ASSIGNMENT

Name:VINAY KUMAR Registration No: 1402000509 Learning Center: SYSTEMS DOMAIN PRIVATE LIMITED Learning Center Code: 2862Course: MBA Subject: FINANCIAL MANAGEMENT Semester: SECONDSubject Code: MB0045Date of submission: ________________________________________ Marks awarded: ________________________________________

Directorate of Distance EducationSikkim Manipal UniversityII Floor, Syndicate HouseManipal 576 104

Signature of Coordinator Signature of Center Signature of Evaluator

1.Explain the liquidity decisions and its important elements. Write complete information on dividend decisions.

Ans: Liquidity decisionsThe liquidity decision is concerned with the management of the current assets, which is a pre-requisite to long-term success of any business firm. This is also called as working capital decision. The main objective of the current assets management is the trade-off between profitability and liquidity, and there is a conflict between these two concepts. If a firm does not have adequate working capital, it may become illiquid and consequently fail to meet its current obligations thus inviting the risk of bankruptcy. On the contrary, if the current assets are too enormous, the profitability is adversely affected. Hence, the major objective of the liquidity decision is to ensure a trade-off between profitability and liquidity. Besides, the funds should be invested optimally in the individual current assets to avoid inadequacy or excessive locking up of funds. Thus, the liquidity decision should balance the basic two ingredients, i.e. working capital management and the efficient allocation of funds on the individual current assets. The important elements of liquidity decisions are:Formulation of inventory policyPolicies on receivable managementFormulation of cash management strategiesPolicies on utilisation of spontaneous finance effectivelyDividends are payouts to shareholders. Dividends are paid to keep the shareholders happy. Dividend decision is a major decision made by the finance manager. Dividend is that portion of profits of a company which is distributed among its shareholders according to the resolution passed in the meeting of the Board of Directors. This may be paid as a fixed percentage on the share capital contributed by them or at a fixed amount per share. The dividend decision is always a problem before the top management or the Board of Directors as they have to decide how much profits should be transferred to reserve funds to meet any unforeseen contingencies and how much should be distributed to the shareholders.Payment of dividend is always desirable since it affects the goodwill of the concern in the market on the one hand, and on the other, shareholders invest their funds in the company in a hope of getting a reasonable return.Retained earnings are the sources of internal finance for financing of corporates future projects but payment of dividend constitute an outflow of cash to shareholders. Although both - expansion and payment of dividend - are desirable, these two are in conflicting tasks. It is, therefore, one of the important functions of the financial management to constitute a dividend policy which can balance these two contradictory view points and allocate the reasonable amount of profits after tax between retained earnings and dividend. All of this is based on formulation of a good dividend policy.

2. Explain about the doubling period and present value. Ans: Doubling time or doubling period

Doubling time = log(2)/ log(l+r) R= rate of returnThe Doubling Time formula is used in Finance to calculate the length of time required to double an investment or money in an interest bearing account.rin the doubling time formula is the rate per period. If one wishes to calculate the amount of time to double their money in a money market account that is compounded monthly, thenrneeds to express the monthly rate and not the annual rate. The monthly rate can be found by dividing the annual rate by 12. With this situation, the doubling time formula will give the number of months that it takes to double money and not years

In addition to expressingras the monthly rate if the account is compounded monthly, one could also use the effective annual rate, or annual percentage yield, asrin the doubling time formula..Example of Doubling Time FormulaJacques would like to determine how long it would take to double the money in his money market account. He is earning 6% per year, which is compounded monthly. Looking at the doubling time formula, we need to consider that the 6% would need to be divided by 12 in order to come to a monthly rate since the account is compounded monthly. Given this,rin the doubling time formula would be .005 (.06/12). After putting this into the doubling time formula, we have:

After solving, the doubling time formula shows that Jacques would double his money within 138.98 months, or 11.58 years.As stated earlier, another approach to the doubling time formula that could be used with this example would be to calculate the annual percentage yield, or effective annual rate, and use it asr. The annual percentage yield on 6% compounded monthly would be 6.168%. Using 6.168% in the doubling time formula would return the same result of 11.58 years.

