2022 (FM)

PART-I

1. Fill in the blanks/one-word answers:

(i) Profitability is a measure of efficiency of a business enterprise.
(ii) Financial management is concerned with procurement and use of funds.
(iii) Finance is the lifeblood and nerve center of a business.
(iv) The future value of money after 2 years by investing Rs. 100 @ 10% interest
p.a. under compounding technique is Rs. 121.
(v) Cost of capital is the minimum return to earn from its projects that a firm
requires.
(vi) Implicit cost is also known as the opportunity cost.
(vii) Capital budgeting is the process of making investment decisions in capital
expenditure.
(viii) The 'pay-back' period method of capital budgeting represents the period in
which the total investment in capital assets pays back itself.
(ix) Constant pay-out ratio means payment of a fixed percentage of profits as
dividends every year.
(x) Capital rationing refers to a situation where a firm is not in a position to invest
in all profitable projects due to constraints on the availability of funds.
(xi) Adequate working capital helps in maintaining liquidity of the business.
(xii) A firm having a high rate of stock turnover will need a lower amount of
working capital.

PART-II

2. Answer in 2-3 sentences:

(i) What is financial management?

Financial management involves planning, organizing, directing, and controlling the
financial resources of an organization. Its objective is to ensure effective utilization of
funds to achieve the goals of profitability and liquidity.

(ii) Define the concept of the time value of money.

The time value of money states that a sum of money is worth more now than in the future
due to its earning capacity. This principle underlies concepts like present value and future
value.

(iii) What do you mean by risk?

Risk refers to the uncertainty associated with the potential outcomes of an investment or
decision, which can lead to financial loss or gain.

(iv) What is a bond?

A bond is a fixed-income security issued by a corporation or government to borrow
funds, promising periodic interest payments and repayment of the principal at maturity.
(v) What is the pay-back period method of investment?
The pay-back period method measures the time it takes for an investment to generate
enough cash inflows to recover the initial investment cost.

(vi) What is IRR?

Internal Rate of Return (IRR) is the discount rate at which the net present value (NPV) of
an investment becomes zero, indicating the efficiency of the investment.

(vii) What is cost of capital?

Cost of capital is the minimum rate of return a firm must earn to cover the cost of raising
funds through equity, debt, or other sources.

(viii) What is a script dividend?

A script dividend is a form of dividend payment in which shareholders are issued
additional shares instead of cash.

(ix) What do you mean by cash credit?

Cash credit is a short-term financing facility provided by banks to businesses, allowing
them to withdraw funds up to a pre-approved limit against security.

(x) Define the concept of working capital.

Working capital refers to the difference between current assets and current liabilities,
indicating a firm’s short-term financial health and liquidity.

PART-III

3. Answer in 75 words:

(i) Write a note on profit maximization.

Profit maximization is the primary goal of financial management, aiming to increase a
firm’s earnings by optimizing revenue and minimizing costs. It ensures the efficient
allocation of resources, providing adequate returns to shareholders. However, it may
neglect long-term growth, social responsibility, and risk management.

(ii) Future value calculation:

(iii) Risk and return:

Risk and return are correlated financial concepts. Risk refers to the potential variability in
returns due to market volatility or uncertainties, while return is the gain or income
generated from an investment. Higher risk often offers the potential for higher returns.

(iv) Shares vs. Debentures:

Shares represent ownership in a company, offering dividends and voting rights.
Debentures are debt instruments, providing fixed interest without ownership or voting
rights.

(v) Self-financing:
Self-financing refers to funding business activities using internal resources, such as
retained earnings, instead of external borrowing. It reduces dependency on external debt
but limits expansion potential.

(vi) Cost of retained earnings:

The cost of retained earnings is the opportunity cost of reinvesting profits in the business
instead of distributing them as dividends.

(vii) Forms of dividends:

Dividends can be cash, stock, property, or script dividends. Each form caters to different
preferences of shareholders and financial strategies of the firm.

(viii) Importance of working capital:

Working capital ensures the smooth functioning of a business by meeting day-to-day
operational expenses. Adequate working capital prevents disruptions and maintains
liquidity.

(ix) Characteristics of equity capital:

Equity capital represents ownership, involves risk, and provides dividends based on
profits. It is a permanent source of funds without mandatory repayment.

(x) Capital budgeting decisions:

Capital budgeting involves evaluating and selecting long-term investment opportunities.
Its importance lies in optimal resource allocation, risk management, and maximizing
shareholder wealth.

