Financial Management

Amity Campus Uttar Pradesh India 201303 ASSIGNMENTS PROGRAM: BFIA SEMESTER-II Subject Name: Study COUNTRY: Roll Number (Reg. No.): Student Name:

Financial Management SOMALIA BFIA01512010-2013019 MOHAMED ABDULLAHI KHALAF

INSTRUCTIONS a) Students are required to submit all three assignment sets. ASSIGNMENT Assignment A Assignment B Assignment C

DETAILS Five Subjective Questions Three Subjective Questions + Case Study Objective or one line Questions

MARKS 10 10 10

b) c) d) e)

Total weight-age given to these assignments is 30%. OR 30 Marks All assignments are to be completed as typed in word/pdf. All questions are required to be attempted. All the three assignments are to be completed by due dates and need to be submitted for evaluation by Amity University. f) The students have to attach a scanned signature in the form.

Signature : __________________________

Date: 27 – June – 2011

( √ ) Tick mark in front of the assignments submitted Assignment A’



Assignment ‘B’

~2~



Assignment ‘C’



SECTION A: Q: 1). In what ways is the wealth maximization objective superior to the profit maximization objective? Explain. ANSWER: Wealth Maximization is the primary goal for management decisions; it considers the risk and timing associated with expected earnings per share in order to maximize the price of the firm’s common stock. Its objective is a widely recognized criterion with which the performance of business enterprise is evaluated. The word wealth refers to the net present worth of the firm. Therefore, wealth maximization is also stated as net present worth. Wealth maximization objective as decisional criterion suggests that any financial action, which creates wealth or which has a net present value above zero is desirable one and should be accepted and any financial actions that do not satisfy this test should be rejected. The wealth maximization objective when used as decisional criterion serves is a very useful guideline in taking investment decisions. This is because the concept of wealth is very clear. It represents present value of the benefits minus the cost of the investment. The concept of cash flow is more precise in connotation than that of accounting profit. Thus, measuring benefit in terms of cash flows generated avoids ambiguity. The wealth maximization objective considers time value of money. A dollar in hand today is worth more than a dollar to be received in the future because, if you had it now, you could invest it, earn interest, and end up with more than one dollar in the future. It recognizes that cash benefits emerging from a project in different years are not identical in value. This is why annual cash benefits of a project are discounted at a discount rate to calculate total value of these cash benefits. At the same time, wealth maximization objective also gives due weight-age to risk factor by making necessary adjustments in the discount rate. Thus, cash benefits of a project with higher risk exposure is discounted at a higher discount rate (cost of capital), while lower discount rate applied to discount expected cash benefits of a less risky project. In this way, discount rate used to determine ~3~

present value of future streams of cash earnings reflect on both the time and the risk. For those above mentioned reasons, wealth maximization objective is considered superior to profit maximization objective. Q: 2). What is capital budgeting? Why is it significant for a firm? ANSWER: The term capital refers to long-term assets used in production, while a budget is a plan that details projected inflows and outflows during some future period. Thus, the capital budget is an outline of planned investments in fixed assets, and capital budgeting is the whole process of analyzing projects and deciding which ones to include in the capital budget. Capital budgeting is the firm’s decision to invest its current funds most efficiently in the long-term assets in the anticipation of an expected flow of benefits over a series of years. Capital budgeting is investment decision-making as to whether a project is worth undertaking or not. It is basically concerned with the justification of capital expenditures. It is the process of planning expenditures on assets whose cash flows are expected to extend beyond one year. A number of factors combined together make capital budgeting, perhaps the most important function financial managers and their staffs must perform. First, since the results of capital budgeting decisions continue for many years, the firm loses some of its flexibility. For example, the purchase of an asset with an economic life of 10 years “locks in” the firm for a 10-year period. Further, because asset expansion is based on expected future sales, a decision to buy an asset that is expected to last 10 years requires a 10-year sales forecast. Finally, a firm’s capital budgeting decisions define its strategic direction, because moves into new products, services, or markets must be preceded by capital expenditures. An erroneous forecast of asset requirements can have serious consequences. If the firm invests too much, it will incur unnecessarily high depreciation and other expenses. On the other hand, if it does not invest enough, two problems may arise. First, its equipment may not be sufficiently modern to enable it to produce ~4~

