2010 financial management solved

8/14/2019 2010 Financial Management Solved

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SAVIOUR Publications

END TERM EXAMINATION FINANCIAL MANAGEMENT -2010

Attempt any 5 questins in!"u#in$ %1 &'i!' is !mpu"s(y)

%1* Explain briefly any five of the following -: +,5.15*(a) Loan Syndication.(b) Decision Tree- refer to %/+a* FM2011.(c) apital !ationing.(d) "#E !atio.

(e) oncentration $an%ing.(f) Explicit cost of capital.(g) Econo&ic 'rder antity.

Ans)1+a** syndicated facility is a lending facility+ defined by asingle loan agree&ent+ in which several ban%s participate. ,toccrs when a borrower wants to raise relatively large a&ont of&oney ic%ly and conveniently. The a&ont exceeds the

exposre li&its of any one lender and the $orrower does notwant to deal with a large n&ber of lenders.

Featu(es-. Two or &ore ban%s contract with a borrower to provide crediton co&&on ter&s and conditions.. * single doc&ent or an agree&ent is &ade./. *lthogh co&&on doc&entation+ a ban% has lti&ately+ the

individal right to ta%e legal action against borrower.0. ,nterest sally accres at a variable or floating rate and isreset periodically+ at agreed intervals.1. 2atrity period is /-3 years.

3a(ties in!"u#e#-. Lead $an%- this ban% is responsible for the arrange&ent withother ban%s and is answerable to the borrower. ,t has the

athority over other ban%s and borrower deals with it directly.


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. 4nder-writing ban%- ,t is the ban% that co&&its to spplyingthe fnds to the borrower 5 if necessary fro& its own resorces ifthe loan is not flly sbscribed./. The ban% that participates in the syndication by lending a

portion of the total a&ont reired.0. $orrower- the co&pany which reires loan.

6ollowing are the steps in4"4e# in p(!ess "ansyn#i!atin. Lead ban% prepares a detailed pro7ect report and &a%es anesti&ate of the capital that wold be reired for the pro7ect.. Enlisting of interested ban%s is done+ who according to thelead ban% wold be interested in giving a loan for financing./. 2eetings+ discssions+ are organi8ed between lead ban% andlenders to negotiate rate of interest+ loan a&ont+ etc.0. Loan applications are prepared with necessary ter&s andconditions.1. Sb&ission of applications to financial instittions (lenders) isfollowed by disbrse&ent of loan to the borrower.

F""&in$ a(e t'e a#4anta$es "an syn#i!atin as sorce

of finance:1) I#entii!atin ptentia" inan!e- the borrower does nothave to search for potential sorce of finance+ it contacts the leadban% and the lead ban% ensres the participation of interestedban%s.2) G# #ea"- $ecase of preli&inary discssions with financialinstittions the co&pany can rely for best deal.

,) &it p(!ess- Since all the doc&entations are carried otby the ban%s+ the process is &ch &ore swift and s&ooth.

1+6*. !efer to 9+ 3.

1+!* Capita" (atinin$ is the process of finali8ing a pro7ecthaving highest rate of retrn which the co&pany will nderta%e ina sitation of constraints of fnds. ,n an econo&ic scenario no

co&pany has nli&ited fnds to invest+ so there are li&ited fndsand resorces available. There is a fixed annal bdget to beinvested in pro7ect. Therefore there is a need of selecting one or


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two pro7ects which can pro&ise high retrns. Since in a practicalcorporate world there are a large vol&e of pro7ects to beselected fro&+ the &ethodology of capital rationing is greatly inneed. 6ollowing are t'e steps in4"4e# in !apita" (atinin$:

. ;roping of pro7ects - Sitable proposals are identified.These are groped as acceptable and non-acceptablepro7ects.

. !an%ing of pro7ects- o&binations of pro7ects are selectedthrogh internal rate of retrn calclation or profitabilityindex. This step also inclde selection or re7ection ofproposal co&pletely becase it is indivisible or it has &anyparts and so&e parts can be accepted # re7ected .