PART-IV

4. Functional Areas of Financial Management

The key functional areas of financial management include:

1. Investment Decisions:
Concerned with allocating funds to long-term assets and projects (capital
budgeting). The objective is to maximize returns while managing risk.
2. Financing Decisions:
Involves determining the capital structure of the firm, deciding the mix of debt,
equity, and other financial instruments to raise funds.
3. Dividend Decisions:
Deals with distributing profits to shareholders or retaining them for reinvestment.
The decision impacts shareholder satisfaction and reinvestment capacity.
 4. Working Capital Management:
Focuses on managing short-term assets and liabilities to ensure liquidity and
operational efficiency.
5. Risk Management:
Involves identifying, analyzing, and mitigating financial risks, such as interest
rate fluctuations, currency exchange risk, or credit defaults.

5. Present Value (PV)

Present value refers to the current worth of future cash flows discounted at a specific rate,
reflecting the time value of money. The formula is:

Present value helps compare cash flows occurring at different times, aiding in investment
and financing decisions. It is widely used in evaluating projects, bonds, and loans.

6. Cost of Capital

Cost of capital is the minimum rate of return a firm must earn to justify the cost of raising
funds. It includes the cost of equity, debt, and retained earnings.

Significance:

1. Investment Decisions: Acts as a benchmark for evaluating projects; projects with

returns below the cost of capital are rejected.
2. Capital Structure Optimization: Helps determine the optimal mix of debt and
equity.
3. Performance Measurement: Indicates the financial health of a company by
comparing return on investment to the cost of capital.

7. Sources of Funds for Indian Businesses

Indian businesses have access to various funding sources:

1. Equity Financing: Raising funds through issuing shares.

2. Debt Financing: Includes bank loans, debentures, and bonds.
3. Retained Earnings: Using profits for reinvestment.
4. Venture Capital and Private Equity: For startups and innovative projects.
5. Trade Credit: Delayed payments to suppliers.
6. Public Deposits: Collecting funds from the public.
7. External Commercial Borrowings (ECB): Loans from international lenders.
8. Government Grants and Subsidies: Support for specific sectors or initiatives.
8. Capital Budgeting

Capital budgeting involves evaluating long-term investments like purchasing machinery

or launching projects.

Factors Influencing Capital Expenditure Decisions:

1. Expected Cash Flows: Projects with higher and consistent cash inflows are
preferred.
2. Risk and Uncertainty: Riskier projects require higher returns to justify the
investment.
3. Rate of Return: Must exceed the cost of capital to be viable.
4. Strategic Fit: Alignment with long-term business goals.
5. Regulatory Environment: Government policies and compliance requirements.

9. Factors Influencing Dividend Decisions

Several factors determine how much dividend a firm should pay:

1. Profitability: Higher profits increase dividend-paying capacity.

2. Liquidity: Sufficient cash is needed to pay dividends.
3. Growth Opportunities: Firms with expansion plans prefer retaining profits.
4. Stability of Earnings: Stable earnings lead to consistent dividend policies.
5. Shareholder Preferences: Balancing preferences for regular income versus
capital gains.
6. Tax Considerations: Dividend distribution tax impacts the decision.
7. Legal Constraints: Companies must adhere to regulations like maintaining a
minimum reserve.

10. Working Capital and Estimation Factors

Definition:
Working capital is the difference between current assets and current liabilities. It ensures
liquidity for day-to-day operations.

Factors to Consider for Estimation:

1. Operating Cycle: Longer cycles require more working capital.

2. Nature of Business: Manufacturing firms need higher working capital than
service-based firms.
3. Seasonal Demand: Seasonal businesses require additional working capital during
peak seasons.
4. Credit Policy: Liberal credit terms increase working capital needs.
5. Inventory Management: Higher inventory levels require more funds.
11. Sources of Temporary Working Capital

To meet variable or temporary working capital needs, firms use:

1. Bank Overdraft: Allows businesses to withdraw more than the account balance.
2. Cash Credit: Short-term financing against assets like inventory or receivables.
3. Trade Credit: Deferred payment terms from suppliers.
4. Commercial Paper: Short-term unsecured promissory notes.
5. Invoice Discounting: Selling invoices to a third party at a discount.
6. Short-term Loans: Borrowing from banks for a specific period.

These sources provide flexibility and quick access to funds for operational needs.

2023(FM)

PART-I

1. Fill in the blanks/one-word answers:

(i) Profit maximization objective ignores the time value of money.

