UNIT-I

1)Define Financial management and Explain Nature and scope of Financial management.

ANSWER:-

Definition: Finance may be defined as the provision of money at the time when it is required. Finance refers to the
management of flow of money through an organization.

Nature of Financial management

Economics is easy to understand when divided into two parts.

1. Micro Economics: It is also known as price theory or theory of the firm. Micro economics explains the behavior of
rational persons in making decisions related to pricing and production.

2. Macro Economics: Macro Economics is a broad concept as it takes into consideration overall economic situation of a
nation. It uses gross national product (GNP) and useful in forecasting.

In order to manage problems related to money principles developed by financial managers, economics, accounting are
used. Hence, finance makes use of economic tools. From Micro economics it uses theories and assumptions. From
Macro economics it uses forecasting models. Even though finance is concerned with individual firm and economics is
concerned with forecasting of an industry.

SCOPE OF FINANCIAL MANAGEMENT: The main objective of financial management is to arrange sufficient finance for
meeting short term and long term needs. A financial manager will have to concentrate on the following areas of finance
function.

1. Estimating financial requirements: The first task of a financial manager is to estimate short term and long term
financial requirements of his business. For that, he will prepare a financial plan for present as well as for future.

2. Deciding capital structure: Capital structure refers to kind and proportion of different securities for raising funds.
After deciding the quantum of funds required it should be decided which type of securities should be raised. It may be
wise to finance fixed assets through long term debts. Even here if gestation period is longer than share capital may be
the most suitable.

3. Selecting a source of finance: An appropriate source of finance is selected after preparing a capital structure which
includes share capital, debentures, financial institutions, public deposits etc. If finance is needed for short term periods
then banks, public deposits and financial institutions may be the appropriate.

4. Selecting a pattern of investment: When funds have been procured then a decision about investment pattern is to be
taken. The selection of an investment pattern is related to the use of funds. A decision will have to be taken as to which
assets are to be purchased? The funds will have to be spent first on fixed assets and then an appropriate portion will be
retained for working capital and for other requirements.

5. Proper cash management: Cash management is an important task of finance manager. He has to assess various cash
needs at different times and then make arrangements for arranging cash. Cash may be required to purchase of raw
materials, make payments to creditors, meet wage bills and meet day to day expenses.

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2.Explain Goals and objectives of Financial Management.

Answer:-

Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. It is
the essential part of the financial manager. Hence, the financial manager must determine the basic objectives of the
financial management. Objectives of Financial Management may be broadly divided into two parts such as:

1. Profit maximization

2. Wealth maximization.

1. Profit Maximization

Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose
of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern. Profit
maximization is also the traditional and narrow approach, which aims at, maximizes the profit of the concern.

2. Wealth Maximization

Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field
of the business concern. The term wealth means shareholder wealth or the wealth of the persons those who are
involved in the business concern. Wealth maximization is also known as value maximization or net present worth
maximization. This objective is an universally accepted concept in the field of business.

FINANCE FUNCTION – AIM

The objective of finance function is to arrange as much funds for the business as are required from time to time. This
function has the following objectives.

1. Assessing the Financial requirements. The main objective of finance function is to assess the financial needs of an
organization and then finding out suitable sources for raising them. The sources should be commensurate with the
needs of the business.

2. Proper Utilization of Funds: Though raising of funds is important but their effective utilisation is more important. The
funds should be used in such a way that maximum benefit is derived from them. The returns from their use should be
more than their cost. The funds committed to various operations should be effectively utilised. Those projects should be
preferred which are beneficial to the business.

3. Increasing Profitability. The planning and control of finance function aims at increasing profitability of the concern. It
is true that money generates money. To increase profitability, sufficient funds will have to be invested.

4. Maximizing Value of Firm. Finance function also aims at maximizing the value of the firm. It is generally said that a
concern's value is linked with its profitability.

3.Explain Profit maximization Vs Wealth maximization.

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Answer:

S.NO. PROFITMAXIMIZATION WEALTH MAXIMIZATION

1 Profits are earned maximized, so that firm can Wealth is maximized, so that wealth of share-holders can be
over-come future risks which are uncertain. maximized.
2 Profit maximization is a yards stick for In wealth maximization stockholders current wealth is
calculating efficiency and economic prosperity evaluated in order to maximize the value of shares in the
of the concern. market.
3 Profit is measured in terms of efficiency of the Wealth is measured in terms of market price of shares.
firm.
4 Profit maximization involves problem of Wealth maximization involves problems related to maximizing
uncertainty because profits are uncertain. shareholder’s wealth or wealth of the firm

4.Explain Major decisions of financial Manager.