* fir& also considers growth and control factor of a pro7ect. ,t notonly selects the best pro7ect bt also ran%s the pro7ects in a fir&in order to get the highest priority. The &ethodology is to have act off point and fnd all the pro7ect above the ct off point andre7ect or delay the pro7ect which are below the ct off point.The ai& of capital rationing is to &axi&i8e the vale of fir& .Exa&ple:

* fir& has following invest&ent opportnities. The fnds availablewith the co&pany are !s.3+33+333.


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1+#* 3(i!e-Ea(nin$ Rati+3E*- ,t is defined as &ar%et price pershare divided by annal earnings per share. ,t is a valation ratioof a co&pany?s crrent share price co&pared to its per-shareearnings.

"#E ratio@ 2ar%et vale of the share#Earning per share(E"S).6or exa&ple+ if a co&pany is crrently trading at !s.13 a shareand earnings over the last &onths were !s.1 per share+ the"#E ratio for the stoc% wold be 3 (13#1).,n general+ a high "#E sggests that investors are expectinghigher earnings growth in the ftre co&pared to co&panies witha lower "#E.,t?s sally &ore sefl to co&pare the "#E ratios of one

co&pany to other co&panies in the sa&e indstry+ or to the&ar%et in general or against the co&pany?s own historical "#E.,t also helps in valing the correct &ar%et price of a share i.e. ,fthe &ar%et price of a share is !s.33 and E"S is 3 the "E is 1.$t if the "E ratio of si&ilar co&panies is then it &eans that itis nder valed and the &ar%et price shold have been !s.3instead of !s.33.Si&ilarly if the "E ratio of other fir&s is 0 then the &ar%et priceshold be !s.A3. The share is over-valed by !s.3."E ratio plays an i&portant part in deciding whether an investorshold invest in the co&pany or not. ,nvestors expect highgrowth in ftre of co&panies with high "E ratio.Short-comings of PE ratio- while calclating the "E ratio earningsper share play an i&portant role. $t the earnings are sally&aniplated and window-dressed which reslts in wrong "E

ratio.

1+e* Cn!ent(atin 7an8in$ after having prepared the cashbdget+ the finance &anager shold ensre that there does notexist a significant deviation between expected cash flows andactal cash flows.To achieve this+ cash &anage&ent efficiency will have to bei&proved throgh a proper control of cash collection and

disbrse&ent.The t&in 69e!ti4es in &anaging the cash flows shold be:-
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. *ccelerate cash collections as &ch as possible.

. Decelerate or delay cash disbrse&ents.* fir& can se decentrali8ed collection syste& %nown as

oncentration $an%ing.,n concentration ban%ing the co&pany establishes a n&ber ofstrategic collection centres in different regions instead of a singlecollection centre at the head office. This syste& redces theperiod between the ti&e a csto&er &ails in his re&ittances andthe ti&e when they beco&e spendable fnds with the co&pany."ay&ents received by the different collection centres aredeposited with their respective local ban%s which in trn transfer

all srpls fnds to the concentration ban% of head office. Theconcentration ban% with which the co&pany has its &a7or ban%accont is generally located at the headarters. oncentrationban%ing is one i&portant and poplar way of redcing the si8e ofthe float. * concern having large n&ber of branches at differentplaces adopts the syste& of decentrali8ed syste& of ban%ingwhere instead of collection &ade at the >.' and deposited at itsban% at >.' + the >.' + &a%es an arrange&ent where csto&ersare reired to send their pay&ent at local collection centre anddeposited there at local branch of the ban%. 6nds beyond apredeter&ined level shall be transferred to a concentration ban%daily.A#4anta$es-. !edction in &ailing ti&e.

. !edction in clearing ti&e./. Effective storage of cash.

1+* Ep"i!it !st !apita"- The ?cost of capital? refers to thecost of a co&pany?s fnds (both debt and eity)+ and is sed toevalate a co&pany?s new pro7ects. ,t is the &ini&& retrn thatinvestors expect for providing capital to the co&pany+ ths setting

a target that the new pro7ect has to &eet.ost of apital @ cost of debtB cost of eity.ost of capital is


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. The borrowing rate of the fir&+ at which it can acire fnds tofinance the proposed pro7ect. The lending rate which the fir& cold have earned if the fir&had invested elsewhere.

