KARPAGAM INSTITUTE OF TECHNOLOGY

MBA CONTINUOUS ASSESSMENT INTERNAL TEST- I

REGULATIONS 2009 III SEMESTER
SERVICE MARKETING
Time: Three Hours

Maximum: 100 Marks

PART A (10x2=20 marks)

1. What is financial management?

Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying general
management principles to financial resources of the enterprise.
2. Explain compound value concept?
Compounding finds the future value of a present value using a compound interest rate.
3. What are the various methods of evaluating capital budgeting proposals?
(A) Traditional methods or Non-Discounted method
(i) pay-back period method or pay out or pay off method
(ii) Improvement of traditional approach to pay back period method
(iii) Rate of return method or accounting method
(B) Time-adjusted method or discounted methods
(i) Net Present Value method
(ii) Internal Rate of Return method
(iii)Profitability Index method
1

4. ABC Ltd., pays no dividends anticipate a long run level of future earnings of Rs.7 per share. The
current price of ABC Ltd share is Rs.55.45, floatation cost for the sale of new equity shares would
average about 10% of the price of the share. What is the cost of new equity capital to ABC Ltd?
Cost of New Equity Share = D/NP
= 7-(10% on Rs 7)/55.45
=(7-0.7)/55.45
= 6.3/55.45*100 = 11.36%
5. What is composite leverage?
It is the product of operating leverage and financial leverage.
Composite leverage = Operating leverage X financial leverage
= % change in EBIT / % change in sale X % change in EPS / % change in EBIT
High operating leverage and high financial leverage combination is high risky for business.
Good combination is that in which lower operating leverage with high financial leverage
6. What are the different forms of dividends?
1. Cash Dividend
Cash dividends are those paid out in the form of a cheque. Such dividends are a form of
investment income and are usually taxable to the recipient in the year they are paid. This is the
most common method of sharing corporate profits with the shareholders of the company.
2. Stock Dividend:Stock or scrip dividends are those paid out in form of additional stock
shares of the issuing corporation, or other corporation (such as its
subsidiary corporation). They are usually issued in proportion to shares
owned (for example, for every 100 shares of stock owned, 5% stock
dividend will yield 5 extra shares). If this payment involves the issue of
new shares, this is very similar to a stock split in that it increases the total
number of shares while lowering the price of each share and does not
change the market capitalization or the total value of the shares held.
3.Property dividend:
When a company or firm pays dividend in the form of assets it is called property dividend.
7. Define the expression working capital?
2

Working capital is required to carry out day to day expenses. Long term funds are required
to create production facilities through purchase of fixed assets such as plant and machinery, land,
building; furniture etc. funds are also needed for short-term purpose for the purchase of raw material,
payment of wages, and other day-to-day expenses etc. These funds are known as working capital.
8. What is cash budget?
An estimation of the cash inflows and outflows for a business for a specific period of time.
Cash budgets are often used to assess whether the entity has sufficient cash to fulfill regular
operations and/or whether too much cash is being left in unproductive capacities.
9. What are sources of internal financing of a firm?
1. Retained Earnings
Retained earnings are an easy source of internal financing to use because they are liquid
assets. Retained earnings are the portion of net income that have retained in the company and not paid
out.
2. Current Assets
Current assets consist of cash or anything that can easily be converted into cash. For example,
stock
10. What are the key functions of venture capital?
The capital which is available for financing the new business venture is called venture capital. It is
a long-term equity investment in novel technology based projects with display potential for
significant growth and financial return.

Part- B (5X16 =80 marks)

