Q.

1 What are the 4 finance decisions taken by a finance manager

Modern approach of financial management provides a conceptual and analytical framework for financial decision making. According to this approach there are 4 major 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 analysis, 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 decision, give an example of a business transaction that would be relevant. There are three types of financial management decisions: Capital budgeting, Capital structure, and Working capital management. Capital budgeting is the process of planning and managing a firm's long-term investments. The key to capital budgeting is size, timing, and risk of future cash flows 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 the return on investment for this opportunity. It quite a lot of work, but we determined that buying the new crusher would bring in 60,000 more tons of production/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 relates to the amount and timing of any cash payments made to the company's stockholders. 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 out, as dividends, any cash that is surplus after it invests in all available positive 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 dividends from one year to the next and managers tend to prefer to pay a steadily increasing dividend rather than paying a dividend that fluctuates dramatically from one year to the next. These criticisms have led to the development of other models 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 consistently high dividend yield, whereas a person with a high income from employment may prefer to avoid dividends due to their high marginal tax rate on income. If clienteles 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 particular clientele. This model may help to explain the relatively consistent dividend 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 the option of selling a portion of their holding. This argument is even more cogent in recent times, with the advent of very low-cost discount stockbrokers. It remains possible that there are taxation-based clienteles for certain types of dividend policies.

Q.2 What are the factors that affect the financial plan of a company? Ans. To help your organization succeed, you should develop a plan that needs to be followed. This applies to starting the company, developing new product, creating a new department or any undertaking that affects the companys future. There are several factors that affect planning in an organization. To create an efficient plan, you need to understand the factors involved in the planning process. A businessman an businesswoman having a meeting image by sumos from Fotolia.com A businessman an businesswoman having a meeting image by sumos from Fotolia.com Organizational planning is affected by many factors. 4e634960-1e4b-65e0-9d0e-ed699b8d2ca4400300

Priorities

In most companies, the priority is generating revenue, and this priority can sometimes interfere with the planning process of any project. For example, if you are in the process of planning a large expansion project and your largest customer suddenly threatens to take their business to your competitor, then you might have to shelve the expansion planning until the customer issue is resolved. When you start the planning process for any project, you need to assign each of the issues facing the company a priority rating. That priority rating will determine what issues will sidetrack you from the planning of your project, and which issues can wait until the process is complete.

Company Resources

Having an idea and developing a plan for your company can help your company to grow and succeed, but if the company does not have the resources to make the plan come together, it can stall progress. One of the first steps to any planning process should be an evaluation of the resources necessary to complete the project, compared to the resources the company has available. Some of the resources to consider are finances, personnel, space requirements, access to materials and vendor relationships.

Forecasting

A company constantly should be forecasting to help prepare for changes in the marketplace. Forecasting sales revenues, materials costs, personnel costs and overhead costs can help a company plan for upcoming projects. Without accurate forecasting, it can be difficult to tell if the plan has any chance of success, if the company has the capabilities to pull off the plan and if the plan will help to strengthen the companys standing within the industry. For example, if your forecasting for the cost of goods has changed due to a sudden increase in material costs, then that can affect elements of your product roll-out plan, including projected profit and the long-term commitment you might need to make to a supplier to try to get the lowest price possible.

Contingency Planning

To successfully plan, an organization needs to have a contingency plan in place. If the company has decided to pursue a new product line, there needs to be a part of the plan that addresses the possibility that the product line will fail. The reallocation of company resources, the acceptable financial losses and the potential public relations problems that a failed product can cause all need to be part of the organizational planning process from the beginning

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 price of a bond because it will indicate the yield received should the bond be purchased. In this section, we will run through some bond price calculations for various types of bond instruments.