Explicit cost- * bsiness expense that is easily identified andacconted for is ter&ed as an explicit cost.Explicit costs represent clear and obvios cash otflows fro& absiness. ,t is opposite to goodwill a&orti8ation+ which is not asclear.C"assii!atin Cst Capita"-1) Ep"i!it !st !apita" is that ct off rate which eatespresent vale of cash inflows to present vale of cash otflows.

,n other words+ it is nothing bt internal rate of retrn. ,n capitalbdgeting decision+ investor will see which invest&ent provideshigh internal rate of retrn bt which co&pany gets the &oney athigh internal rate of retrnC it &eans that co&pany is accepting&oney at high explicit cost of capital. o shold re&e&ber:a) This cost will be in &oney for&.b) 6or deciding explicit cost of capital+ co&pany will add allsorces cost of capital and try to &ini&i8e it.F( Eamp"e

* co&pany accepts loans by issing new debentres of !s.A+33+333. This co&pany also pro&ises to pay !s. A+333 per year+co&panys total inflow will be F A+33+333 and total otflow of cashwill be F A3+333 per year and if there is nothing cost of capital+then this loan can be repaid within 3 years. $t it is not possiblethat co&pany wold receive loan withot giving interest. So+

&ini&& vale of interest which co&pany pays on the conditionthat it will eal the present vale of !s. A+33+333 and !s. A3+333will be explicit cost of capital. This decision will be ta%en at theti&e when co&pany gets loan. ,f co&pany is giving high interestrate on loan+ then its net explicit cost will be less becase+interest is given ot of net profit and co&pany can save tax and ifwe ad7sted this tax rate+ explicit cost will be less than actalinterest on loan.2) Imp"i!it !st !apita"- is also %nown as the opportnity costof capital.


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distribting it to the shareholders+ it is retained and ploghedbac%. >ad the profits been distribted+ the shareholders coldhave invested it and earned &ore. ,&plicit cost is nothing bt theopportnity foregone to invest it elsewhere.

1+$* E!nmi! (#e( quantity-refers to the order antity that&ini&i8es total inventory holding carrying and ordering costs.>ere a fnda&ental estion is answered i.e. >ow &ch toorder=Gow+ the si8e of the order shold be sch that the costsassociated with the &anage&ent of inventory are &ini&&.T'e !sts ass!iate# &it' In4ent(y-

. *nnal "rchase ost(D) - which is *nnal De&and(D) x"rice of the prodct() or D.. *nnal 'rder ost(D#9 HS)- where D#9 @ no. of orders peryear(9@order antity) S@ cost of placing one order. Therefore&ltiplying the orders per year with cost of one order wold resltin total order cost in a year. (,nspection+ re7ection+ delay costsrefers to the order cost)./. *nnal arrying or >olding osts- average inventoryHholdingcost per nit wold give the annal holding cost. *verageinventory@ 9# and holding cost per nit is >. Therefore theholding cost wold be 9#H>. (warehose+ power+ pilferage costsand the cost of capital(interest) are the carrying and holdingcosts.)

The annal prchase costs is variable with the antity ordered+

therefore it is not considered as a cost associated with inventorycontrol+ as it is the cost for the inventory and not the cost for its&anage&ent.arrying costs and ordering costs are inversely proportional i.e. ifthere are few orders+ high antity is ordered+ therefore orderingcosts wold be less bt the carrying#holding cost wold be &oreas the antity ordered wold be high and vice-versa.


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The E.'.9 6or&la:- %:.

9H@Econo&ic 'rder 9antityE.g. for E.'.9- 'ne nit of I costs() !s.033 and the annalde&and(D) is 333 nits.ost of one order(S) is !s. 3 and holding cost(>) is 3J perann&.(of the cost)Therefore E.'.9 wold be :-

@K333@01 nits.

;NIT -I

%2* ow wold it fnction on daily
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basis if it doesnt have enogh cash to &eet its day-to-dayexpenses.Therefore+ ,nvesting decision is an essential one which reiresthe right &ix and balance between long-ter& and short ter& goal.

The invest&ent decision also concerns what specific invest&entsto &a%e. Since there is no garantee of a retrn for &ostinvest&ents+ the finance depart&ent &st deter&inean expected retrn. This retrn is not garanteed+ bt is theaverage retrn on an invest&ent if it were to be &ade &anyti&es.The invest&ents &st &eet three &ain criteria:,t &st &axi&i8e the vale of the fir&.