Answer:-

1) Capital Budgeting Decisions: Capital budgeting decision is important, as it involves proper allocation of funds.
These decisions are made considerably for long period of time in order to get benefits in future. While taking
capital budgeting decision, finance manager needs to evaluate the cost of capital and risk involved in it. Finance
manager must have complete knowledge about the techniques used for evaluating such as Net Present Value
(NPV), IRR, discounted cash flow, etc

2) Capital Structure Decisions: Capital structure decisions play an important role in designing the capital structure
which is suitable for the company. It is the duty of finance manager to develop an optimum capital structure
which involves less amount of cost of capital, less amount of risk but which can generate huge amount of
returns. While developing capital structure, finance managers must also consider the financial and operating
leverages of the firm.

3) Dividend Decisions: Dividend decision is also important for organization to design the dividend policy. Dividend
policy involves the amount of profits to paid as dividend to shareholders or reinvested in the organizations.
Shareholders emphasize on getting higher amount of dividend, whereas management of company tries to
maintain profits to face uncertainties in future. The dividend policy of the firm mainly depends of profitability.

4) Working Capital Decisions: Working capital management is an addition of fixed capital investment. Working
capital management is an important element of every organization, as it helps in continuing the business
processes. Decisions related to working capital are known as working capital decisions. The essential elements of
working capital are cash, accounts receivable and inventory. Each element of working capital involves some kind
of risk in it.

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 UNIT-II
1)Explain Sources of Finance.
Answer:-
Sources of finance mean the ways for mobilizing various terms of finance to the industrial concern. Sources of finance
state that, how the companies are mobilizing finance for their requirements. The companies belong to the existing or
the new which need sum amount of finance to meet the long-term and short-term requirements such as purchasing of
fixed assets, construction of office building, purchase of raw materials and day-to-day expenses.

Internal Sources of Finance

1. Personal funds:-Main source of finance for sole traders and for partnerships.
2. Retained profits:-

 Value of profits that the business keeps (after taxes, dividends) to use within the business
 Often used for purchasing and/or upgrading fixed assets
 Some might be kept for contingency fund - emergencies, unforeseeable expenditure
 Advantage of using this is that it does not incur any interest charges

3. Sale of assets

 Selling unused assets

o Old machinery, computer equipment that have been replaced
 If a business has chosen to relocate, then raise finance through selling of old land, buildings
 In more extreme cases --> sell some fixed assets to survive a liquidity problem (how quickly
you can get your hands on your cash)

External Sources of Finance

Share Capital

 Main source of finance for most Limited Liability Companies

 Money raised from selling shares in the company

Loan Capital

 Medium to LT sources of finance from commercial lenders such as banks

 Interest charges are imposed and can be Fixed of Variable, depending on the agreement
between borrower and lender
 The amount borrowed is paid back in installments over a period
o For e.g, Mortgage - If the borrower fails to repay, then the lender can repossess the
property
 Also Debentures (LT Loans issued by a business)

Overdrafts

 Allows a business to temporarily overdraw on it's bank account

o Take out more money than it has in it's account.
 Commonly used when businesses have minor cash flow problems
 Usually more cost effective than bank loans even though it can demand a relatively high rate
of interest
 Used as ST sources of finance

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  Provides flexibility for businesses that might occasionally face cash flow problems

2.Briefly explain about EBIT-EPS analysis.

The EBIT-EPS analysis gives the best ratio of debt to equity which the businesses can use to find an
optimum balance in their debt and equity financing. The analysis shows the effect of the balance
sheet’s structure on the company’s earnings.

Basics of EBIT-EPS Approach

It is important to understand what EBIT and EPS mean to understand what the analysis is meant
to be.
 EBIT refers to earnings before interest and tax. The metric makes interest and taxes
irrelevant. Therefore, an investor can understand how the company is performing out of the
balance sheet’s composition which essentially makes interest and taxes the focal point of
consideration. In terms of EBIT, there is no difference if a company has huge debt or no debt
at all. The repercussions will be the same.
 EPS or earnings per share is the metric that shows a company’s earnings including interests
and taxes. It is an important metric because it shows the earnings on a per-share basis which
helps the investors understand how a company performs on an overall basis. If a company’s
overall profit soars high but the payment to investors is low, it is a bad gesture for investors
owning a fixed number of shares. EPS shows this dynamic rule simply and in a clear manner.
The ratio between these two metrics can show how the bottom line results, the company’s EPS, are
related to its performance irrespective of its capital structure, the EBIT.

