time Value of Money TVM is very useful in capital budgeting as it helps management get an idea of their cash flows. In capital budgeting, we discount the future cash flows to their present value to determine whether the project is worthy of investment or not ‘When a company plans to make investments, for example, in machinery, to take over another company, ete,, it ‘wants fo get an idea of whether that investment will pay off or not. Or companies need to know whether the cash flows from the investment are sufficient to recoup at least the initial outlay. The TVM helps a business in deciding and analyzing this aspect with the use of a discount rate, 3. Finance Decisions And Time Value of Money ‘The importance of the time Value of money is not only for corporate decision-making but also on a personal level. Knowing the TVM concept will help you see the financial impact of every financial decision we make, It ‘would help you plan our financial goals arid help us to meet financial challenges. It would also help us to compare and evaluate two or more investment options, 4. Investing and Time Value of Money Because of inflation, prices will rise over time, And the value of the available money will decrease over time Therefore, the money you have is worth more today thanin the future, Therefore, itis very important that you invest the money instead of keeping it in yourself or in a normal bank account, And the TVM helps you make the better investment decision based on the following factors: (a) Inflation ~ It is the continuous rise of the price level. The money in your pocket has more purchasing power today than in five years after that. Therefore, an appropriate investment can only maintain or inerease the value of your mon (b) Risk the futur your risk by investing it right now (c) Investment Opportunity — There are many ways and options in which you can invest your money However, you lose the opportunity if you wait to invest your money. Any delay will lose the value of your money over time, uncertain so you may lose ome or all of your money in the future, but you can reduce13. Explain the compounding & discounting technique in relation to time value of money? [BHALOTIA] [9883034569] [30%] ‘Time Value of Money says that the worth of a unit of money is going to be changed in future. Put simply, the value of one rupee today will be decreased in future, The whole concept is about the present value and future value of money. There are two methods used for ascertaining the worth of money at different points of time, namely, compounding and discounting. Compounding method is used to know the future value of present money. Conversely, discounting is a way to compute the present value of future money Compounding is helpful to know the future values, of the cash flow, at the end of the particular period, at a definite rate. Contrary to this, Discounting is used to determine the present value of the future cash flow, at a certain interest rate, Here, in this article, we've described the differences between compounding and discounting, Techniques of compounding ‘The “time value of money” describes the effects of compounding. An amount invested today has more value than the same amount invested at a later date because it can utilize the power of compounding. Compounding is the process by which interest is earned on interest, When a principal amount is invested, interest is eamed on the principal during the first period or year. In the second period or year, interest is earned on the original principal plus the interest camed in the first period, Over time, this reinvestment process can help an account grow significantly. Technique of discounting: ‘The present value of a sum of money to be received at a future date is determined by discounting the future value at the interest rate that the money could eam over the period. This process is known as Discounting. ‘The present value interest factor declines as the interest rate rises and as the length of time increases. Differencs en_ compoundin: Discounting: BASIS FOR companion ‘COMPOUNDING DISCOUNTING Meaning The method used to determinethe __ | The method used to determine the future value of present investment is | present value of future cash flows is known as Compounding. known as Discounting. [Concept If we invest some money today, what _| What should be the amount we will be the amount we get at a future | need to invest today, to get a specific date. amount in future, lUse of Compound interest rate. Discount rate Known Present Value Future Value Factor Future Value Factor or Compounding | Present Value Factor or Discounting Factor Factor Formula FV=PV(1 +n" PVEFV/(1+ A"14, Briefly explain how the role in the financial dec’ n making. [2022 H] [RKB] [50%] OR Discuss the relationship between Risk and Return. [2021H old] ‘The risk and retum constitute the framework for taking investment decision. It has generally been found that there is a direct relationship between risk and return. An investment proposal involving low risk has low return while a proposal involving higher risk has higher return. risk-return relationship model RELATIVE COMFORT ZONE HIGH Low Risk Low Retum | High Return | High Retum RISK Low Low HIGH RETURN Following is the main type of relationship of risk and return. 1. Direct Relationship between Risk and Return (A) High Risk - High Return According to this type of relationship, if investor will take more risk, he will get more reward. § million, it means his risk of loss is million dollar @B) Low Risk - Low Return Ii also direct relationship between risk and return, If investor decreases investment. It means, he is, decreasing his risk of loss, at that time, his return will also decrease. 2. Negative Relationship between Risk and Return (A) High Risk Low Return : Sometime, investor increases investment amount for getting high return but with increasing return, he faces low return because it is nature of that project. There is no benefit to inerease investment in such project. Suppose, there are 1,00,000 lotteries in which you will earn the prize of You have bought 50% of total lotteries. But, if you buy 75% of lotteries, Prize will same but at increasing of risk, your return will decrease. (B) Low Risk High Return ‘There are some projects, if you invest low amount, you can eam high return, For example, Govt. of India need money. Because, govt, needs this money in emergency and Govt. is giving high return on small investment. If you get this opportunity and invest your money, you will get high return on your small risk of loss of money. he investedUnit 2: Sources of Capital & Cost of Capital: [5 + 5] [Optional theo: 15. What are the various sources of long term finance of limited company? Explain merits and demerits of any three of them. [2013 Pass] [BHALOTIA] [9883034569] [30%] ‘Sources of Long-term Finance of a Business (A) Share capital or Equity share (B) Preference shares (C) Retained earning (D) Debentures’Bonds of different types (©) Loans from financial institutions (A) Share capital or Equity share Equity Share Capital isa basic source of finance for any firm. It represents the ownership interest in the company ‘The characteristics of equity Share Capital are a direct consequence of its position in the company’s control, income and assets. Equity Share Capital does not have any maturity and there is no compulsion to pay dividend. ‘The Equity Share Capital provides funds, more or less, on a permanent basis. It also works as a base for ereating the debt and loan capacity of the firm. The