,t &st &aintain right balance between long-ter& and short-ter&goals.,t &st &axi&i8e shareholder vale.Finan!in$ De!isin

*ll fnctions of a co&pany need to be paid for one way oranother. ,t is p to the finance depart&ent to figre ot how topay for the& throgh the process of financing.There are two ways to finance an invest&ent: sing a co&pany?sown &oney or by raising &oney fro& external fnders. Each hasits advantages and disadvantages.There are two ways to raise &oney fro& external fnders: byta%ing on debt or selling eity. Ta%ing on debt is the sa&e asta%ing on a loan. The loan has to be paid bac% with interest+which is the cost of borrowing. Selling eity is essentially sellingpart of yor co&pany.


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,f all the &oney is borrowed then interest wold be too &ch andprofit wold conseently decrease. *nd if all the &oney isowned then there wold be no chance to dedct interest fro&profit which wold eventally lead to higher tax. (,nterest is

allowed to be dedcted fro& profit while calclating tax)Therefore+ an appropriate capital strctre is also within thescope of financing decision.Di4i#en# #e!isinDividend refers to that part of profits of a co&pany which isdistribted by the co&pany a&ong its shareholders. ,t is theretrn to the shareholders on the invest&ents &ade by the& inthe shares of the co&pany.

This decision is &ade by the directors of the co&pany. Thisdecision affects not only the share vale of the co&pany bt alsothe capital strctre.Liqui#ity #e!isins- refers to the &aintaining liidity position ofa fir& to avoid insolvency. ,t is i&portant to have cash or nearcash assets in order to &aintain liidity position in anorganisation. $t high invest&ents in sch crrent assets canaffect the profitability of an organisation. ,f excess cash is held inhands then the opportnity cost is of corse lost. That cash coldhave been sed to prchase fixed assets.There are 2 situations:-1. High liquidity & low profitability-,n this case+ if it re&ainsnprofitable+ it will eventally go ban%rpt. ,ts available cash willbe sed to finance the losses+ bt when the cash rns ot+ theassets of the co&pany will have to sold off becase there will be

insfficient fnds to replace the& as they wear ot. The co&panywill beco&e s&aller and s&aller and will eventally fail.2. High profitability & low liquidity- if a co&pany expands sorapidly that it is constantly aciring new assets+ it &ay very wellget behind on its pay&ents to the sppliers and creditors de tothe lac% of cash. ,n other words+ the co&pany is spending &oney&ch faster than it is &a%ing it+ even thogh it is &a%ing a lot.Eventally+ the creditors wold de&and their &oney and+ if the

co&pany does not have enogh cash to pay p+ the creditors willta%e the co&pany to cort. * 7dge wold order that the creditors


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are entitled to their &oney and the assets of the co&pany woldbe sold off in order to raise cash to pay the&.

So far the ob7ective is concerned the above stated three

decisions are sa&e i.e. &axi&i8ing shareholders wealth. *s theirob7ectives are sa&e the decisions are interrelated. * co&panyhaving profitable invest&ent opportnities generally prefer lowerdividend pay ot ratio.'n the other hand having a good invest&ent &eans profit of theco&pany wold be &ore+ and &ore dividend can be paid toshareholders.Si&ilarly+ finance fnction and invest&ent fnctions are also

highly correlated. ost of capital plays a &a7or role in decidingwhether to accept or re7ect invest&ent opportnities.6inancing decisions also dependent on a&ont of to be retainedin the profit.So+ it can be conclded that invest&ent+ financing and dividenddecisions are interrelated and are to be ta%en 7ointly %eeping inview their 7oint effect on the shareholders wealth.

%,* Explain the long ter& and short ter& sorces of raisingfinance. +15*

Ans),) There are a n&ber of ways fro& which a bsiness canraise finance fro&. S&all bsinesses finance the&selves insteadof ta%ing loans. They can borrow fro& friends fa&ilies as well.6inance- is a process or a transaction which provides fnds for a

bsiness.Sorces of finance- sorces which fnds or finances a bsiness.On t'e 6asis time pe(i# su(!es inan!e !an eit'e( 6e"n$-te(m ( s'(t-te(m)I) '(t te(m inan!in$- sally the repay&ent ti&e is -1years.Short ter& finance is concerned with decisions relating to crrentassets and crrent liabilities and is also called as wor%ing capitalfinance.