Bonds can be priced at a premium, discount, or at par. If the bonds price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bonds price is lower than its par value, the bond will sell at a discount because its interest rate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bonds coupon rate in comparison to the average rate most investors are currently receiving in the bond market. Required yield or required rate of return is the interest rate that a security needs to offer in order to encourage investors to purchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interest rates. Fundamentally, however, the price of a bond is the sum of the present values of all expected coupon payments plus the present value of the par value at maturity. Calculating bond price is simple: all we are doing is discounting the known future cash flows. Remember that to calculate present value (PV) which is based on the assumption that each payment is re-invested at some interest rate once it is receivedwe have to know the interest rate that would earn us a known future value. For bond pricing, this interest rate is the required yield. (If the concepts of present and future value are new to you or you are unfamiliar with the calculations, refer to Understanding the Time Value of Money.) Here is the formula for calculating a bonds price, which uses the basic present value (PV) formula:

C = coupon payment n = number of payments i = interest rate, or required yield M = value at maturity, or par value The succession of coupon payments to be received in the future is referred to as an ordinary annuity, which is a series of fixed payments at set intervals over a fixed period of time. (Coupons on a straight bond are paid at ordinary annuity.) The first payment of an ordinary annuity occurs one interval from the time at which the debt security is acquired. The calculation assumes this time is the present. You may have guessed that the bond pricing formula shown above may be tedious to calculate, as it requires adding the present value of each future coupon payment. Because these payments are paid at an ordinary annuity, however, we can use the shorter PV-of-ordinary-annuity formula that is mathematically equivalent to the summation of all the PVs of future cash flows. This PVof-ordinary-annuity formula replaces the need to add all the present values of the future coupon. The following diagram illustrates how present value is calculated for an ordinary 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 decreases for those coupon payments that are further into the future the present value of the second coupon payment is worth less than the first coupon and the third coupon is worth the lowest amount today. The farther into the future a payment is 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 values of all future cash flows, but unlike the bond-pricing formula we saw earlier, it doesnt require that we add the value of each coupon payment. (For more on calculating the time value of annuities, see Anything but Ordinary: Calculating the Present and Future Value of Annuities and Understanding the Time Value of Money. ) By incorporating the annuity model into the bond pricing formula, which requires us to also include the present value of the par value received at maturity, we arrive at the following formula:

Lets 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, a coupon rate of 10%, and a required yield of 12%. In our example well assume that coupon payments are made semi-annually to bond holders and that the next coupon payment is expected in six months. Here are the steps we have to take to calculate the price: 1. Determine the Number of Coupon Payments: Because two coupon payments will be made each 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 semiannual, divide the coupon rate in half. The coupon rate is the percentage off the bonds par value. As a result, each semi-annual 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 be divided by two because the number of periods used in the calculation has doubled. If we left the required yield at 12%, our bond price would be very low and inaccurate. Therefore, the required semi-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 discount; the bond price is less than its par value because the required yield of the bond is greater than the coupon rate. The bond must sell at a discount to attract investors, who could find higher interest elsewhere in the prevailing rates. In other words, because investors can make a larger return in the market, they need 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 and coupon payments in half to represent the two payments per year. You may be now wondering whether there is a formula that does not require steps two and three outlined above, which are required if the coupon payments occur more than once a year. A simple modification of the above formula will allow you to adjust interest rates and coupon payments to calculate a bond price for any payment frequency:

Discuss the implication of financial leverage for a firm.