Present value: PV=C1 / (1+r)n

C1 = Cash flow at period 1 r = rate of return n = number of periods

Present Value (PV) is a formula used in Finance that calculates the present day value of an amount that is received at a future date. The premise of the equation is that there is "time value of money".Time value of money is the concept that receiving something today is worth more than receiving the same item at a future date. The presumption is that it is preferable to receive $100 today than it is to receive the same amount one year from today, but what if the choice is between $100 present day or $106 a year from today? A formula is needed to provide a quantifiable comparison between an amount today and an amount at a future time, in terms of its present day value.

Use of Present Value FormulaThe Present Value formula has a broad range of uses and may be applied to various areas of finance including corporate finance, banking finance, and investment finance. Apart from the various areas of finance that present value analysis is used, the formula is also used as a component of other financial formulas.

Example of Present Value FormulaAn individual wishes to determine how much money she would need to put into her money market account to have $100 one year today if she is earning 5% interest on her account, simple interest.The $100 she would like one year from present day denotes theC1portion of the formula, 5% would ber, and the number of periods would simply be 1.Putting this into the formula, we would have

When we solve for PV, she would need $95.24 today in order to reach $100 one year from now at a rate of 5% simple interest.

Solution: The generalised formula for shorter compounding periods is:Fv(n) = PV(1+i/m)^mXnWhere, FVn= future value after n yearsPV = cash flow todayi = nominal interest rate per annumm = number of times compounding is done during a yearn = number of years for which compounding is doneM= 12/3 (quarterly compounding)1000(1+0.10/4)^4*21000(1+0.10/4)^8Rs 1218The amount of rs 1000 after 2 years would be Rs 1218.

3. Write short notes on: a) Operating Leverage Ans: Operating leverageis the ratio of a company'sfixed coststo itsvariable costs.How it works/Example:Here is the formula for operating leverage:Operating Leverage = [Quantityx(Price - VariableCost per Unit)] / Quantity x (Price - Variable Cost per Unit) - Fixed Operating CostTo see how operating leverage works, let's assume Company XYZ sold 1,000,000 widgets for $12 each. It has $10,000,000 offixed costs(equipment, salaried personnel, etc.). It only costs $0.10 per unit to make each widget.Using this information and the formula above, we can calculate that Company XYZ's operating leverage is:Operating Leverage = [1,000,000 x ($12 - $0.10)] / 1,000,000 x ($12 - $0.10) - $10,000,000 = $11,900,000/$1,900,000 = 6.26 or 626%This means that a 10% increase inrevenuesshouldyielda 62.6% increase inoperating income(10% * 6.26).Why it Matters:In a sense, operating leverage is a means to calculating a company's breakeven point. However, it's also clear from the formula that companies with high operating leverage ratios can essentially make moremoneyfrom incrementalrevenuesthan other companies, because they don't have to increase costs proportionately to make thosesales. Accordingly, companies with high operating leverage ratios are poised to reap more benefits from good marketing, economic pickups, or other conditions that tend to boost sales.Likewise, however, companies with high operating leverage are more vulnerable to declines inrevenue, whether caused by macroeconomic events, poor decision-making, etc.It is important tonotethat some industries require higherfixed coststhan others. This is why comparing operating leverage is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this context.b) Financial Leverage: Financial leverageis the amount ofdebtthat an entity uses to buy moreassets. This is done to avoid investing an organization's own equity capital in such purchases.The financial leverage formula is measured as the ratio of total debt to total assets. As the proportion of debt to assets increases, so too does the amount of financial leverage. Financial leverage is favorable when the uses to which debt can be put generate returns greater than theinterest expense associated with the debt. Many companies use financial leverage rather than acquiring more equity capital, which could reduce the earnings per share of existing shareholders.Example Able Company uses $1,000,000 of its own cash to buy a factory, which generates $150,000 of annual profits. The company is not using financial leverage at all, since it incurred no debt to buy the factory.Baker Company uses $100,000 of its own cash and a loan of $900,000 to buy a similar factory, which also generates a $150,000 annual profit. Baker is using financial leverage to generate a profit of $150,000 on a cash investment of $100,000, which is a 150% return on its investment.Baker's new factory has a bad year, and generates a loss of $300,000, which is triple the amount of its original investment.Formula: Financial leverage=Operating Income/ Net Incomec) Combined leverage : This leverage shows the relationship between a change in sales & the corresponding variation in taxable income. If the management feels that a certain percentage change in sale would result in percentage change to taxable income they would like to know the level or degree of change & hence they adopt this leverage.