(ii) When the cash flows occur at the end of each period, the annuity is called ordinary
annuity.
(iii) The present value of money to be received on a future date will be less.
(iv) The effective cost of debenture is lower compared to shares.
(v) Cost of capital is the minimum rate of return expected by its investors.
(vi) The formula to compute the cost of preference capital is:

Cost of Preference Capital=[P.D+(NP-RV)/n]/(NP+RV)/2*100

(vii) Cost of retained earnings is the opportunity cost of dividends foregone by the
shareholders.
(viii) The simplest capital budgeting technique is payback period method.
(ix) Payback period =

(x) Script dividend promises to pay the shareholders at a future date.

(xi) The gross working capital is a going concern concept.
(xii) EOQ stands for Economic Order Quantity.
PART-II

2. Answer in 2-3 sentences:

(i) What do you mean by wealth maximization?

Wealth maximization focuses on increasing the market value of a company’s shares. It
emphasizes long-term growth and considers the time value of money and associated
risks.

(ii) Name the techniques of time value of money.

The main techniques are Net Present Value (NPV), Future Value (FV), Annuities, and
Discounted Cash Flow (DCF) analysis.

(iii) What is systematic risk?

Systematic risk is the inherent risk that affects the entire market or a particular segment,
caused by factors like economic changes, inflation, or geopolitical events.

(iv) What is factoring?

Factoring is a financial service where a business sells its accounts receivable to a third
party (factor) at a discount for immediate cash.

(v) Define marginal cost of capital.

Marginal cost of capital is the cost of raising an additional unit of capital. It reflects the
incremental cost of funds for new projects.

(vi) Define capital budgeting.

Capital budgeting is the process of evaluating and selecting long-term investment
projects that align with a firm’s strategic objectives.

(vii) What do you mean by bonus issue?

A bonus issue involves distributing additional shares to existing shareholders without
charge, based on the number of shares they already own.

(viii) What is speculative motive?

The speculative motive is holding cash to take advantage of future investment
opportunities or unforeseen changes in market conditions.

(ix) What is the nature of cash?

Cash is the most liquid asset, used to meet immediate expenses and obligations. It acts as
the lifeblood of a business for smooth operations.

(x) What do you mean by inventory?

Inventory refers to goods and materials a business holds for production or sale. It
includes raw materials, work-in-progress, and finished goods.
PART-III

3. Answer in 75 words:

(i) Importance of Financial Management:

Financial management ensures efficient allocation of resources, cost control, and
profitability. It helps in planning and decision-making for investments, financing, and
dividends. Proper financial management supports liquidity, growth, and risk mitigation,
ensuring long-term sustainability and shareholder wealth maximization.

(ii) Future Value Calculation:

(iii) Systematic vs. Unsystematic Risk:

Systematic risk is market-wide and uncontrollable, like economic recessions.
Unsystematic risk is specific to a company or industry, like management inefficiencies,
and can be reduced through diversification.

(iv) Characteristics of Equity Shares:

Equity shares represent ownership, provide voting rights, and offer dividends based on
profits. They are permanent and carry higher risk but no fixed returns.

(v) Cost of Debt:

Cost of debt refers to the effective interest rate a company pays on its borrowed funds. It
is calculated post-tax since interest expenses are tax-deductible.

(vi) Need for Capital Budgeting:

Capital budgeting helps in evaluating and selecting long-term projects, ensuring optimal
resource utilization and alignment with strategic objectives.

(vii) Cash Dividend vs. Stock Dividend:

A cash dividend is a payout in cash to shareholders, while a stock dividend involves
issuing additional shares instead of cash.

(viii) Kinds of Working Capital:

Working capital can be permanent (required continuously) or temporary (needed to meet
seasonal demands).

(ix) VED Analysis:

VED (Vital, Essential, Desirable) analysis classifies inventory based on criticality. Vital
items are indispensable, essential items are necessary but replaceable, and desirable items
are optional.

(x) Inventory Turnover Ratio:

Inventory Turnover Ratio = Cost of Goods SoldAverage Inventory\frac{\text{Cost of
Goods Sold}}{\text{Average Inventory}}Average InventoryCost of Goods Sold.
It measures how efficiently inventory is managed and replenished.

