1) What is an agency problem and how it can be mitigated?
Ans. An agency problem arises when there is a conflict of interest between principals (such as
shareholders) and agents (such as managers or employees) who are supposed to act on behalf of the
principals.
Causes of Agency Problems:
1. Divergence in Goals: Agents may pursue goals that are not aligned with those of the principals.
2. Information Asymmetry: Agents often possess more information than principals, which can lead to
opportunistic behaviour.
3. Risk Aversion: Agents may prefer safer decisions to protect their own position rather than taking risks
that could benefit principals.
4. Principal-Agent Separation: When principals cannot closely monitor agents, it becomes easier for
agents to act in their own interest.
Mitigation Strategies:
1. Aligning Incentives: Designing compensation packages (e.g., performance-based pay, stock
options) that align the interests of agents with those of principals can incentivize agents to act
in the principals' best interests.
2. Monitoring and Accountability: Implementing monitoring mechanisms such as regular
reporting, audits, and performance evaluations can help reduce opportunistic behaviour by
agents.
3. Board Oversight: Having an independent and competent board of directors can provide
oversight and ensure that agents act in accordance with the principals' interests.
4. Clear Communication and Transparency: Enhancing transparency in decision-making
processes and ensuring clear communication of goals and expectations can reduce
misunderstandings and mitigate agency conflicts.
5. Legal and Regulatory Frameworks: Enforcing laws and regulations that promote fairness
and accountability in corporate governance can provide a framework for mitigating agency
problems.
2) What is leasing? Explain financial lease and operating lease.
Ans. Leasing is a contractual arrangement in which one party (the lessor) grants the use of an asset to
another party (the lessee) for a specified period in exchange for periodic payments. Leasing allows
businesses and individuals to use assets without having to purchase them outright, providing flexibility
and potential financial advantages depending on the type of lease.
Financial Lease:
A financial lease, also known as a capital lease, is a type of lease where the lessee essentially assumes
the risks and rewards of ownership of the leased asset. Key characteristics of a financial lease include:
1. Ownership Transfer: The lease agreement often includes a provision for the lessee to
purchase the asset at the end of the lease term at a bargain purchase option (typically a
nominal amount).
2. Long-Term Nature: Financial leases are usually long-term in nature, often covering a large
part of the asset's useful life.
3. Accounting Treatment: Financial leases are treated as if the lessee owns the asset for
accounting purposes, meaning they are capitalized on the lessee's balance sheet, and both the
asset and liability are recorded.
6) What is irrelevance concept of dividend policy?
Ans. Dividend irrelevance theory posits that dividends don’t have any effect on a company’s stock
price. A dividend is typically a cash payment made from a company’s profits to its shareholders as a
reward for investing in the company.
Dividend irrelevance theory goes on to state that dividends can hurt a company’s ability to be
competitive in the long term since the money would be better off reinvested in the company to
generate earnings.
Although there are companies that have likely opted to pay dividends instead of boosting their
earnings, there are many critics of dividend irrelevance theory who believe that dividends help a
company’s stock price to rise.
7) How is EPS and ROE calculated?
Ans. Earnings Per Share (EPS):
EPS is a measure of the company's profitability per outstanding share of common stock. It
indicates how much profit the company has generated for each share of its common stock.
Formula for EPS:
Where:
 Net Income: This is the company's total earnings after deducting all expenses, taxes,
and interest payments.
 Preferred Dividends: If the company has issued preferred stock, any dividends paid
to preferred shareholders are subtracted from net income.
 Weighted Average Number of Common Shares Outstanding: This represents the
average number of common shares outstanding during the period, adjusted for any
changes in the number of shares outstanding.
ROE measures the profitability of a company relative to its shareholders' equity. It
shows how effectively a company is using its equity to generate profits.
 Formula for ROE:
 Net Income: Same as in the EPS calculation, it represents the company's total earnings.
  Average Shareholders' Equity: This is the average of the beginning and ending
shareholders' equity for the period. Shareholders' equity is the difference between
total assets and total liabilities on the balance sheet.
Operating Lease:
An operating lease is a type of lease in which the lessor retains ownership of the asset, and the lessee
uses the asset for a specific period that is typically shorter than the asset's economic life. Key
characteristics of an operating lease include:
1. No Ownership Transfer: The lessee does not have the option to purchase the asset at the end
of the lease term at a bargain price. The lessor retains ownership throughout the lease period.
