Q1. What are the 4 finance decisions taken by a finance manager.

Modern approach of financial management provides a conceptual and analytical fra mework for financial decision making. According to this approach there are 4 maj or decision areas that confront the Finance Manager these are:1. Investment Decisions 2. Financing Decisions 3. Dividend Decisions 4. Financial Analysis, Planning and Control Decisions a) Investment Decisions; Investment decisions are made by investors and investment managers. Investors commonly perform investment analysis by making use of fundamental anal ysis, technical analysis, screeners and gut feel. Investment decisions are often supported by decision tools. The portfolio theory is often applied to help the investor achieve a satisfactory return compared to the risk taken. b) Financing Decisions; What are the three types of financial management decisions? For each type of dec ision, give an example of a business transaction that would be relevant. There are three types of financial management decisions: Capital budgeting, Capita l structure, and Working capital management. Capital budgeting is the process of planning and managing a firm s long-term investm ents. The key to capital budgeting is size, timing, and risk of future cash flow s is the essence of capital budgeting. For example, yesterday I received a call from our manager over our Sand & Gravel Operations. He is looking into buying a new crusher (to crush stone into gravel and sand). I helped him today evaluate t he return on investment for this opportunity. It quite a lot of work, but we det ermined that buying the new crusher would bring in 60,000 more tons of productio n/sales within the 1st year of owning the machine. Capital Structure refers to the c) Dividend Decisions The Dividend Decision is a decision made by the directors of a company. It relat es to the amount and timing of any cash payments made to the company s stockholder s. The decision is an important one for the firm as it may influence its capital structure and stock price. In addition, the decision may determine the amount of taxation that stockholders pay. There are three main factors that may influence a firm s dividend decision: Free-cash flow Dividend clienteles Information signalling Under this theory, the dividend decision is very simple. The firm simply pays ou

t, as dividends, any cash that is surplus after it invests in all available posi tive net present value projects. A key criticism of this theory is that it does not explain the observed dividend policies of real-world companies. Most companies pay relatively consistent divi dends from one year to the next and managers tend to prefer to pay a steadily in creasing dividend rather than paying a dividend that fluctuates dramatically fro m one year to the next. These criticisms have led to the development of other mo dels that seek to explain the dividend decision. Dividend clienteles A particular pattern of dividend payments may suit one type of stock holder more than another. A retiree may prefer to invest in a firm that provides a consiste ntly high dividend yield, whereas a person with a high income from employment ma y prefer to avoid dividends due to their high marginal tax rate on income. If cl ienteles exist for particular patterns of dividend payments, a firm may be able to maximise its stock price and minimise its cost of capital by catering to a pa rticular clientele. This model may help to explain the relatively consistent div idend policies followed by most listed companies. A key criticism of the idea of dividend clienteles is that investors do not need to rely upon the firm to provide the pattern of cash flows that they desire. An investor who would like to receive some cash from their investment always has t he option of selling a portion of their holding. This argument is even more coge nt in recent times, with the advent of very low-cost discount stockbrokers. It r emains possible that there are taxation-based clienteles for certain types of di vidend policies. Information signalling

Q2. What are the factors affecting financial plan of a company? Ans. We live in a society and interact with people and environment. What happen s to us is not always accordance to our wishes. Many things turn out in our live are uncontrollable by us. Many decisions we take are the result of external influenc es.So do our financial matters.There are many factors affect our personal financ ial planning. Range from economic factors to global influences.Aware of factors affecting your money matters below will certainly benefit your planning. Factors Affecting Financial Plan 1.Nature of the industry:- Here, we must consider whether it is a capital intens ive of labour intensive industry.This will have a major impact on the total asse ts that the firm owns. 2. Size of the company: -The size of the company greatly influences the availabi lity of funds from different sources.A small company normally finals it difficult to rai se funds from long term sources at competitive terms. On the other hand, large c ompanies like Reliance enjoy the privilege of obtaining funds both short term an d long term at attractive rates. 3. Status of the company in the industry:-A well established company enjoying a good market share, for its products normally commands investors confidence.Such a company can tap the capital market for raising funds in competitive term for im plementation new projects to exploit the new opportunity emerging from changing