11.(a) Explain the concept and significance of risk and return of a portfolio?
3

RISK AND RETURN OF THE PORTFOLIO

Portfolio is the Combination of two or more assets or investments.
Portfolio Expected Return is the weighted average of the expected returns of the securities or
assets in the portfolio.
Weights are the Proportion of total funds in each security which form the portfolio Wj Kj.
Wj = funds proportion invested in the security.
Kj = expected return for security J.
The risk of the portfolio could be determined what it was in the process of individual assets?
Benefits of portfolio holdings are bearing certain benefits to single assets.
Including the various types of industry securities - Diversification of assets.
The portfolio construction leads to bring down the risk of the portfolio than the risk of single assets.
It is not the simple weighted average of individual security.
Risk is studied through the correlation/co-variance of the constituting assets of the portfolio. The
Correlation among the securities should be relatively considered to maximize the return at the
given level of risk or to minimize the risk.
Correlation of the expected returns of the constituent securities in the portfolio.
It is a Statistical expression which reveals the securities earning pattern in the portfolio as together.
Positive correlation means that Return of the securities in the portfolio are moving together in same
direction.
Negative correlation which illustrates that the Return of the securities are moving in opposite
direction.
Zero correlation reveals that there is - No relationship in between the earnings pattern among the
securities of the portfolio.
The Co-efficient of correlation normally ranges in between 1 and +1.
Diversification of the Risk of Portfolio
Diversification of the portfolio can be done through the selection of the securities which have
negative correlation among them which formed the portfolio. The return of the risky and riskless
assets is only having the possibilities to bring down the risk of the portfolio.

 The risk of the portfolio cannot be simply reduced by way adopting the principle of correlation of
returns among the securities in the portfolio. To reduce the risk of the portfolio, the classification of
the risk has to be studied, which are as follows:
The risk can be further classified into two categories viz Systematic and Unsystematic risk of the
securities
Systematic Risk - which cannot be controlled due to market influences which is known as
Uncontrollable risk, cannot be avoided
Unsystematic Risk - Which can be minimized or reduced this type of risk through diversification of
the securities in the portfolio
Systematic Risk- Unavoidable, Uncontrollable risk - finally Market risk War, inflation, political
developments
Unsystematic Risk- Avoidable, Controllable risk. Strike, Lock out, Regulation
Systematic Risk: Which only requires the investors to expect additional return/ compensation to bear the
Unsystematic Risk: The investors are not given any such additional compensation to bear unlike the
earlier.
The relationship could be obviously understood through the study of Capital Asset Pricing Model
(CAPM).
Developed by William F. Sharpe
Explains the relationship in between the risk and expected / required return
Behaviour of the security prices
Extends the mechanism to assess the dominance of a security on the total risk and return of a
portfolio
Highlights the importance of bearing risk through some premium
Efficiency of the markets
Investors are well informed
No transaction costs - No intermediation cost during the transaction
No single investor is to influence the market Risk and Return
Investor preferences
Highest return for given level of risk Or
Lowest risk for a given level of return
Risk - Expected value, standard deviation
5

RELATIONSHIP BETWEEN THE RISK AND RETURN

Total Return - Risk free rate of return= Excess return (Risk premium)
Total return = Risk free return + Risk premium
Kj = Rf + bj (KmRf)
Bj is nothing but Beta of the security i.e., market responsiveness of the security. Beta differs from
one security to another.
It is normally expressed as a b
b = Non Diversifiable risk of asset or Portfolio/ Risk of the Market Portfolio
Risk of the portfolio = after diversification, the risk of the market portfolio is non diversifiable
(OR)
(b) What are the general principles of valuation of shares? Explain.
VALUATION OF SHARES
FACTORS WHICH INFLUENCE THE VALUE OF SHARES
The factors which influence the value of shares can be broadly classified into two groups- internal
and external factors. They are stated below(i) Internal factors:
1. Net worth of Assets (realizable value of all assets minus all liabilities)
2. Earning capacity of assets
3. Return on investments
4. Profit after tax
5. Profit available to equity shareholders
6. Earnings per share
7. Dividend per share or Rate of dividend.
(ii) External Factors:
1. General economic condition of the country.
2. Political and social environment.
3. International economic scenario.
4. International political environment.
5. Demand for shares.
6. Growth prospect of the industry.
6