2. Short-Term Nature: Operating leases are generally shorter-term compared to financial
leases and are often used for equipment or assets with shorter useful lives.
3. Accounting Treatment: Operating leases are treated as rental expenses on the lessee's
income statement.
3) What are the disadvantages of payback period and accounting rate of
return system?
Ans. Disadvantages of Payback Period:
1. Ignores Time Value of Money: The payback period method does not consider the
time value of money, meaning it fails to account for the fact that money received or
spent in the future is not equivalent to money received or spent today.
2. Ignores Cash Flows Beyond Payback Period: It focuses solely on the time it takes
to recover initial investment costs. As a result, it disregards cash flows occurring after
the payback period, potentially overlooking the overall profitability of an investment.
3. Subjective Cut-off Point: The selection of the payback period may be arbitrary and
subjective, leading to inconsistencies in decision-making across different projects or
organizations.
4. Risk and Uncertainty: The payback period does not explicitly consider the risk
associated with future cash flows, such as variability in income or costs over time.
Disadvantages of Accounting Rate of Return (ARR):
1. Ignores Time Value of Money: Similar to the payback period, ARR does not
incorporate the time value of money. It uses accounting profits, which are based on
accrual accounting principles and may not reflect the actual cash flows.
2. Subject to Accounting Policies: The ARR calculation relies on accounting profits,
which can be influenced by various accounting policies and estimates. This can lead
to inconsistencies in ARR calculations across different companies or projects.
3. Ignores Cash Flows: ARR uses accounting profits rather than cash flows, which can
distort the evaluation of a project's profitability, especially if there are significant
differences between accounting profit and actual cash flow.
4. Ignores Investment Size: ARR does not consider the size of the investment or the
initial outlay required. Projects with different initial investments may have the same
ARR, potentially leading to misleading comparisons.
8) Write short notes on – a) Bonus share b) ESOP
Ans. Bonus Share: Bonus shares, also known as scrip dividends or capitalization issues, are
additional shares distributed to existing shareholders free of charge by a company.
Key Points:
 No Cash Outflow: Shareholders receive bonus shares without any cash outlay.
 Proportionate Increase: Bonus shares are typically issued in proportion to existing shareholdings.
 Impact on Shareholder Equity: While the number of shares held by each shareholder increases, their
proportional ownership in the company remains unchanged.
 Impact on EPS: Issuing bonus shares does not affect the company's earnings per share (EPS) directly
because there is no change in total earnings or the number of shares outstanding.
Example:
 If a company issues bonus shares in a 1:1 ratio, shareholders receive one additional share for every
share held. For instance, if an investor holds 100 shares, they receive an additional 100 shares as
bonus shares.
b) ESOP (Employee Stock Ownership Plan):
 An Employee Stock Ownership Plan (ESOP) is a program that allows employees to acquire ownership
in the company they work for by receiving shares of the company's stock or the right to purchase
shares at a discounted price.
Key Points:
 Allocation: Companies allocate ESOP shares to employees based on various criteria such as seniority,
performance, or a combination of factors.
 Vesting Period: ESOPs often have a vesting period, during which employees must remain with the
company to receive full ownership of allocated shares.
 Tax Benefits: In some jurisdictions, ESOPs offer tax advantages for both the company and
participating employees.
 Liquidity: Employees may face restrictions on selling ESOP shares until certain conditions are met,
such as retirement or leaving the company.
Example:
 A company establishes an ESOP where eligible employees receive annual allocations of company
shares based on their tenure and performance. The shares vest over a five-year period, after which
employees can fully exercise their ownership rights or sell their shares if allowed by the plan.
9) What is EBIT-EPS analysis?
Ans. EBIT-EPS analysis, also known as indifference point analysis, is a financial planning tool used to evaluate
the impact of different capital structures (mix of debt and equity) on the earnings per share (EPS) of a
company. It helps in determining the level of earnings before interest and taxes (EBIT) at which two different
financing options (usually involving different proportions of debt and equity) result in the same EPS.
Key Components of EBIT-EPS Analysis:
1. EBIT (Earnings Before Interest and Taxes):
o EBIT represents the operating profit of a company before deducting interest expenses and
taxes. It is a measure of the company's profitability from core operations.
2. EPS (Earnings Per Share):
o EPS is a financial metric that indicates the portion of a company's profit allocated to each
outstanding share of common stock. It is calculated as net income divided by the weighted
average number of shares outstanding.