PART-IV

4. Scope and Objectives of Financial Management

Scope of Financial Management

1. Investment Decisions:
o Evaluates and selects long-term investment opportunities (capital
budgeting).
o Includes risk-return analysis and resource allocation.
2. Financing Decisions:
o Determines the capital structure (mix of debt and equity).
o Focuses on raising funds from appropriate sources.
3. Dividend Decisions:
o Decides how much profit to retain or distribute as dividends.
o Balances shareholder satisfaction and reinvestment needs.
4. Working Capital Management:
o Manages short-term assets and liabilities.
o Ensures liquidity and smooth business operations.

Objectives of Financial Management

1. Profit Maximization:
o Aims to maximize short-term earnings.
2. Wealth Maximization:
o Focuses on increasing shareholder wealth and long-term growth.
3. Liquidity Management:
o Ensures adequate cash flow for daily operations.
4. Risk Management:
o Minimizes financial risks through diversification and prudent financing.

5. Debentures and Their Types

Definition of Debentures

Debentures are long-term debt instruments used by companies to borrow money at a

fixed rate of interest. They are repayable after a specific period.
Types of Debentures

1. Secured Debentures:
o Backed by specific company assets as collateral.
2. Unsecured Debentures:
o Not backed by assets and carry higher risk.
3. Convertible Debentures:
o Can be converted into equity shares after a certain period.
4. Non-convertible Debentures:
o Cannot be converted into equity shares.
5. Redeemable Debentures:
o Repaid on maturity or after a fixed period.
6. Irredeemable Debentures:
o Not repayable during the lifetime of the company but only on liquidation.

6. Average and Composite Cost of Capital

Definition:

The average cost of capital is the weighted cost of all sources of financing, such as
equity, debt, and retained earnings.

Formula for Weighted Average Cost of Capital (WACC):

Importance:

1. Assists in evaluating project viability.

2. Helps in optimizing the capital structure.
3. Used for financial planning and investment appraisals.

7. Nature and Concept of Capital Budgeting

Nature of Capital Budgeting:

1. Long-term Perspective: Focuses on evaluating projects with long-term

implications.
2. Irreversible Decisions: Investments made are often irreversible.
 3. Risk and Uncertainty: Includes forecasting future cash flows under uncertain
conditions.

Concept of Capital Budgeting:

Capital budgeting involves evaluating and selecting projects that maximize a firm's value.
Techniques include:

 Payback Period: Time to recover the initial investment.

 Net Present Value (NPV): Present value of cash inflows minus initial
investment.
 Internal Rate of Return (IRR): Discount rate that makes NPV zero.
 Profitability Index: Ratio of present value of inflows to outflows.

8. Factors to Consider for Dividend Policy

1. Profitability:
o Higher profits enable higher dividends.
2. Cash Flow Position:
o Dividends require adequate cash reserves.
3. Stability of Earnings:
o Firms with stable earnings often adopt consistent dividend policies.
4. Growth Opportunities:
o Companies with expansion plans retain earnings rather than paying
dividends.
5. Shareholder Expectations:
o Dividend policies are often aligned with shareholder preferences for
income or capital gains.
6. Tax Considerations:
o Dividends are subject to taxes, influencing the payout decision.
7. Legal Restrictions:
o Companies must comply with statutory regulations when declaring
dividends.

9. Importance of Working Capital in Manufacturing

1. Ensures Smooth Operations:

o Sufficient working capital avoids production delays and disruptions.
2. Timely Procurement of Raw Materials:
o Ensures raw materials are available when needed.
3. Liquidity Management:
o Helps meet short-term obligations like wages and utility payments.
4. Improves Creditworthiness:
o Adequate working capital strengthens the company’s reputation with
suppliers and creditors.
5. Supports Sales Growth:
 o Facilitates offering credit to customers, boosting sales.

10. Working Capital and Short-term Sources

Definition of Working Capital:

Working capital is the difference between current assets and current liabilities. It ensures
liquidity for daily operations.

Short-term Sources of Working Capital Funds:

1. Trade Credit:
o Suppliers extend credit for raw materials and goods.
2. Bank Overdraft:
o Allows withdrawal beyond the bank account balance.
3. Cash Credit:
o Short-term borrowing secured against inventory or receivables.
4. Commercial Paper:
o Unsecured promissory notes issued for short-term financing.
5. Factoring:
o Selling accounts receivable to a third party for immediate cash.
6. Invoice Discounting:
o Borrowing funds by pledging unpaid invoices.
7. Short-term Loans:
o Loans from banks or financial institutions for temporary needs.

“TAKE A BREAK THEN START STUDYING FMIS WHICH IS THE NEXT PAPER”