The formula which is used to calculate this is as follows-

Degree of combined leverage = Degree of operating leverage * Degree of financial leverage.

4. Explanation of factors affecting capital structure

Ans: Factors affecting capital structure (1) Cash Flow Position:While making a choice of the capital structure the future cash flow position should be kept in mind. Debt capital should be used only if the cash flow position is really good because a lot of cash is needed in order to make payment of interest and refund of capital.(2) Interest Coverage Ratio-ICR: With the help of this ratio an effort is made to find out how many times the EBIT is available to the payment of interest. The capacity of the company to use debt capital will be in direct proportion to this ratio. (3) Debt Service Coverage Ratio-DSCR:This ratio removes the weakness of ICR. This shows the cash flow position of the company.This ratio tells us about the cash payments to be made (e.g., preference dividend, interest and debt capital repayment) and the amount of cash available. Better ratio means the better capacity of the company for debt payment. Consequently, more debt can be utilised in the capital structure.(4) Return on Investment-ROI:The greater return on investment of a company increases its capacity to utilise more debt capital.(5) Cost of Debt:The capacity of a company to take debt depends on the cost of debt. In case the rate of interest on the debt capital is less, more debt capital can be utilised and vice versa.(6) Tax Rate:The rate of tax affects the cost of debt. If the rate of tax is high, the cost of debt decreases. The reason is the deduction of interest on the debt capital from the profits considering it a part of expenses and a saving in taxes. (7) Cost of Equity Capital:Cost of equity capital (it means the expectations of the equity shareholders from the company) is affected by the use of debt capital. If the debt capital is utilised more, it will increase the cost of the equity capital. The simple reason for this is that the greater use of debt capital increases the risk of the equity shareholders.Therefore, the use of the debt capital can be made only to a limited level. If even after this level the debt capital is used further, the cost of equity capital starts increasing rapidly. It adversely affects the market value of the shares. This is not a good situation. Efforts should be made to avoid it.

