QUESTION BANK

BBM – 402, INTRODUCTION TO FINANCIAL MANAGEMENT

Session: 2014-15, Revised in January 2015

Question Bank distributed to students on 17/02/15.

UNIT – 1
1. Define Financial Management. Explain the various scope and functions of Financial Management?
2. Write short notes on the following:
(a) Inter relationship between investment, financing and dividend decisions
(b) Finance functions
3. State the role of the financial manager and explain his functions in an organization.
4. In what respect is the objective of wealth maximization superior to profit maximization?
5. What do you mean by wealth maximization and profit maximization? Which one do you suggest? Why?
6. Distinguish between:
a) Financial management and economics
b) Financial management and accounting
7. What are the main functions of the modern finance manager? How do they differ from his traditional
counterpart?
8. Assuming wealth maximization to be the objective of financial management, show how the financing,
investment and dividend decisions of a company can help to attain this objective.
9. Explain the role of Finance Manager in the changing scenario of Financial Management in India.
10. Contrast the objective of maximizing earnings with that of maximizing wealth.
11. As an investor, do you think that some managers are paid too much? Do their rewards come at your expense?
UNIT – 2
12. What is an annuity? Is an annuity worth more or less than a lump sum payment received now that would be
equal to the sum of all the future annuity payments?
13. Contrast the calculation of future value with the calculation of present value. What is the difference?
14. The “Rule of 72” suggests that an amount will double in 12 years at a 6 per cent compound annual rate or
double in 6 years at 12 per cent annual rate. Is this a useful rule, and is it an accurate one?
15. (A) Someone you know is about to retire. His firm has given him the option of retiring with a lumpsum of
$20,000 or an annuity of $2,500 for ten years. Which is worth more now, if an interest rate of 7% is utilized for
the annuity? Do not consider taxes.
(B) A firm's earnings are $5,000 and are growing at 10% a year. Approximately how many years will it take for
earnings to triple?
(C ) You are considering the purchase of a $50,000 machine, which is expected to generate $11,511.19 annually
for 8 years. What is the expected return on the investment?
16. The following cash-flow stream need to be analyzed:
Cash flow stream End of Year
(IN RS.) 1 2 3 4 5
W 100 200 200 300 300
X 600 - - - -
Y - - - - 1,200
Z 200 - 500 - 300
A) Calculate the future value of each stream at the end of year 5 with a compound annual interest rate of 10 per
cent.
B) Compute the present value of each stream if the discount rate is 14 per cent.
17. a) How much do I need to invest at 8% per year, in order to have Rs. 10,000 in 1 year, 2 year and in 10
years.
b) An investor deposits Rs.10,000. Ten years later it is worth Rs. 17,910. What rate of return did the
investor earn on the investment?
c) You invest Rs. 10,000. During the first year the investment earned 20% for the year. During the second
year, you earned only 4% for that year. How much is your original deposit worth at the end of the two years?
18. a) What is the future value of a 4-year annuity, if the annual interest is 5%, and the annual payment is Rs.
1,000?
b) How much would you need to deposit every month in an account paying 6% a year to accumulate by Rs.
1,000,000 by age 65 beginning at age 20?
19. Find out the effective rate of interest in the following cases:
Case A: Nominal rate of interest = 8% compounded quarterly.
Case B: Nominal rate of interest = 11% compounded half-yearly.
Case C: Nominal rate of interest = 12% compounded 6 times in a year.
Case D: Nominal rate of interest = 12% compounded 12 times a year.
20. a) At the end of 6 years, Mr. X will start receiving a pension of Rs. 1,000 per month and will keep receiving it for
the next 20 years. How much can he borrow now @ 10%, so that both the principal and the interest can be paid
off with 25% of the pension amount? Assume that the interest payable will be accumulated till the first pension
is received.
b) Consier a loan of Rs 10,00,000 that is paid aff annually over a period of nine years. Calculate the amount of interest
and loan principle repaid corresponding to each payment if the interest rate is 6% per year.
21. Mr. X wishes to purchase an annuity contract that will pay him Rs. 7,000 a year for the rest of his life. The life
insurance company figures that his life expectancy is 20 years, based on its actuary tables. The company imputes
a compound annual interest rate of 6 percent in its annuity contracts.
a) How much will Mr. X have to pay for the annuity?
b) How much would he have to pay if the interest rate were 8 per cent?
22. You borrow Rs. 10,000 at 14 per cent compound annual interest rate for four years. The loan is repayable in four
equal annual instalments payable at the end of each year.
a) What is the annual payment that will completely amortize the loan over four years?
b) Of which equal payment, what is the amount of interest? What is the amount of loan principal?