competitively. Second, if it has inadequate capacity, it may lose market share to rival firms, and regaining lost customers requires heavy selling expenses, price reductions, or product improvements, all of which are costly. Timing is also important; capital assets must be available when they are needed. Effective capital budgeting can improve both the timing and the quality of asset acquisitions. If a firm forecasts its needs for capital assets in advance, it can purchase and install the assets before they are needed. Note, though, that if a firm forecasts an increase in demand and then expands to meet the anticipated demand, but sales do not increase, it will be saddled with excess capacity and high costs, which can lead to losses or even bankruptcy. Thus, an accurate sales forecast is critical. Capital budgeting typically involves substantial expenditures, and before a firm can spend a large amount of money, it must have the funds lined up, due to that large amounts of money are not available automatically. Therefore, a firm contemplating a major capital expenditure program should plan its financing far enough in advance to be sure funds are available. For conclusion, capital budgeting is highly significant to the firm, because of the flowing reasons;  It influences the firm’s growth in the long run; decision to invest in long-term assets has a decisive influence on the rate and direction of its growth. A wrong decision can prove disastrous for the continued survival of the firm; unwanted or unprofitable expansion of assets will result in heavy operating costs to the firm. On the other hand, inadequate investment in assets would make it difficult for the firm to compete successfully and maintain its market share.  It affects the risk of the firm; long-term commitment of funds may also change the risk complexity of the firm. If the adoption of investment increases average gain but causes frequent fluctuations in its earnings, the firm will become more risky.  It involves commitment of large amount of funds; Investment decisions generally involve large amount of funds, which make it imperative for the firm to plan its investment programs very carefully and make an advance arrangement for procuring finances internally or externally. ~5~

 It is irreversible, and if reversible it is at substantial loss; most investment decisions are irreversible. It is difficult to find a market for such capital items once they have been acquired. The firm will incur heavy losses if such assets are scrapped.  It is among the most difficult decisions to make; Investments decisions are the most complex ones. They are an assessment of future events, which are difficult to predict. It is really a complex problem to correctly estimate the future cash flow of an investment. Economic, social, & technological forces cause the uncertainty in cash flow. Q: 3). Explain the factors influencing working capital policy of a firm. ANSWER: Working Capital Policy refers to the firm’s basic policy decisions regarding target levels for each category of current assets and how current assets will be financed. Working capital policy involves two basic questions: 1) What is the appropriate amount of current assets for the firm to carry, both in total and for each specific account? And 2) How should current assets be financed? The working capital policy of a firm is influenced by numerous factors. The important ones are: 1) Nature of business: The working capital requirement of a firm is closely related to the nature of its business. A service firm, like electricity and water supply or a transport corporation, which has a short operating cycle and which sells predominantly on cash basis, has a modest working capital requirement. On the other hand, a manufacturing concern like a machine tools unit, which has a long operating cycle and which sells largely on credit, has a very substantial working capital requirement. 2) Terms of sales and purchases: Credit sales granted by the concerns to its customers as well as credit terms granted by the suppliers also affect the working capital. If the credit terms of the purchases are more favorable and at the same time those of sales less liberal, less cash will be invested in the inventory. With more

~6~

favorable credit terms, working capital requirements can be reduced. 3) Manufacturing cycle: The length of manufacturing cycle influences the quantum of working capital needed. Manufacturing process always involves a time. The length of manufacturing period depends on the nature of product as well as the technology used. Shorter the manufacturing cycle; lesser the working capital required. 4) Rapidity of turnover: If the inventory turnover is high, the working capital requirements will be low. With a better inventory control, a firm is able to reduce its working capital requirements. When a firm has to carry on a large slow moving stock, it needs a larger working capital as against another whose turnover is rapid. A firm should determine the minimum level of stock, which it will have to maintain throughout the period of its operation. 5) Business cycle: Cyclical changes in the economy also influence quantum of working capital. In a period of boom, when the business is prosperous, there is need of larger amount of working capital due to increases in sales, rise in price etc and vice-versa. 6) Changes in technology: Changes in technology may lead to improvements in processing of raw materials, savings in wastage, greater productivity, and more speedy production. All these improvements may enable the firm to reduce investments in inventory. 7) Seasonal variation: The inventory of raw materials, spares and stores depends on the condition of supply. If the supply is prompt and adequate the firm can manage with small inventory. However, if the supply were unpredictable and scant then the firm, to ensure the continuity of production, would have to acquire stocks as and when they are available and carry larger inventory on an average. 8) Production Policy: A firm marketed by pronounced seasonal fluctuations in its sales may pursue a production policy which may reduce the sharp variations in working capital requirements. For example, a manufacturer of ceiling fans may maintain a steady production throughout the year rather than intensify the production activity during the peak business season. Such a production policy may dampen the fluctuations in working capital requirements. ~7~

