Subject Code: IMT-59

Subject Name : FINANCIAL

MANAGEMENT

Objective: To develop knowledge of financial system, financial institutions and basic concepts / techniques of corporate finance. Contents : THE FINANCE FUNCTION: GOALS, OBJECTIVES AND ETHICS Scope of Finance, Real and Financial Assets, Equity and Borrowed Funds, Finance and Management Functions, Financial Functions, Investment Decision, Financing Decision, Dividend Decision, Liquidity Decision, Financial Procedures and Systems, Financial Managers Role, Fund Raising, Fund Allocation, Profit Planning, Understanding Capital Markets, Financial Goal: Profit Maximisation Versus Wealth Maximisation, Profit Maximisation, Objections to Profit Maximisation, Maximising Profit after Taxes, Maximising EPS, Shareholders Wealth Maximisation (SWM), Need for a Valuation Approach, Risk-return Trade-off, Agency Problems: Managers Versus Shareholders Goals, Financial Goal and Firms Mission and Objectives, Organisation of the Finance Functions, Status and Duties of Finance Executives, Controllers and Treasurers Functions in the Indian Context DOMESTIC, ECONOMIC AND FINANCIAL ENVIRONMENT Background of the Indian Economy, Developments Till 1991, Macroeconomic Reforms, Micro Economic Reforms, The Eleventh Plan Proposals, Gaps in the Development Process, The Agricultural Segment, Manufacturing, Infrastructure, Encouraging Human Development, Financial System, Funds Raised by Government, Commercial Banks, Commercial Paper, Capital Market, Financing Industry, The External Environment; Free Trade Agreements (FTAs), Foreign Investment Inflows, External Debt, Foreign Exchange Reserves, Meeting Investment Requirements INTERNATIONAL ECONOMIC AND FINANCIAL ENVIRONMENT World GNI and Ranking of Individual Countries, Growth in International Trade and Finance, The Importance of the Multinational Corporation, Methods of Doing International Business, World Trade Organization, Forms of Economic Integration among Nations, Balance of Payments, Global Financial Systems, Exchange Rate Systems, Gold Standard, Bretton Woods System, The International Monetary Fund, Special Drawing Rights (SDRs), Criticism of the IMF, Central Bank Operations, Currency Board, Bank for International Settlements, Multilateral Development Banks , World Bank Group, Goals, Foreign Exchange Markets, Growth of Derivative Products, Growth of International Currency Markets, Eurocurrency Market, European Monetary System EMS, Major Financing Instruments in Global Capital Markets, Money Market Instruments, Bond and Note Issues, Structured Finance, Equity Financing in the International Markets , Foreign Currency Inflows into India, Developments in the World Economy CONCEPTS OF RISK AND RETURN Capital Market Theory: An Overview, Return on a Single Asset, Risk of Rates of Return: Variance and Standard Deviation, Portfolio Theory, Portfolio Return: Two-Asset Case, Portfolio Risk: Two Asset Case, Risk Diversification: Systematic and Unsystematic Risk, Systematic Risk, Unsystematic Risk, Total Risk, Capital Asset Pricing Model (CAPM), Assumptions of CAPM, Characteristics Line, Security Market Line (SML), Implications and Relevance of CAPM, Implications, Limitations of CAPM, Financial Goals and Strategy FINANCIAL RATIO ANALYSIS Users of Financial Analysis, Nature of Ratio Analysis, Standards of Comparison, Types of Ratios, Liquidity Ratios, Current Ratio, Quick Ratio, Cash Ratio, Interval Measure, Net Working Capital Ratio, Leverage Ratios, Debt Ratio, Debt-Equity Ratio, Other Debt Ratios, Coverage Ratios, Activity Ratios, Inventory Turnover, Debtor (Account Receivable) Turnover, Assets Turnover Ratios, Profitability Ratios, How is Profit Measured, Gross Profit Margin, Net Profit Margin, Net Margin Based on NOPAT, Operating Expense Ratio, Return on Investment (ROI), Return on Equity (ROE), Earning Per Share (EPS), Dividends Per Share (DPS or DIV), Dividend-Payout Ratio, Dividends and Earnings Yields, Price-Earnings Ratio, Market Value-to-Book Value (MV/BV) Ratio, Tobins , Evaluation of a Firms Earning Power, Comparative Statements Analysis, Financial Management. ............................................ Page 1 of 5 ............................................................................... IMT-59

