ASSIGNMENT

NAME
ROLL NO
PROGRAMME
SEMESTER
SUBJECT CODE & NAME

NEHA VATS
1311000729
MBA
2
MB0045 FINANCIAL MANAGEMENT

Q1. TCS has emerged as India's most admired company ahead of

Hindustan Unilever, ITC, and Infosys, says global management consultancy
Hay Group. TCS replaced last year's winner group company Tata Steel by
scoring highest on parameters such as corporate governance, financial
soundness, and talent management. Two criteria in particular, Leadership,
and Creating Shareholder Value separated the winners. How do you think
effective interaction between HR and finance department of a firm helps in
achieving its skills? Do you think that TCS has preferred the profit
maximization approach over the wealth maximization approach?
Ans:

Interaction between HR and finance functions:

Financial management is also related to human resource department as it provides

manpower to all the functional areas of the management. Financial manager should

carefully evaluate the requirement of manpower to each department and then

allocate the required finance to the human resource department as wages, salary,
remuneration, commission, bonus, pension, and other monetary benefits to the
human resource department. If an organisation formulates and implements a policy
for attracting competent manpower, it has to pay the most competitive salary
packages to them. However, by attracting competent manpower, capital and
productivity of an organisation. improves..

Goals of Financial Management:

Financial management means maximisation of economic welfare of its shareholders.
Maximisation of economic welfare means maximisation of wealth of its
shareholders. There are two versions of the goals of financial management of the
firm Profit Maximisation and Wealth Maximisation.

Profit maximization:
Profit maximisation is the traditional and narrow approach, which aims at
maximising the profit of the concern. Profit maximisation has been criticised on
many accounts:

In this sense, profit is neither defined precisely nor correctly. It creates

unnecessary conflicts regarding the earning habits of the business concern.
Differences in interpretation of the concept of profit thus expose the
weakness of profit maximisation.
Profit maximisation neither considers the time value of money nor the net
present value of the cash inflow. It does not differentiate between profits of
current year with the profits to be earned in later years.
.

Wealth maximization:
Wealth maximisation is possible only when the company pursues policies that would
increase the market value of shares of the company. It has been accepted by the
finance managers as it overcomes the limitations of profit maximisation.
The following arguments are in support of the superiority of wealth
maximisation over profit maximisation:

Wealth maximisation is based on the concept of cash flows. Cash flows are a
reality and not based on any subjective interpretation. On the other hand,
profit maximisation is based on accounting profit and it also contains many
subjective elements.

Wealth maximisation considers time value of money. Time value of money

translates cash flow occurring at different periods into a comparable value at
zero period. In this process, the quality of cash flow is considered critical in all
decisions as it incorporates the risk associated with the cash flow stream..

Q3. a) How do you think the trend of capital structure across the Indian
corporates affect the economy as a whole?
b) What proportion of debt and equity should be taken up in the capital
structure of a firm?
c) Discuss the theories that are propounded to understand the
relationship between financial leverage and value of the firm.
Trend of capital structure 2 b) proportion of debt and equity 3 c) explain
the theories 5
Ans:

Trends of capital structure:-

Capital structure of the company should be such that the company derives
maximum benefits from it and is able to adjust it easily to changing conditions.
Companies aim to find an appropriate proportion of different types of capital which
will minimise the cost of capital and maximise the market value.

Proportion of debt and equity:

Debt- equity ratio is an indicator of the relative contribution of creditors and owners.
A debt-equity ratio of 2:1 indicates that for every 1 unit of equity, the company can
raise 2 units of debt. By normal standards, 2:1 is considered as a healthy ratio, but
it is not always a hard and fast rule that this standard is insisted upon. A ratio of 5:1
is considered good for a manufacturing company while a ratio of 3:1 is good for
heavy engineering companies.