advantages and limitations of Equity Share Capital may be summarized as follows’ Advantages of Equity Share Financing: (a) Itis a permanent source of funds. (b) The new Equity Share Capital increases the corporate flexibility for the point of view of capital structure planning (c) Equity Share Capital does not involve any mandatory payments to shareholders, (d) It may be possible to make further issue of share capital by using a right offering. In general, selling right shares involves no change in the relationship between ownership and control. limitations of Equity Share Financi (2) Cost of eapital is the highest of all sources. (b) Equity Share Capital has a burden of Corporate Dividend Tax on the company (c) New issue of Equity Capital may reduce the EPS. (B) Preference shar. The Preference Share Capital is also owner’s capital but has a maturity period. In India, the preference shares must be redeemed within a maximum period of 20 years from the date of issue, The rate of dividend payable on preference shares is also fixed. As against the equity share capital, the preference shares have two references: (i) Preference With respect fo payment of div Advantage (a) The preference shares carry limited voting right though they are a part of the capital. (b) The cost of capital of preference shares is less than that of equity shares. (©) The preference share financing may also provide a hedge against inflation. (@) A company does not face liquidation or other legal proceedings if it fails to pay the preference dividendsDisadvantages (a) The cost of capital of preference shares is higher than cost of debt. (b) Non-payment of dividend may adversely affect the value of the firm. (©) The compulsory redemption of preference shares after 20 years will entail a substantial eash outflow from the company (C) Retained earnings Long-term funds may also be provided by accumulating the profits of the company and by ploughing them back into business, Such funds belong to the ordinary shareholders and increase the net worth of the company. A. public limited company must plough back a reasonable amount of profit every year keeping in view the legal requirements in this regard and its own expansion plans. Such funds also entail almost no risk. Further, control of present owners is also not diluted by retaining profits. (D) Debentures or Bonds: As compared with preference shares, debentures provide a more convenient mode of long- term funds. The cost of capital raised through debentures is quite low since the interest payable on debentures can be charged as expense before tax. From the investors’ point of view, debentures offer a more attractive prospect than the preference shares since interest on debentures is payable whether or not the company makes profits Advantages (a) The cost of debentures is much lower than the cost of preference or equity capital as the interest is tax- deductible, Also, investors consider debenture investment safer than equity or preferred investment and, hence, may require a lower return on debenture investment. (b) Debenture financing does not result in dilution of control (©) Ina period of rising prices, debenture issue is advantageous. The fixed monetary outgo decreases in real terms as the price level increases, Disadvantages (a) Debenture interest and capital repayment are obligatory payments. (b) The protective covenants associated with a debenture issue may be restrictive, (©) Debenture financing enhances the finaneial risk associated with the firm. (@) Since debentures need to be paid during maturity, a large amount of eash outflow is needed at that time. {E) Loans from Financial Institutions: In India specialised institutions provide long- term financial assistance to industry. Thus, the Industrial Finance Corporation of India, the State Financial Corporations, the Life Insurance Corporation of India, the National ‘Small Industries Corporation Limited, the Industrial Credit and Investment Corporation, the Industrial Development Bank of India, and the Industrial Reconstruction Corporation of India provide term loans to companies,16. What are the various sources of short term finance of limited company? Discuss [BHALOTIA] [9883034569] [20%] ‘Sources of Short-term Finance of a Business (A) Trade credit It represents credit granted by suppliers of goods, ete., as an incident of sale. The usual duration of such eredit is 15 to 90 days. It generates automatically in the course of business and is common to almost all business operations. It can be in the form of an ‘open account’ or ‘bills payable’. Trade credit is preferred as a source of finance because it is without any explicit cost and till a business is a going concern it keeps on rotating. Another very important characteristic of trade credit is that it enhances automatically with the inerease in the volume of business (B) Accrued Expenses and Deferred Income: Acorued expenses represent liabilities which a company has to pay for the services which it has already received ‘Such expenses arise out of the day to day activities of the company and hence represent a spontaneous source of finance. Deferred income, on the other hand, reflects the amount of funds received by a company in liew of goods and to be provided in the future, Since these receipts increase a company’ liquidity, they are also considered to be an important source of spontaneous finance. (© Ads Manufacturers and contractors engaged in producing or constructing costly goods involving considerable length of manufacturing or construction time usually demand advance money from their customers at the time of accepting their orders for executing their contracts or supplying the goods. This is a cost free source of finance and really useful (D) Commercial Pap: A Commercial Paper is an unsecured money market instrument issued in the form of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in the year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources of short term borrowings and to provide an additional instrument to investors. Subsequently, in addition to the Corporate, Primary Dealers and All India Financial Institutions have also been allowed to issue Commercial Pape Commercial Papers can be issued for maturities between 15 days and a maximum up to one year from the date of issue. These can be issued in denominations of Rs 5 lakh or multiples thereof. All eligible issuers are required to get the eredit rating (©) Bank Advances: Bank advances are in the form of loan, overdraft, cash credit and bills purchased/discounted ete. Banks do not sanction advances on a Jong term basis beyond a small proportion of their demand and time liabilities. Advances are granted against tangible securities such as goods, shares, government promissory notes, Bills ete. In very rare ceases, clean advances may also be allowed,17. What is the weighted average cost of capital? What weights do you take into consideration for computation of weighted average cost of capital? Which of them do you recommend most? Why? [BHALOTIA] [9883034569] [10%] The weighted Average Cost of Capital can be computed by u weights. If there is a difference between market value and book value weights, the weighted average cost of capital would also differ. Thi value is used. ing the “Book Value” or the “Market value” as ghted average cost is usually higher than it would be if the book The Market values weights are sometimes preferred to the book value weights due to following reasons a, Market value represents the true expectations of the investors as they presumably