9) Market conditions: The degree of competition prevailing in the market-place has an important bearing on working capital needs. When competition is intense, a larger inventory of finished goods is required to promptly serve customers who may be inclined to wait because other manufacturers are ready to meet their needs. Further, generous credit terms may have to be offered to attract customers in a highly competitive market. Thus, working capital needs tend it be high because of greater investment in finished goods inventory and accounts receivable. If the market is strong and competition is weak, a firm can manage with smaller inventory of finished goods, because customers can be supplied with some delay. Further, in such a situation the firm can insist on cash payment and avoid lock-up of funds in accounts receivable – it can even ask for advance, partial or total. Q: 4). A- How Finance function is related to investment function? B- Explain different functions performed by a finance manager. ANSWER: A- Finance function is mainly concerned with the determination of optimum capital structure of the company keeping in mind cost, control and risk. It is also known as Procurement of Fund. And Investment Function, also known as Effective Utilization of Fund. In this respect finance department has to identify the investment opportunities and to choice the best one, after a proper evaluation. Investment function and Finance function are inter-related and inter-connected. They are inter-related because the goal of those functions is one and the same. Their ultimate objective is only one; achievement of maximization of shareholders’ wealth or maximizing the market value of the shares. All the decisions are also interconnected or inter-dependent also. Let us illustrate this aspect with an example. If a firm wants to undertake a project requiring funds, this investment decision cannot be taken, in isolation, without considering the availability of finances, which is a finance decision. So both decisions are inter-connected. So far the objective of these two functions is the same; maximizing shareholders wealth. As their objectives are same the decisions are interrelated. A company, having profitable investment opportunities ~8~

generally prepares a good financing, and good investment means profit of the company would be more. Finance function and investment functions are also highly correlated. Cost of capital plays a major role whether to accept or not investment opportunities. Financing decisions also dependent on amount of to be retained in the profit. So, we can conclude that investment and finance functions are interrelated and are to be taken jointly keeping in view their joint effect on the shareholders wealth. B- Financial Managers perform several functions including; 1) Estimation of capital requirements: A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programs and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise. 2) Determination of capital composition: Once the estimation has been made, the capital structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties. 3) Choice of sources of funds: For additional funds to be procured, a company has many choices like; a) b) c) d)

Issue of shares and debentures. Loans to be taken from banks and financial institutions. Public deposits to be drawn like in form of bonds. Choice of factor will depend on relative merits and demerits of each source and period of financing.

4) Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible. 5) Disposal of surplus: The net profits’ decisions have to be made by the finance manager. This can be done in two ways: 6) Dividend declaration: It includes identifying dividends and other benefits like bonus.

~9~

the

rate

of

7) Retained profits: The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company. 8) Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials, etc. 9) Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc Q: 5). ‘Generally individuals show a time preference for money.’ Give reasons for such a preference. ANSWER: Generally individuals show a time preference for money, because Individuals prefer possession of a given amount of cash now, rather than the same at some time in the future. The main reason for the time preference or time value of money is: 1) Risk: There is uncertainty about the receipt of the money in future. 2) Preference for present consumption: Most persons and companies have a preference for present consumption of goods, commodities and services. 3) Investment opportunities: Most persons and companies have a preference for present money because of the availability of opportunities of investment for earning additional cash flows.

~ 10 ~

SECTION B: Q: 1). A- What is the importance of working capital for a manufacturing firm? B- What shall be the repercussion if a firm has (a) paucity of working capital, (b) Excess working capital? ANSWER: A- Working capital is very important concept in finance. It represents the funds available with the company for day to day operations. Working capital finances the cash conversion cycle. Company cannot survive with negative working capital which represents that the company has no funds for day to day operations Essentially working capital is the answer to the question: "How much short term funding do you need to operate this business?” Short term funding is important because, with long term funding already in place, the business still needs short term funding to operate. Without the short term funding, the business will go bankrupt. Another concept is net working capital which means surplus of current assets over current liabilities. A positive NWC is good for a company. Some time, if creditors demand their money from company, at this time company's high working capital saves company from this situation. You know that selling of current assets is easy in small period of time but Company cannot sell their fixed assets with in small period of time. So, if Company has sufficient working capital, Company can easily pay off the creditors and create his reputation in market. But if a company has zero working capital and then company cannot pay creditors in emergency time and either company becomes bankrupt or takes loan at higher rate of Interest. In both condition, it is very dangerous and always Company's Account Manager tries to keep some amount of working capital for creating goodwill in market. Positive working capital enables also to pay day to day expenses like wages, salaries, overheads and other operating expenses. Because sufficient working capital can not only pay maturity liabilities but also outstanding liabilities without any more delay.