7. Transparency in information flow.

8. Insider trading
9. General impulse in capital and securities market.
10. Investors education and their perspective towards capital market.
METHODS OF VALUATION OF SHARES
The methods of valuation depend on the purpose for which valuation is required. Generally, there
are three methods of valuation of shares:
1. Net Assets Method of Valuation of Shares
Under this method, the net value of assets of the company is divided by the number of shares to
arrive at the value of each share. For the determination of net value of assets, it is necessary to estimate
the worth of the assets and liabilities. The goodwill as well as non-trading assets should also be included in
total assets. The following points should be considered while valuing of shares according to this method:
Goodwill must be properly valued
The fictitious assets such as preliminary expenses, discount on issue of shares and debentures,
accumulated losses etc. should be eliminated.
The fixed assets should be taken at their realizable value.
Provision for bad debts, depreciation etc. must be considered.
All unrecorded assets and liabilities (if any) should be considered.
Floating assets should be taken at market value.
The external liabilities such as sundry creditors, bills payable, loan, debentures etc. should be
deducted from the value of assets for the determination of net value.
The net value of assets, determined so has to be divided by number of equity shares for finding out the
value of share. Thus the value per share can be determined by using the following formula:
Value per Share= (Net Assets-Preference Share Capital)/Number of Equity Shares
2. Yield or Market Value Method of Valuation Of Shares
The expected rate of return in investment is denoted by yield. The term "rate of return" refers to the
return which a shareholder earns on his investment. Further it can be classified as (a) Rate of earning and
(b) Rate of dividend. In other words, yield may be earning yield and dividend yield.
a. Earning Yield
7

Under this method, shares are valued on the basis of expected earning and normal rate of return.
The value per share is calculated by applying following formula:
Value per Share = (Expected rate of earning/Normal rate of return) X Paid up value of equity share
Expected rate of earning = (Profit after tax/paid up value of equity share) X 100
b. Dividend Yield
Under this method, shares are valued on the basis of expected dividend and normal rate of return.
The value per share is calculated by applying following formula:
Expected rate of dividend = (profit available for dividend/paid up equity share capital) X 100
Value per share = (Expected rate of dividend/normal rate of return) X 100
3. Earning Capacity Method Of Valuation Of Shares
Under this method, the value per share is calculated on the basis of disposable profit of the
company. The disposable profit is found out by deducting reserves and taxes from net profit. The following
steps are applied for the determination of value per share under earning capacity:
Step 1: To find out the profit available for dividend
Step 2: To find out the capitalized value
Capitalized Value = (Profit available for equity dividend/Normal rate of return) X 100
Step 3: To find out value per share
Value per share = Capitalized Value/Number of Shares
12.(a) Capital expenditure decisions are by far the most important decisions in the field of
management illustrate?
Capital expenditure decisions often represent the most important decisions taken by a firm.
Capital expenditures are defined as investments to acquire fixed or long lived assets from which a
stream of benefits is expected. Such expenditures represent an organization's commitment to produce and
sell future products and engage in other activities. Capital expenditure decisions, therefore, form a
foundation for the future profitability of a company.
Capital expenditure activities are made up of two distinct processes: (a) making the decision and (b)
implementing it, which may include performing a post-appraisal. This Practice deals only with the first
process.
Their importance stems from three inter-related reasons:
8

 Long-term effects: The consequences of capital expenditure decisions extend far into the future.
The scope of current manufacturing activities of a firm is governed largely by capital expenditures
in the past. Likewise current capital expenditure decisions provide the framework for future
activities. Capital investment decisions have an enormous bearing on the basic character of a firm.
Irreversibility: The market for used capital equipment in general is iIl-organised. Further, for
some types of capital equipments, custom made to meet specific requirement, the market may
virtually be non-existent. Once such equipment is acquired, reversal of decision may mean
scrapping the capital equipment. Thus, a wrong capital investment decision, often cannot be
reversed without incurring a substantial loss.
Substantial outlays: Capital expenditures usually involve substantial outlays. An integrated
steel plant, for example, involves an outlay of several thousand millions. Capital costs tend to
increase with advanced.
(OR)
(b) What is Modigilani-Miller approach to the problem of cost of capital structure? Under
what assumptions do their conclusion hold good?
Franco Modigliani and Meron H.Miller (M-M) developed a hypothesis, which
fundamentally affects the understanding of effects of gearing. They argue that in the absence
of corporate tax, cost of capital and the market value of the firm remain invariant to the
changes in capital structure or degree of leverage.
However, when corporate taxes are assumed to exist, their hypothesis is similar to the
Net Income Approach.
MM Theory Assumptions
1. The capital market is assumed to be perfect.
2. The investors are free to buy and sell securities and are well informed about the risk and return
involved in different securities. All securities are infinitely divisible.
3. There are no transaction costs. There is no brokerage or other transaction charges.
4. The debt is less expensive than equity. Increase in debt level will cause to increase the cost of
debt. The increased debt will increase the financial risk of the firm and expectations of the equity
holders will be more.
5. There is no benefit to debt financing other than reduction in corporate income taxes due to tax
shield of interest payments of debt.
9