Trend Analysis, Inter-firm Analysis, Utility of Ratio Analysis, Diagnostic Role of Ratios, Strategic Analysis, Cautions in Using Ratio Analysis, Financial Ratios as Predictors of Failure, Non-parametric Analysis, Multiple Discriminate Analysis TIME VALUE OF MONEY Time Value of Money, Compounding, Discounting VALUATION OF SECURITIES Concepts of Value, Book Value, Replacement Value, Liquidation Value, Going Concern Value, Market Value, Features of a Bond, Bonds Values and Yields, Bond with Maturity, Yield to Maturity, Current Yield, Yield to Call, Bond Value and Amortization of Principal, Bond Values and Semi-annual Interest Payments, Pure Discount Bonds, Perpetual Bonds, Bond Values and Changes in Interest Rates, Bond Maturity and Interest Rate Risk, Bond Duration and Interest Rate Sensitivity, The Term Structure of Interest Rates, The Expectation Theory, The Liquidity Premium Theory, The Segmented Markets Theory, Default Risk and Credit Rating, Valuation of Preference Shares, Features of Preference and Ordinary Shares, Valuation of Ordinary Shares, Dividend Capitalization, Single Period Valuation, Multi-period Valuation, Growth in Dividends, Normal Growth, Super-normal Growth, Firm Paying No Dividends, Earnings Capitalization, Equity Capitalization Rate, Caution in Using Constant-growth Formula, Linkages Between Share Price, Earnings and Dividends, How To Value Growth Opportunities?, How Significant is the Price-earnings (P/E) Ratio?, Can P/E Ratio Mislead? CASH FLOWS AND CAPITAL BUDGETING Nature of Investment Decisions, Importance of Investment Decisions, Types of Investment Decisions, Expansion and Diversification, Replacement and Modernization, Mutually Exclusive Investments, Independent Investments, Contingent Investments, Capital Budgeting Process, Capital Investments, Capital Investment Planning and Control, Investment Evaluation Criteria, Investment Decision Rule, Evaluation Criteria, Net Present Value Method, Why is NPV Important?, Acceptance Rule, Evaluation of the NPV Method, Internal Rate of Return Method, Uneven Cash Flows: Calculating IRR by Trial and Error, Level Cash Flows, NPV Profile and IRR, Acceptance Rule, Evaluation of IRR Method, Profitability Index, Acceptance Rule, Evaluation of Pi Method, Payback, Acceptance Rule, Evaluation of Payback, Payback Reciprocal and the Rate of Return, Discounted Payback Period, Accounting Rate of Return Method, Acceptance Rule, Evaluation of ARR Method, NPV Versus IRR, Equivalence of NPV and IRR Case of Conventional Independent Projects, Lending and Borrowing-type Projects, Non-Conventional Investments: Problem of Multiple IRRs, Difference: Case of Ranking Mutually Exclusive Projects, Reinvestment Assumption and Modified Internal Rate of Return (MIRR), Varying Opportunity Cost of Capital , ENP Versus Pi, Investment Decisions under Capital Rationing, Why Capital Rationing?, External Capital Rationing, Internal Capital Rationing THE COST OF CAPITAL Significance of the Cost of Capital, Investment Evaluation, Designing Debt Policy, Performance Appraisal, The Concept of the Opportunity Cost of Capital , Shareholders Opportunities and Values, Creditors Claims and Opportunities, Risk Differences in Shareholders and Creditors Claims, General Formula for the Opportunity Cost of Capital, Weighted Average Cost of Capital vs. Specific Costs of Capital, Component Costs of Capital and Security Valuation, Valuation of Bonds, Valuation of Preference Shares, Valuation of Equity (Ordinary Shares), Determining Component Costs of Capital, Cost of Debt, Debt Issued at Par, Debt Issued at Discount or Premium, Tax Adjustment, Cost of the Existing Debt, Cost of Preference Capital, Irredeemable Preference Share, Redeemable Preference Share, Cost of Equity Capital, Is Equity Capital Free of Cost?, Cost of Internal Equity: The Dividend-growth Model, Cost of External Equity: The Dividend Growth Model, EarningsPrice Ratio and the Cost of Equity, Cost of Equity and the Capital Asset Pricing Model, Systematic and Unsystematic Risk, Cost of Equity and the Capital Asset Pricing Model (CAPM);, The Weighted Average Cost of Capital, Book Value vs. Market Value Weights, Flotation Costs, Cost of Capital and Investment Analysis, Divisional and Project Cost of Capital, The Pure-Play Technique, The Cost of Capital for Projects CAPITAL STRUCTURE: THEORY AND POLICY Assumptions of Traditional Capital Structure Theories, Relevance of Capital Structure: The Net Income and the Traditional Views, The Net Income Approach, The Traditional View, Criticism of the Traditional View, Irrelevance of Capital Structure: NOI Approach and the Mm Hypothesis without Taxes, Arbitrage Process, Key Assumptions, Criticism of the Mm Hypothesis, Relevance of Capital Structure: The Mm Hypothesis under Corporate Taxes, Value of Interest Tax Shield, Value of The Levered Firm, Enhancing the Firm Value Through Debt: Infosys Technologies Limited, Implications of the Mm Hypothesis with Corporate Taxes, Capital Structure Planning and Policy, Elements of Capital Structure, Framework for Capital Structure: The FRICT Analysis, Approaches to Establish Target Capital Structure, EBIT-EPS Analysis, Valuation Approach, Cash Flow Analysis, Practical Considerations in Determining Capital Structure, Assets, Growth Opportunities, Debt- and Non-debt Tax Shields, Financial Flexibility and Operating Strategy, Loan Covenants, Financial Slack, Financial Management. ............................................ 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Sustainability and Feasibility, Control, Marketability and Timing, Issue Costs, Capacity of Raising Funds, Managers Attitude Towards Debt, Capital Structure. DIVIDEND POLICIES Objectives of Dividend Policy, Firms Need for Funds, Shareholders Need for Income, Practical Considerations in Dividend Policy, Firms Investment Opportunities and Financial Needs, Shareholders Expectations, Constraints on Paying Dividends, Stability of Dividends, Constant Dividend Per Share or Dividend Rate, Constant Payout, Constant Dividend Per Share Plus Extra Dividend, Merits of Stability of Dividends, Danger of Stability of Dividends, Target Payout and Dividend Smoothing: Lintners Model of Corporate Dividend Behaviour, Forms of Dividends, Cash Dividend, Bonus Shares, Advantages of Bonus Shares, Limitations of Bonus Shares, Conditions for the Issue of Bonus Shares, Share Split, Bonus Share vs. Share Split, Reasons for Share Split, Reverse Split, Dividend Policy Analysis. WORKING CAPITAL MANAGEMENT Concepts of Working Capital, Focusing on Management of Current Assets, Focusing on Liquidity Management, Operating and Cash Conversion Cycle, Gross Operating Cycle (GOC), Cash Conversion or Net Operating Cycle, Permanent and Variable Working Capital, Balanced Working Capital Position, Determinants of Working Capital, Nature of Business, Market and Demand Conditions, Technology and Manufacturing Policy, Credit Policy, Availability of Credit from Suppliers, Operating Efficiency, Price level Changes, Issues in Working Capital Management, Current Assets to Fixed Assets Ratio, Liquidity vs. Profitability: Riskreturn trade-off, The Cost Trade-off, Estimating Working Capital Needs , Policies for Financing Current Assets, Matching Approach, Conservative Approach, Aggressive Approach, Short-term vs. Long-term Financing, Sources of Working Capital, Trade Credit, Accrued Expenses and Deferred Income, Bank Finance for Working Capital, Commercial Paper