reflect economic b, Market value weights are not influenced by the arbitrary accounting policy of the firm. ©. It considers price level changes and, therefore, reflects current cost of capital. Because of this market value weights for calculating the cost of capital is theoretically more appealing But it suffers from the following limitations a, Market value weights are operationally inconvenient as market values undergo frequent fluctuations. ‘This will affect the overall cost of capital and, in tum decision criterion for investment. b, Market values of all sources of capital are not readily available, ©. Use of market values tends to shift a greater importance towards the larger amounts of equity fun particularly when additional financing is undertaken ‘When the shares are not listed in any stock exchange, the use of market value weights is impossible and Demerits of ma Due to above limitations, it is desirable to use the book value weights. This method has the following advantages: a, Book value weights are easily Otreadily available from published accounts, b. The capital structure targets are usually set in terms of book values. c. To evaluate the riskiness of the company, the book value debt-equity ratios are analyzed by the investors. 4. It is easier to evaluate the performance of a financial manager in producing funds comparing on the basis of book values, ¢. When the shares of the company are not listed in any stock exchange the use of book value weights is the only alternative. However, the book value weights system suffers from the following limitations: a, Itdoes not truly reflect the economic values. b. Book values weights may be based on arbitrary accounting policies followed to calculate retained earnings and value of assets, ‘The book value weights system is not consistent with the definition of the overall cost of capital, which is defined as the minimum rate of return required to maintain the company’s market value 4. Theoretically, it is very difficult to justify the use of book value weights. Selection of appropriate weights by using both the altematives - book value and market values is an important aspect to calculate weighted average cost of capital. Both have their own commendable features. Market value weights are operationally inconvenient as compared to book value weights. However, market values weights are theoretically consistent and sound, and therefore a better indicator of firm’s cost of capital, provided market value of various sources of capital are readily available and they seems to be stable.Unit 3: Leverage & Capital structure theories [5 + 5 = 10] [Optional theory] 18. What do you mean by capital structure? Discuss the pattern of capital structure. [BHALOTIA] [9883034569] [10%] A firm needs funds for long term requirements and working capital, These funds are raised through different sources both short term and long term. The long term funds required by a firm are mobilized through owners funds (equity share, preference shares and retained eamings) and long term debt (debentures and bonds), A mix of various long term sources of funds employed by a firm is called capital structure. According to Gerestenberg, “Capital structure of a company refers to the composition or make-up of its capitalization and it ineludes all long term capital resources, viz, loans, bonds, shares and reserves”. Thus eapital structure is made up of debt and equity securities and refers to permanent financing of a firm Financial Manager has to plan the appropriate mix of different securities in total capitalization in such a way as to minimize the cost of capital and maximize the eamings per share to the equity shareholders. There may be four fundamental pattems of capital structure as follows: (a) Equity capital only(including Reserves and Surplus) (b) Equity and preference capital (©) Equity, preference and long term debt ie. debentures, bonds and loans from financial institutions ete. (@) Equity and long term debt. 419. What do you mean by Optimum Capital Structure? Discuss the features of an optimum capital structure. [RKB] [20 %] The theory of optimal capital structure deals with the issue of the right mix of debt and equity in the long term capital structure of a firm. This theory states that if'@ company takes on debt, the value of the fitm increases up to a point, Beyond that point if debt continues to increase then the value of the firm will start to decrease Similarly if the company is unable to repay the debt within the specified period then it will affect the goodwill of the company in the market and may ereate problems for collecting further debt. Therefore, the company should select its optimum capital structure ‘The main features of an optimum capital structure ay (@) Profitability: The capital structure of the company should be most profitable, The most profitable capital structure is one that tends to minimize cost of financing and maximize earnings per equity share. (b) Solvency: The patter of capital structure should be so devised as to ensure that the firm does not run the risk of becoming insolvent. Excess use of debt threatens the solvency of the company. The debt content should not, therefore, be such that which increases risk beyond manageable limits. (©) Flexibility: The capital structure should be flexible to meet the requirements of changing conditions. Moreover, it should also be possible for the company to provide funds whenever needed to finance its profitable activities. (@ Conservatism: The capital structure should be conservative in the sense that the debt content in the total capital structure does not exceed the limit which the company can bear. In other words, it should be such as is commensurate with the company’s ability to generate future cash flows, (©) Control: The capital structure should be so devised that it involves minimum risk of loss of control of the company20. Mention the factors that ate to be considered in determi capital structure? [BHALOTIA] [9883034569] [30%] (a) Trading on equity or financial leverage: Through this device, the capital is highly-geared. In this case, the company issues more debentures and preference shares with fixed rate of interest and dividend. As a result, the dividend rate of equity shares can be substantially raised. (b) Risk, income and control of the enterprise: Risk, income and control move together, Greater income and control may cover greater risk. Equity shareholders undertake greater risk than the fixed interest-bearing securities, The control is also concentrated in their hands, So this aspect should be considered in capital structure. (©) Operating leverage: ‘on operating fixed cost of the company. Itrefleets the operating risk, If operat should introduce relatively small amount of debt capital, (@ EBIT-EPS analysis: To maximise earings per share (EPS) of equity shareholders, while planning capital structure the behaviour of EPS at varying levels of earnings before interest and tax (EBIT) under alternative financial plans should be studied (©) Cost of capital: Lower cost of capital increases the value of the firm, Cost of capital is influenced by capital structure. Debt capital is usually cheaper because of lower risk and tax deductibility. So debt-equity mix has to be ‘made in such a way that overall cost of capital becomes minimum, () Control: Capital structure is affected by the extent to which the promoters desire to maintain control over the aflaits of the company. If the company issues more equity shares, there will be dilution of control, To avoid