business environment. 4. Sources of finance available:-Sources of finance could be group into debt and equity. Debt is cheap but risky whereas equity is costly.A firm should aim at op timum capital structure that would achieve the least cost capital structure.A la rge firm with a diversified product mix may manage higher quantum of debt becaus e the firm may manage higher financial risk with a lower business risk.Selection of sources of finances us closely linked to the firms capacity to manage the ri sk exposure. 5.The capital structure of a company:- Capital structure of a company is influen ced by the desire of the existing management of the company to remain control over t he affairs of the company.The promoters who do not like to lose their grip over the affairs of the company normally obtain extra funds for growth by issuing pre ference shares and debentures to outsiders. 6. Matching the sources with utilization:-The product policy of any good financi al plan is to match the term of the source with the term of investment.To finance f luctuating working capital needs, the firm resorts to short term finance.All fix ed assets-investment are to be finance by long term sources. It is a cardinal pr incipal of financial planning. 7. Flexibility:-The financial plan of company should possess flexibility so as t o effect changes in the composition of capital structure when ever need arises. If the ca pital structure of a company is flexible, it will not face any difficulty in cha nging the sources of funds.This factor has become a significant one today becaus e of the globalization of capital market. 8. Government Policy:-SEBI guidelines, finance ministry circulars, various claus es of Standard Listing Agreement and regulatory mechanism imposed by FEMAa nd Department of CorporateAffairs (Govt of India) influence the financial plans of corporate today. Management of public issues of shares demands the companies wit h many status in India.They are to be compiled with a time constraint.

Q.3 Show the relationship between required rate of return and coupon rate on the value of a bond. Ans. It is important for prospective bond buyers to know how to determine the pr ice of a bond because it will indicate theyieldreceived should the bond be purch ased. In this section, we willrun through some bond price calculations for vario us types of bond instruments.Bonds can be priced at a premium,discount, or at pa r . If the bond s price is higher than its par value, it will sell at a premium b ecause its interest rate is higher than current prevailing rates. If the bond s pr ice is lower than its par value, the bond will sell at a discount because its in terestrate is lower than current prevailing interest rates. When you calculate t he price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bond s couponrate in comparison to the average rate most investors are currently r eceiving in the bond market.Required yield or required rate of return is the int erest rate that a security needs to offer in order to encourage investors to pur

chase it. Usually the required yield on a bond is equal to or greater than the c urrent prevailing interest rates.Fundamentally, however, the price of a bond is the sum of the present valuesof all expectedcouponpayments plus the present valu e of the par value at maturity.Calculating bond price is simple: all we are doin g is discounting the known future cash flows. Remember that tocalculate present value (PV) which is based on the assumption that each payment is re-investedat s ome interest rate once it is received we have to know the interest rate that would earn us a known future value. For bond pricing, this interest rate is the requi red yield. (If the concepts of present and future value are new to you or you a re unfamiliar with the calculations, refer to Understanding the Time Value of Money Here is the formula for calculating a bond s price, which uses the basic present v alue (PV)formula:C = coupon paymentn = number of paymentsi = interest rate, or r equired yieldM = value at maturity, or par valueThe succession of coupon payment s to be received in the future is referred to as anordinary annuity, which is a series of fixed payments at set intervals over a fixed period of time. (Couponso n a straight bond are paid at ordinary annuity.) The first payment of an ordinar y annuity occursone interval from the time at which the debt security is acquire d. The calculation assumes thistime is the present. You may have guessed that the bond pricing formula shown above may be tediousto calculate, as it requires adding the present value of each future couponpayment . Because these payments are paid at an ordinary annuity, however, wecan use the shorter PV-of-ordinary-annuity formula that is mathematicallyequivalent to the summation of all the PVs of future cash flows. This PV-of-ordinary-annuity formu la replaces the need to add all the present values of the futurecoupon. The foll owing diagram illustrates how present value is calculated for anordinary annuity : Each full moneybag on the top right represents the fixed coupon payments (future value)received in periods one, two and three. Notice how the present value decr eases for those coupon payments that are further into the future the present val ue of the second coupon payment is worthless than the first coupon and the third coupon is worth the lowest amount today. The farther intothe future a payment i s to be received, the less it is worth today is the fundamental concept for which the PV-of-ordinary-annuity formula accounts. It calculates the sum of the present valuesof all future cash flows, but unlike the bond-pricing formula we s aw earlier, it doesn trequire that we add the value of each coupon payment. By incorporating the annuity model into the bond pricing formula, which requires usto also include the present value of the par value received at maturity, we a rrive atthe following formula: Let s go through a basic example to find the price of a plain vanilla bond. Example 1: Calculate the price of a bond with a par value of $1,000 to be paid in ten years , acoupon rate of 10%, and a required yield of 12%. In our example we ll assume th at coupon payments are made semi-annually to bond holders and that the next coup on payment is expectedin six months. Here are the steps we have to take to calcu late the price: 1. Determine the Number of Coupon Payments: Because two coupon payments will be madeeach year for ten years, we will have a total of 20 coupon payments. 2. Determine the Value of Each Coupon Payment: Because the coupon payments are semi-annual, divide the coupon rate in half. The coupon rate is the percentage off the bond s par value.As a result, each semi-ann ual coupon payment will be $50 ($1,000 X 0.05). 3. Determine the Semi-Annual Yield: Like the coupon rate, the required yield of 12% must bedivided by two because th e number of periods used in the calculation has doubled. If we left therequired yield at 12%, our bond price would be very low and inaccurate. Therefore, the re quiredsemi-annual yield is 6% (0.12/2).