(8) Floatation Costs:Floatation costs are those expenses which are incurred while issuing securities (e.g., equity shares, preference shares, debentures, etc.). These include commission of underwriters, brokerage, stationery expenses, etc. Generally, the cost of issuing debt capital is less than the share capital. This attracts the company towards debt capital.(9) Risk Consideration: There are two types of risks in business:(i) Operating Risk or Business Risk: (ii) Financial Risk: (10) Flexibility:According to this principle, capital structure should be fairly flexible. Flexibility means that, if need be, amount of capital in the business could be increased or decreased easily. Reducing the amount of capital in business is possible only in case of debt capital or preference share capital.If at any given time company has more capital than as necessary then both the above-mentioned capitals can be repaid. On the other hand, repayment of equity share capital is not possible by the company during its lifetime. Thus, from the viewpoint of flexibility to issue debt capital and preference share capital is the best.(11) Control:According to this factor, at the time of preparing capital structure, it should be ensured that the control of the existing shareholders (owners) over the affairs of the company is not adversely affected.If funds are raised by issuing equity shares, then the number of companys shareholders will increase and it directly affects the control of existing shareholders. In other words, now the number of owners (shareholders) controlling the company increases.This situation will not be acceptable to the existing shareholders. On the contrary, when funds are raised through debt capital, there is no effect on the control of the company because the debenture holders have no control over the affairs of the company. Thus, for those who support this principle debt capital is the best.(12) Regulatory Framework:Capital structure is also influenced by government regulations. For instance, banking companies can raise funds by issuing share capital alone, not any other kind of security. Similarly, it is compulsory for other companies to maintain a given debt-equity ratio while raising funds.Different ideal debt-equity ratios such as 2:1; 4:1; 6:1 have been determined for different industries. The public issue of shares and debentures has to be made under SEBI guidelines.(13) Stock Market Conditions:Stock market conditions refer to upward or downward trends in capital market. Both these conditions have their influence on the selection of sources of finance. When the market is dull, investors are mostly afraid of investing in the share capital due to high risk.On the contrary, when conditions in the capital market are cheerful, they treat investment in the share capital as the best choice to reap profits. Companies should, therefore, make selection of capital sources keeping in view the conditions prevailing in the capital market.(14) Capital Structure of Other Companies:Capital structure is influenced by the industry to which a company is related. All companies related to a given industry produce almost similar products, their costs of production are similar, they depend on identical technology, they have similar profitability, and hence the pattern of their capital structure is almost similar.5. Explanation of risk in capital budgeting with examples

Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). The notion implies that a choice having an influence on the outcome exists (or existed). Potential losses themselves may also be called "risks. "

The five different sources of risk are:Project-specific risk Project-specific risk could be traced to something quite specific to the project. Managerial deficiencies or error in estimation of cash flows or discount rate may lead to a situation of actual cash flows realised being less than the projected cash flow.

Competitive or competition risk: Unanticipated actions of a firms competitors will materially affect the cash flows expected from a project. As a result of this, the actual cash flows from a project will be less than that of the forecast.

Industry-specific risk: Industry-specific risks are those that affect all the firms in the particular industry. Industry-specific risk could be again grouped into technological risk, commodity risk and legal risk. Let us discuss the groups in industryspecific risks, as follows: Technological risk : The changes in technology affect all the firms not capable of adapting themselves in emerging into a new technology.Example The best example is the case of firms manufacturing motor cycles with two stroke engines. When technological innovations replaced the two stroke engines by the four stroke engines, those firms which could not adapt to new technology had to shut down their operations. Commodity risk : It is the risk arising from the effect of price-changes on goods produced and marketed.Legal risk: It arises from changes in laws and regulations applicable to the industry to which the firm belongs.Example The imposition of service tax on apartments by the government of India, when the total number of apartments built by a firm engaged in that industry exceeds a prescribed limit. Similarly, changes in importexport policy of the government of India have led to either closure of some firms or sickness of some firms. All these risks will affect the earnings and cash flows of the project.International risk : These types of risks are faced by firms whose business consists mainly of exports or those who procure their main raw material from international markets.The firms facing such kind of risks are as follows:The rupee-dollar crisis affected the software and BPOs, because it drastically reduced their profitability.Another example is that of the textile units in Tirupur in Tamil Nadu, which exports the major part of the garments produced. Strengthening of rupee and weakening of dollar, reduced their competitiveness in the global markets.The surging crude oil prices coupled with the governments delay in taking decision on pricing of petro products eroded the profitability of oil marketing companies in public sector like Hindustan Petroleum Corporation Limited.Another example is the impact of US sub-prime crisis on certain segments of Indian economy.The changes in international political scenario also affected the operations of certain firms.

Market riskFactors like inflation, changes in interest rates, and changing general economic conditions affect all firms and all industries. Firms cannot diversify this risk in the normal course of business.There are many techniques of incorporation of risk perceived in the evaluation of capital budgeting proposals. They differ in their approach and methodology as far as incorporation of risk in the evaluation process is concerned.a) NPV can be computed using risk free rate.

