Q1. What are the goals of financial management?

The financial management has to take three important decision viz. (i) Investment decision i.e., where to invest fund and in what amount, (ii) Financing decision i.e., from where to raise funds and in what amount, and (iii) Dividend i.e., how much to pay dividend and how much to retain for future expansion. In order to make these decisions the management must have a clear understanding of the objective sought to be achieved. It is generally agreed that the financial objective of the firm should be maximization of owners economic welfare. There are two widely discussed approaches or criterion of maximizing owners welfare -(i) Profit maximization, and (ii) Wealth maximization. It should be noted here that objective is used in the sense of goal or goals or decision criterion for the three decisions involved Profit Maximization: Maximization of profits is very often considered as the mainobjective of a business enterprise. The shareholders, the owners of the business, invest their funds in the business with the hope of getting higher dividend on their investment. Moreover, the profitability of the business is an indicator of the sound health of the organisation, because, it safeguards the economic interests of various social groups which are directly or indirectly connected with the company e.g. shareholders, creditors and employees. All these parties must get reasonable return for their contributions and it is possible only when company earns higher profits or sufficient profits to discharge the obligations to them.

Wealth Maximization: The wealth maximization (also known as value maximization or Net Present Worth Maximization) is also universally accepted criterion for financial decision making. The value of an asset should be viewed in terms of benefits it can produce over the cost of capital investment.

Prof. Era Solomon has defined the concept of wealth maximization as follows- The gross present worth of a course of action is equal to the capitalized value of the flow of future expected benefits, discounted (or as capitalized) at a rate which reflects their certainty or uncertainty. Wealth or net amount of capital investment required to achieve the benefits being discussed. Any financial action which creates wealth or which has a net present worth above zero is a desirable one and should be undertaken. Any financial action which does not meet this test should be rejected. If two or more desirable courses of action are mutually exclusive (i.e., if only one can be undertaken) then the decision should be to do that which creates most wealth or shows the greatest amount of net present worth. In short, the operating objective for financial management is to maximize wealth or net present worth. Thus, the concept of wealth maximization is based on cash flows (inflows and outflows) generated by the decision. If inflows are greater than outflows, the decision is good because it maximizes the wealth of the owners.

We have discussed above the two goals of financial management. Now the question is which one is the best or which goal should be followed in decision making. Certain objections have been raised against the profit maximization goal which strengthen the case for wealth maximization as the goal of financial decisions.

Q2. Explain the factors affecting Financial Plan. We live in a society and interact with people and environment. What happens to us is not alwaysaccordance to our wishes. Many things turn out in our live are uncontrollable by us. Manydecisions we take are the result of external influences. So do our financial matters. There aremany factors affect our personal financial planning. Range from economic factors to globalinfluences. Aware of factors affecting your money matters below will certainly benefit yourplanning. Factors Affecting Financial Plan 1.Nature of the industry: - Here, we must consider whether it is a capital intensive of labour intensive industry. This will have a major impact on the total assets that the firmowns. 2.Size of the company: -The size of the company greatly influences the availability of funds from different sources. A small company normally finals it difficult to raise fundsfrom long term sources at competitive terms. On the other hand, large companies likeReliance enjoy the privilege of obtaining funds both short term and long term at attractiverates. 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 forimplementation new projects to exploit the new opportunity emerging from changingbusiness 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 optimum capitalstructure that would achieve the least cost capital structure. A large firm with adiversified product mix may manage higher quantum of debt because the firm maymanage higher financial risk with a lower business risk. Selection of sources of finances us closely linked to the firms capacity to manage the risk exposure. 5.The capital structure of a company: -Capital structure of a company is influenced bythe desire of the existing management of the company to remain control over the affairsof the company. The promoters who do not like to lose their grip over the affairs of thecompany normally obtain extra funds for growth by issuing preference shares anddebentures to outsiders. 6.Matching the sources with utilization: -The product policy of any good financial planis to match the term of the source with the term of investment. To finance fluctuatingworking capital needs, the firm resorts to short term finance. All fixed assets-investmentare to be finance by long term sources. It is a cardinal principal of financial planning. 7.Flexibility:-The financial plan of company should possess flexibility so as to effectchanges in the composition of capital structure when ever need arises. If the capitalstructure of a company is flexible, it will not face any difficulty in changing the sourcesof funds. This factor has become a significant one today because of the globalization of capital market.