Notes:
a. b. c. d. Write answers in your own words as far as possible and refrain from copying from the text books/handouts. Answers of Ist Set (Part-A), IInd Set (Part-B), IIIrd Set (Part C) and Set-IV (Case Study) must be sent together. Mail the answer sheets alongwith the copy of assignments for evaluation & return. Only hand written assignments shall be accepted. 5 Questions, each question carries 1 marks. 5 Questions, each question carries 1 marks. 5 Questions, each question carries 1 marks. Confine your answers to 150 to 200 Words. Two Case Studies : 5 Marks. Each case study carries 2.5 marks.

A. First Set of Assignments: B. Second Set of Assignments: C. Third Set of Assignments: D. Forth Set of Assignments:

ASSIGNMENTS
FIRST SET OF ASSIGNMENTS Marks Assignment-I = 5

PART A
1. Contrast the objective of maximizing earnings with that of maximizing wealth. 2. An investor is holding IDBI deep discount bonds purchased for Rs 12750/- to be redeemed after 30 years at a face value of Rs 5,00,000. What is the interest rate implicit in the bond? What is the current value of bond if the current market yield is 9%? 3. a) The risk free return is 8% and the expected return on market portfolio is 12%. If the required return on a stock is 15%, what is its beta? b )An investor is 50 years of age today. He will retire at the age of 60. In order to receive Rs 2,00,000 annually for 10 years after retirement, how much amount should he have at the time of retirement. Assume the required rate of return is 10%. 4. Write short notes on : Financial Management. ............................................ Page 3 of 5 ............................................................................... IMT-59

a. Leverage ratios b. Earning per share 5. The required rate of return of investors is 15%. ABC Ltd. Declared & paid annual dividend of Rs4/- per share. It is expected to grow at the rate of 20% for the next 2 years and at the rate of 10% thereafter. Compute the price at which he should sell it? SECOND SET OF ASSIGNMENTS Assignment-II = 5 Marks