loss of contro, the ‘company should use more debt capital and preference capital (g) Cash flow analysis: The Company should prepare a projected cash flow statement forthe next 56 years to get an idea ‘of cash inflows, IFfsture cash inflows position is steady or stable, more debt capital can be employed. But iffature cash inflows position is unstable, debt capital should be avoided. (hy Stability of sales: Ifthe company’s sales are stable, itcan employ more debt capital because there will beno difficulty in meeting fixed obligations @ Size of the company: If the size of the company is large, it can raise fund easily from different sources, So its capital structure ean be suitably designed. () Legal requirements or restrictions: The finance manager has to comply with the legal requirements or restrictions while deciding about the capital structure, (k) Corporate taxation: Corporate taxation is an important fa sources of financing, ¢ g., dividend on shares is not deductible but interest on borrowed capital and cost of raising, finance are allowed as deduction for taxation purpose. So capital structure planning needs to consider corporate taxation factor @® Government policies: Lending policies of financial institutions, SEBI rules and regulations, government's, monetary and fiscal policies affect capital structure decisions, (im) Purpose of financing: If the funds are required for manufacturing or productive purposes, funds should be raised from long-term sourees. If the finds are needed for welfare facilities to employees of the company, internal sources should be tapped (n) Period of finance: When permanent funds are needed, equity shares should be issued but when finance is required for 8-10 years, itis appropriate to raise borrowed funds. It indicates the vulnerability of operating profit of change in volume of sales and depends leverage is high, the company or in determining the choice between differentBhalotia Classes (9883034569): FM theory 6' Semester Pass (for 2024) 21. Write a short note on EBIT-EPS analysis [BHALOTIA] [50%] The EBIT-EPS analysis is one of the most widely used techniques employed in financial management to design an appropriate capital structure which ensures the highest EPS under firm’s expected range of EBIT. In others words, this analysis is very useful to examine the effect of financial leverages on the behavior of EPS under alternatives financial plans with varying levels of EBIT. This technique is applied within this framework as because, EPS is considered as one of the most important yardstick or tool of financial management to evaluate 's performance for the investor EBIT-EPS anal ues of new equity shares is not taken into consideratio there will be no EBIT indifference point (2) When we consider a set of altematives plans that may give negative EBIT, which is imaginary and hence provide negative EPS. (3) The EBIT-EPS analysis does not take cognizance of the implicit cost associated with the debt. (4) This technique sometimes ignores the risk factor associated with the increase of debt financing, under the alternatives financing plans, then 22. Write a short note on Trading on Equity [RKB] [95%] Trading on Equity Meaning —Trading on equity means using the borrowed capital to generate revenue that boosts the profits of equity sharcholders, i.e., to make the profits by investing in the debt higher than the loan’ interest costs. Financial leverage also refers to trading on equity Trading on equity in financial management involves a strategy where a company takes debt as bonds, debentures, loans, or-preferred stocks, company applies this strategy to inerease the equity sharcholder’s return oniiavestinnt What is The Purpose of Trading/on Equity? (a) The primary’ purpose is to ifterease thé weatth ofthe shareholders, (b) Trading on equity is empléyed, whet the Company-wants more finance from debt sources rather than equity. (c) The comipaiiyitises this sirategy to ensure tflatGontrofver the company remains the same (4) A compaimightiaiso use the trading on equif¥stfategy to increase the company’s market share price Advantages of Trading on Equity: It gives the company access to extra eapital, which makes it possible to invest in assets that will generate a profit, As the interest on a loan is tax deductible, the company pays less amount in taxes overall. Disadvantages of Trading on Equity (a) Trading on equity involves disadvantages as well. ‘The inabi for any reason is one of the primary disadvantages it faces. (b) Similarly, the company’s liabilities may grow if interest rates rise (c) The borrowed debt funds may not fulfill the purpose for which it is borrowed, (A) In the worst scenario, the company can also become bankrupt. ity of the company to pay back the interest - 20 -Admission Going on for B.com, M.com, CA, CMA, CS XI, XII. Contact.23. What do you mean by working Capital Management? [10%] Meaning: ‘Working Capital is a part ofthe capital which is needed for meeting day to day requirement ofthe business concern. For example, payment to creditors, salary paid to workers, purchase of raw materials etc., normally it consists of recurring in nature. It can be easily converted into cash. Hence, erm capital. is also known as short Working capital management is also one of the important parts of the financial management, It is concemed with short-term finance of the business concem which is a closely related trade between profitability and liquidity. Efficient working capital management leads to improve the operating performance of the busine: concern and it helps to meet the short- term liquidity. Hence, study of working capital management is not only an important part of financial management but also are overall management of the business concern 24. Concept of Working Capital [BHALOTIA] [9883034569] [10%] | Working capital can be classified or understood with the help of the following two important concepts. Gross Working Capital Gross Working Capital is the general concept which determines the working capital concept. Thus, the gross working capital is the capital invested in total current assets of the business concern. Gross Working Capital is simply called as the total current assets of the coneem. Gross Working Capit current Assets B: Net Working Capital Net Working Capital is the specific concept, which, considers both current assets and current liability of the concern. Net Working Capital is the exeess of eurrent assets over the current liability of the coneem during a particular period. If the current assets exceed the current liabilities it is said to be positive working capital; itis reverse, it is said to be Negative working capital ‘Current Assets — Current Liabill Net Working Capit 25. Importance/Significance of Working Capital [RKB] [10%] Working capital is a vital part of a business and can provide the following advantages to a business: (a) Higher return on capital: Firms with lower working capital will post a higher return on capital Therefore, shareholders will benefit from a higher return for every dollar invested in the business,(b) Improved credit profile and solvency: The ability to meet short-term obligations is a pre- requisite to long-term solvency. And it is often a good indication of counterparty’s credit risk. Adequate working capital management will allow a business to pay on time its short-term obligations. This could include payment for a purchase of raw materials, payment of salaries, and other operating expenses (©) Higher profitability: According to some receivables is an important driver