8.Government Policy:-SEBI guidelines, finance ministry circulars, various clauses of Standard Listing Agreement and regulatory mechanism imposed by FEMA andDepartment of Corporate Affairs (Govt of India) influence the financial plans of corporate today. Management of public issues of shares demands the companies withmany status in India. They are to be compiled with a time constraint. Q3. Explain the time value of money. Ans. The time preference for money is generally expressed by an interest rate which remains positive even in the absence of any risk. It is called the risk free rate. For example, if an individuals time preference is 8%, it implies that he or she is willing to forego Rs. 100 today to receive Rs.108 after a period of one year. Thus he or she considers Rs. 100 and Rs. 108 as equivalent in value. In reality though, this is not the only factor he or she considers. He or she requires another rate for compensating him or her for the amount of risk involved in such an

investment. This risk is called the risk premium. Required rate of return = Risk-free rate + Risk premium Contd. Page 4 ---4---There are two methods by which the time value of money can be calculated: 1 Compounding technique 2 Discounting technique Compounding technique :- In the compounding technique, the future values of all cash inflow at the end of the time horizon at a particular rate of interest are calculated. The amount earned on an initial deposit becomes part of the principal at the end of the first compounding period.Thecompounding of interest can be calculated by the following equation: A = P [1+(i)]n Where, A = Amount at the end of the period P = Principal at the end of the year i = Rate of interest n = Number of years Discounting Technique :- In the discounting technique, the present value of the future amount is determined. Time value of money at time zero on the time line is calculated. This technique is in contrast to the compounding approach where we convert the present amounts into future amounts. P = A ___1____

Q4. XYZ India Ltds share is expected to touch Rs. 450 one year from now. The company is expected to declare a dividend of Rs. 25 per share. What is the price at which an investor would be willing to buy if his or her required rate of return is 15%? P0 = D1/(1+Ke) + P1/(1+Ke) ={25/(1+0.15)} + {450/(1+0.15)}

=21.74 + 391.30 =Rs. 413.04 An investor would be willing to buy the share at Rs. 413.04

Q5. Below Table depicts the statistics of a firm and its sales requirements. Compute the DOL according to the values given in the table. Table: Statistics of a Firm Sales in units 2000 Sales revenue Rs. 20000 Variable cost 10000 Contribution 6000 Fixed cost 0 EBIT 6000 10 marks

Solution: DOL= {Q(SV)} / {Q(SV)F} {2000(10000)} / {2000(10000) 0} =2000000/2000000 =DOL=1

The DOL according to the values given in the table is 1.

Q6. What are the assumptions of MM approach? Ans :- Miller and Modigliani criticise traditional approach that the cost of equity remains unaffected by leverage up to a reasonable limit and K0 remains constant at all degrees of leverage. They state that the relationship between leverage and cost of capital is elucidated as in NOI approach. Table below depicts the assumptions regarding Miller and Modigliani (MM) approach: perfect capital markets Rational behavior Homogeneity Taxes Dividend payout. Perfect capital mark

Figure : Analysis of Miller and Modigliani Approach Perfect capital markets Securities can be freely traded, that is, investors are free to buy and sell securities (both shares and debt instruments), no hindrances on the borrowings, no presence of transaction costs, securities are infinitely divisible, and availability of all required information at all times.

Investors behave rationally They choose the combination of risk and return which is most advantageous to them. Homogeneity of investors risk perception All investors have the same perception of business risk and returns. Taxes There is no corporate or personal income tax.