6. Interest rates are equal between borrowing and lending, firms and individuals
7. The capital markets are efficient. The information is cost less and readily available to all
investors.
8. There are no personal taxes and corporate income taxes.
9. All investors are only price-takers. No individual can influence the market price of security by the
scale of transactions
10. The firms investment schedule and cash flows are assumed to be constant and perpetual.
13.(a) What factors should be considered in determining the capital structure of a
company? Explain.
Capital structure refers to mix of different sources of long-term funds (such as equity shares, preference
shares, long-term loans or debts like debentures or bonds, retained earnings.
Factors determining capital structure
Financial Leverage or Trading on Equity
Operating Leverage
EBIT/EPS Analysis
Cost of Capital
Growth and stability of sales
Nature and size of the firm
Flexibility
Cash Flow Analysis
Control
Marketability
Floatation Costs
Legal Constraints
Capital Market conditions
Asset structure
Purpose of Financing
Period of finance

(OR)
(b) What are the essentials of Walters dividend model? Explain its short comings?
10

Prof.Walters approach supports the doctrine that dividend decisions are relevant and
affect the value of the firm. The relationship between the internal rate of return earned by the
firm and its cost of capital is very significant in determining the dividend policy to maximize the
wealth of the shareholders.
Prof.Walters model is based on the relationship between the firms return on investment
and the cost of capital or the required rate of return.
Assumptions of Walters Model
1.

Internal financing: The firm finances all investment through retained earnings, that
is
debt or new equity is not issued.

2.

Constant Return and cost of capital: The firms rate of return, r and its cost of
capital k is constant

3.

100 percent payout or retention: All earnings are either distributed as dividends or
reinvested internally immediately.

4.

Constant EPS and DPS: The value of the earnings per share, EPS and the dividend
per share DPS may be changed in the model to determine results, but any given
value of EPS or DPS are assumed to remain constant forever in determining a given
value.

5.

Infinite Time: The firm has a very long or infinite life.

14.(a) Discuss the principles, needs and determinants of working capital to an

manufacturing firm?
Principles of Working capital
Working capital is the amount of funds necessary to cover the cost of operating the enterprise.
Need for Working Capital
Replenishment of Inventory
Provision for operating expenses
Support for credit sales
Provision of a Safety Margin
Factors determining Working capital requirements of an manufacturing firm:
11

 Nature or character of business

Size of business/scale of operations
Production policy
Manufacturing process/ length of production cycle
Seasonal variations
Working capital cycles
Rate of stock turnover
Credit policy
Business cycles
Rate of growth of business
Earning capacity and dividend policy
Price level changes
Tax level
Other factors such as operating efficiency, management ability, irregularities of supply,
import policy, asset structure, importance to labour, banking facilities etc.,
(OR)
(b)What are the objectives of cash management and various basic problems in the cash
management? Explain?
Cash Management:
Cash Management refers to management of cash balance and the bank balance including the
short term deposits.
Objectives of cash Management:
1. Meeting the Payment Schedule:
2. Minimizing funds committed to Cash Balances:
Basic Problems in Cash Management
Good cash management is:
1. Knowing when, where, and how the cash needs will occur,
2. Knowing what the best sources are for meeting additional cash needs; and,
12

3. Being prepared to meet these needs when they occur, by keeping good relationships with
bankers and other creditors.
If the business fails good cash management then they fail to meet their cash needs and
they cant maintain good relationship with their bankers and creditors.
15.(a) Explain the sources from which a large sized industrial enterprise can raise capital for its
various requirements?
Long term funds are the base for the financial structure of a large sized industrial enterprise.
The various sources of raising long-term funds are
Equity Shares
Preference Share/ Preferred Stock
Debentures
Ploughing Back of Profits
Term Loans from Financial Institutions
Lease Financing
Hire Purchase
Venture Capital Financing
Private Equity
(OR)
15.(b) Describe briefly the SEBI regulations as to venture capital finance?
Definition of Venture capital:
Definitions in various countries:
India:
Venture capital fund is a fund formed as a trust or a company under the regulations which
-

Has dedicated pool of capital

raised in the specified manner and

invested in venture capital undertaking

Venture Capital undertaking is domestic company,

-

whose shares are not listed

13

which is in the business for providing services, production or manufacturing of articles which are not
in the negative list.