YearCash Flows(in flows) in RSPV factor at 10%PV ofCash Flows (inflow)

1400000.90936360

2500000.82641300

3150000.75111265

4300000.68320490

PV of Cash inflows109415

PV of Cash Outflows-100000

NPV9415

b) NPV can be computed using risk-adjusted discount. YearCash Flows(in flows) in RSPV factor at 20%PV ofCash Flows (inflow)

1400000.83333320

2500000.69434700

3150000.5798685

4300000.48214460

PV of Cash inflows91165

PV of Cash Outflows-100000

NPV-8835

The project would be acceptable when no allowance is made for risk. However, it will not be acceptable if risk premium is added to the risk free rate. By doing so, it moves from positive NPV to negative NPV. If the firm were to use the internal rate of return (IRR), then the project would be accepted, when IRR is greater than the risk-adjusted discount rate.

6. Objectives of cash management : Ans: Cash management is a broad term that refers to the collection, concentration, and disbursement of cash. It encompasses a company's level of liquidity, its management of cash balance, and its short-term investment strategies. In some ways, managing cash flow is the most important job of business managers. If at any time a company fails to pay an obligation when it is due because of the lack of cash, the company is insolvent. Insolvency is the primary reason firms go bankrupt. Obviously, the prospect of such a dire consequence should compel companies to manage their cash with care. Moreover, efficient cash management means more than just preventing bankruptcy. It improves the profitability and reduces the risk to which the firm is exposedObjective of cash management

1) To make Payment According to Payment Schedule:-Firm needs cash to meet its routine expenses including wages, salary, taxes etc.Following are main advantages of adequate cash-a)To prevent firm from being insolvent.b)The relation of firm with bank does not deteriorate.c)Contingencies can be met easily.d)It helps firm to maintain good relations with suppliers.

(2) To minimise Cash Balance:-The second objective of cash management is to minimise cash balance. Excessive amount of cash balance helps in quicker payments, but excessive cash may remain unused & reduces profitability of business. Contrarily, when cash available with firm is less, firm is unable to pay its liabilities in time. Therefore optimum level of cash should be maintain.

Baumol model with assumptions

Most firms try to minimise the sum of the cost of holding cash and the cost of converting marketable securities to cash.Baumols cash management model helps in determining a firms optimum cash balance under certainty. As per the model, cash and inventory management problems are one and the same.

There are certain assumptions that are made in the model. They are as follows:1. The firm is able to forecast its cash requirements with certainty and receive a specific amount at regular intervals.2. The firms cash payments occur uniformly over a period of time i.e. a steady rate of cash outflows.3. The opportunity cost of holding cash is known and does not change over time. Cash holdings incur an opportunity cost in the form of opportunity foregone.4. The firm will incur the same transaction cost whenever it converts securities to cash. Each transaction incurs a fixed and variable cost.For example, let us assume that the firm sells securities and starts with a cash balance of C rupees. When the firm spends cash, its cash balance starts decreasing and reaches zero. The firm again gets back its money by selling marketable securities. As the cash balance decreases gradually, the average cash balance will be: C/2. This can be shown in following figure:. The firm incurs a cost known as holding cost for maintaining the cash balance. It is known as opportunity cost, the return inevitable on the marketable securities. If the opportunity cost is k, then the firms holding cost for maintaining an average cash balance is as follows:Holding cost = k (C/2)Whenever the firm converts its marketable securities to cash, it incurs a cost known as transaction cost. Total number of transactions in a particular year will be total funds required (T), divided by the cash balance (C) i.e. T/C. The assumption here is that the cost per transaction is constant. If the cost per transaction is c, then the total transaction cost will be:Transaction cost = c (T/C)The total annual cost of the demand for cash will be:Total cost = k (C/2) + c (T/C)