of small bus archers, the management of account payables and nesses’ profitability (@) Higher liquidity: A large amount of cash ean be tied up in working capital, so a company managing it efficiently could benefit from additional liquidity and be less dependent on external financing, ‘This is especially important for smaller businesses as they typically have limited access to external funding sources. Also, small businesses often pay their bills in cash from earnings so efficient working capital management will allow a business to better allocate its resources and improve their cash management. (e) Increased business value: Firms with more efficient working capital management will generate more free cash flows which will result in higher business valuation and enterprise value. (®) Favorable financing conditions: A firm with a good relationship with its trade partners and paying its suppliers on time will benefit from favorable financing terms such as discount payments from its suppliers and banking partners. (g) Uninterrupted production: firm paying its suppliers on time will also benefit from a regular flow of raw materials, ensuring that the production remains uninterrupted and clients receive their goods on time. (a Ability to face shocks and peak demand: Efficient working capital management will help a firm to survive through a crisis or ramp up production in case of an unexpectedly large order. 26. Classification of Working Capital [BHALOTIA] [10%] | Working capital may be of different types as follows: {a) Gross Working Capital: Gross working capital refers to the amount of funds invested in various components of current assets. It consists of raw materials, work in progress, debtors, finished goods, etc. (©) Net Working Capital: The excess of eurrent assets over current liabilities is known as Net working capital. ‘The principal objective here is to leam the composition and magnitude of current assets required to meet current liabilities (e) Positive Working Capit: Fhis refers to the surplus of eurrent assets over current liabilities. (4) Negative Working Capital: Negative working capital refers to the excess of current liabilities over current assets (c) Permanent Working Capital: The minimum amount of working capital which even required during the dullest season of the year is known as Permanent working capital (f) Temporary or Variable Working Capital: It represents the additional current assets required at different times during the operating year to meet additional inventory, extra cash, ete,Bhalotia Classes (9883034569): FM theory 6' Semester Pass (for 2024) 27. Explain the concept of working capital cycle (operating cycle) [BHALOTIA] [9883034569] [99%]************ Operating Cycle Approach / Working Capital Cycle Every business organisation needs adequate working capital because the conversion of cash into finished goods to debtors and back to cash is not instantaneous, It takes some time. For example, in a manufacturing is used to purchase raw materials. They are not consumed immediately. ‘They remain some time in stores in order to ensure smooth production and to protect the firm against the risk of non-availability of raw materials in future. Then they are issued from stores to production centre for conversion. This conversion also generally takes some time. When certain expenses such as Wages and overheads are incurred on it, it gets itself converted into semi-finished goods or work-in-progress and, finally, into finished goods. These finished goods will have to be stored for some time before sale. Next, finished goods are sold to customers which may take the form of cash or receivables/debtors. Receivable! debtors, when realised, again take the form of cash and the eyele starts again. This can be explained with the help of the following diagran m, cash The continuing flow from cash fo stppliefS, tolinventory.t6AeKounts receivable and back into cash is called the working capital €¥EIE or opetatingleyet®. Inl@therWordS, the term operating eyele refers to the length of time which begins With the acquisitioft of faw midterials off firftiland ends with the final realisation of cash from debtors, ing Cyc! ig capital depends upon the length of working capital eyele. So, it is important to measure working €apital-eycle for management of working capital, The financial statements i, Profit and Loss Account and Balanice Sheet, can guide us to measure working capital eyele. ‘The steps involved in the determination of the. i cycle are shown below: Particulars 7 Measurement of Oper: Strictly speaking, the Voluitte, of wor I. Raw materials holding period Worksin-progress period Finished goods holding period Debtors collection period Gross Operating Cycle Less: Creditors payment period 6 let Operating Cycle - 23 -Admission Going on for B.com, M.com, CA, CMA, CS XI, XII. Contact.Bhalotia Classes (9883034569): FM theory 6' Semester Pass (for 2024) 28. What factors are to be considered in deter ing the working capital need of a firm? [14 H, 16 H] [RKB] [98%]****** Following are the factors to be considered while determining the working capital requirement 1, Nature of business: A company’s working capital requirements are basically related to the kinds of business it conducts, Generally speaking, trading and financial firms require relatively large amounts of working capital, Public utilities comparatively’ small amounts, whereas manufacturing concems stand between these two extremes, their needs depending upon the character of industry of which they are a part 2. Production policies: Depending upon the kind of items manufactured, a company is able to offset the effect off: seasonal fluctuations upon working capital by adjusting its production schedules, The choice rests between varying output in order to adjust inventories to seasonal requirements and maintaining a steady rate of production and permitting stocks of inventories to build up during off-season periods. It will thus be obvious that a level production plan would involve a higher investment in working capital. 3, Manufacturing process: If the manufacturing process in an industry entails a longer period because of its complex character, more working capital is required to finance that process. The longer it takes to make an approach and the greater its cost, the larger the Inventory tied up In Its manufacture and, therefore, higher the amount of working capital 4. Turnover of circulating capital: The speed with which the circulating capital completes its round Le., conversion of cash into inventory of raw material Into Inventory of finished goods. Inventory of finished goods into book debts or accounts receivables and book debt into cash account, plays an Important and decisive role in judging the adequacy of working capital ‘8. Growth and expansion of business: Asa company grows, itis logical to expect that larger amount of working capital will be‘fequired though It Is difficult todraw up firm_rules for the relationship between the growth in the volume of alcompany’s businéss afi the growth of its working eapital 6. Business ele Mluctuations: Reqitiremeiits of Workifg capital of a company vary with the business variation. Ata time when the price level Comes uipiand bodm condition prevail, the psychology of the management isto pile upabig stock ofrawmaterial and other goods likef¥tabe used in the business operations as there is an expectation to take advantage of fower prices. The expansion of Business units caused by the inflationary conditions creates demand for more and Moré capital, 