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# MBA- Semester 2 Assignment - Marks 60 (6X10=60) MB0045 Financial Management - 4 Credits

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## Subject Code - MB0045

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## Note: Each question carries 10 Marks. Answer all the questions.

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Q.1 Considering the following information, what is the price of the share as per Gordons Model?

Details of the Company Net sales Net profit margin Outstanding preference shares No. of equity shares Cost of equity shares Retention ratio Rate of interest (ROI) Answer: P= E (1-b)/ Ke-br Where P is the price of the share, E is Earnings per Share, b is Retention ratio (1b) is dividend payout ratio, Ke is cost of equity capital, br is growth rate in the rate of return on investment. P= 3.6(1-0.40) / 0.12-(0.4x0.16) P= 2.16 / 0.056 P= 38.57 Rs.120 lakhs 12.5% Rs.50 lakhs@ 12% dividend 25, 000 12% 40% 16%

Q.2 Examine the components of working capital & also explain the concepts of working capital.

Answer: In simple words, working capital is the money you must have to get a business off the ground. The money that will get you by, until the business is making a profit. The main components of working capital are:

Cash. Cash is one of the most liquid and important components of working capital. Holding cash involves cost because the worth of cash held, after a year will be less than the value of cash as on today. Excess of cash balance should not be kept in business because cash is a non-earning asset.-Hence, a proper and judicious cash management is of utmost importance in business. Marketable Securities. These securities also don't give much yield to the business because of two reasons, (i) Marketable securities act as a substitute for cash, (ii) These are used are temporary investments. These are held not for speculative balances, but only as a guard against possible shortage of bank credit. Accounts Receivable. Too many debtors always lock up the firm's resources especially during inflationary tendencies. This is a two step account. When goods are sold, inventories are reduced and accounts receivables are created. When payment is made, debtors reduce and cash level increases. Thus, quantum of debtors depends on two things, (i) volume of Credit sales (ii) average length of time between sales and collections. The entrepreneur should determine the optimal credit standards. An optimal credit policy should be established and the firm's operations should be continuously monitored to achieve higher sales and minimum bad debt losses. Inventory. Inventories represent a substantial amount of firm's assets. Inventories must be properly managed so that this investment doesn't become too large, as it would result in blocked capital which could be put to productive use elsewhere. On the other hand, having too little or small inventory could result in loss of sales or loss of customer goodwill. An optimum level of inventory, therefore, should be maintained.

Q.3 Internal capital rationing is used by firms for exercising financial control. How does a firm achieve this? Answer: Capital rationing is a business decision to limit the amount available to spend on new investments or projects. The practice describes restricting channels of outflow of funds by placing a cap on the number of new projects. Capital rationing may be employed by different kinds of companies to achieve desired financial targets. The theory behind capital rationing practices is that, when fewer new projects are undertaken, the company is better able to manage them through more time and resources dedicated to existing projects and each new project. Internal capital rationing Impositions of restrictions by a firm on the funds allocated for fresh investment is called internal capital rationing. This decision may be the result of a conservative policy pursued by a firm. Restriction may be imposed on divisional heads on the total amount that they can commit on new projects. Another internal restriction for capital budgeting decision may be imposed by a firm based on the need to generate a minimum rate of return. Under this criterion only projects capable of generating the managements expectation on the rate of return will be cleared. Generally internal capital rationing is used by a firm as a means of financial control.

Q.4 What are the objectives of working capital management? Briefly explain the various elements of operating cycle. Answer:

Introduction: Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital.

Working capital refers to that part of firms capital which is required for financing short term or current assets such as cash, marketable securities, debtors, and inventories. In other words working capital is the amount of funds necessary to cover the cost of operating the enterprise.

Meaning:

Working capital means the funds (i.e.; capital) available and used for day to day operations (i.e.; working) of an enterprise. It consists broadly of that portion of assets of a business which are used in or related to its current operations. It refers to funds which are used during an accounting period to generate a current income of a type which is consistent with major purpose of a firm existence.

## Objectives of working capital:

Every business needs some amount of working capital. It is needed for following purposes-

For the purchase of raw materials, components and spares. To pay wages and salaries.

To incur day to day expenses and overhead costs such as fuel, power, and office expenses etc. To provide credit facilities to customers etc.

## Factors that determine working capital:

The working capital requirement of a concern depend upon a large number of factors such as ? Size of business ? Nature of character of business. ? Seasonal variations working capital cycle ? Operating efficiency ? Profit level. ? Other factors.

Sources of working capital: The working capital requirements should be met both from short term as well as long term sources of funds.

? Financing of working capital through short term sources of funds has the benefits of lower cost and establishing close relationship with banks.

? Financing of working capital through long term sources provides the benefits of reduces risk and increases liquidity

Q.5 Define risk. Examine the need for assessing the risks in a project. Answer: In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss (or impact) and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled in descending order. In practice the process of assessing overall risk can be difficult, and balancing resources used to mitigate between risks with a high probability of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled. Intangible risk management identifies a new type of a risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability. For example, when deficient knowledge is applied to a situation, a knowledge risk materializes. Relationship risk appears when ineffective collaboration occurs. Process-engagement risk may be an issue when ineffective operational procedures are applied. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value, and earnings quality. Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity. Risk management also faces difficulties in allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending (or manpower or other resources) and also minimizes the negative effects of risks

Q.6 Briefly examine the significance of identification of investment opportunities in capital budgeting process Answers: Capital budgeting is a complex process which may be divided into the following phases:

1. Identification of potential investment opportunities 2. Assembling of proposals investments 3. Decision making 4. Preparation of capital budget and appropriations 5. Implementation 6. Performance review

Identification of Potential Investment Opportunities: The capital budgeting process begins with the identification of potential investment opportunities. Usually, the planning body (it can be an individual or a committee, formal or informal) develops estimates for future sales which serve as the basis of setting production targets. This information, in turn, helps one to identify required investments in plant and equipment.

For imaginative identification of investment ideas, it is helpful to: (a) monitor external environment regularly to scout for investment opportunities; (b) formulate a well defined corporate strategy based on a thorough analysis of strengths, weakness, opportunities, and threats; (c) share corporate strategy and perspectives with persons who are involved in the process of capital budgeting, and (d) motivate employees to make suggestion.