Srimathe Ramanujaya Namaha Name Registration no Course Subject & Code Date Krishnan Chari 1208001521 MBA Financial

Management 19th May 2013 Semester -2 MBA0045

Answer To Q2 PV of an annuity factor of Rs 500 for 4 years Annuity 500 discount rate 10% tenor 4 years formulae = PV=A*((1+i)^n-1)/(i*(1+i)^n) Present value Present value of cash flow annuity =PV annuity factor x cash factor flow, 0.909 454.5 0.827 413.5 0.751 375.5 0.683 341.5 3.17 1585

Year=n 1 2 3 4

Cash flow 500 500 500 500

Present value discounted at 10%, given by ( cash flow/(1+0.10)^n (500/(1+0.10)^1 (500/(1+0.10)^2 (500/(1+0.10)^3 (500/(1+0.10)^4 Total sum ( PV FACTOR)

The present value of an annuity cash flow of Rs 500 received every year for 4 years is therefore Rs 1585

Answer q3. Based on the data provided, we use the dividend growth model to estimate the cost of equity capital Currnet market price per share Rs 110 Dividend expectation in period is Rs 5 per share Growth rate in dividends is 10% p.a The dividend growth rate model for cost of equity is given by Cost of equity (K)= (D/Pe)+g Where D = dividend expectation Pe= current price of equity g= the growth rate in equity dividends using the above data , the cost of equity as per dividend growth model works out to be as follows Cost of equity =(5/110)+(10%)= 4.55%+10% =14.54% p.a

Answer to question 5 Initial outlay of investment is Rs 1,00,000 The risk free rate and the risk premium is 10% p.a Based on the cash flow structure, the NPV is computed first using the discount rate as risk free rate at 10% as follows Cash flow Cash outflow inflow 0 -100000 0 1 40000 2 50000 3 15000 4 30000 PV factor formula 1/(1+0.10)^1 1/(1+0.10)^2 1/(1+0.10)^3 1/(1+0.10)^4 PV factor 1 0.909 0.826 0.751 0.683 PV of cash inflows 36364 41322 11270 20490 109446 PV of cash outflows 100000

Year

100000

NPV of the project is the PV of cash inflowPV of Cash outflow

9446

Answer Q5 continued

Under the second scenario, the NPV of the project is computed using the risk free rate of 10% and also the risk premium of 10% which results in the discount rate being increased to 20%. The NPV of the project after valuing the cash inflows and outflows of the project at 20% p.a is as follows
Year 0 1 2 3 4 Cash flow outflow -100000 Cash inflow 0 40000 50000 15000 30000 1/(1+0.20)^1 1/(1+0.20)^2 1/(1+0.20)^3 1/(1+0.20)^4 PV factor 1 0.833 0.694 0.579 0.482 33333 34722 8681 14468 91204 100000 PV of cash inflows PV of cash outflows 100000

NPV of the project is the PV of cash inflow-PV of Cash outflow

-8796

When the discount rate includes the risk premium the NPV of the project is in the negative and indicates that the project should rejected as it does not recover the financial risk of the project investments

Answer to Q4.

The basic assumptions of the Modiflani Miller model of capital structure and firm valuations are as under : Perfect capital markets : According to this assumption, securities can be freely traded where in investors can buy and sell securities without transaction cost , securities are infinitely divisible and availability of all required information at all times. Rationale behavior of investors : Investors are assumed to behave rationally meaning using the right combination of risk and return. Homogenous risk perception : It is assumed that risk perception across investors is the same in term sof business risk and uncertainty of returns. Dividend payout is assumed to be 100% of the corporate earnings.

The value of the firm is independent of the degree of financial leverage obtained by the firm. This is a proposition of MM approach to value of the firm.

Answer to Q6. Credit policy of the company sets standards for management of the account receivable or debtors of the company and also the terms of doing business with its customers. Some of the critical areas that a credit policy must address or focus on are as follows. 1.Credit terms : The credit policy should specify the reasonable terms on which the company should offer credit terms for customers say in no of days credit such as 30 days or 45 days etc. The policy should specify clearly the distinct credit terms that should be offered as between institutional and retail clients. For institutional clients who form part of distributional chain, credit terms may be longer than that offered for retail clients. Companies generally sell their commodities in cash for the retail segment and only 2. Cash discount : The credit policy should also address the cash discounts that it needs to offer for customers for any early payments made. For example it may be clearly state that cash discount of 2% will be provided for any early payments over the traditional 30 day credit period. 3. Receivables management : The credit policy should also adhere to management of receivables in the sense it should lay down the standard operating procedure for the following a) Routine follow up and reporting of aging of receivables b) Methods of dealing with doubtful and default receivables