,t incldes the following:-


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1) 7an8 C(e#it- it involves the cash credit+ over draft and billsdisconting facility wherein short-ter& financial needs of a fir& is&et.ash credit- a loan a&ont is sanction and credited to the sers

accont. ,nterest is charged fro& the ti&e the a&ont is credited.'ver-draft- a facility which allows the ser to withdraw an a&ontin excess of the a&ont present in the accont. There is a li&it towhich an ser can withdraw.$ill Disconting is a short ter& sorce of finance+ whereby $ills!eceivable received fro& debtors is en cashed fro& the ban% ata disconted rate.2) T(a#e C(e#it- trade credit is the credit extended by the seller

to the prchaser for the prchase of goods and services. Tradecredit facilitates the prchase of spplies withot i&&ediatepay&ent. ,t is co&&only sed by bsiness organisations as asorce of short-ter& financing. ,t is granted to those csto&erswho have reasonable a&ont of financial standing and goodwill.,. Fa!t(in$- it is a short-ter& finance where a fir& sells itsaccont receivables to another fir& %nown as factor. The titlealso transfers and the factor is entitled to receive a&ont directlyfro& the debtors.

*ctally the factor bys a fir&s receivables and the collection ofthese receivables is the factors 7ob.


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,t can either be internal or external.1) Inte(na" su(!es in!"u#e-+a* Equity s'a(es-They represent the ownershipposition in aco&pany. The holders of the eity shares+ called shareholders+

are the legal owners of the co&pany.'rdinary shares are also called permanent capital since theydont have a &atrity period. *lthogh these do not en7oy thepreferential rights sch as clai& on dividends#assets etc theyhave voting rights which the preference shareholders lac%. Theyare also eligible for right isses.+6* 3(ee(en!e s'a(es- These shares carry preferential rightsover other shares. "reference shareholders have the right to

receive dividends prior to other shares. They also have a clai&on assets.These are %nown as hybrid secrities becase it has the featresof both eity shares and debentres.,t si&ilar to eity shares in the sense that- dividend is not dedctable while calclating tax. Go legal obligation to pay dividend.

!epresent the ownership of the holders.,t is si&ilar to debentres in the sense that- Dividend rate is fixed in both debentres and preferenceshares. lai& on assets and dividends prior to eity share holders.+NOTE Equity = 3(ee(en!e s'a(es a(e a"s 8n&n asse!u(ity inan!in$*+!* Retaine# Ea(nin$s- 4sally a co&pany does not distribte

all its profits as dividends. ,t retains a part of it and can se it forexpansion and growth. ,t is also %nown as ploghing bac% ofprofits. * balance sheetfigre shown nder the headingretained earningsis the s& of all profits retained since theinception of the co&pany.

2) Ete(na" su(!es in!"u#e-

+a* De6entu(es-it is an ac%nowledge&ent &ade by a co&panywhich agrees that it has ta%en loan. ,t is a doc&ent issed by aco&pany nder its co&&on seal wherein all the details li%e the
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a&ont+ &atrity period etc are stated. The holders of thisdoc&ent are the creditors of the co&pany. The fir& pro&ises topay both the interest and principal.,t is a secred for& of financing where the clai& on both the

interest and assets is prior to both the preference and eityshares. *n nsecred debentre is %nown as na%ed debentres.+6* 3u6"i! Depsits- "blic deposits are an i&portant sorce offinancing the long-ter& reire&ents of a co&pany. The ter&?pblic deposit? i&plies any &oney received by a co&panythrogh the deposits or loans collected fro& the pblic. Thepblic incldes the general pblic+ e&ployees and shareholdersof the co&pany bt excldes the &oney received in the for& of