Limitations of EBIT-EPS Analysis

Although EBIT-EPS analysis is a good way to check the earning sensitivity of a company, it has
certain limitations too.
No Consideration of Risk
The EBIT-EPS analysis does not consider the risk associated with a business project. It simply
shows whether the earnings are enough for a corporation. It is not needed in case of a profit larger
than returns, but it can be hurting if the opposite situation is there. When the profits are low, but
the interest is high, then businesses may be in turmoil.
Contradictory Results
When new equity shares are not considered in a different alternative financial plan, the results
arising out of this can get erroneous. The comparison of plans also becomes difficult when the
number of alternatives increases.
Over-capitalization of Funds
This analysis ignores the over-capitalization of the funds. Beyond a certain point, additional capital
should not be employed to generate a return in excess of the payments that should be made for its
use. The analysis does not address such cases.

3.Define Cost of Capital and Explain measurement of Cost of Capital.

Answer:-

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Definition of Cost of Capital.

According to Solomon Ezra, “Cost of capital is the minimum required rate of earning or the cut-off
rate of capital expenditures”.

measurement of Cost of Capital:-

Cost of capital is measured for different sources of capital structure of a firm. It includes cost of
debenture, cost of loan capital, cost of equity share capital, cost of preference share capital, cost of
retained earnings etc.

A. Cost of Debentures:- The capital structure of a firm normally includes the debt capital. Debt may
be in the form of debentures bonds, term loans from financial institutions and banks etc. The
amount of interest payable for issuing debenture is considered to be the cost of debenture or debt
capital (Kd). Cost of debt capital is much cheaper than the cost of capital raised from other sources,
because interest paid on debt capital is tax deductible.

The cost of debenture is calculated in the following ways:

(i) When the debentures are issued and redeemable at par: Kd = r (1 – t)
where Kd = Cost of debenture
r = Fixed interest rate

t = Tax rate

(ii) When the debentures are issued at a premium or discount but redeemable at par

Kd = I/NP (1 – t)
where, Kd = Cost of debenture
I = Annual interest payment

t = Tax rate

Np = Net proceeds from the issue of debenture.

(iii) When the debentures are redeemable at a premium or discount and are redeemable after ‘n’
period:

Kd
I(1-t)+1/N(Rv – NP) / ½ (RV – NP)
where Kd = Cost of debenture .
I = Annual interest payment

t = Tax rate

NP = Net proceeds from the issue of debentures

Ry = Redeemable value of debenture at the time of maturity

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B. Cost of Preference Share Capital:
For preference shares, the dividend rate can be considered as its cost, since it is this amount which
the company wants to pay against the preference shares. Like debentures, the issue expenses or the
discount/premium on issue/redemption are also to be taken into account.

(i) The cost of preference shares (KP) = DP / NP

Where, DP = Preference dividend per share
NP = Net proceeds from the issue of preference shares.

(ii) If the preference shares are redeemable after a period of ‘n’, the cost of preference shares (K P) will
be:

where NP = Net proceeds from the issue of preference shares

RV = Net amount required for redemption of preference shares

DP = Annual dividend amount.
There is no tax advantage for cost of preference shares, as its dividend is not allowed deduction
from income for income tax purposes. The students should note that both in the case of debt and
preference shares, the cost of capital is computed with reference to the obligations incurred and
proceeds received. The net proceeds received must be taken into account while computing cost of
capital

C. Cost of Equity or Ordinary Shares:

The funds required for a project may be raised by the issue of equity shares which are of permanent
nature. These funds need not be repayable during the lifetime of the organisation. Calculation of the
cost of equity shares is complicated because, unlike debt and preference shares, there is no fixed
rate of interest or dividend payment.Cost of equity share is calculated by considering the earnings
of the company, market value of the shares, dividend per share and the growth rate of dividend or
earnings.

(i) Dividend/Price Ratio Method:

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An investors buys equity shares of a particular company as he expects a certain return (i.e.
dividend). The expected rate of dividend per share on the current market price per share is the cost
of equity share capital. Thus the cost of equity share capital is computed on the basis of the present
value of the expected future stream of dividends.

Thus, the cost of equity share capital (K e) is measured by:

Ke = where D = Dividend per share
P = Current market price per share.

If dividends are expected to grow at a constant rate of ‘g’ then cost of equity share capital

(Ke) will be Ke = D/P + g.

This method is suitable for those entities where growth rate in dividend is relatively stable. But this
method ignores the capital appreciation in the value of shares. A company which declares a higher
amount of dividend out of given quantum of earnings will be placed at a premium as compared to a
company which earns the same amount of profits but utilizes a major part of it in financing its
expansion programme.

4.Explain about theories of capital structure.

Answer.

Capital structure is the major part of the firm’s financial decision which affects the value of the firm and it leads to
change EBIT and market value of the shares. There is a relationship among the capital structure, cost of capital and
value of the firm. The aim of effective capital structure is to maximize the value of the firm and to reduce the cost of
capital. There are two major theories explaining the relationship between capital structure, cost of capital and value
of the firm.