~ 11 ~

One of advantages of positive working capital is that Company can do every risky work without any tension of self security. B- The paucity or shortage of working capital leads to a company’s bankruptcy. Working capital is a good measure of liquidity because it looks at debts that must be paid within one year or less. A firm must have adequate working capital as much as needed. It should be neither excessive nor inadequate. Both situations are dangerous. Excessive working capital means the firm has idle funds which earn no profits for the firm. Inadequate working capital means the firm does not have sufficient funds for running its operations. It will be interesting to understand the relationship between working capital, risk and return. The basic objective of working capital management is to manage firm’s current assets and current liabilities in such a way that the satisfactory level of working capital is maintained; neither inadequate nor excessive. Positive working capital generally indicates that a company is able to pay off its short-term liabilities almost immediately. Negative working capital generally indicates a company is unable to do so. This is why analysts are sensitive to decreases in working capital; they suggest a company is becoming overleveraged, is struggling to maintain or grow sales, is paying bills too quickly, or is collecting receivables too slowly. Increases in working capital, on the other hand, suggest the opposite. When not managed carefully, businesses can grow themselves out of cash by needing more working capital to fulfill expansion plans than they can generate in their current state. This usually occurs when a company has used cash to pay for everything, rather than seeking financing that would smooth out the payments and make cash available for other uses. As a result, working capital shortages cause many businesses to fail. The most efficient companies invest wisely to avoid these situations. Q: 2). A- Why should inventory be held? B- Why is inventory management important? C- Explain the objectives of inventory management? ANSWER: AInventory means the raw materials, work-in-process goods and completely finished goods that are considered to be the ~ 12 ~

portion of a business's assets those are ready or will be ready for sale. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company. The Inventories are held for the following reasons. 1) Smooth production: to ensure smooth production as per the requirements of marketing department, inventories are procured and sold. 2) To achieve Competitive edge: Most of the retail and industrial organizations carry inventory to ensure prompt delivery to customers. No firm likes to lose customers on account of the item being out of stock. 3) Gaining Quantity Discount: Sometimes buying in large volumes may give the firm quantity discounts. This quantity discounts may be substantial that the firm will take benefit of it. 4) Hedge against uncertain lead times: Lead time is the time required to procure fresh supplies of inventory. Uncertainty due to supplier taking more than the normal lead time will affect the production schedule and the execution of the orders of customers as per the orders received from customers. To avoid all these problems arising from uncertainty in procurement of fresh supplies of inventories, the firms maintain higher levels of inventories for certain items of inventory. B- Inventories are the most significant part of current aspects of most of the firms. Since they constitute an important element of total current assets held by a firm the need to manage inventories efficiently and effectively for ensuring optimal investment in inventory cannot be ignored. Any lapse on the part of management of a firm in managing inventories may cause the failure of the firm. Inventory management is an important part of a business because inventories are usually the largest expense incurred from business operations. C- The major objectives of inventory management are to: 1) Maximize the satisfaction of customers. 2) Minimize the investment in inventory. 3) Achieve low cost plant operation. ~ 13 ~

These objectives conflict each other. Therefore, a scientific approach is required to arrive at an optimal solution for earning maximum profit on investment in inventories. Q: 3). Explain the assumptions & implications of NI approach & the NOI approach. Illustrate your answer with hypothetical examples. ANSWER: The Net Income Approach (NI-approach) has been suggested by Durand. According to this approach a firm can increase its value or lower the overall cost of capital by increasing the proportion of debt in the capital structure. In other words, if the degree of financial leverage increases the weighted average cost of capital will decline with every increase in the debt content in total funds employed, while the value of firm will increase. Reverse will happen in a converse situation. Net income approach is based on the following three assumptions & implications: 1) There are no corporate taxes. 2) The cost of debt is less than cost of equity or equity capitalization rate. 3) The use of debt content does not change at risk perception of investors as a result both the kd (debt capitalization rate) and kc (equity-capitalization rate) remains constant. Example: A company expects its annual EBIT to be $50,000. The company has $200,000 in 10% bonds and the cost of equity is 12.5 % (ke). Calculation of the Value of the firm:

~ 14 ~

According to the net operating income (NOI) approach the market value of the firm is not affected by the capital structure changes. The market value of the firm is found out by capitalizing the net operating income at the overall or the weighted average cost of capital, which is constant. The overall capitalization rate depends on the business risk of the firm. It is independent of financial mix. If NOI and average cost of capital are independent of financial mix, market value of firm will be a constant are independent of capital structure changes. The critical assumptions of the NOI approach are: 1) The market capitalizes the value of the firm as a whole. Thus the split between debt and equity is not important. 2) The market uses an overall capitalization rate, to capitalize the net operating income. Overall cost of capital depends on the business risk. If the business risk is assumed to remain unchanged, overall cost of capital is a constant. 3) The use of less costly debt funds increases the risk to shareholder. This causes the equity capitalization rate to increase. Thus, the advantage of debt is offset exactly by the increase in the equitycapitalization rate. 4) The debt capitalization rate is constant. 5) The corporate income taxes do not exist. Thus, we find that the weighted cost of capital is constant and the cost equity increase as debt is substituted for equity capital. Example: Let us assume that a firm has an EBIT level of $50,000, cost of debt 10%, the total value of debt $200,000 and the WACC is 12.5%. Let us find out the total value of the firm and the cost of equity capital (the equity capitalization rate). Solution: EBIT = $50,000 WACC (overall capitalization rate) = 12.5% Therefore, total market value of the firm = EBIT/Ko $50,000/12.5%  $400,000 Total value of debt =$200,000 Therefore, total value of equity = Total market value - Value of debt  $400,000 - $200,000  $200,000 Cost of equity capital = Earnings available to equity holders/Total market value of equity shares Earnings available to equity holders = EBIT - Interest on debt  $50,000 - (10% on $200,000)  $30,000 Therefore, cost of equity capital = $30,000/$200,000  15% Verification of WACC: 10% x ($200,000/$400,000) + 15% x ($200,000/$400,000)  12.5%

~ 15 ~

CASE STUDY Just-in-Time Inventory Creates Volatility Just-in-time (JIT) delivery systems have had a dramatic impact on efficiency and profitability. Firms can reduce inventory to bare bones levels. Lead time, the time between ordering and shipping, is down substantially. One manufacturer indicates lead time is now one to three days, less than half what is was five years ago. Lantech, a manufacturer of machines used to wrap plastic around pallets, is an example of a company that has taken substantial advantage of JIT techniques. Lantech can now build a special order machine in ten hours. The same machine took five weeks to build ten years ago. All companies have been forced to adapt to the instantaneous nature of orders. A customer will call in the morning wanting goods for the next day, or even that afternoon. Gone are the days of ordering weeks in advance. Even those companies that can't speed up the manufacturing process are reluctant to stockpile inventory. Worthington Industries, a steel producer, indicated that it will pass on some orders needing quick delivery rather than build up inventory. Many firms no longer attempt to forecast demand for their products; they merely react to new orders as rapidly as possible. The economic result is increased volatility. Excluding defense orders, capital goods orders were up 4.6% in February, down 3.1% in March, and up 1.9% in April. TALKING IT OVER AND THINKING IT THROUGH! Q: 1).

How does JIT increase profits?

ANSWER: Just-in-time (JIT) is a system used to minimize inventory investment. The idea of JIT is to have zero inventories or as near zero as possible without adversely affecting production or sales. The goal of this strategy is to cut down on inventory costs; 1) Holding less inventory, so that there are lower storage costs, lower levels of spoilage, and less risk of obsolescence. 2) Coordinating with suppliers to minimize the cost of reordering inventory. The goal of the JIT is to minimize the costs of holding and ordering inventory. ~ 16 ~

In addition to reducing the holding and ordering costs of inventory, there are other considerations in determining the appropriate level of inventory. One consideration is taxes on inventory. There may be a state tax based on the value of inventory held as of a specified date, in that case, you would hold on the smallest amount of inventory that would not cause a shortage of goods for your customers. Companies using JIT inventory management system increase their profit, through cutting down inventory costs without affecting production process or sales. Q: 2).

What impact does JIT have on inventory obsolescence?

ANSWER: Inventory obsolescence is when inventory is no longer salable. Possibly due to too much inventory on hand, out of fashion or out of demand. Implementing JIT inventory management system prevents the company from been under such circumstances. Q: 3).

What is the danger of not holding product in inventory?