4) What are explicit and implicit cost of capital? Give examples.
Ans. Explicit Cost of Capital:
Explicit costs of capital are those costs that can be easily identified and measured in monetary terms.
These costs are typically contractual and involve direct payments to capital providers. Examples
include:
1. Interest Payments on Debt: When a company borrows money through loans or bonds, it
incurs interest expenses. The interest rate represents the explicit cost of debt capital.
2. Dividends Paid to Shareholders: For equity capital, explicit costs can be seen in the
dividends paid to shareholders. These payments represent the return demanded by equity
investors.
3. Underwriting Fees: When issuing new securities (like stocks or bonds), companies may pay
fees to investment banks or underwriters. These fees are explicit costs of raising capital.
Example 1: Interest on Debt
 Scenario: A company borrows $1,000,000 at an annual interest rate of 5%.
 Explicit Cost: The explicit cost of debt capital would be $50,000 per year (5% of
$1,000,000).
Implicit Cost of Capital:
Implicit costs of capital are more nuanced and less tangible than explicit costs. They represent the
opportunity cost of using funds for a particular purpose instead of the next best alternative. Examples
include:
1. Opportunity Cost of Internal Funds: When a company uses retained earnings (instead of
distributing them as dividends), the implicit cost is the return shareholders could have earned
if those funds were invested elsewhere.
2. Lost Interest on Cash Holdings: Holding large amounts of cash instead of investing it can
result in an implicit cost, as the cash could have been earning interest or generating returns.
Example 1: Opportunity Cost of Internal Funds
 Scenario: A company decides to use $500,000 of retained earnings for a new project instead
of distributing them as dividends.
 Implicit Cost: The implicit cost is the return shareholders could have earned if they had
received the dividends and invested them elsewhere.
5) Is equity capital free of cost? Explain.
Ans. Some economists and finance professionals argue that the equity capital is free of cost. The reason for
this argument is that it is not binding legally for firms to pay dividends to ordinary shareholders. Moreover, the
equity dividend rate is not fixed like the interest rate or preference dividend rate. It is, therefore, wrong to
assume that equity capital is free of cost.
As is obvious, equity capital involves an opportunity cost; and the ordinary shareholders supply funds in the
expectation of dividends (along with capital gains) commensurate with their risk of investment. The market price
of the shares that are determined by the demand and supply forces in a fit and well-functioning capital market
reflects the required rate return of ordinary shareholders.
10) Explain the concept of Operating cycle & Cash cycle.
Ans. Operating Cycle
The operating cycle, also known as the cash conversion cycle (CCC), is the time period between the
acquisition of inventory and the collection of cash from receivables. It measures how long a
company’s cash is tied up in its operations. The operating cycle is composed of three main
components:
1. Inventory Period: The time it takes for a company to purchase inventory and sell it. This is the period
during which the inventory is held before it is sold.
2. Accounts Receivable Period (Days Sales Outstanding): The time it takes to collect payment from
customers after a sale is made.
3. Accounts Payable Period (Days Payable Outstanding): The time a company takes to pay its suppliers
after purchasing inventory.
The formula for the operating cycle is: Operating Cycle=Inventory Period+ Accounts Receivable Period
Cash Cycle
The cash cycle, also known as the net operating cycle or cash conversion cycle, refines the operating
cycle by accounting for the time a company can delay payments to its suppliers. The cash cycle
measures the time between when a company pays for its inventory and when it receives cash from the
sale of that inventory
The formula for the cash cycle is: Cash Cycle=Operating Cycle−Accounts Payable Period
Let's take an example to illustrate these cycles:
 Inventory Period: 40 days (time taken to sell the inventory)
 Accounts Receivable Period: 30 days (time taken to collect receivables)
 Accounts Payable Period: 20 days (time taken to pay suppliers)
Operating Cycle=Inventory Period+ Accounts Receivable Period
Operating Cycle=40 days+30 days=70 days
Cash Cycle=Operating Cycle−Accounts Payable Period
Cash Cycle=70 days−20 days=50 days
11) What is Rights share?
Ans. A rights share, also known as a rights issue, is a mechanism by which a company raises
additional capital by offering its existing shareholders the opportunity to purchase additional shares at
a discounted price before the shares are offered to the public. This method allows companies to raise
funds quickly while giving current shareholders the chance to maintain their proportional ownership
in the company.