Capital structure theories

Modern approach Traditional Approach

Net Operating Modiglaini-

Net Income
income Miller
Approach
Approach Approach

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1. NET INCOME (NI) APPROACH
According to this approach, the capital structure decision is relevant to the valuation of the firm. In
other words, a change in the capital structure leads to a corresponding change in the overall cost of
capital as well as the total value of the firm. According to this approach, use more debt finance to
reduce the overall cost of capital and increase the value of firm.
Net income approach is based on the following three important assumptions:
1. There are no corporate taxes.
2. The cost debt is less than the cost of equity.
3. The use of debt does not change the risk perception of the investor.

2. NET OPERATING INCOME (NOI) APPROACH

According to this approach, the change in capital structure will not lead to any change in the total
value of the firm and market price of shares as well as the overall cost of capital. NI approach is
based on the following important assumptions; The overall cost of capital remains constant; There
are no corporate taxes; The market capitalizes the value of the firm as a whole.

3. MODIGLIANI AND MILLER APPROACH

Modigliani and Miller approach states that the financing decision of a firm does not affect the
market value of a firm in a perfect capital market. In other words MM approach maintains that the
average cost of capital does not change with change in the debt weighted equity mix or capital
structures of the firm.
Modigliani and Miller approach is based on the following important assumptions:
• There is a perfect capital market.
• There are no retained earnings.
• There are no corporate taxes.
• The investors act rationally.
• The dividend payout ratio is 100%.

TRADITIONAL APPROACH
It is the mix of Net Income approach and Net Operating Income approach. Hence, it is also called as
intermediate approach. According to the traditional approach, mix of debt and equity capital can
increase the value of the firm by reducing overall cost of capital up to certain level of debt.
Traditional approach states that the Ko decreases only within the responsible limit of financial
leverage and when reaching the minimum level, it starts increasing with financial leverage.

UNIT-III

1)Explain Techniques of Time Value of Money

Answer.

“Time value of money means that the value of a sum of money received today is more than
its value received after some time”

There are two techniques of estimating time value of money

1. Discounting Technique or the Present Value Method

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2. Compounding Technique or the Future Value Method

1. Discounting or Present Value Method:

The current value of an expected amount of money to be received at a future date is known as
Present Value. If we expect a certain sum of money after some years at a specific interest rate, then
by discounting the Future Value we can calculate the amount to be invested today, i.e., the current
or Present Value.

2. Compounding or Future Value Method:

Compounding is just the opposite of discounting. The process of converting Present Value into
Future Value is known as compounding.

Future Value of a sum of money is the expected value of that sum of money invested after n number
of years at a specific compound rate of interest.

2.Define Capital Budgeting and Explain Methods of Capital Budgeting.

DEFINITION
Capital budgeting (investment decision) as, “Capital budgeting is long term planning for making and
financing proposed capital outlays.”

Methods of Capital Budgeting

Traditional methods Modern Methods

Pay Back Accounting Rate of NPV IRR PI

Period Return

TRADITIONAL METHODS:
1. PAY-BACK PERIOD METHOD
The ‘pay back’ sometimes called as pay out or pay off period method represents the period in which the total
investment in permanent assets pays back itself. This method is based on the principle that every capital
expenditure pays itself back within a certain period out of the additional earnings generated from the capital
assets.
Initial Investment

Pay Back Period= Annual Cash inflows

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2. AVERAGE RATE OF RETURN:
This method takes into account the earnings expected from the investment over their whole life. It is
known as accounting rate of return method for the reason that under this method, the Accounting
concept of profit (net profit after tax and depreciation) is used rather than cash inflows. According
to this method, various projects are ranked in order of the rate of earnings or rate of return.

(a) Average Rate of Return Method (ARR):

Under this method average profit after tax and depreciation is calculated and then it is divided by
the total capital outlay or total investment in the project. The project evaluation. This method is one
of the traditional methods for evaluating.

ARR = (Average Annual profits)/ (Net investment in the project) x 100.

(b) Average Return on Average Investment Method:

This is the most appropriate method of rate of return on investment Under this method, average
profit after depreciation and taxes is divided by the average amount of investment; thus:
Average Return on Average Investment = (Average Annual Profit after depreciation and taxes)/
(Average Investment) x 100.