ANSWER: There are many dangers and risks faced by a company which doesn’t hold products in inventory, including: 1) Risk of non-smooth sale operations: The Company may not possibly be able to produce the goods immediately after they are demanded by the customers. Hence it is needed to hold some finished goods in inventory to attain customer satisfaction. 2) In addition to the requirement to hold the inventory for routine transactions, the company may like hold them to guard against risk of unpredictable changes in demand. For example; the demand for finished goods may suddenly increase (especially in case of seasonal type of products) and if the company is unable to supply them, it may mean gain of competition and loss of profitable opportunity. Hence, company will like to maintain sufficient supply of finished goods. 3) Price rise: The price of raw materials involved in the production my rise, lifting the cost of production. To get rid of that it’s better to have some finished goods in inventory.

~ 17 ~

SECTION C 40 MULTIPLE CHOICE QUESTIONS Q: 1). Which of the following statements is true with respect to the mobilization of funds by a finance manager? a) Analysis of variance between the targeted costs and actual costs incurred and reporting on the same. b) Assessing the costs and benefits of a project under consideration. c) Interacting with banking agencies for procuring funds. (√) d) Appraisal of investment proposals given by various departments. e) Deciding the optimum quantity of raw materials to be ordered for procurement. Q: 2). Which of the following is not a source of long-term finance? a) b) c) d) e)

Equity capital. Preference capital. Debenture capital. Commercial paper. Reserves and surplus. (√)

Q: 3). Which of the following approaches advocates that the overall capitalization rate remains constant for all degrees of leverage and that there is no optimal capital structure? I. II. III. IV. a) b) c) d) e)

Traditional approach. Miller and Modigliani approach. Net operating income approach. Net income approach. Only (I) above Only (II) above Both (II) and (III) above. Both (III) and (IV) above (II), (III) and (IV) above. (√)

Q: 4). For Jayalakshmi Sarees Ltd. the face value of the irredeemable preference share is Rs.500, dividend is equal to 15% and the applicable tax rate is 30%, then the cost of the preference share is ~ 18 ~

a) b) c) d) e)

15.0% 10.5% 8.5% 4.5% Data is insufficient. (√)

Q: 5). Which of the following would cause a firm’s EOQ to increase, other things held constant? a) b) c) d) e)

Carrying cost as a percentage of unit price increases. Fixed ordering costs per order doubles. Purchase price of inventory items doubles. Safety level stock increases. Decrease in annual usage of materials. (√)

Q: 6). Which of the following is a technique for monitoring the status of the receivables? a) b) c) d) e)

Ageing schedule. (√) Outstanding creditors. Selection matrix. Funds flow analysis. Credit evaluation.

Q: 7). Which of the following is not a relevant factor in an efficient cash management system for a business entity? a) Billing promptly and thereafter mailing the same to the customers. b) Payment of interest on term loans whenever it is due. (√) c) Collection of receivables from the branch. d) Depositing the cheque immediately to the bank on receiving the same from the customers. e) Making a centralized payment system for the suppliers. Q: 8). Which of the following changes in credit policy is/are likely to reduce the investment in receivables? I. II. III. IV.

Liberalizing credit standards. Hastening the collection process. Extending the credit period. Reducing the cash discount. ~ 19 ~

a) b) c) d) e)

Only (I) above Only (II) above Both (II) and (III) above Both (III) and (IV) above (II), (III) and (IV) above.

N.B: the correct answer is (I), (II) and (IV) above. (√) Q: 9). Which of the following types of factoring does not carry the service elements of factoring? a) Recourse Factoring b) Full Factoring c) Maturity Factoring d) Invoice Discounting. (√) e) Non-Recourse Factoring. Q: 10). Which of the following is not a reason to make capital expenditure decisions very important in corporate finance? a) Once the decision is taken, it has far reaching consequences extending over a considerably long period, which influences the risk complexion of the firm b) These decisions involve huge amount of money c) These decisions once taken are irreversible d) These are among the most difficult to make when the company is faced with various potentially viable investment opportunities e) The liquidity position of a firm is very much dependent on its investment in fixed assets. (√) Q: 11). Which of the following statements is/are correct for a project with a positive NPV? I. II. III. IV. a) b) c) d) e)

IRR exceeds the cost of capital. Payback period will be more than the cut-off rate. BCR is greater than 1. NBCR is more than zero. Only (I) above Only (II) above. Both (I) and (III) above Both (III) and (IV) above (I), (III) and (IV) above. (√) ~ 20 ~

Q: 12). The price-earnings estimating the cost of a) b) c) d) e)

ratio

approach

is

used

for

Debenture capital Preference capital Equity capital (√) Term loan Fixed deposits.