Theories of Capital Structure:

The proportion of debt and equity in a firms capital structure has to be
independently decided case to case. A proposal, though not being favourable to
lenders, may be taken up if they are convinced with the earning potential and longterm benefits.
Assumptions:
The following are some common assumptions made:

The firm has only two sources of funds, debt and ordinary shares.
There are no taxes, both corporate and personal.
The investment decisions of a company are constant, that is, the firm does
not invest any further in its assets.

Based on the assumptions regarding the capital structure, we derive the following
formulae:
Cost of Debt :
Debt capital being constant, Kd is the cost of debt which is the discount rate at
which the discounted future constant interest payments are equal to the market
value of debt, that is,
Kd = I/B
Cost of Equity:
It is assumed that there is a 100% dividend payout and constant earnings. Such
being the case, the cost of equity is the discount rate at which the discounted future
dividend/earnings are equal to the market value of equity.
Cost of equity capital Ke = (D1/P0) + g .
Retained earnings being zero, g = br
Firm Value:

The net operating income being constant, overall cost of capital is

represented as K0 = W1 K1 + W2 K2. That is, K0 = (B/V)K1 + (S/V)K2

K0 = I + NI/V or EBIT/V

Q4. HPCL was established in 1952, operates from 500 different locations,
including refineries, terminals, LPG plants, aviation service facilities, etc.
They developed a Lotus Notes workflow tool and deployed it across the
organisation so that any capital investment proposal from any operating
location in the country can be routed to relevant reviewers and approving
authorities. With the implementation of the new online system, the total
cost savings as a result of reduced man-hours amounts to about Rs 25
lakh per annum. 1. What do you think would have been the complexities
involved in implementing this new project at HPCL? 2. What are the
various phases in the capital budgeting process? To what extent do you
believe that automation can ease out the process?

Ans:

Capital Budgeting Process:

Capital budgeting process involves three steps Financial appraisal, Technical

appraisal and Economic appraisal. Figure 8.1 depicts the capital budgeting process.

Capital budgeting process

1 Technical appraisal:
The technical appraisal deals with the technical aspects of the project. The technical
aspects of a project are:

Selection of process know-how

Decision on determination of plant capacity
Selection of plant, equipment and scale of operation
Plant design and layout
General layout and material flow
Construction schedule

Technical appraisal ensures implementation of all the technical aspects of the

project.
2 Economic appraisal:
The economic appraisal deals with economic and social impacts of a project. It
examines the impact of the project on the following:

Environment
Income distribution in the society
Fulfilment of certain social objective like generation of employment
and attainment of self sufficiency Materially altering the level of
savings and investment in the society.

Economic appraisal examines the project from the social point of view. Hence, is
referred to as social cost benefit analysis.
3 Financial appraisal:

Financial appraisal is to examine the financial viability of the project. Financial

appraisal technique examines:

Cost of the project

Investment outlay
Means of financing
The cost of capital
Expected profitability
Expected incremental cash flows from the project
Break-even point
Cash break-even point

Under this appraisal, the risk and returns at various stages of project execution are
assessed.

Phases of Capital Structure:

There are various phases involved in capital budgeting decisions such as:

Identification of investment opportunities

Evaluation of each investment proposal
Examination of the investments required for each investment proposal
Preparation of the statements of costs and benefits of investment proposals
Estimation and comparison of the net present values of the investment
proposals that have been cleared by the management on the basis of
screening criteria
Examination of the government policies and regulatory guidelines, for
execution of each investment proposal screened and cleared based on the
criteria stipulated by the management
Budgeting for capital expenditure for approval by the management

Q5. A)Indicate whether the operating cycle in the following industries is

short (less than 30 days), medium (less than 6 months) or long (more
than 6 months) Steel, rice, vegetables, fruits, jewelry, processed food,
furniture, mining, flowers and textiles
b) Companies with the shortest working capital cycles have current ratios
much lower than the firms with longer cycles. What is your view on this
statement? How do you think the operating cycle affects operating profit
margins?
c) Discuss the relationship between working capital management and
market performance of a company? Do you think the kind of relationship
varies depending on the type of industry?
a) duration b) operating cycle c) need for working capital
Ans: A)Duration:

Short: vegetables, fruits, flowers

Medium: rice, fruits, processed food,
Long: Steel, jewelry, furniture, mining, textiles

Operating Cycle:The time gap between acquisition of resources and collection of cash from
customers is known as the operating cycle. It is also referred to as the working
capital cycle.
Operating cycle of a firm involves the following elements:
Acquisition of resources from suppliers
Payment disbursements to suppliers
Conversion of raw materials into finished products
Sale of finished products to customers
Collection of cash from customers for the goods sold

Phases of an operating cycle

The five phases of the operating cycle occur on a continuous basis.
Cash outflows are certain. However, cash inflows are uncertain because of
uncertainties associated with effecting sales as per the sales forecast and ultimate
timely collection of amount due from the customers to whom the firm has sold its
goods. As cash inflows do not match with cash out flows, firm has to invest in
various current assets to ensure smooth conduct of day to day business operations.
Therefore, the firm has to assess the operating cycle time of its operation for
providing adequately for its working capital requirements. A standard operating
cycle may be for any time period, but it does not generally exceed a financial year.
Operating Cycle = IC Period + RC Period
IC Period = Inventory Conversion Period
RC Period = Receivables Conversion Period

Need for Working Capital:

The need for working capital arises on account of two reasons:
To finance operations during the time gap between sale of goods on credit
and realisation of money from customers of the firm
To finance investments in current assets for achieving the growth target in
sales
Therefore, to finance the operations in operating cycle of a firm, working capital is
required. Negligence of management on working capital may result in technical
insolvency and even liquidation of a business unit. Inefficient working capital
management may cause either inadequate or excessive working capital, which is
dangerous.
Q6. Nirma acquired Core Healthcare Ltd. in FY 2007. To bring about
improvement in terms of liquidity in the script of the Company , it has
gone for a stock split because it hasnt had any buyback in the recent
past. Nirma paid Interim dividend in 2007 to avoid the higher dividend tax
announced in that years budget. Henkel, on the other hand, has a very
weak Dividend Policy. The major reason being that the company has weak
operations and low margins. There is no record of Stock Splits and
Buybacks by Henkel India in the past. Discuss the dividend polices of
these two companies.
Ans: Dividend policy has a direct influence on the two components of shareholders
return dividends and capital gains. A low payout and high retention may have the
effect of accelerating the earnings growth.
Investors of growth companies realise their money in the form of capital gains.
Dividend pay-out ratio will be low for such companies. The influence of dividend
policy on future capital gains happens in distant future and therefore, by all means
it is uncertain.
Dividend policy of a firm is a residual decision. In true sense, it means that a firm
with sufficient investment opportunities will retain the entire earnings to fund its
growth avenues. Conversely, if no such avenues are forthcoming, the firm will payout its entire earnings. So there exists a relationship between return on investments
r and the cost of capital k. So, as long as r exceeds k, a firm shall have good
investment opportunities.
That is, if the firm can earn a return r higher than its cost of capital k, it will
retain its entire earnings. If this source is not sufficient, it will go in for additional
sources in the form of additional financing like equity issue, debenture issue or term
loans. Thus, the dividend decision is a trade-off between retained earnings and
financing decisions.

Stock Split:
A stock split is a method to increase the number of outstanding shares by
proportionately reducing the face value of a share.
The reasons for splitting shares are as follows:

To make shares attractive: The prime reason for affecting a stock split is
to reduce the market price of a share to make it more attractive to investors.
Shares of some companies enter into higher trading zone making it out-ofreach to small investors.

Indication of higher future profits Share split is generally considered a

method of management communication to investors, that the company is
expecting high profits in future.

Higher dividend to shareholders When shares are split, the company

does not resort to reducing the cash dividends.

Buybacks of shares:
The repurchase of outstanding shares by a company in order to reduce the number
of shares on the market.Companies will buy back the shares still available,or to
eliminate any threat by shareholders who may be looking for a controlling
stake.Companies buy back shares on the open market over an extended period of
time.