MODERN METHODS:-

1. NET PRESENT VALUE

Net present value method is one of the modern methods for evaluating the project proposals. In this
method cash inflows are considered with the time value of the money. Net present value describes
as the summation of the present value of cash inflow and present value of cash outflow. Net present
value is the difference between the total present values of future cash inflows and the total present
value of future cash outflows.
NPV = Total Present value of cash inflows – Net Investment

2.INTERNAL RATE OF RETURN METHOD

This method is popularly known as time adjusted rate of return method/discounted rate of return
method also. The internal rate of return is defined as the interest rate that equates the present
value of expected future receipts to the cost of the investment outlay. This internal rate of return is
found by trial and error.
IRR=BASE YEAR+N1/(N1-
N2)*DR

3. PROFITABILITY INDEX METHOD

The profitability index (PI) is the ratio of the present value of change in operating cash inflows to the
present value of investment cash outflows:

Profitability Index=TPVCFAT/INVESTMENT

TPVCFAT=TOTAL PRSENT VALUE CASHFLOW AFTER TAX.

3.Briefly Explain about Capital Budgeting Process.

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Capital budgeting is a complex process as it involves decisions relating to the investment of current
funds for the benefit to the achieved in future and the future is always uncertain. However the
following procedure may be adopted in the process of capital budgeting:

Step 1 and 2 = Project generation,

Step3 = Project evaluation
Step4 and 5 =project selection
Step 6 = project execution
PROJECT GENERATION
1. Identification of Investment Proposals:
The capital budgeting process begins with the identification of investment proposals. The proposal
or the idea about potential investment opportunities may originate from the top management or
may come from the rank and file worker of any department or from any officer of the organization.

2. Screening the Proposals:

The expenditure planning committee screens the various proposals received from different
departments. The committee views these proposals from various angels to ensure that these are in
accordance with the corporate strategies or a selection criterion’s of the firm and also do not lead to
departmental imbalances.

PROJECT EVALUATION
3. Evaluation of Various Proposals:
The next step in the capital budgeting process is to evaluate the profitability of various proposals.
There are many methods which may be used for this purpose such as payback period method, rate
of return method, net present value method
PROJECT SELECTION
4. Fixing Priorities:
After evaluating various proposals, the unprofitable or uneconomic proposals may be rejected
straight ways. But it may not be possible for the firm to invest immediately in all the acceptable
proposals due to limitation of funds., internal rate of return method etc.

5. Final Approval and Preparation of Capital Expenditure Budget:

Proposals meeting the evaluation and other criteria are finally approved to be included in the
Capital expenditure budget. However, proposals involving smaller investment may be decided at the
lower levels for expeditious action. PROJECT EXECUTION
6. Implementing Proposal:
Preparation of a capital expenditure budgeting and incorporation of a particular proposal in the
budget does not itself authorize to go ahead with the implementation of the project.

7. Performance Review:
The last stage in the process of capital budgeting is the evaluation of the performance of the project.
The evaluation is made through post completion audit by way of comparison of actual expenditure
of the project with the budgeted one, and also by comparing the actual return from the investment
with the anticipated return.

4.Explain Techniques of Investment appraisal.

Answer:-

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 UNIT-IV

1)What is dividend policy and Explain walter’s model for dividend policy.

Answer:-

According to the Institute of Chartered Accountant of India, dividend is defined as “a distribution

to shareholders out of profits or reserves available for this purpose”.

Walter's Theory on Dividend Policy

Walter’s model on dividend policy believes in the relevance concept of a dividend. According to this
concept, a dividend decision of the company affects its valuation. Walter’s theory further explains
this concept in a mathematical model.

Formula for Walter's Model

Walter’s formula to calculate the market price per share (P) is:

P = D/k + {r*(E-D)/k}/k, where

P = market price per share

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D = dividend per share

E = earnings per share

r = internal rate of return of the firm

k = cost of capital of the firm

Criticism of Walter's Dividend Model

Walter's theory is based on some principles like most other theories, and among all other dividend
policy theories, it is the best. However, the theory is not free from criticism.
 As the theory considers the entire amount of dividend to be retained or distributed, it is a
theory that is not quite practical in nature.
 Walter's theory also requires the Cost of Capital and the Internal Rate of Return to be
constant which is impractical in nature.
 Walter's model also considers that starting earnings and dividends never change. However,
Earnings Per Share (EPS) and Dividend Per Share may change.
 To be considered under Walter's model, a company must have an infinite life, which is quite
impractical to assume.

2.Explain major forms of dividend and theories of dividend.

(A) Cash dividend: A cash dividend is a usual method of paying dividends. Payment of dividend is
cash results in the reduction out flow of funds and reduces the net worth of the company. The
share holders get an opportunity to invest the cash in any manner, they desire.

(B) Scrip (or) Bond dividend: A scrip dividend promises to pay the share holders at a future
specific date. In case a company does not have sufficient funds to pay dividends in cash, it may
issue notes or bonds for amounts due to the share holders. The objective of scrip dividends is to
postpone the immediate payment of cash. A scrip dividend bears interest and is accepted as
collateral security.