Q: 13).

Consider the following projects.

I. Project B which has a Net Benefit Cost Ratio less than one but more than zero. II. Project C whose present value of inflows is less than the present value of outflows. III. Project D which has a cost of capital less than the internal rate of return. IV. Project E which has the highest annual capital charge compared to all other projects. Which of the project(s) mentioned above can be accepted? a) b) c) d) e)

Only (I) above Both (I) and (III) above (√) Both (III) and (IV) above (II), (III) and (IV) above (I), (III), and (IV) above

Q: 14). If the net benefit cost ratio is 0.3, the net present value is Rs. 60,000, the present value of the cash inflows associated with the project is a) b) c) d) e)

Rs. 78,000 Rs.2,00,000 (√) Rs.2,60,000 Rs.2,78,000 Rs.2,80,000

Q: 15).

The letter of credit is

a) A letter sent by the bank to its client which confirms that a loan has been sanctioned ~ 21 ~

b) An arrangement in which a bank undertakes to pay a supplier of the client of the bank, if its client fails to pay for the goods purchased from the supplier. (√) c) An arrangement between a firm and its bank which facilitates timely collection of receivables of the firm d) A letter sent by a firm to its customer which states that the credit period has been extended e) A letter sent by a supplier to a firm which states that the supplier has agreed to supply goods on credit to the firm. Q: 16). Which of the following factors does not influence the working capital management policies of a firm? a) Excise duties on the capital equipments. b) Sudden increase in the demand for the product of the company. c) Adoption of better technology leading to the reduction in production time. d) Sudden stoppage of the supply of a major raw material. e) Increase in the short term interest rate. (√) Q: 17). a) b) c) d) e)

Which of the following assets is least liquid?

Work in process. (√) Cash and bank balance Debtors Bills receivable Certificates of deposits.

Q: 18). As a general rule, the capital structure that maximizes the market value of a company a) b) c) d) e)

Maximizes its average cost of capital Maximizes its earnings per share. (√) Maximizes the chance of bankruptcy Minimizes the cost of capital of the company Minimizes the cost of debt capital of the company.

Q: 19). Which of the following is not a type of bank finance for working capital? a) Cash credit b) Overdraft c) Commercial paper ~ 22 ~

d) Purchasing and discounting of bills e) Packing credit. (√) Q: 20). Which of the following statements is/are true regarding difference between fixed assets and current assets? I. In comparison to management of fixed assets, the time value of money is less significant in management of current assets. II. The liquidity position of a firm is mainly dependent on the investment in current assets, whereas fixed assets have only a limited role in the matter of liquidity. III. In any short run, immediate need of the company for adjustments to fluctuations in sales can be made only through adjustments with fixed assets. a) b) c) d) e)

Only (I) above Only (II) above Both (I) and (II) above. (√) Both (II) and (III) above All (I), (II) and (III) above.

Q: 21). If the cost of an investment is Rs. 2 lakh and it pays Rs.17,500 in perpetuity at an interest rate of 8% p.a., the benefit cost ratio of the investment is a) –1.29 b) –0.09 c) 0.70 d) 1.09 (√) e) 1.22. Q: 22). Which of the following are the quantitative measures to prove the creditworthiness in order to enjoy trade credit from the suppliers? I. II. III. IV.

Good track record of profitability and liquidity. A free and frank discussion with the suppliers. A record of prompt payments by the company to other suppliers. Negotiation with suppliers for payments to synchronize with the company’s cash inflows.

a) Both (I) and (III) above. (√) b) Both (II) and (IV) above ~ 23 ~

c) Both (III) and (IV) above d) (I), (II) and (III) above e) (II), (III) and (IV) above. Q: 23). Which of the following is not a cost incurred for maintaining receivables? a) b) c) d) e)

Collection cost Financing cost. (√) Cash discount Administrative cost Defaulting cost.

Q: 24). Which of the following is not a motive for the companies to hold cash? a) Transaction motive. b) Precautionary motive. c) Speculative motive. d) Lack of proper synchronization between cash inflows and outflows. (√) e) Capital investments. Q: 25). The surplus cash available with a firm can be identified as cash I. Available for meeting unforeseen disbursements. II. Available on certain definite dates for making specific payments such as account of tax, dividends, capital expenditure, etc. III. Not required to meet any specific payments and is a sort of general reserve. a) b) c) d) e)

Only (II) above Only (III) above. (√) Both (I) and (II) above Both (I) and (III) above All (I), (II) and (III) above.