4. Plug the Amounts Into the Formula: From the above calculation, we have determined that the bond is selling at a dis count; the bond price is less than its par value because the required yield of t he bond is greater than the couponrate. The bond must sell at a discount to attr act investors, who could find higher interestelsewhere in the prevailing rates. In other words, because investors can make a larger return inthe market, they ne ed an extra incentive to invest in the bonds. Accounting for Different Payment Frequencies In the example above coupons were paid semi-annually, so we divided the interest rate andcoupon payments in half to represent the two payments per year. You may be now wonderingwhether there is a formula that does not require steps two and three outlined above, which arerequired if the coupon payments occur more than o nce a year. A simple modification of the above formula will allow you to adjust interest rates and coupon payments to cal culate a bond price for any payment frequency: Notice that the only modificatio n to the original formula is the addition of F , which representsthe frequency of c oupon payments, or the number of times a year the coupon is paid. Therefore,for bonds paying annual coupons, F would have a value of one. Should a bond pay quar terly payments, F would equal four, and if the bond paid semi-annual coupons, F would be two

Q4. Discuss the implication of financial leverage for a firm? Ans. Concept of Financial Leverage Leverage is the action of a lever or the mechanical advantage gained by it; it als o means effectiveness or power . The common interpretation of leverage is derived fro m the use or manipulation of a tool or device termed as lever, which provides a substantive clue to the meaning and nature of financial leverage. Concept of Financial Leverage Leverage may be defined as the employment of an asset or funds for which the fir m pays a fixed cost or fixed return. The fixed cost or return may, therefore be thought of as the full annum of a lever. Financial leverage implies the use of f unds carrying fixed commitment charge with the objective of increasing returns t o equity shareholders. Financial leverage or leverage factor is defined, as the ratio of total value of debt to total assets or the total value of the firm. For example, a firm having a total value of Rs. 2,00,000 and a total debt of Rs. 1, 00,000 would have a leverage factor of 50 percent. There are difficult measures of leverage such as. i. The ratio of debt to total capital ii. The ratio of debt to equity iii. The ratio of net operating income (earning before interest and taxes) to fixed charges) The first two measures of leverage can be expressed either in boo k v8lue or market value the debt of equity ratio as a measure of financial lever age is more popular in practice. Risk & Financial Leverage: Effects of financial Leverage: The use of leverage results in two obvious effect s: i. Increasing the shareholders earning under favorable economic conditions, and ii. Increasing the financial risk of the firm. Suppose there are two compani es each having a Rs. 1,00,000 capital structure. One company has borrowed half o

f its investment while the other company has only equity capital: Both earn Rs. 2,00,000 profit. The ratio of interest on the borrowed capital is 10%and the rat e of corporate tax 50%. Let us calculate the effect of financial leverage, both in the shareholders earnings and the Company s financial risk in these two compani es. Effect of Leverage on the financial risk of the company: Financial risk broadly defined includes both the risk of possible insolvency and the changes in the ear nings available to equity shareholders. How does the leverage factor leads to th e risk possible insolvency is self-explanatory. As defined earlier the inclusion of more and more debt in capital structure leads to increased fixed commitment charges on the part of the firm as the firm continues to lever itself, the chang es of cash insolvency leading to legal bankruptcy increase because the financial c harges incurred, by the firm exceed the expected earnings. Obviously this leads to fluctuations in earnings available to the equity shareholders.

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Q.1 Discuss the objective of profit maximization vs wealth maximization. The financial management come a long way by shifting its focus from traditional approach to modern approach. The modern approach focuses on wealth maximization rather than profit maximization. This gives a longer term horizon for assessment , making way for sustainable performance by businesses. A myopic person or business is mostly concerned about short term benefits. A sho rt term horizon can fulfill objective of earning profit but may not help in crea ting wealth. It is because wealth creation needs a longer term horizon Therefore , Finance Management or Financial Management emphasizes on wealth maximization r ather than profit maximization. For a business, it is not necessary that profit should be the only objective; it may concentrate on various other aspects like i ncreasing sales, capturing more market share etc, which will take care of profit ability. So, we can say that profit maximization is a subset of wealth and being a subset, it will facilitate wealth creation Giving priority to value creation, managers have now shifted from traditional ap proach to modern approach of financial management that focuses on wealth maximiz ation. This leads to better and true evaluation of business. For e.g., under wea lth maximization, more importance is given to cash flows rather than profitabili ty. As it is said that profit is a relative term, it can be a figure in some cur rency, it can be in percentage etc. For e.g. a profit of say $10,000 cannot be j udged as good or bad for a business, till it is compared with investment, sales etc. Similarly, duration of earning the profit is also important i.e. whether it is earned in short term or long term. In wealth maximization, major emphasizes is on cash flows rather than profit. So , to evaluate various alternatives for decision making, cash flows are taken und er consideration. For e.g. to measure the worth of a project, criteria like: present value of its cash inflow