shares and debentres.The rate of interest payable by the co&pany on pblic deposits islower than the interest on loans fro& ban%s and other financialinstittions. Sch an interest is a tax dedctible expense.pblic deposits are nsecred+ the depositors &ay have to bearthe ris% of loss of &oney in the event of failre of the co&pany.+!* Lans (m 6an8s-* loan is the prchase of the present seof &oney with the pro&ise to repay the a&ont in the ftrewithin a specified date and at a specified rate of interest.* for&alagree&ent is &ade to facilitate sch loans.The lenders esti&ate the worth and goodwill of the co&panybefore lending. ,t is ta%en to finance long-ter& capital needs of aco&pany sch as prchasing fixed assets etc. "ay&ent ter&scan either be &onthly+ arterly or yearly as agreed.+#* 3(9e!t Finan!in$- "ro7ect finance is a long

ter& financing of infrastrctre and indstrial pro7ects basedpon the pro7ected cash flows of the pro7ect rather than thebalance sheets of the pro7ect sponsors.There is a high debt 5eity ratio in financing of pro7ects. Thefinancier principally loo%s to the assets and revene of thepro7ect in order to secre the loan. ,t is sally &ore epensi4ede to its non recorse natre.

;NIT -II


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%The best way to vale eity share is that based ondividendsM. Exa&ine this state&ent. >ow wold yo vale ashare on which on dividend is being paid= +15*

Ans)


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Dividends are sally paid till the co&pany is operatingprofitability+ therefore holder is expected to hold it till then.Therefore the dividends play a crcial role in eity shares.Assumptins-

. Dividends are paid at the end of the year after the date ofprchase.?a"uatin-The vale of eity shares is the s& of the present vales offtre cash flows(dividends) disconted at the reired rate ofretrn of investors. @'en #i4i#en#s a(e !nstant an# # nt $(&-3. DBe &'e(e D. #i4i#en# Be. Rate (etu(n 3. ?a"ue

equity s'a(es)


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+6* Cst #e6entu(e 7e(e Ta +7T)d($T)@ ,"#G"H33+G"@Get "roceeds@ A33+333.,nterest "ayable(,") @HA33333#33@P+333.Therefore d($T)@ P333#A33333H33@J

d(*T)@ H(-tax)@H(-3.03)@Q.J+!* Cst te(m "an +AT* l(*T)@AJ ost of ter& loan $efore Tax ($T) @AH(-3.03) @ 3.AJ.Rl(*T)H(-tax)As!e(tainin$ &ei$'ts-

u(!e Amunt @ei$'t

Eity A33333 3.

Debentres A33333 3.$an% Loan 033333 3.


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and disconts the& into present vale a&onts sing a discontratethat represents the pro7ect?s cost of capitaland its ris%.Gext+ all of the invest&ent?s ftre positive cash flows areredced into one present vale n&ber. Sbtracting this n&ber

fro& the initial cash otlay reired for the invest&ent providesthe net present vale (G"N) of the invest&ent.

The steps t !a"!u"atin$ net p(esent 4a"ue a(e-) Deter&ine the net cash inflow in each year of the invest&ent.

) Select the desired rate of retrn.

/) 6ind the discont factor for each year based on the desired

rate of retrn selected.

0) Deter&ine the present vales of the net cash flows by&ltiplying the cash flows by the discont factors.

1) Total the a&onts for all years in the life of the pro7ect.

) Lastly sbtract the total net initial invest&ent.

Internal Rate of Return MethodThe internal rate of retrn &ethod considers the ti&e vale of&oney+ the initial cash invest&ent+ and all cash flows fro& theinvest&ent. $t nli%e the net present vale &ethod+ the internalrate of retrn &ethod does not se the desired rate of retrn btesti&ates the discont rate that &a%es the present vale of

sbseent net cash flows eal to the initial invest&ent. Thisdiscont rate is called ,!!.,nternal rate of retrn for an invest&ent proposal is the discontrate that eates the present vale of the expected net cashflows with the initial cash otflow.This ,!! is then co&pared to a criterion rate of retrn that can bethe organi8ations desired rate of retrn for evalating capital

invest&ents.Me(its IRR-
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. ,!! ta%es Ti&e Nale of &oney into consideration whilecalclating cash flows.. >elps in &axi&i8ing the shareholders wealth by selecting theappropriate pro7ect where !', is &ore than '(cost of capital).