7. Terms of purchase and sales: A business unit, making purchases on etedit basis and selling its finished products on cash basis, will require lower amount of working capital, on the contrary, a concern having no credit facilities and at the same time forced to grant credit to its customers may find itself in a tight position, 8. Dividend policy: A desire to maintain an established dividend policy may affect working capital, often changes in working capital bring about an adjustment of dividend policy. The relationship between dividend policy and working capital is well established and very few companies declare a dividend without giving due consideration to its effects on cash and their needs for cash, A shortage of working capital often acts as a powerful reason for reducing or skipping a cash dividend. On the other hand, a strong position may justify continuing dividend payment. - 24 -Admission Going on for B.com, M.com, CA, CMA, CS XI, XII. Contact.29. Various sources of finance to meet working capital requirements [BHALOTIA] [9883034569] [60%] Working Capital requirement can be normalized from short-term and long-term sources. Fach source will have both merits and limitations up to certain extract. Uses of Working Capital may be differing from stage to stage Short-Term Sources of Working Capit 1 Indigenous Bankers Private money-lenders and other country bankers used to be the only source of finance prior to the establishment of commercial banks. They used to charge very high rates of interest and exploited the customers to the largest extent possible 2. Trade Credit Trade credit represents the credit extended by the supplier of goods and services. It is a spontaneous source of finance in the sense that it arises in the normal transactions of the firm without specific negotiations, provided the firm is considered creditworthy by its supplier. It is an important source of finance representing 25% to 50% of short-term financing. 3. Working capital advance by commercial banks Working capital advance by commercial banks represents the most important source for financing current assets. Forms of Bank Finance: Working capital advance is provided by commercial banks in three primary ways: (i) eash credits / overdrafts, (ii) loans, and (iii) purchase / discount of bills. In addition to these forms of direct commercials banks help their customers in obtaining credit from other sources through the letter of 4.Cash Credit / Overdraft Under a cash credit or overdraft arrangerient, @ pre-determined limit for borrowing is specified by the bank. The borrower ean draw as often ay required provided the out standings do not exceed the eash credit / overdraft limit. 5 Loam These are advances of fixed amounts which are credited to the eurrent account of he borrower or released to him in cash. The bortower is charged with interest on the entire loan amount, irrespective of how much he draws 6. Purchase / Discount of Bills: A bill arises out of a trade transaction. The seller of goods draws the bill on the purchaser. The bill may be either clean or documentary (a documentary bill is supported by a document of title to goods like a railway receipt or a bill of lading) and may be payable on demand or after a usance period which does not exceed 90 days. 1. Letter of Credit: A letter of credit is an arrangement whereby a bank helps its customer to obtain credit from its (customer's) suppliers. When a bank opens a letter of credit in favour of its customer for some specific purchases, the bank undertakes the responsibility to honour the obligation of its customer, should the customer fail to do so,Long-term Sources of Working Capital: 1. Shares: Issue of shares is the most important sources for raising the permanent or long term capital, A Co: can issue various types of shares as equity. Preference & deferred shares. 2, Debentures: It is an instrument issued by the company acknowledging its debt to its holder. The debenture holders are the creditors of the company. A fixed rate of interest is paid on debentures. The interest on debt, is charge against profit & loss all. 8. Public deposits: Public deposits are the fixed deposits accepted by a business enterprises directly from the public this source of raising short term & medium finance was very popular” in the absence of banking facilities 4. Ploughing Back of profits: Which means the re- investments by concem of its surplus earnings in its business of finance & it most suitable for an established firm for its expansion, modemization & replacement ete it is the cheapest rather cost fi 5. Loans from financial institutions: Financial institutions such as commercial banks, LIC, Industrial Corporation of India (IFC) SFC State Industrial development corporation, IDBI etc. 30. Working Capital Investment Policies / Approaches/ Strategies to Financing Current Assets. [BHALOTIA] [30%] ‘Working capital financing policy basically deals withthe sourees and the amount of working capital that a company should maintain. A firm isnot only concerned about the amount of current assets but also about the proportions of short-term and long-term sources for financing the current assets. There are several working capital investment policies a firm may adopt after taking into account the variability of its cash inflows and outflows and the level of risk, 1. Conservative Policy: As the name suggests, this policy tries to avoid the risk involved in financing of current assets. Here, relatively high proportions of long-term sources are to be used for financing current assets, The firm not only matches the current assets with current liabilities but also keeps some excess amount to meet any uncertainty This is the lowest risk working eapital policy and fails to ensure optimum utilization of funds. Hence it cuts down the expected retums of the shareholders. This policy is illustrated below. Line A denotes the fixed assets and Line B denotes the permanent working capital which is financed through long-term sources. Certain portion of fluctuating current assets, which is shown by dashed Line C, is also financed by long-term sources. Under this policy some part of fluctuating current assets is financed through short-term sources.Fluctuating Carent Aves > ety an Lang Ferm Dee 2. Aggressive Policy: Aggressive working capital financing policy is a risky policy that requires maximum amount of investment in ‘current assets, Fluctuating as well as permanent current assets under this policy will be financed through short-term debt. In this policy debt is collected on time and payments to the ereditors are made as Tate as possible. This poliey has been illustrated below. According to this approach long-term sourees are used to finance the fixed assets, which are shown by Line A: buta portion of permanent current assets, shown by the dotted Line B, is also financed through long-term sources. The remaining part of permanent current assets, depicted by Line C, and the entire amount of fluctuating current assets, shown by the curved Line D, are financed by short-term debt. Fluctuating Curent Asset » Shot ecm Debt Eaquty and Long Term Debt3. Hedging Policy (Balanced Policy) (Matching Policy) (Moderate Policy): (One of the policies by which a firm finances its working capital needs is the hedging policy, also known as matching policy. This policy works in an arrangement where the current assets of the business are used perfectly to match the current liabilities. As per this approach, fixed and permanent current assets ate financed through long-term sources and