(c) Property Dividend: Property dividends are paid in the form of some assets other than cash.
They are distributed under exceptional circumstances and are not popular in India.
(d) Stock Dividend: Stocks dividend means the issue and the bonus shares to the existing share
holders. If a company does not have liquid resources, it is better to declare stock dividends. Stock
dividend amounts to capitalization of earnings and distribution of profits among the existing share
holders without affecting the cash position of the firm.

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Theories of Dividend:-

1. Walter’s model

2. Gordon’s model

3. Modigliani and Miller’s hypothesis

1. Walter’s model:
Professor James E. Walterargues that the choice of dividend policies almost always affects the value
of the enterprise. His model shows clearly the importance of the relationship between the firm’s
internal rate of return (r) and its cost of capital (k) in determining the dividend policy that will
maximise the wealth of shareholders.

Walter’s model is based on the following assumptions:

1. The firm finances all investment through retained earnings; that is debt or new equity is not
issued;

2. The firm’s internal rate of return (r), and its cost of capital (k) are constant;

3. All earnings are either distributed as dividend or reinvested internally immediately.

4. Beginning earnings and dividends never change. The values of the earnings pershare (E), and the
divided per share (D) may be changed in the model to determine results, but any given values of E
and D are assumed to remain constant forever in determining a given value.

5. The firm has a very long or infinite life.

2. Gordon’s Model:
One very popular model explicitly relating the market value of the firm to dividend policy is
developed by Myron Gordon.

Gordon’s model is based on the following assumptions.

1. The firm is an all Equity firm

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2. No external financing is available

3. The internal rate of return (r) of the firm is constant.

4. The appropriate discount rate (K) of the firm remains constant.

5. The firm and its stream of earnings are perpetual

6. The corporate taxes do not exist.

7. The retention ratio (b), once decided upon, is constant. Thus, the growth rate (g) = br is constant
forever.

8. K > br = g if this condition is not fulfilled, we cannot get a meaningful value for the share.

According to Gordon’s dividend capitalisation model, the market value of a share (Pq) is equal to the
present value of an infinite stream of dividends to be received by the share.

3. Modigliani and Miller’s hypothesis:

According to Modigliani and Miller (M-M), dividend policy of a firm is irrelevant as it does not affect
the wealth of the shareholders. They argue that the value of the firm depends on the firm’s earnings
which result from its investment policy.

Thus, when investment decision of the firm is given, dividend decision the split of earnings between
dividends and retained earnings is of no significance in determining the value of the firm. M – M’s
hypothesis of irrelevance is based on the following assumptions.

1. The firm operates in perfect capital market

2. Taxes do not exist

3. The firm has a fixed investment policy

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4. Risk of uncertainty does not exist. That is, investors are able to forecast future prices and
dividends with certainty and one discount rate is appropriate for all securities and all time periods.
Thus, r = K = Kt for all t.
Under M – M assumptions, r will be equal to the discount rate and identical for all shares. As a
result, the price of each share must adjust so that the rate of return, which is composed of the rate
of dividends and capital gains, on every share will be equal to the discount rate and be identical for
all shares.

3.Explain dividend policies Indian corporate.

Answer:-

Firms may pursue any one of the following dividend policies:

1. Generous or liberal dividend policy: Firms that follow this policy reward shareholders
generously by stepping up dividend over the time.

2. Stable dividend policy: Firms may follow the policy of: Stable dividend payout ratio: According
to this policy, the percentage of earnings paid out of dividends remains constant. The dividends will
fluctuate with the earnings of the company. Stable rupee (inflation adjusted) dividend policy: As per
this policy the rupee level of dividends remains stable.

3. Low regular dividend plus extra dividend policy: As per this policy, a low, regular dividend is
maintained and when times are good an extra dividend is paid. Extra dividend is the additional
dividend optionally paid by the firm if earnings are higher than normal in a given period. Although
the regular portion will be predictable, the total dividend will be unpredictable.

4. Residual dividend policy: Under this policy, dividends are paid out of earnings not needed to
finance new acceptable capital projects. The dividends will fluctuate depending on investment
opportunities available to the company.

5. Multiple dividend increase policy: Some firms follow the policy of very frequent and small
dividend increases. The objective is to give shareholders an illusion of movement and growth.

6. Uniform cash dividend plus bonus policy: Under this policy, the minimum rate of dividend per
share is paid in cash plus bonus shares are issued out of accumulated reserves. However, bonus
shares are not given compulsorily on an annual basis. They may be given over a period of a certain
number of years, for example 3-5 years depending on the accumulated reserves of the company that
can be utilized for the purpose of issuing bonus.

4.Explain Determinants of dividend.