Financial leverage as opposed to operating leverage relates to the financingactivities of a firm and measures the effect of earnings before interest andtax (EBIT) on earnings per share (EPS) of the company.A companys sources of funds fall under two categories Those which carry a fixed financial charges like debentures, bonds andpreference shares and Those which do not carry any fixed charges like equity sharesDebentures and bonds carry a fixed rate of interest and have to be paid off irrespective of the firms revenues. Though dividends are not contractualobligations, dividend on preference shares is a fixed charge and should bepaid off before equity shareholders are paid any. The equity holders areentitled to only the residual income of the firm after all prior obligations aremet.Financial leverage refers to the mix of debt and equity in the capitalstructure of the firm. This results from the presence of fixed financialcharges in the companys income stream. Such expenses have nothing todo with the firms performance and earnings and should be paid off regardless of the amount of earnings before income and tax (EBIT).It is the firms ability to use fixed financial charges to increase the effects of changes in EBIT on the EPS. It is the use of funds obtained at fixed costswhich increase the returns on shareholders.A company earning more by the use of assets funded by fixed sources issaid to be having a favourable or positive leverage. Unfavourable leverageoccurs when the firm is not earning sufficiently to cover the cost of funds.Financial leverage is also referred to as Trading on Equity.Use of Financial Leverage Studying the degree of financial leverage (DFL) at various levels makesfinancial decision-making, on the use of fixed sources of funds, for fundingactivities easy. One can assess the impact of change in earnings beforeinterest and tax (EBIT) on earnings per share (EPS).Like operating leverage, the risks are high at high degrees of financialleverage (DFL). High financial costs are associated with high DFL. Anincrease in financial costs implies higher level of EBIT to meet thenecessary financial commitments.A firm which is not capable of honouring its financial commitments may beforced to go into liquidation by the lenders of funds. The existence of the firm is shaky under these circumstances.On one side the trading on equity improves considerably by the use of borrowed funds and on the other hand, the firm has to constantly worktowards higher EBIT to stay alive in the business. All these factors shouldbe considered while formulating the firms mix of sources of funds.One main goal of financial planning is to devise a capital structure in order to provide a high return to equity holders. But at the same time, this shouldnot be done with heavy debt financing which drives the company on to thebrink of winding up. Impact of financial leverage Highly leveraged firms are considered very risky and lenders and creditorsmay refuse to lend them further to fuel their expansion activities. On beingforced to continue lending, they may do so with their own conditions likeearning a minimum of X% EBIT or stipulating higher interest rates than themarket rates or no further mortgage of securities.Financial leverage is considered to be favourable till such time that the rateof return exceeds the rate of return obtained when no debt is used.The company not using debt to finance its assets has a higher DFLcompared to that of a company using it. Financial leverage does not existwhen there is no fixed charge financing.

Q.5 The cash flows associated with a project are given below: Year Cash flow 0 (100,000) 1 25000 2 40000

3 50000 4 40000 5 30000 Calculate the a) payback period. b) Benefit cost ratio for 10% cost of capital

Ans. a) Payback period: The cash flows and the cumulative cash flows of the projects is shown under in table Table Cash flows and cumulative cash flows Year Project Cash flows (Rs.) Cumulative Cash flows 1 25,000 25,000 2 40,000 65,000 3 50,000 115,000 4 40,000 155,000 5 30,000 185,000 From the cumulative cash flow column the initial cash outlay of Rs. 1,00,000 lies between 2nd year and 3rd year in respect of project. Therefore, payback period for project is: = = 2.54 years Pay-back period for project B is 2.54 years.

b) Benefit cost ratio for 10% cost of capital Table: Present Value (PV) of Cash inflows Year Cash in flows PV factor at 15% PV of Cash in flows 1 25,000 0.909 22,725 2 40,000 0.826 33,040 3 50,000 0.751 37,550 4 40,000 0.683 27,320 5 30,000 0.621 18,630 PV of Cash inflow 139,265 Initial Cash out lay 1,00,000 NPV 39,265

Benefit cost ratio = PV of Cash inflow Initial Cash outlay = 139,265

1,00,000 = 1.39

. A companys earnings and dividends are growing at the rate of 18% pa. The growth rate isexpected to continue for 4 years. After 4 years, from year 5 onwards, the growth rate will be 6%forever. If the dividend per share last year was Rs. 2 and the investors required rate of return is10% pa, what is the intrinsic price per share or the worth of one share. Ans

P = Intrinsic price per share E = Earnings per share =18%, D = Dividend per share =2 r = Rate of return =10% P = [2(1.18)/(1.10)1]+ [2(1.18)2/(1.10)2]+ [2(1.18)3/(1.10)3] + [2(1.18)4/(1.10)4]+ [2(1.18)4(1.06)/(1.10)5]+ [2(1.18)4(1.06)2/(1.10)6] +. =2.15+2.30+2.47+2.65+2.55+2.46 Intrinsic price per share = 14.58