23. Mr. Srinivas is going to retire after 6 months. He has a choice between (a) an annual pension of Rs. 8,000 as long
as he lives, and (b) a lump sum amount of Rs. 50,000. If expects to live for 20 years and the interest rate is 10%,
which option would you suggest him to go for?
24. Your father has promised to give you Rs. 1,00,000 in cash on your 25 th birthday. Today is your 16th birthday. He
wants to know two things: (a) If he decides to make annual payments into a fund after one year, how much will
each have to be if the fund pays 8 per cent? (b) If he decides to invest a lump sum in the account after one year
and let it compound annually, how much will the lump sum be? (c) If in (a) the payments are made in the
beginning of the year, how much will be the value of annuity?
25. A) A finance company has advertised saying that, it will pay a lump sum of Rs. 44,650 at the end of 5 years to
anyone who deposits Rs. 6,000 per annum. Mr. A is interested, but he wants to know the implicit rate of
interest.
B) Mr. A deposits at the end of each year Rs. 2,000, Rs. 3,000, Rs. 4,000, Rs. 5,000 and Rs. 6,000 for the
consequent 5 years respectively. He wants to know his series of deposits value at the end of 5 years with 6 per
cent rate of compound interest.
UNIT – 3
26. Why does the payback period bias the process of asset selection toward short-lived assets?
27. Why does the net present value method favour larger projects over smaller ones when used to choose between
mutually exclusive projects? Is this a problem?
28. Contrast the internal rate of return method of project evaluation and selection with the net present value
method. Why might these two discounted cash flow techniques lead to conflicts in project rankings?
29. What is capital budgeting? Why is capital budgeting significant to the firm? What kinds of proposals are found in
a firm’s capital budget?
30. How do you calculate the Accounting rate of return? What are its limitations?
31. A company has to select one of the following two projects. Cash flow is:
Year 0 1 2 3 4
Project X 11,000 6,000 2,000 1,000 5,000
Project Y 10,000 1,000 1,000 2,000 10,000
Calculate: (a) Payback period, (b) ARR, (c) NPV at 10% (d) PI at 15% (e) IRR
Suggest the best alternative on the above basis.
32. ABC Company is considering a new product line to supplement its range line. It is anticipated that new product
line will involve cash investment of Rs. 7,00,000 at time 0 and Rs. 1 million in year one. After tax cash inflows of
Rs. 250,000 are expected in year 2, Rs. 3,00,000 in year 3, Rs. 3,50,000 in year 4, and Rs. 4,00,000 ech year
thereafter though year 10. Though the product ine might be vibal after year 10, the company prefers to be
conservative and all calculations at that time.
a) If the required rate of return is 15%, what is the net present value of the project? Is it acceptable?
b) What is its internal rate of return?
c) What would be the case if the required rate of return was 10%
d) What is the projects payback period?
33. XYZ Company is considering the replacement of two old machines with a new, more efficient machine. It has
determined that the relevant after tax incremental operating cash flows of this replacement proposal are as
follows:
End of year 0 1 2 3 4 5 6 7 8
Cash Flows (Rs) -404,424 86,890 106,474 91,612 84,801 84,801 75,400 66,000 92,400
What is the project’s net present value if the required rate of return is 14 per cent? Is the project
acceptable?
34. The following two projects A and B require an investment of Rs. 2,00,000 each. The income after taxes for these
projects is as follows:
Year Project A (in Rs.) Project B (in Rs.)
1 80,000 20,000
2 80,000 40,000
3 40,000 40,000
4 20,000 40,000
5 --- 60,000
6 --- 60,000
Using the following criteria, determine which of the project is preferable:
1. 8 years pay back 2. Average rate of return 3. NPV if the cost of capital is 10%
35. ABC limited has under consideration two mutually exclusive proposals for the purchase of new equipment.
Particulars Machine X Machine Y
Net cash outlay 1,00,000 75,000
Salvage value Nil Nil
Life (years) 5 5
PBDT (Rs.)
1 25,000 18,000
2 30,000 20,000
3 35,000 22,000
4 25,000 20,000
5 20,000 16,000
Assuming tax rate to be 50 per cent, suggest to the management, the best alternative using:
(a) Pay back period, (b) ARR, and (c) NPV at 10 per cent
36. An enterprise has to decide on either of the following proposals. Assuming a required rate of return of 10 per
cent p.a., evaluate the investment proposals as under:
(a) Average rate of return method (ARR), (b) Pay back period, and (c) Profitability index
Proposal A Proposal B
Cost of investment Rs. 20,000 Rs. 28,000
Life (years) 4 5
Scrap value NIL NIL
Inflows after depreciation and tax
Year 2006 2007 2008 2009 2010
Proposal A 500 2,000 3,500 2,500 ---
Proposal B --- 3,400 3,400 3,400 3,400
Each proposal will require an additional working capital of Rs. 2,000, which will be received back in full after the
expiry of each project life. Depreciation is provided under straight line method.