PART B
1. Discuss the important functions performed by financial markets. 2. Important ratios of the firm for the year 2011 are given below: Stock Velocity Debt collection period Creditors payment period Gross Profit Gross Profit margin Cash & Bank balance Credit purchases 4 2 months 73 days Rs 2,00,000 20% 5% of sales 25%

The firm expects an increase of 50% in sales in the ensuing year. Estimate the working capital requirement of the firm for the ensuing year. 3. Despite its weakness the pay back period method is popular in practice. What are the reasons for its popularity?

4. Describe the traditional view on the optimum capital structure. Compare & contrast this view with the net operating income approach 5. Define cost of capital? Explain its significance in financial decision making.

THIRD SET OF ASSIGNMENTS

Assignment-III = 5 Marks

PART C
1. Write short notes on: a. Bonus shares b. Share split 2. How would you determine the optimum level of current assets? Illustrate your answer 3. Band Box is considering the purchase of a new wash & dry equipment in order to expand its operations. Two types of options are available; A low speed system (LSS) with a Rs. 20000 initial cost and a high speed system (HSS) with an initial cost of Rs. 30000. Each system has a 15 year life and no salvage value. The net cash flows after taxes (CFAT) associated with each investment proposal are ; Low Speed System (LSS) Rs. 4000 High Speed System (HSS) Rs. 6000

CFAT for Years 1 through 15

Which Speed System should be chosen by BandBox, assuming 14% cost of capital? 4. A company is considering raising Rs 100 lakh by one of the two alternative methods, viz 14% institutional term loan and 13% non convertible debentures. The term loan option would attract no major Financial Management. ............................................ Page 4 of 5 ............................................................................... IMT-59

incidental cost. The debentures would have to be issued at a discount of 2.5% and would involve Rs 1 lakh as cost of issue. Advice the company as to the better option based on effective cost of capital in each case . Assume a tax rate of 35%

5. Differentiate between: a. Conservative approach & Aggressive approach of financing the working capital b. Net Income approach and net operating income approach of capital structure theories

FOURTH SET OF ASSIGNMENTS

Assignment-IV = 2.5 Each Case Study

CASE STUDY - I
Aries Ltd. wishes to raise additional finance of Rs 10 lakh for meeting its investment plans. It has Rs 2,10,000 in the form of retained earnings available for investment purposes. The following are the further details: 1.Debt- equity mix 30:70 2 Cost of debt: Upto Rs 1,80,000, 10%(before tax);beyond 1,80,000 12% (before tax) 3 Earning per share, Rs 4 4 Dividend payout, 50% of earnings 5 Expected growth rate in dividend 10% 6 Current market price per share, Rs 44 7 Tax rate 35% You are required: a) To determine the pattern for raising additional finance, assuming the firm intends to maintain the existing debt / equity mix. b) To determine the post tax average cost of additional debt c) To determine the cost of retained earnings and cost of equity d) Compute the overall weighted average after tax cost of additional finance.

CASE STUDY-II
Seshasayee Industries Ltd. is considering replacing a hand operated weaving machine with a new fully automated machine .Given the following information ,advise the management whether the machine should be replaced or not. Assume the company has only this machine in 25% block of assets and the block of assets and the block will cease to exist after the useful life of the automated machine. EXISTING SITUATION One full time operators salary Rs 36000 Variable Overtime Rs 3000 Fringe Benefits Rs 3000 Cost of defects Rs 3000 Original price of hand operated machine Rs 60000 Expected life 10 years Age 5 Years Depreciation method WDV Current salvage value of old machine Rs 36000 Tax rate 35% Required rate of return 15% PROPOSED SITUATION Fully automated operation ,no operator needed Cost of machine Rs 180000 Transportation Charges Rs 3000 Installation Cost Rs 15000 Expected life 5 years Depreciation method WDV Annual maintenance Rs 3000 Cost of defects Rs 3000 Salvage after 5 years Rs 20000

Financial Management. ............................................ Page 5 of 5 ............................................................................... IMT-59