Key Features of Rights Shares
1. Exclusive Offer to Existing Shareholders: Only existing shareholders have the right to
purchase these additional shares, typically in proportion to their current holdings.
2. Discounted Price: The shares are offered at a price lower than the current market price,
making them an attractive investment for shareholders.
3. Ratio of Rights Issue: The company specifies a ratio in the rights issue announcement. For
example, a 1:3 rights issue means that a shareholder can buy one additional share for every
three shares they already own.

12) What is Operating leverage, financial leverage and Total
leverage? Distinguish between them.
Ans. Operating leverage refers to the degree to which a company uses fixed costs in its
operations. It measures the sensitivity of a company's operating income (EBIT) to changes in
sales volume. Companies with high operating leverage have a higher proportion of fixed
costs relative to variable costs. This means that a small change in sales can lead to a larger
change in operating income.
Formula:
Degree of Operating Leverage (DOL)=Percentage Change in EBIT/Percentage Change in Sal
es
Example: If a company has high fixed costs like machinery, rent, and salaries, an increase in
sales will significantly impact its EBIT, because the fixed costs remain constant while
revenue increases.
Financial Leverage
Financial leverage refers to the degree to which a company uses borrowed funds (debt) to
finance its operations. It measures the sensitivity of a company's net income to changes in
operating income. Companies with high financial leverage have a higher proportion of debt
relative to equity. This means that a change in EBIT will result in a more significant change
in net income due to the interest obligations on the debt.
Formula:
Degree of Financial Leverage (DFL)=Percentage Change in Net Income/Percentage Change i
n EBIT
Example: If a company finances a large portion of its assets through debt, an increase in
EBIT will result in a proportionally larger increase in net income because the interest
expenses on the debt remain fixed.
Total Leverage
Total leverage is the combined effect of operating leverage and financial leverage. It
measures the sensitivity of a company's net income to changes in sales. Total leverage
indicates how a change in sales will affect the bottom line (net income), incorporating both
the effects of fixed operating costs and fixed financial costs (interest on debt).
Formula: Degree of Total Leverage (DTL)=Percentage Change in Net Income /
Percentage Change in Sales
Example: A company with both high fixed costs (operating leverage) and significant debt
(financial leverage) will experience substantial changes in net income with relatively small
changes in sales.
17) What is financial management? What are the objectives of
financial management?
Ans. Financial management is the strategic planning, organizing, directing, and controlling of
financial activities within an organization. It involves the application of management principles
to the financial assets of a company, with the goal of maximizing the value of the organization
and ensuring its financial stability. This includes making decisions about capital investment,
financing, dividend distribution, and working capital management.
Objectives of financial management
Profit maximisation
It seeks to generate the highest level of profits possible, given the resources available to an organisation.
Typically measured in terms of net income, it maximises the difference between an organisation's revenue and
its expenses.
Wealth maximisation
The objectives of financial management also include increasing an organisation's total value, as measured by
its market capitalization or asset value. In contrast to profit maximisation, which focuses on short-term profits,
wealth maximisation considers the long-term impact of financial decisions on an organisation's value.
Liquidity management
It is a key component of financial management that involves ensuring that an organisation has enough cash
and other liquid assets to meet its short-term obligations. It includes controlling the organisation's cash inflows
and outflows and ensuring enough liquidity to pay operational expenditures and satisfy financial commitments
when they become due.
Solvency management
The debt capital market can play an important role in ensuring the solvency of organisations by providing a
source of long-term financing that can be used to meet obligations over the long term.
Asset management
The objectives of financial management encompass making decisions about the acquisition, use, and disposal
of an organisation's assets to maximise their value.
Capital structure management
The debt capital market can be a valuable source of financing for organisations seeking to optimise their
capital structure. By issuing debt securities, organisations can access a reliable source of long-term financing
while also taking advantage of a lower cost of capital compared to equity financing.
13) What is Annuity? How is important for an investment
calculation?
Ans. An annuity is a series of equal payments made at regular intervals over a specified period. These
payments can be made annually, semi-annually, quarterly, monthly, or at any other regular interval.
Annuities are commonly used in financial planning and investment calculations, especially in retirement
planning and the valuation of financial products.
Importance of Annuity for Investment Calculation
1. Retirement Planning: Annuities are crucial in retirement planning as they provide a steady
income stream, helping retirees manage their finances and ensure they do not outlive their
savings.