fluctuating current assets are financed through short-term sources. This policy is a medium risk proposition and. requires @ good amount of attention. For example, if'a bank loan is due to be paid after six: months, the company vill ensure that sufficient amount of cash will be available to repay the loan on the date of maturity even though it may or may not currently have sufficient cash In case of a growth firm, the amount of fixed assets and permanent current asset go on increasing with the passage of time but the volume of fluctuating current assets change with the change in production level. In the following figure, Line A and Line B is upward slopped indicating that they go on inereasing with the passage of time and as per hedging principle they are financed through long-term sources like equity and long-term debt. Fluctuating current assets, which are shown by the curved Line C, should be financed through short term sources > Short Term ity > guy and Long Term Dobe 31. Length of operating cycle is the major determinant of the working capital needs of a business firm — Explain. [3" yr old 2021] [BHALOTIA] [1%] One of the methods for forecasting working capital requirement is based on the concept of operating cyele. The various constituents of current assets and current liabilities have a direct bearing on the computation of working capital and the operating cycle, The holding period of various constituents of Current Assets and Current Liabilities eyele may either contract or expand the net operating eyele period, Shorter the operating cycle period, lower will be the requirement of working capital and vice-versaUnit 6 & Unit 7: Capital Budgeting [5 + 10 = 15 Marks] [Optional theory] 32. What is capital Budgeting? What are the Purposes of Capital Expenditure Decisions [BHALOTIA] [50%] Capital budgeting decision may be defined as “Firms decisions to invest its eurrent funds most efficiently in long, term activities in anticipation of an expected flow of future benefits over a series of year. The firm’s capital budgeting decisions will include addition, disposition, modification and replacement of fixed assets Definitions: Charles. T. Homgreen defined capital budgeting as out lay”, According to Keller and Ferrara, “Capital Budgeting represents the plans for the appropriation and expenditure for fixed asset during the budget period”. Robert N. Anthony defined as “Capital Budget is essentially a list of what management believes to be worthwhile projects for the acquisition of new capital assets together with the estimated cost of each product” budge The selection of the most profitable project of capital investment is the key funetion of Financial Manager. ‘The decisions taken by the management in this area affect the operations of the firm for many years Capital budgeting decisions may be generally needed for the following purposes: Hence, following may be considered as major or specific objectives in respect of investment in fixed assets under long-term basis: (a) Modification atid Replacement of existing facilities (b) Quality improvement in the present projects, (©) Expansion of business through creating additional facilities, (d) Creation of new product and itiproving the quality of existing products (e) Product diversification for survival undé the competitive market scenario. (1) Cost reduction initiatives which may require the purchase of most sophisticated and modern equipments. (g) Exploration of new ideas through Research and Development (h) Replacement of manual. work by automation process (i) Maximization of wealth of the shareholders. (Achievement of various social objectives complying with statutory obligations. (say, setting up of waste treatment plant to reduce environmental pollution). Long term planning for making and financing proposed capital 33. What do you mean by capital budgeting? Discuss its importance. [BHALOTIA] [30%] Financing and investment of funds are two erucial finanei capital budgeting requires a number of decisions to be taken in a situation in which funds are invested and benefits are expected over a long period, The term capital budgeting means planning for capital assets. It involves proper project planning and commercial evaluation of projects to know in advance technical feasibility and financial viability of the project. functions. The investment of funds also termed asImportance of Capital Budgeting Capital Budgeting decisions are considered important for a variety of reasons. Some of them are the following: (a) Crucial decisions: Capital budgeting decisions are crucial, affecting all the departments of the firm, So the capital budgeting decisions should be taken very carefully (b) Long-run decisions: The implications of capital budgeting decisions extend to a longer period in the future. The consequences of a wrong decision will be disastrous for the survival of the firm. (c) Large amount of funds: Capital budgeting decisions involve spending large amount of funds. As such proper care should be exercised to see that these funds are invested in productive purchases. (4) Rigid: Capital budgeting decision can not be altered easily to suit the purpose. Because of this reason, when once funds are committed in a project, they are to be continued till the end, loss or profit no matter 34. What are the process (Steps) of capital budgeting? [10%] The major steps in the capital budgeting process are given below. They are a) Generation of project. b) Evaluation of the project: c) Selection of the project and d) Execution of the project. The capital budgeting process may include a few more steps. As each step is significant they are usually taken by top management (a) Generation of Project Depending upon the nature of the firm, investment proposals can emanate from a variety of sources. Projects ‘may be classified into five categories, (i) New products or expansion of existing products, (ii) Replacement of equipment or buildings. (iii) Research and development. iv) Exploration (¥) Others like acquisition of a pollution control device ete, Investment proposals should be generated for the productive employment of firm's funds, Howev. systematic procedure must be evolved for generating profitable proposals to keep the firm healthy (b) Evaluation of the project: The evaluation of the project may be done in two steps, First the costs and benefits of the project are estimated in terms of eash flows and secondly the desirability of the project is judged by an appropriate criterion, It is important that the project must be evaluated without any prejudice on the part of the individual, While selecting a criterion to judge the desirability of the project, due consideration must be given to the market value of the firm. (©) Selection of the project: After evaluation of the projeet, the project with highest return should be selected. There is no hard and fast rule set for the purpose of selecting a project from many altemative projects. Normally the projects are screened at various levels. However, the final selection of the project vests with the top level management (@ Execution of project: After selection of a project, the next step in capital budgeting process is to implement the project, Thus the funds are appropriated for capital expenditures. The funds are spent in accordance with appropriations made in the capital budget funds for the purpose of project execution should be spent only after seeking format permission for the controller. The follow — up comparison of actual performance with original estimates ensure better control