/. Effective &eans to select a proposal.0. "refers cash flows to acconting ratios which &a%es it &orerealistic in natre.Deme(its IRR-1) 2ch of calclation is reired.. *ss&es that ,!! re&ains sa&e for the ftre cash flows./. Got advisable to rate &tally exclsive pro7ects

Let?s illstrate with an exa&ple: sppose O*G o&pany wants toby a s&all pblishing co&pany. O*G deter&ines that the ftrecash flows generated by the pblisher+ when disconted at aJ annal rate+ yields a present vale of /3 &illion. ,f thepblishing co&pany?s owner is willing to sell for 3 &illion+ thenthe G"N of the pro7ect wold be 3 &illion (/3 - 3 @ 3). The 3&illion dollar G"N represents the intrinsic valethat will beadded to O*G if it nderta%es this acisition.So+ O*Gs pro7ect has a positive G"N+ bt fro& a bsinessperspective+ the fir& shold also %now what rate of retrnwill begenerated by this invest&ent. To do this+ the fir& wold si&plyrecalclate the G"N eation+ this ti&e setting the G"N factor to8ero(not sing G"N)+ and solve for the now n%nown discontrate. The rate that is prodced by the soltion is thepro7ect?s internal rate of retrn(,!!).

6or this exa&ple+ the pro7ect?s ,!! cold+ depending on theti&ing and proportions of cash flow distribtions+ be eal to3J.Ths+ O*G+ given its pro7ected cash flows+ has a pro7ect with a3J retrn. ,f there were a pro7ect that O*G cold nderta%e witha higher ,!!+ it wold probably prse the higher-yielding pro7ectinstead. Ths+ the seflness of the ,!! &easre&ent lies in itsability to represent any invest&ent opportnity?s retrn and to

co&pare it with other possible invest&ents.
http://www.investopedia.com/terms/i/intrinsicvalue.asphttp://www.investopedia.com/terms/a/acquisition.asphttp://www.investopedia.com/terms/a/acquisition.asphttp://www.investopedia.com/terms/r/rateofreturn.asphttp://www.investopedia.com/terms/i/intrinsicvalue.asphttp://www.investopedia.com/terms/a/acquisition.asphttp://www.investopedia.com/terms/r/rateofreturn.asp


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Die(en!es-There are circ&stances#scenarios nder which the net presentvale &ethod and the internal rate of retrn &ethods will reachdifferent conclsions. Lets discss these scenarios

!ena(is 1-La($e initia" in4estmentG"N: The net present vale &ethod will favor a pro7ect with alarge initial invest&ent becase the pro7ect is &ore li%ely togenerate large net cash inflows.

,!!: $ecase the internal rate of retrn &ethod sespercentages to evalate the relative profitability of an invest&ent+the a&ont of the initial invest&ent has no effect on the otco&e.

onclsion: Therefore+ the internal rate of retrn &ethod is &oreappropriate in this scenario.!ena(is 2-Die(en!e in t'e timin$ an# amunt net !as'in"&sG"N: The net present vale &ethod ass&es that all net cashinflows fro& an invest&ent earn the desired rate of retrn sed inthe calclation. The desired rate of retrn sed by the net presentvale &ethod is sally the organi8ations weighted-average costof capital+ a &ore conservative and &ore realistic expectation in&ost cases.,!!: Differences in the ti&ing and a&ont of net cash inflowsaffect a pro7ects internal rate of retrn. This reslts fro& the factthat the internal rate of retrn &ethod ass&es that all net cashinflows fro& a pro7ect earn the sa&e rate of retrn as thepro7ects internal rate of retrn.

onclsion: ,n this scenario choosing G"N is a better choice.!ena(i ,-3(9e!ts &it' "n$ useu" "ieG"N: $oth &ethods favor pro7ects with long sefl lives as apro7ect earns positive net cash inflow dring the extended years.