Each scheme launched or fund set up by a venture capital fund shall have firm commitment from the
investors for contribution or an amount or at least Rupees five crores before the start of operations by
the venture capital fund

Negative list covers following activities:

-

Non-banking financial services [excluding those Non Banking Financial companies which are
registered with Reserve Bank of India and have been categorized as Equipment Leasing or Hire
Purchase companies.

Gold financing [excluding those companies, which are engaged in gold financing for jewellery.

Activities not permitted under the Industrial Policy of Government of India

Any other activity which may be specified by the SEBI.

UK
Venture capital includes the business of carrying
-

Investing in, advising on investments which are, venture capital investment

managing investments which are, arranging transaction in, venture capital investments.

Advising on investments or managing investments in relation to portfolios or establishing, operating or

winding up collective investment schemes invests only in venture capital investments

Any custody activities as related to above.

Venture Capital Investment is investment which at the time of investment is made, is,
-

in a new and developing company

in a management buy out or buy-in or

Made as means of financing the invitee Company or venture and accompanied by a right of
consultation.

Malaysia:
Venture capital company (VCC) and Venture Capital Management Company (VCMC) means a
corporation that deals in investments of securities of venture companies and are registered as VCC or
VCMC under the guidelines:
14

Venture company means a company which utilizes seed-capital, start-up and early stage financing
and,
-

in relation to VCC is not listed and

in relation to VCMC is not listed at the point of first investment by such VCMC.

Taiwan
Venture capital investment enterprise is a Company limited by shares, which,
-

engages in venture capital investment business under the approval of Ministry of Finance,

specializes in the investments either in foreign or domestic technological enterprises assist the
management and supervision of such enterprise

China
Foreign invested venture capital investment (FIVCEI) means foreign invested enterprise
established within the territory of China by foreign investors or foreign investors with Companies and
established under Chinese Law.
Venture capital investment means a type of investment activity pursuant to which equity investment are
injected mainly into high and new-tech enterprises that have not been publicly listed.
In India earlier the venture capital funding was not allowed in the Real Estate and the Gold
Financing.
To redress these issues and the other operational issues Securities and Exchange Board of India (SEBI)
set up an Advisory Committee on Venture Capital under the Chairmanship of Dr. Ashok Lahiri, Chief
Economic Advisor, Ministry of Finance, Government of India for advising SEBI in matters relating to the
development and regulation of venture capital funds industry in the country.
Terms of Reference for Advisory Committee on Venture Capital were 1. To advise SEBI on issues related to development of Venture Capital Fund industry.
2. To advise SEBI on matters relating to regulation of Venture Capital Funds and Foreign Venture
Capital Investors.
3. To advise SEBI on measures required to be taken for changes in legal framework / amendments.
15

OPERATIONAL ISSUES
1. Lock-in of shares after listing:
The requirement of lock-in of shares after listing may be removed.
2. Investment in listed companies:
The minimum limit of investment in unlisted companies may be reduced from 75 per cent, as
present, to 66.67 per cent. The remaining portion of 33.33 per cent or less may be permitted to be invested
in listed securities. The aforesaid limit of investment shall be achieved by the end of the life cycle of a fund.
A life cycle of more than 10 years will
have to be justified by the fund and subject to careful examination by SEBI. Wherever such investments
trigger the takeover code, all requirements of the code will have to be fulfilled by the VCF/FVCI and no
exemption from the clauses may be provided. However, where as a result of investments made under
mandatory requirement of takeover code, investment restrictions are breached, the same may not be
considered as a violation of SEBI (VCF/FVCI) Regulations.
3. Type of instruments of investment:
Some kind of hybrid instruments which are optionally convertible into equity may be permitted as a
class of investment instruments under the 66.67 per cent (now recommended) portion of the investible
funds.
4. Special Purpose Vehicles (SPV):
SPVs which are mandated for promotion/investment of a Venture Capital Undertaking (VCU) may
be permitted up to a maximum of 33.33 per cent portion of investible funds.
5. Investment in Non Banking Financial Services:
VCFs/FVCIs may be permitted to invest in NBFC in equipment leasing and hire purchase.