37. Determine the average rate of return from the following data of two machines A and B.
Machine A Machine B
Original cost Rs. 56,125 Rs. 56,125
Additional investment in net WC Rs. 5,000 Rs. 6,000
Estimated life in years 5 5
Estimated salvage value Rs. 3,000 Rs. 3,000
Average income tax rate (%) 55 55
Annual estimated income after depreciation and taxes:
Year 1 2 3 4 5
M/c A 3,375 5,375 7,375 9,375 11,375
M/c B 11,375 9,375 7,375 5,375 3,375
Depreciation has been charged on straight line basis.
38. A company is considering an investment proposal of Rs. 50,000 to install new milling controls. The facility has a
life expectancy of 5 years. The company’s tax rate is 55% and no investment tax credit is allowed. The firm uses
straight line depreciation. The estimated cash flow before Tax (CFBT) from the proposed investment proposal is
as follows:
Year 1 2 3 4 5
CFBT (Rs.) 10,000 11,000 14,000 15,000 25,000
Compute the following:
1. Pay back period
2. Average rate of return
3. Internal rate of return
4. NPV @ 10% discount rate
5. PI at 10% discount rate
UNIT – 4
39. Critically examine the advantages and disadvantages of raising funds by issuing shares of different types.
40. Critically evaluate the utility of preferred stock as a means of obtaining long-term funds.
41. What are various sources available to Indian businessmen for raising funds? Explain.
42. “Commercial banks provide only short-term finance.” Do you agree? Explain the various forms of bank finance.
43. Give a comparative evaluation of the various methods that are open to meet the financial requirement of a
business.
44. What are the main sources of finance available to industries for meeting short-term as well as long-term
financial requirements? Discuss.
45. What is working capital management? What is the need to maintain optimum working capital? Discuss the
consequences of inadequate and excess working capital.
46. Give a note regarding the factors determining working capital needs of a business firm and the steps involved in
estimation of working capital needed by a firm.
47. Determine the working capital required to finance a level of activity of 1,80,000 units of output for a year. The
cost structure is as under:
Cost per unit (Rs.)
Raw material 20
Direct Labour 5
Overheads (including depreciation of Rs. 5) 15
Total cost 40
Profit 10
Selling price 50
Additional information:
 Minimum desired cash balance is Rs. 20,000
 Raw materials are held in stock on an average, for 2 months
 Work-in-progress (assume 50% completion stage) will approximate to half-a-month production.
 Finished goods remain in warehouse, on an average for a month.
 Suppliers of materials extend a months credit and debtors are provided 2 months credit. The cash sales
are 25% of total sales.
  There is a time lag in payment of wages of a month in the case of overheads.
48. XYZ Ltd. Makes on an average of 20% on sales. In working out the profit margin., depreciation is added to the
cost of production.
The company maintains one month’s stock for raw-materials and also for finished product. In order to maintain
a minimum degree of solvency and liquidity. The company does not allow the cash balance to drop below Rs.
1,50,000. The management desires of carry a 20% margin in managing working capital.
Other yearly estimates of the company are as follows:
Sale of 2 month’s credit Rs. 30,00,000
Materials to be consumed (suppliers extend one month credit) Rs. 7,00,000
Wages (time lag-one month) Rs. 6,00,000
Manufacturing expenses payable at the end of the year Rs. 60,000
(These are paid one month in arrears)
Total administration expenses for the year Rs. 2,60,000
(these are paid one month in arrears)
Advertising and promotional expenses Rs. 1,00,000
(payable quarterly in advance)
The company pays income-tax in 4 equal instalments, and one instalment is paid in the next year. The total
income-tax liability of the year amounts to Rs. 3,20,000. Prepare forecast for working capital requirements on
cash cost basis.
49. ABC Company sells goods on a gross profit of 25% depreciation is taken into account as a part of cost
production. The following are the annual figures given to you:
Sale (two month’s credit) Rs. 18,00,000
Materials consumed (one month’s credit) Rs. 4,50,000
Wages paid (one month lag in payment) Rs. 3,60,000
Cash manufacturing expenses (one month lag in payment) Rs. 4,80,000
Administration expenses (one month lag in payment) Rs. 1,20,000
Sales promotion expenses (Paid quarterly in advance) Rs. 60,000
Income tax payable in four instalments of which one lies in the (next year) Rs. 1,50,000
The company keeps one month’s stock of both raw-materials and finished goods. It also keeps Rs. 1,00,000 in
cash. You are required to estimate the working capital requirements of the company on cash cost basis
assuming 10% safety margin.