*s long as the net cash inflows in a year is positive+ no &atterhow s&all+ the net present vale increases+ and the pro7ectsdesirability i&proves.,!!: Li%ewise+ the internal rate of retrn &ethod considers each

additional sefl year of a pro7ect another year that its c&lative


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net cash inflow will earn a retrn eal to the pro7ects internalrate of retrn.onclsion: $oth G"N and ,!! sitable.!ena(i


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() "ay bac% period() *verage rate of retrn.(/) Get present vale. +15*Ans)H) Initia" ut"ayIn4estment.20000)

ea( Cas' F"& Cumu"ati4e !as'"&

333 333 333 A333/ 0333 3330 3333 /3331 3333 03331) 3ay 6a!8 pe(i#. E+7C*J

E@n&ber of years i&&ediately preceding the year of finalrecovery2$@ balance a&ont to be recovered(3+333-A+333@+333@ ash flow dring year of final recovery0333"ay bac% period@ B(3333-A333)#0333@ B#@ 2yea(s an# /mnt's)+2*A4e(a$e Rate Retu(n+ARR)@ *verage annal

profits#*verage invest&entH33.*verage annal profits@ Total profits#no.of years@ 0333#1@A033.*verage otlay@ initial otlay#@ 3333#@ 3333Therefore *!!@ A033#3333H33@ A0J.

+,* Net 3(esent ?a"ue+N3?*alclation of ".N of cash inflows

ea( Ris8 Fa!t(

K10

Cas' In"&s 3(esent

?a"ue +3)?* .3P3 333 3P3A .A 333 0P1/ .Q1 0333 /3300 .A/ 3333 A/31 . 3333 3


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;NIT I?%*


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Imp(tan!e-1) Cas' Mana$ement- ,dentifies the cash balance which allowsfor the bsiness to &eet day to day expenses+ and redces cash

holding costs.2) In4ent(y mana$ement-,dentifies the level of inventory whichallows for ninterrpted prodction bt redces the invest&ent inraw &aterials and &ini&i8es reordering costs hence increasesthe cash flow. $esides this+ the lead ti&es in prodction sholdbe lowered to redce


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1) ie t'e i(m : * large fir& needs &ore wor%ing capital thana s&all fir&. ,n order to sstain the high vol&e of prodctionand sales+ a large fir& has to &aintain greater crrent assets.2) Natu(e 7usiness* trading concern has to &aintain &ore

inventory than a &anfactring concern. Therefore+ &orewor%ing capital is reired by a trading concern. "blic tilityconcerns sch as railways+ electricity spply concerns+ gasagencies reire less wor%ing capital becase &ost of theirtransactions are on cash basis. Si&ilarly+ hotels and restarantsneed little wor%ing capital as stoc% and debtors are not high.,) Type 3(#u!tin 3(!ess * fir& sing labor intensivetechnie needs &ore wor%ing capital to pay wages and salaries.

* highly ato&atic plant will need less wor%ing capital and &orefixed capital.


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operations with relatively less wor%ing capital. ,n sch a case+cash reire&ents are s&all.) easna" 4a(iatins: So&e enterprises need greater wor%ingcapital dring particlar seasons. 6or exa&ple+ a sgar &ill

reires &ore wor%ing capital dring Dece&ber to *pril whenprodction ta%es place. ,t reires &ch less wor%ing capital inother &onths.) Cntin$en!ies: ,f the de&and for and prices of prodcts of as&all enterprise are sb7ect to wide and nexpected flctations+provision has to be &ade for arranging higher a&onts ofwor%ing. capital. Trade cycles &ay affect the a&ont of wor%ingcapital reired in an enterprise.

10) Te(ms pu(!'ase an# sa"e: ,f the fir& prchases raw&aterials on credit and sells on cash basis+ it reires lesswor%ing capital. ,f it bys on cash basis and sells its prodct oncredit+ it will need a large a&ont of wor%ing capital becase ofinstant pay&ents and slow collections.11) Imp(tan!e "a6u(: ,f pro7ect is labor intensive+ largea&ont of wor%ing capital is reired.

%* The finance depart&ent of a co&pany provides the followinginfor&ation() The carrying cost per nit of inventory are !s.3() The fixed cost per order are !s.3(/) The n&ber of nits reired is /3+333 per year.Deter&ine the econo&ic order antity (E'9)+ total n&ber inyear and the ti&e gap between two orders. +15*

Ans))*nnal De&and(!)@ /3+333 nitsarrying cost per nit(h)@ !s.3'rdering cost(p)@ !s.3!@ /3333+ p@ 3+ h@ 3.

. E.'.9@ @ /0 approxi&ately.

. Total orders in a year@ /3333#/0@ AQ (approx)./. ;ap between orders@ /1#AQ@ 0days (approx).


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2010 financial management solved

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