2. Time Value of Money: Annuities help in understanding the time value of money. By
calculating the present and future values of annuities, investors can determine how much to
invest today to achieve a desired future income stream.
3. Loan Repayments: Mortgages and other loans often involve annuity calculations to
determine the periodic payment amounts.
4. Investment Valuation: Annuities are used in the valuation of investments like bonds, which
pay periodic interest.
14) What is Weighted average cost of capital? How is it calculated?
Ans. The Weighted Average Cost of Capital (WACC) is a financial metric that calculates a company’s
overall cost of capital, taking into account the proportion of equity, debt, and other sources of capital used
to finance its operations. It represents the average rate of return a company is expected to pay its security
holders to finance its assets. WACC is essential for investment decisions, company valuation, and financial
strategy because it serves as the discount rate for evaluating the net present value (NPV) of a project or
investment.
WACC is calculated by weighting the cost of each component of the company’s capital structure (debt,
equity, and preferred stock) by its respective proportion in the overall capital. The general formula for
WACC is:
15) Explain par value, issue price, book value and Market value of an
equity share.
Ans.
 Par value, also known as face value or nominal value, is the value assigned to a share of stock
when it is first issued by a company. It is a static value that does not change over time and is
typically a very small amount, often set at $1 or even less. Par value is more of a legal and
accounting concept rather than a market-driven figure.
 Issue price is the price at which a company sells its shares to investors when they are first
issued. This price is determined based on various factors including the company's financial
performance, market conditions, and investor demand.
 Book value per share is the net asset value of a company divided by the number of
outstanding shares. It represents the value of the company's equity as recorded on its
balance sheet. The book value is calculated using historical costs and does not necessarily
reflect the current market value.
 Market value per share is the current price at which a share is traded on the stock market. It
fluctuates based on supply and demand, investor perception, and overall market conditions.
18) What are the differences between Profit maximisation and
Wealth maximisation?
Ans.
Profit maximisation Wealth maximisation
Maximising a company’s profits. Maximising the wealth of shareholders.
Increasing the business’s earning capacity. Enhancing stock value for stakeholders and
shareholders.
Increasing a company’s capacity to generate Improving the business’s share price.
maximum returns with the minimum input.
Does not acknowledge the time value of Takes into account the time value of money.
money.
19) What is Gross Working capital & Net working capital? What are
the factors which influence working capital decisions?
Ans. Gross Working Capital refers to the total current assets of a company. Current assets are
those assets that are expected to be converted into cash within a year and include cash, accounts
receivable, inventory, marketable securities, and other short-term assets.
 Formula: Gross Working Capital=Total Current Assets
 Importance: It indicates the liquidity and short-term financial health of the company by
showing the total resources available to meet short-term obligations.
Net Working Capital is the difference between current assets and current liabilities. It represents the
excess of current assets over current liabilities and indicates the short-term financial stability and
efficiency of a company in managing its working capital.
 Formula: Net Working Capital=Current Assets−Current Liabilities\
 Importance: Positive net working capital indicates that a company can cover its short-term
liabilities with its short-term assets, which is crucial for maintaining operations without
liquidity issues. Negative net working capital suggests potential liquidity problems.
Factors Influencing Working Capital Decisions
1. Nature of Business
o Impact: Companies in industries with longer production cycles (e.g., manufacturing) typically
require more working capital compared to those in services or retail with shorter cycles.
2. Business Cycle
o Impact: During periods of growth or expansion, companies may need more working capital
to finance increased production and sales. Conversely, during a downturn, working capital
needs may decrease.
3. Production Cycle
o Impact: The time taken to convert raw materials into finished goods affects the amount of
working capital required. Longer production cycles necessitate higher working capital.
4. Credit Policy
o Impact: Liberal credit policies can lead to higher accounts receivable and increased working
capital needs. Conversely, strict credit policies reduce the need for working capital but might
impact sales.
5. Inventory Management
o Impact: Efficient inventory management can reduce the amount of capital tied up in stock,
thereby lowering working capital requirements.
16) What are the advantages of having equity capital?
Ans. Equity capital refers to the funds raised by a company in exchange for ownership
stakes, typically through the issuance of shares of stock. This form of financing has several
advantages for businesses, which are crucial for growth, stability, and strategic planning.
Here are the key advantages of having equity capital:
1. No Repayment Obligation
 Permanent Capital: Unlike debt, equity does not need to be repaid. This provides a stable
source of funding that remains within the company indefinitely, unless the company decides
to buy back shares.