Thus the top management should follow the above procedure before taking actual expenditure deccuss the different Types of Investment Projects [40%] | 's generally classify their investment project into the project into the following categories for carrying out the screening process as stated in our earlier section (a) Replacement for the maintenance of business: This involves expenditure for replacing worn-out or damaged capital and equipment used to produce some profitable products. (b) Replacement for cost reduction: Investment required to replace working but obsolete equipment with modern equipment, which are supposed to reduce the average cost of production (say, by reducing the labour costs, material costs, electricity and fuel costs, ete.), fall into this category. (©) Expansion of output of some traditional products and their markets: Investment needed to expand the production of some traditional products of a firm in their existing or traditional markets, are included in category. These investment projects may be taken up in response to increase demand for such products, say, in the domestic market. (@) Search for new markets and increase in the production of non-traditional products: In a fast changing business world, the efficient operation of a firm also requires investment in developing new products and expanding the market for such produets, both in the domestic and extemal fronts. (©) Complying with statutory obligations: ‘These investment proje required by any firm to fulfill some statutory obligations like population control, health and safety regulations, ete. imposed by the Government. include such investments which are 36. Discuss briefly the NPV method of evaluation of projects [80%] [PV method The net present value miéthod is a classic method of evaluating the investment proposals. It is one of the methods of discounted cash flow techniques. which recognizes the importance of time value of money. It correctly postulates that cash flows arising at time periods differ in Walue and are comparable only with their equivalents i.e. present values It is a method of caleulating the present value of cash flows (inflows and outflows) of an investment proposal using the cost of capital as an appropriate discounting rate. The net present value will be arrived at by subtracting the present value of eash outflows from the present'value of cash inflows. According to Ezra Soloman, present value of the east of the Acceptance Rule: If the NPV is positive or at-least equal to zero, the project can be accepted. If itis negative, the proposal can be rejected, Among the various alternatives, the project which gives the highest po: PV should be selected NPV is positive ~ Cash inflows are generated at a rate higher than the minimum required by the firm, NPV is zero ~ Cash inflows are generated at a rate equal to the minimum required, ‘NPV is negative = Cash inflows are generated at a rate lower than the minimum required by the firm, The market value per share will increase if the project with positive NPV is selected. The accept/reject criterion under the NPV method ean also be put as: Merits: The following are the merits of the net present value (NPV) methods (a) Consideration to total Cash Inflows: The NPV methods considers the total cash inflows of investment opportunities over the entire life-time of the projects unlike the payback period methods. nent,(b) Recognition to the Time Value of Money: This methods explicitly recognizes the time value of money, which is investable for making meaningful financial decisions. (©) Changing Discount Rate: Due to change in the risk pattern of the investor different discount rates can be used (@) Best decision criteria for Mutually Exclusive Projects: This Method is particularly useful for the selection of mutually exclusive projects. It serves as the best decision criteria for mutually exclusive choice proposals. (©) Maximisation of the Shareholders Wealth: Finally, the NPV method is instrumental in achieving the objective of the maximization of the shareholders’ wealth. This method is logically consistent with the company’s objective of maximizing shareholders’ wealth in terms of maximizing market value of shares, and theoretically correct for the selections of investment proposals, Demerits: The following are the demerits of the net present value method: (a) Itis difficult to understand and use. (b) The NPV is calculated by using the cost of capital as a discount rate. But the concept of cost of capital itself is difficult to understand and determine (€) It does not give solutions when the comparable projects are involved in different amounts of investment. (4) It does not give correct answer to a question when altemative projects of limited funds are available, with unequal lives 37. Discuss briefly IRR method of evaluation of projects. [30%] IRR method follows discounted cash flow technique which takes into account the time value of money. The internal rate of return is the interest rate which equates the present value of expected future cash inflows with the initial capital outlay. In other words, itis the rate at which NPV is equal zero. Whenever a project report is prepared, IRR is to be worked out in order to ascertain the viability of the project. ‘This is also an important guiding factor to finaneial institutions and investors, Acceptance Rule If the internal rate of return exceeds the required rate of retum, then the project will be accepted. If the project's IRR is less than the required rate of return, it should be rejected. In case of ranking the proposals the technique of IRR is significantly used. The projeets with highest rate of retum will be ranked as first compared to the lowest rate of return projects ‘Thus, the IRR acceptance rules are Accept if IRR > k Reject if IRR G bn), (@ ‘The firm has an infinite life, Griticism of the Model: Gordon postilated some unreafistic A¥sumptionsin hissnodsl. So, the model is criticized from various points of view for his unrealistic asstimptions "VheSe afte — (a) It is asstfiéd in this model that she finm/MloeS not issii€ anylHiew share or debenture, it meets the requirement of the additional capital only by the retained eamis, This assiimption is not correct, because it is found in most of the cases that Whe a firm requires additional fund, mee the requirement of that additional fund by issuing new shares or debentir6s (b) It is assumed in this model that the firm'sinternal rate of retum will always remain fixed. Even this assumption is use if profit is ploughed back, then the amount of capital employed of the firm inereases and as a result of it, the internal rate of return (r) decreases, (© Itis assumed in this model that the cost of capital for the firm will always remain fixed, It is also not correct. Because, ifthe degree of risk changes, the cost of capital also changes. As the degree of risk of a firm does not alway’ remain fixed, the cost of capital (K) can not be remained fixed. (@) In some cases, no real value of Price is obtained from this model (©) Itis mentioned in this model that the value of share inereases as retained earings increases under the condition ofr > K. But it ean not be known from this model that for what value of b, the value of share is maximum under the condition of r> K. @ In case of determining the value of the shares payout ratio no debt capital in the capital structure of not correct, bet no other factor is considered in Gordon’s model except dividend - 37-Admission Going on for B.com, M.com, CA, CMA, CS XI, XII. Contact.