16

6. Investment in Real Estate:

VCFs/FVCIs may be permitted to invest in real estate.
7. Investment in Gold Financing:
Gold financing may be removed from negative list for VCF/FVCI. However, such financing should
be restricted to gold financing for jewelry alone and not pure trade and speculation in gold.
ISSUES RELATING TO VENTURE CAPITAL FUNDS
1. Investment in offshore VCUs:
VCF may be permitted to invest in offshore VCUs. RBI may be requested to periodically announce
the overall limit for investment by the VCFs and inform SEBI accordingly.
2. Flexibility to distribute in-specie:
The in-specie distribution of assets may be permitted at any time, as per the preference of
investor(s).
ISSUES RELATING TO FOREIGN VENTURE CAPITAL INVESTORS:
1. Appointment of custodians:
The appointment of custodian by FVCI may be continued to facilitate the maintenance of records
and a smooth transition when the VCUs shares get listed.
2. Investment Limits:
The restriction of not investing more than 25 per cent of the investible funds of a FVCI in a single
VCU may be removed.
TAX RELATED ISSUES
1. Section 10(23 FB):
If clause (c) of Explanation I of Section 10(23FB) is deleted, no further amendments to this Section
will be required whenever SEBI changes the definition of Venture Capital Undertaking. After deletion of
17

this clause, all VCFs which are formed as trust/company duly registered with SEBI would be eligible for
exemption under Section 10(23FB).
Alternatively, the definition of Venture Capital Undertaking under clause (c) of Explanation I of
Section 10(23FB) may be aligned with definition of Venture Capital Undertaking as defined under SEBI
Regulations.
2. Exits:
For the sake of clarity and for the removal of ambiguity, a suitable clarification may be issued
through a Central Board of Direct Taxes (CBDT) circular. Alternatively, in line with Explanation 2 under
section 10(23FB), Explanation 3 may be added providing that VCFs would continue to enjoy tax exemption
even after they receive foreign securities in lieu of domestic securities held by them in a Venture Capital
Undertaking.
3. Section 115U:
For the sake of clarity and uniformity, a suitable illustration may be issued through a CBDT circular.
FOREIGN EXCHANGE CONTROL RELATED ISSUES
Wholly owned Indian subsidiaries of FVCIs registered with SEBI may be exempted from the
minimum capitalization requirement of an Indian company.
Majority of these recommendations have been accepted by SEBI and others have been send to
Reserve Bank of India for their recommendations.
Investment in India by Venture capitalists.
Given hereunder is the list of sectors where the investment is usually made by the venture capital
companies.
1.
2.
3.
4.
5.
6.
7.
8.

IT and IT-enabled services

Software Products (Mainly Enterprise-focused)
Wireless/Telecom/Semiconductor
Banking
PSU Disinvestments
Media/Entertainment
Bio Technology/Bio Informatics
Pharmaceuticals
18

9. Electronic Manufacturing
10. Retail
Conclusion:
The changes in the venture capital regulation will have a positive impact on investment by venture
capitalists. In 2003 India was ranked fifth in the Asia pacific region with investment of $774.01 million in
42 companies. Japan topped the list with investment of $7297.71 millions in 77 companies.
Venture capital investments in India has been increasing over the period.
Private equity and venture capital firms invested about $1.5 bln in 125 Indian companies during
2005. The 2005 Indian VC activity represented a slight decrease from 2004 when 129 companies raised
$1.6 bln. A total of 63 out of the 125 companies closed rounds of over $10 mln. The Venture capital
investment will definitely get the boost as the investment has now been allowed in Real Estate and Gold
Financing and certain other restrictions have been eased with.

19