 Cash Flow Management: With no fixed interest payments or principal repayments,
companies have more flexibility in managing their cash flow, particularly during periods of
low revenue.
2. Strengthened Balance Sheet
 Improved Financial Stability: Equity capital enhances a company's net worth and
strengthens its balance sheet, making it more attractive to lenders and investors.
 Debt Capacity: A strong equity base can improve a company’s credit rating, allowing it to
borrow more easily and at better terms in the future if needed.
3. Shared Risk
 Risk Distribution: The risks associated with the business are shared among the shareholders.
This reduces the financial burden on the company in case of downturns, as shareholders
bear the risk of losses.
 No Collateral Requirement: Equity financing does not require collateral, unlike many forms
of debt, thus preserving the company’s assets for operational use.
4. Enhanced Credibility and Market Perception
 Investor Confidence: Raising equity from reputable investors can enhance the company’s
credibility and signal market confidence in its potential.
 Publicity and Visibility: For publicly traded companies, issuing equity can increase market
visibility and attract media attention, which can be beneficial for business growth and brand
recognition.
5. Flexibility and Growth Opportunities
 Capital for Growth: Equity capital provides the necessary funds for expansion, research and
development, marketing, and other growth initiatives without the pressure of repayment.
 Strategic Partnerships: Equity financing can involve strategic investors who bring not only
capital but also expertise, networks, and other resources that can drive business growth.
6. Aligning Interests
 Ownership Stake: Investors and shareholders have a vested interest in the success of the
company. This alignment can lead to more support and resources from investors who are
motivated to see the company succeed.
20) Explain the concept of time value of money.
Ans. The time value of money (TVM) is the concept that a sum of money is worth more
now than the same sum will be at a future date due to its earnings potential in the interim. The
time value of money is a core principle of finance. A sum of money in the hand has greater
value than the same sum to be paid in the future. The time value of money is also referred to
as the present discounted value.
 Opportunity Cost: Money available today can be invested to earn returns. The opportunity
to earn interest or returns on investment makes money received today more valuable than
money received in the future.
 Inflation: Over time, inflation erodes the purchasing power of money. Thus, a dollar today
can buy more goods and services than a dollar in the future.
 Risk: Future cash flows are uncertain and carry risk. Receiving money today eliminates the
uncertainty associated with future cash flows.
 Consumption Preference: Individuals prefer current consumption over future consumption,
valuing immediate access to funds.
21) What is Preference capital? Why it is called quasi-equity or
hybrid financing.
Ans Preference capital, also known as preferred stock or preference shares, is a type of
equity financing where shareholders have a higher claim on the company's assets and
earnings compared to common shareholders. However, preference shareholders typically do
not have voting rights and their dividends are fixed, unlike dividends on common stock
which can fluctuate based on company performance.
Preference capital is often referred to as quasi-equity or hybrid financing due to its unique
characteristics that combine elements of both equity and debt:
1. Equity-Like Features:
o Dividends: Preference shares pay fixed dividends, similar to interest payments
on debt. However, unlike debt, these dividends are not mandatory and can be
skipped if the company's profits are insufficient.
o Priority in Liquidation: Preference shareholders rank higher than common
shareholders in terms of claim on assets during liquidation, similar to creditors
in debt financing.
2. Debt-Like Features:
o Fixed Payments: The fixed dividend payments resemble interest payments on
debt, providing certainty to preference shareholders about their income.
o Non-Voting Rights: Like bondholders, preference shareholders generally do
not have voting rights in the company's decision-making processes.
3. Flexibility in Financing: Companies can issue preference shares to raise capital
without diluting the voting control of existing shareholders, as preference
shareholders typically do not have voting rights.

Group B –
1) What is an IPO? Explain the various steps in the process of issuing IPO.
Ans. An Initial Public Offering (IPO) is the process through which a private company becomes a
public company by offering its shares to the general public for the first time. This allows the company
to raise capital from external investors by selling shares of ownership in the company.
Steps in the Process of Issuing an IPO
The process of issuing an IPO involves several key steps, each crucial for ensuring regulatory
compliance, investor interest, and successful transition to a publicly traded company:
1. Preparation and Planning
 Selection of Underwriters: The company selects investment banks (underwriters) to manage
the IPO process. These underwriters help in determining the offering price, structure, and
marketing strategy.