Q: 26). Which of the following is false with regard to the concept of cost of capital? a) It considers the various sources of long term finance. ~ 24 ~

b) It is a weighted average of the costs of the various sources of long term finance used by the firm. c) It is expressed in post tax terms. d) It assumes that the risk characterizing the new investment proposals differs significantly from the risk level of the existing investments of the firm. (√) e) It assumes that the firm will continue to pursue the same financing policies. Q: 27). Other things remaining the same, which of the following project appraisal criteria will remain unchanged if the cost of capital is changed? a) b) c) d) e)

Net present value Internal rate of return. (√) Benefit cost ratio Net benefit cost ratio Annual capital charge.

Q: 28).

Consider the following data:

Raw-material storage period 40 days Conversion period 2 days Finished goods storage period 20 days Average collection period 18 days Average payment period 25 days The gross operating cycle is a) b) c) d) e)

55 days. 80 days. (√) 87 days. 105 days. 110 days.

Q: 29). M/s Priya Garments and Exports is considering to buy a new piece of equipment, which is expected to cost Rs.4,00,000 and will produce cash flows of Rs. 100,000 every year for the next 6 years (the first cash flow will be exactly one year from today). If the company is able to invest in an upgrade which would cost Rs. 120,000 in year 3, it would increase the annual cash flows from 4th year onwards to Rs.

~ 25 ~

200,000. If the discount rate appropriate for the company is 15%, the NPV of the investment is approximately a) Rs.28,765 b) Rs.36,674 c) Rs.45,295 d) Rs.49,672 (√) e) Rs.52,605 Q: 30). Which of the following is the principal tool in effective cash management? a) Capital budget. b) Cash flow statement. c) Funds flow statements. d) Cash budget. (√) e) Financial statement analysis. Q: 31).

Current assets do not include

a) Cash and bank b) Short-term investments c) Sundry debtors d) Outstanding expenses. (√) e) Inventory. Q: 32). Which of the following is false with regard to the Accounting Rate of Return (ARR) as an appraisal criterion for projects? a) It considers the profits over the entire life of the project b) It gives more weight to the earlier receipts than the later receipts. (√) c) It considers accounting profits instead of cash flows d) It serves as a measure of profitability of the investment e) It ignores the time value of money. Q: 33). Which of the following is not a factor affecting the composition of working capital? a) Nature of business b) Nature of raw material used c) Degree of competition in the market ~ 26 ~

d) Tax structure of a company. (√) e) Process technology used. Q: 34). Which of the following is not a merit of using book values as weights for calculating the weighted average cost of capital? a) The book value weights are independent of the fluctuations of the market prices. b) The calculation of weights is simple. c) The book values of the different sources of finance are approximately related to their present economic values. (√) d) The book value weights are suitable for a firm whose securities are not traded regularly. e) The book value weights are the most suitable for the unlisted firms. Q: 35). Which of the following is not a function of finance manager? a) b) c) d) e)

Mobilization of funds. Deployment of funds. Control over the use of funds. Risk-return trade off. Optimum utilization of stores. (√)

Q: 36). Which of the following is not true about Commercial Papers (CPs)? a) CPs are issued at a discount to face value. b) The minimum maturity period of CPs is 15 days. c) CPs are unsecured in nature. d) CPs are not negotiable by endorsement and delivery. (√) e) Prior approval of RBI is not needed for CP issues. Q: 37). a) b) c) d) e)

The sinking fund factor is the inverse of

Capital Recovery Factor. (√) Future Value Interest Factor. Future Value Interest Factor for Annuity. Present Value Interest Factor for Annuity. Present Value Interest Factor. ~ 27 ~

Q: 38). Ms. Remani has taken a car loan for Rs. 200,000 to be repaid in 60 equal monthly installments at the end of every month. If the loan carries an interest rate of 10% p.a., compounded quarterly, calculate the amount of each installment? a) b) c) d) e)

Rs.4,150 Rs.4,240 Rs.4,465 (√) Rs.4,618 Rs.4,763

Q: 39). The objective of financial management is to increase the wealth of the shareholders means to a) b) c) d) e)

Increase the physical assets owned by the firm. Increase the market value of the shares of the firm. (√) Increase the current assets of the firm. Increase the cash balance of the company. Increase the total number of outstanding shares of the company.

Q: 40). Which of the following functions of the Indian financial system influences the growth of investment and living standards in the society? a) Risk function. b) Liquidity function. c) Payment function. d) Savings function. (√) e) Policy function.

~ 28 ~