50. Define cost of capital. Discuss in detail the steps involved in computation of WACC.
51. What is cost of equity? Write a detailed note on approaches available for computation of cost of equity.
52. Your company’s share is quoted in the market at Rs. 20 currently. The company pays a dividend of Re. 1 per
share and investor’s market expects a growth rate of 5 per cent per year.
a) Compute the company cost of equity capital
b) If the anticipated growth rate is 6% p.a. calculate the indicated market price per share.
53. S.L. Industries limited has assets of Rs. 3,20,000 that have been financed with Rs. 1,04,000 of debt and Rs/
1,80,000 of equity and a general reserve of Rs. 36,000. The company’s initial profits after interests and taxes for
the yaer 31-03-2009 were Rs. 27,000. It pays 8 per cent interest on debt. The company is in the 50 per cent tax
bracket. It has 1800 equity shares of Rs. 100 each, selling at a market price of Rs. 120 per share. Calculate WACC.
UNIT – 5
54. Define capital structure? Discuss the important factors that should be considered while determining capital
structure.
55. What do you mean by optimum capital structure? Discuss its features and approaches to determine appropriate
capital structure.
56. What is leverage? Discuss in detail various types of leverages.
57. Write a detailed note on EBIT-EPS analysis.
58. The EBIT-EPS chart suggests that the higher the debt ratio, the higher are the earnings per share for any level of
EBIT above the indifference point. Why do firms sometimes choose financing alternatives that do not maximize
EPS?
59. Define financial leverage and the degree of financial leverage (DFL). How are they two related?
60. ABC Ltd. Has a DOL of 2 at its current production and sales level of 10,000 units. The resulting operating income
figure is Rs. 1,000.
a) If sales are expected to increase by 20 per cent from the current 10,000 unit sales position, what would be the
resulting operating profit figure?
b) At the company’s new sales position of 12,000 units, what is the firm’s “new” DOL figure?
61. The capital structure of Bhatt Software Ltd., Bangalore, consists of an equity share capital of Rs. 10,00,000
(Shares of Rs. 100 each) and Rs. 10,00,000 of debentures. Sales increased by 20% from 1,00,000 units to
1,20,000 units, the selling price is Rs. 10 per unit, variable cost amount to Rs. 6 per unit and fixed expenses
amount to Rs. 2,00,000. The income tax rate is assumed to be 50%.
a) You are required to calculate the following:
1. The percentage increase in EPS
2. The degree of financial leverage at 1,00,000 and 1,20,000 units.
3. The degree of operating leverage at 1,00,000 and 1,20,000 units.
b) Comment on the behaviour of operating and financial leverage in relation to increase in production from
1,00,000 to 1,20,000 units.
62. A newly established company wishes to determine an appropriate capital structure. It can issue 12 per cent
debentures and 10 per cent preference capital and the existing tax rate is 35 per cent. The company requires Rs.
50 lakh.
The possible capital is

Plan Debenture capital (%) Preference capital (%) Equity capital (%)
1 00 00 100
2 30 00 70
3 30 20 50
4 50 00 50
5 50 20 30
If EBIT is 12 per cent calculate EPS.
63. A manufacturing company has the following capital structure:
40,000 equity shares of Rs. 50 each Rs. 20,00,000
Retained earnings Rs. 10,00,000
10% debentures Rs. 10,00,000
12% preference shares Rs. 5,00,000
Long term debts at 11 per cent Rs. 55,00,000
The present EBIT is Rs. 10,00,000. The company is contemplating an expansion programme requiring an
additional investment of Rs. 10,00,000.
It is hoped, that the company will be able to maintain the same rate of earnings. To raise the additional
capital the company has the following alternatives:
1). To issue debentures at 11 per cent
2). To issue preference share at 13 per cent
3). To raise the entire additional capital through equity shares.
Examine these alternatives and suggest which alternative is best for the company. Assume tax rate to be at 35
per cent.
64. What is the relationship between leverage and cost of capital according to NI and NOI approach?
65. What is MM approach? What are the main propositions of MM approach?
66. From the following particulars of PQR Company, calculate operating and financial leverages. The company’s
current sales revenue is Rs. 15,00,000 and sales are expected to increase by 25 per cent. Rs. 9,00,000 incurred
on variable expenses for generating Rs. 15,00,000 sales revenue. The fixed cost is Rs. 2,50,000. The company has
Rs. 20,00,000 equity shares capital and Rs. 20 lakh, 10 per cent debt capital. Calculate operating leverage and
financial leverage. Rs. 10 equity and 50 per cent tax rate.
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Refrences:
1. I M PANDEY FINANCIAL MANAGEMENT
2. VAN HORNE FINANCIAL MANAGEMENT
3. SUNINDRA BHATT FINANCIAL MANAGEMENT