 Due Diligence: The company and underwriters conduct extensive due diligence to assess
financial statements, business operations, legal compliance, and potential risks.
2. Filing with Regulatory Authorities
 Submission to SEC (Securities and Exchange Commission): In the United States, the
company files the prospectus and other required documents with the SEC for review and
approval. The SEC ensures that all disclosure requirements are met to protect investors.
 Review Process: The SEC reviews the prospectus and may provide comments that the
company must address before the IPO can proceed.
3. Marketing and Roadshow
 Marketing Strategy: The underwriters, together with the company’s management team,
develop a marketing strategy to promote the IPO to potential investors.
 Roadshow: Company executives and underwriters embark on a roadshow, which involves
presentations and meetings with institutional investors, analysts, and potential buyers of the
IPO shares. This helps generate interest and gauge investor demand.
4. Price Setting
 Book Building: During the roadshow, the underwriters solicit indications of interest from
institutional investors to determine demand for the IPO shares at various price levels. This
process is known as book building.
 Setting the Offering Price: Based on investor demand and market conditions, the
underwriters and company management agree on the final offering price per share. This price
is critical as it determines the valuation of the company and the amount of capital raised.
5. Allocation of Shares
 Allocation to Investors: The underwriters allocate shares to institutional investors and individual
investors based on their indications of interest and other criteria. The goal is to achieve a balanced
distribution of shares while maximizing proceeds for the company.
6. Execution and Trading
 Effective Date: Once the SEC approves the IPO and all necessary preparations are
completed, the company announces the effective date when shares will start trading on the
stock exchange.
 Market Debut: On the effective date, the company’s shares are listed and traded on the stock
exchange. Investors can buy and sell shares based on market demand and the offering price
set during the IPO process.
2) Explain the Discounted cash flow techniques of capital budgeting.
Ans. Discounted Cash Flow (DCF) techniques are widely used in capital budgeting to evaluate
the profitability and feasibility of investment projects by discounting future cash flows to their
present value. These techniques help in making informed decisions about whether to proceed
with a project based on its potential returns compared to the initial investment.
Net Present Value (NPV)
 Definition: NPV measures the difference between the present value of cash inflows
(benefits) and outflows (costs) associated with an investment project. A positive NPV
indicates that the project is expected to generate more cash inflows than outflows,
thereby adding value to the company.
Internal Rate of Return (IRR)
 Definition: IRR is the discount rate that makes the NPV of an investment zero, i.e., it
is the rate at which the present value of cash inflows equals the present value of cash
outflows.
Profitability Index (PI)
 Definition: PI measures the ratio of present value of future cash flows to the initial
investment outlay. It indicates the value created per unit of investment.
Advantages of DCF Techniques:
 Considers Time Value of Money: Accounts for the opportunity cost of capital by discounting
future cash flows.
 Flexible: Can accommodate varying cash flow patterns and investment horizons.
 Objective: Provides a quantitative basis for decision-making, focusing on maximizing
shareholder value.
 Integration: Consistent with financial theory and principles of valuation.
Limitations of DCF Techniques:
 Estimation Risks: Relies on accurate forecasts of future cash flows, which can be challenging
and subject to error.
 Assumption Sensitivity: Results can be sensitive to changes in discount rates and cash flow
projections.
 Complexity: Requires understanding of finance principles and careful application of
methodologies.
3) What are the three propositions of Miller & Modigliani’s capital structure theory?
Explain.
Ans. Propositions of Miller & Modigliani's Capital Structure Theory
1. Proposition I: Modigliani-Miller Proposition I (No Taxes)
Assumption: There are no taxes, bankruptcy costs, or other market imperfections.
Statement: The capital structure of a firm is irrelevant to its market value. In other
words, the value of a company is determined solely by its investment decisions
(project cash flows) and not by how those investments are financed (through equity or
debt).
Explanation: Under perfect market conditions without taxes or bankruptcy costs,
investors can create any desired level of leverage (debt) or unleveraged (pure equity)
position through personal borrowing or lending. Therefore, the overall cost of capital
(WACC) remains constant regardless of the debt-to-equity ratio. Investors adjust their
required rate of return on equity to reflect the increased risk of leverage, thereby
maintaining the overall value of the firm regardless of its capital structure.
2. Proposition II: Modigliani-Miller Proposition II (No Taxes)
Assumption: The cost of equity rises linearly with leverage due to increased financial
risk.