Answer:-

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1. Profitable Position of the Firm
Dividend decision depends on the profitable position of the business concern. When the firm earns
more profit, they can distribute more dividends to the shareholders.
2. Uncertainty of Future Income
Future income is a very important factor, which affects the dividend policy. When the shareholder
needs regular income, the firm should maintain regular dividend policy.
3. Contractual constraints
Often, the firm’s ability to pay cash dividends is constrained by restrictive provisions in a loan
agreement. Generally, these constraints prohibit the payment of cash dividends until a certain level
of earnings have been achieved, or they may limit dividends to a certain amount or a percentage of
earnings. Constraints on dividends help to protect creditors from losses due to the firm’s
insolvency. The violation of a contractual constraint is generally grounds for a demand of immediate
payment by the funds supplier.
4. Internal constraints
The firm’s ability to pay cash dividends is generally constrained by the amount of excess cash
available rather than the level of retained earnings against which to charge them. Although it is
possible for a firm to borrow funds to pay dividends, lenders are generally reluctant to make such
loans because they produce no tangible or operating benefits that will help the firm repay the loan.
Although the firm may have high earnings, its ability to pay dividends may be constrained by a low
level of liquid assets.

5. Legal Constrains

The Companies Act 1956 has put several restrictions regarding payments and declaration of
dividends. Similarly, Income Tax Act, 1961 also lays down certain restrictions on payment of
dividends.
6. Liquidity Position
Liquidity position of the firms leads to easy payments of dividend. If the firms have high liquidity,
the firms can provide cash dividend otherwise, they have to pay stock dividend.
7. Sources of Finance
If the firm has finance sources, it will be easy to mobilize large finance. The firm shall not go for
retained earnings.
8. Growth Rate of the Firm
High growth rate implies that the firm can distribute more dividends to its shareholders.

UNIT-V

1)Define working capital and explain significance and classification of working capital.
Answer:-
Definition
In the words of Shubin, “Working capital is the amount of funds necessary to cover the cost of
operating the enterprise”.
Significance
Gross working capital concept focuses attention on the two aspect of current asset management. They are:
1). Optimum investment in current assets:
Investment in current asset must be just adequate to the needs of the firm. On the other hand excessive
investment in current asset should be avoided.
2). Financing of current asset:

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Need for working capital arise due to the increasing level of business activity. Therefore, there is a need to
provide it quickly. If there is surplus fund arise that should be invested in short term securities.
Net Working Capital Concept
As per this concept the excess of current asst over current liabilities represents net working capital. Similar view
is expressed by Guthmann, Gerstenberg, Goel Etc.
Net Working Capital represents the amount of current asset which remain after all the current liabilities were
paid. It may be either positive or negative. It will be positive if current asset exceed current liabilities and vice
versa.
To quote Roy Chowdry, “Net Working Capital indicates the liquidity of the liquidity of business whilst gross
working capital denotes the quantum of working capital with which business has to operate.
Significance
Net Working Capital Concept focuses on two aspects. They are:
1). Maintaining liquidity position:
Excess current assets help in meeting its financial obligation within the operating cycle of the firm. Negative
and excess working capitals both are bad to the firm.
2). To decide upon the extent of long term capital in financing current asset:
Net working capital means the portion of current asst that should be financed by long term funds. This concept
helps to decide the extent of long term fund required in finance current assets.
Kinds of working capital
The categorization of working capital can be made either based on its concept or the need to maintain current
asset either permanently and or temporarily. As per conceptual view it may be classified in to gross and net
work in capital. Gestenberg has conveniently classified the working capital in to regular or permanent working
capital and temporary or variable working capital.
Gross working capital or quantitative
Net working capital or qualitative
Temporary or variable working capital
Permanent or regular working capital
Types of working capital
Concept base
Time base
Permanent working capital
This is the minimum investment kept in the form of inventory of raw materials, work in process, finished goods,
stores and spares and book debt to facilitate uninterrupted operation in a firm. Though this investment is
stable in short run, it certainly varies in long run depending upon the expansion programs undertaken by the
firm. It may increase or decrease over a period of time.
Temporary working capital
Any additional working capital apart from permanent working capital required to support the changing
production and sales activities is referred to as temporary working capital. A firm required to maintain an
additional amount current asset temporarily over and above permanent working capital.
Temporary
Permanent
Components of working capital
1). Current Asset
Current are those assets that in the ordinary course of business can be or will be turned into cash within an
accounting period. It includes cash, marketable securities, inventories, sundry debtors, banks and prepaid
expenses.

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2). Current Liabilities
Current liabilities are those liabilities intent to be paid in the ordinary course of business within a reasonable
period. It consist of sundry creditors, loans and advances, bank over draft, short term borrowing, taxes and
proposed dividend.
2.Explain factors determining the working capital.