present value of cash

outflows (net present value) is taken. This approach considers cash flows rather than profits into consideration and also use discounting technique to find out worth of a project. Thus, maximization of wealth approach believes that money ha s time value. An obvious question that arises now is that how can we measure wealth. Well, a b asic principle is that ultimately wealth maximization should be discovered in in creased net worth or value of business. So, to measure the same, value of busine ss is said to be a function of two factors earnings per share and capitalization rate. And it can be measured by adopting following relation: Value of business = EPS / Capitalization rate At times, wealth maximization may create conflict, known as agency problem. This describes conflict between the owners and managers of firm. As, managers are th e agents appointed by owners, a strategic investor or the owner of the firm woul d be majorly concerned about the longer term performance of the business that ca n lead to maximization of shareholder s wealth. Whereas, a manager might focus on ta king such decisions that can bring quick result, so that he/she can get credit f or good performance. Roll No : 521026396 However, in course of fulfilling the same, a manager might opt for risky decisio ns which can put on stake the owner s objectives. Hence, a manager should align his/her objective to broad objective of organizati on and achieve a tradeoff between risk and return while making decision; keeping in mind the ultimate goal of financial management i.e. to maximize the wealth o f its current shareholdershe objections are:(i) Profit cannot be ascertained well in advance to express the probability of r eturn as future is uncertain. It is not at possible to maximize what cannot be k nown. (ii) The executive or the decision maker may not have enough confidence in the e stimates of future returns so that he does not attempt future to maximize. It is argued that firm s goal cannot be to maximize profits but to attain a certain lev el or rate of profit holding certain share of the market or certain level of sal es. Firms should try to satisfy rather than to maximize (iii) There must be a balance between expected return and risk. The possibility of higher expected yields are associated with greater risk to recognise such a b alance and wealth Maximization is brought in to the analysis. In such cases, hig her capitalisation rate involves. Such combination of expected returns with risk variations and related capitalisation rate cannot be considered in the concept of profit maximization. (iv) The goal of Maximization of profits is considered to be a narrow outlook. E vidently when profit maximization becomes the basis of financial decisions of th e concern, it ignores the interests of the community on the one hand and that of the government, workers and other concerned persons in the enterprise on the ot her hand. Keeping the above objections in view, most of the thinkers on the subject have c ome to the conclusion that the aim of an enterprise should be wealth Maximizatio n and not the profit Maximization. Prof. Soloman of Stanford University has hand led the issued very logically. He argues that it is useful to make a distinction between profit and profitability . Maximization of profits with a vie to maximisin g the wealth of shareholders is clearly an unreal motive. On the other hand, pro

fitability Maximization with a view to using resources to yield economic values higher than the joint values of inputs required is a useful goal. Thus the prope r goal of financial management is wealth maximization.

Q2. Explain the Net operating income approach to capital structure theories. Answer : The net operating income approach assumes that creditors do not increas e their required rate of return as a company takes on debt, but investors do. Fu rther, the rate at which investors increase their required rate of return as the financing mix is shifted toward debt exactly offsets the weighting away from th e more expensive equity and toward the cheaper debt. The result is that the cost of capital remains constant regardless of the financing mix. This approach conc ludes that there is no optimal financing mixany mix is as good as any other. Net Operating Income Approach was also suggested by Durand. This approach is of the opposite view of Net Income approach. This approach suggests that the capita l structure decision of a firm is irrelevant and that any change in the leverage or debt will not result in a change in the total value of the firm as well as t he market price of its shares. This approach also says that the overall cost of capital is independent of the degree of leverage. Features of NOI approach: * At all degrees of leverage (debt), the overall capitalization rate would r emain constant. For a given level of Earnings before Interest and Taxes (EBIT), the value of a firm would be equal to EBIT/overall capitalization rate. * The value of equity of a firm can be determined by subtracting the value o f debt from the total value of the firm. This can be denoted as follows: Value of Equity = Total value of the firm Value of debt * Cost of equity increases with every increase in debt and the weighted aver age cost of capital (WACC) remains constant. When the debt content in the capita l structure increases, it increases the risk of the firm as well as its sharehol ders. To compensate for the higher risk involved in investing in highly levered company, equity holders naturally expect higher returns which in turn increases the cost of equity capital.