Statement: The cost of equity (required rate of return) increases linearly with
leverage (debt-to-equity ratio).
Explanation: As a company increases its use of debt, the financial risk perceived by
equity holders increases because debt holders have priority in receiving payments. To
compensate for this increased risk, equity holders demand a higher expected return.
This proposition suggests that while the cost of debt is lower than equity due to
interest tax shields and lower bankruptcy costs, the increasing cost of equity offsets
these benefits, resulting in a constant overall WACC.
3. Proposition III: Modigliani-Miller Proposition II (Corporate Taxes)
Assumption: Corporate taxes exist, but personal taxes and bankruptcy costs do not
distort capital structure decisions.
Statement: The value of a leveraged firm is equal to the value of an unleveraged firm
plus the present value of tax shields on debt.
Explanation: When corporate taxes are considered, interest payments on debt are tax-
deductible, providing a tax shield that reduces the overall cost of capital for leveraged
firms. This tax shield increases the value of the firm, leading to a lower WACC
compared to an unleveraged firm. However, the increased value from tax shields is
offset by the higher cost of equity due to financial risk, resulting in a similar overall
value of the firm under perfect market conditions.

4) What are angel investors and venture capital? Enumerate the differences between them.
Basis for Comparison Venture Capitalist
Meaning A venture capitalist (VC) can be
described as an investor in private
equity who lends capital to
companies with high growth
potential in exchange for equity
stakes.
What is it? Professionally managed
public/private firm.
Money Pools money from funds,
foundations, corporations, and
insurance companies, to invest.
Investment The investment made in the pre-
profitability business.
Post Investment role Strategic
Investment size Comparatively large
Screening Undertaken by an outside firm
specialised in the same or an
experts' team.
Approach to agency risk control Principal-agent approach
Stresses on Investment criteria as per initial
screening of investment
opportunities.
3. Internal Rate of Return (IRR) Method
Angel Investor
Angel investors are people who
offer promising start-up
businesses funding by offering a
share of the company, generally
as royalties or equity.
Individual investors (often
successful businessmen ).
Invest their own funds.
4. Profitability Index (PI) Method
An investment made in the pre-
revenue business.
Active
Less
Undertaken by the angel investor
as per their own experience.
Incomplete contracts approach
Investment criteria as per ex-post
involvement.
 Definition: IRR is the discount rate that equates the present value of cash inflows with the
initial investment outlay, resulting in a zero NPV.
 Decision Criterion: Accept the project if IRR > Discount Rate; reject it if IRR < Discount
Rate. Higher IRR indicates higher return on investment.
 Advantages:
o Accounts for the time value of money.
o Intuitive measure of project profitability.
o Provides a single rate of return for comparison with hurdle rates.
 Disadvantages:
o May result in multiple IRRs or no real IRR in complex cash flow patterns.
o Assumes reinvestment of cash flows at the IRR, which may not be realistic.
 Definition: PI measures the ratio of present value of future cash flows to the initial
investment outlay.
 Decision Criterion: Accept the project if PI > 1; reject it if PI < 1. Higher PI indicates greater
value created per unit of investment.
 Advantages:
o Considers the time value of money.
o Useful in comparing projects with different initial investment requirements.
 Disadvantages:
o Does not provide absolute measure of profitability like NPV.
o Relies on accurate estimation of cash flows and discount rates.

5) What are the differences between various methods of Capital budgeting.

Payback Period Method
 Definition: Payback period is the time required for a project to recover its initial investment
outlay from the cash inflows generated by the project.
 Decision Criterion: Projects with shorter payback periods are preferred as they recover the
initial investment sooner.
 Advantages:
o Simple and easy to understand.
o Emphasizes liquidity and risk by focusing on how quickly initial investment is recovered.
 Disadvantages:
o Ignores cash flows beyond the payback period.
o Does not consider the time value of money.
o Ignores profitability and overall project value.
2. Net Present Value (NPV) Method
 Definition: NPV calculates the present value of all cash inflows and outflows associated with
a project, discounted at a specified rate (cost of capital or hurdle rate).
 Decision Criterion: Accept the project if NPV > 0; reject it if NPV < 0. Higher NPV
signifies greater value creation.
 Advantages:
o Considers the time value of money.
o Incorporates all cash flows throughout the project's life.
o Maximizes shareholder wealth.
 Disadvantages:
o Requires estimation of discount rate, which can be subjective.
o Complex calculation involving forecasting future cash flows.