The Working capital requirements of a concern depend upon a large number of factors such as
nature and size of business, the character of their operations, the length of production cycles, the
rate of stock turnover and the state of economic situation.
1. Nature or Character of Business: The Working capital requirements of a firm basically depend
upon the nature of its business. Public utility undertakings like Electricity. Water supply and
Railways need very limited working capital because they offer cash sales only and supply services,
not products, and as such no funds are tied up in inventories and receivables.
2. Size Business/Scale of Operations: The working capital requirements of a concern are directly
influenced by the size of its business which may be measured in terms of scale of operations.
Greater the size of business unit, generally larger will be the requirements of working capital.
3. Production Policy: In certain industries the demand is subject to wide fluctuations due to
seasonal variations. The requirements of working capital in such cases depend upon the production
policy.
4. Manufacturing Process/Length of Production Cycle: In manufacturing business, the
requirements of working capital increase in direct proportion to length of manufacturing process.
5. Seasonal Variations: In certain industries raw material is not available throughout the year.
They have to buy raw materials in bulk during the season to ensure an uninterrupted flow and
process them during which gives rise to more working capital requirements.
6. Working Capital Cycle: In a manufacturing concern, the working capital cycle starts with the
purchase of raw material and ends with the realization of cash from the sale of finished products.

3.Explain Cash management Models.

Answer:-
Definition: Cash Management refers to the collection, handling, control and investment of the
organizational cash and cash equivalents, to ensure optimum utilization of the firm’s liquid
resources. Money is the lifeline of the business, and therefore it is essential to maintain a sound
cash flow position in the organization.

Cash Management Models

Cash management requires a practical approach and a strong base to determine the requirement of
cash by the organization to meet its daily expenses. For this purpose, some models were designed to
determine the level of money on different parameters.

The two most important models are discussed in detail below:

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The Baumol’s EOQ Model

Based on the Economic Order Quantity (EOQ), in the year 1952, William J. Baumol gave the
Baumol’s EOQ model, which influences the cash management of the company.

This model emphasizes on maintaining the optimum cash balance in a year to meet the business
expenses on the one hand and grab the profitable investment opportunities on the other side.

The following formula of the Baumol’s EOQ Model determines the level of cash which is to be
maintained by the organization:

Where,
‘C’ is the optimum cash balance;
‘F’ is the fixed transaction cost;
‘T’ is the total cash requirement for that period;
‘i’ is the rate of interest during the period

The Miller – Orr’ Model

According to Merton H. Miller and Daniel Orr, Baumol’s model only determines the cash
withdrawal; however, cash is the most uncertain element of the business.

There may be times when the organization will have surplus cash, thus discouraging withdrawals;
instead, it may require to make investments. Therefore, the company needs to decide the return
point or the level of money to be maintained, instead of determining the withdrawal amount.

This model emphasizes on withdrawing the cash only if the available fund is below the return point
of money whereas investing the surplus amount exceeding this level.

4.Define Inventory Management and Explain Methods of Inventory Management.

The dictionary meaning of the inventory is stock of goods or a list of goods. In accounting language,
inventory means stock of finished goods. In a manufacturing point of view, inventory includes, raw
material, work in process, stores, etc.

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ABC Analysis
ABC analysis stands for Always Better Control Analysis. It is an inventory management technique
where inventory items are classified into three categories: A, B, and C. The items in the A category
of inventory are closely controlled as it consists of high-priced inventory, which may be less in
number but are very expensive.
Just In Time (JIT) Method
In the Just in Time method of inventory control, the company keeps only as much inventory as it
needs during the production process. With no excess inventory in hand, the company saves the cost
of storage and insurance. The company orders further inventory when the old inventory stock is
close to replenishment.
Material Requirements Planning (MRP) Method
Material Requirements Planning is an inventory control method in which the manufacturers order
the inventory after considering the sales forecast. MRP system integrates data from various areas of
the business where inventory exists.
Economic Order Quantity (EOQ) Model
Economic Order Quantity technique focuses on making a decision regarding how much quantity of
inventory the company should order at any point in time and when they should place the order. In
this model, the store manager will reorder the inventory when it reaches the reordering level.
Minimum Safety Stocks
The minimum safety stock is the inventory level that an organization maintains to avoid a stock-out
situation. It is the level when we place the new order before the existing inventory is over.
VED Analysis
VED stands for Vital Essential and Desirable. Organizations mainly use this technique for
controlling spare parts of inventory. Like, a higher level of inventory is required for vital parts that
are very costly and essential for production.
Fast, Slow & Non-moving (FSN) Method
FSN method of inventory control is very useful for controlling obsolescence. All the inventory items
are not used in the same order; some are required frequently, while some are not required at all.

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