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Financial Management
M!OF "#2D$
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SAP NO'REGN NO% &&&&&&&&&&&&&&&&&&&&&&&
Section A (20 Marks)
Write short notes on any four of the following
1. Leasing as a Source of Finance
2. Portfolio Diversification and Risk
3. heories of ca!ital structure
". Different ca!ital #udgeting a!!raisal $ethods
%. &o$!onents of working ca!ital
Section B (30 marks)
(Attempt any three)
1. Define the ter$ 'cono$ic value added. (ow is it calculated)
2. Descri#e the #asic as!ects of the conce!t of cost of ca!ital.
3. '*!lain the conce!t of financial leverage and its i$!act on 'PS.
". What is $eant #y ca!ital rationing) What are the ste!s involved in ca!ital rationing)
Section C (50 marks)
(Attempt all questions. Eery question carries !0 marks)
Read the case +'cono$ic ,alue -dded. and answer the following .uestions/
Case Stu"y# Economic $alue A""e"
While 0value1 is a general ter$2 +value added3 has s!ecific $eanings. 4 teach 5anage$ent
-ccounting and when 4 say +What is value added)3 $ost of the students would say that it is
0adding a feature to a !roduct1. 4t $ay #e !roduct develo!$ent #ut not necessarily value
addition. 4 !oint to a $ulti$edia hanging fro$ the ceiling and say +his is !resently rotated
$anually. 4ts !resent !rice is Rs."%2666. 4f the $anufacturer introduces a feature for rotating
through a re$ote control at an additional cost of Rs.1%26662 would it #e called value addition)3
5ost $ay#e inclined to say2 +7es Sir32 #ut it is +8o Sir.3
Why2 no one would !ay a hefty su$ of Rs.1%2666 for the new feature. 'ven if so$eone is willing
to !ay2 it still does not add any value. 4t is only when the $anufacturer can fetch say Rs.9%26662
value addition has occurred. 4n this way2 #y using a feature costing Rs.1%26662 the $anufacturer
has reali:ed an additional Rs.262666 there#y increasing the #otto$ line #y Rs.%2666.
4ts Profit ; Loss -ccounts for the last year are given #elow/
-n entity can increase ,alue addition #y <i=#ringing u! new !roducts or services which have a
higher value in the eyes of a custo$er than the cost of in!uts used such as $aterials2 co$!onents
and services used to $ake the$2 <ii= ca!ture un>ta!!ed $arket of new seg$ents or geogra!hical
areas2 <iii= i$!roving .uality and raising !rices2 <iv= reducing costs #y switching over to chea!er
raw $aterials2 si:e reduction and co$#inations2 and finally <v= reducing2 as far as !ossi#le2 non>
value added activities such as setu!2 storage2 trans!ortation2 wait and ins!ection.
4n econo$ics2 the value addition is calculated #y the following for$ula/
,alue -dded ? ,alue of sales less the cost of #ought>in goods and services.
4n this for$ula2 only cost of #ought>in goods and services has #een accounted for. 4t co$!letely
ignores la#our cost2 de!reciation2 $ark>u! etc. 4n fact2 they are factors of !roduction <land2
la#our and ca!ital=. hey !rovide +services3 which raise value of +in!uts3 to a $uch higher
reali:ed value. he difference would #e shared a$ong the$.
he ,alued added in our e*a$!le and its distri#ution is shown in the #elow ta#le/
hen what is 'cono$ic ,alue -dded)
'cono$ic ,alue -dded <',-= concentrates only on one of the factors of !roduction i.e. &a!ital.
4t $easures sur!lus value created #y total invest$ents which include funds !rovided #y #anks2
#ond>holders and share holders. 4t is $ore useful than Rate of Return <R@4= or 4nternal Rate of
Return <4RR=in evaluating o!erations of an enter!rise.
-ccounting !rofessor Steven @r!urt fro$ Singa!ore 5anage$ent Aniversity e*!lains/ +@ne of
the !ri$ary insights fro$ the ',- conce!t is recognition that growing earnings does not
necessarily increase fir$ value or stock !rice. ',- focuses attention on how a fir$ uses its
ca!ital #y asking2 +4s a fir$ generating earnings a#ove and #eyond that e*!ected #y the $arket
<the !roviders of the ca!ital=)3
(ow relevant is ',- today) Res!onds Stern2 +So$e $ay say that ',- was a fad of the 1BB6s2
#ut earning $ore than the cost of ca!ital is not a fad. 4t is what all co$!anies should do all of the
ti$e. hat they do not is sur!rising. -ll of the talk on governance2 also not a fad2 never
de$anded this si$!le re.uire$ent. Antil #oards do2 ',- will re$ain as relevant as it was in the
he relevant for$ula is/
',-? <Return on &a!ital > &ost of &a!ital= * otal &a!ital
We need three figures/
1. 8@P-
2. 4nvest$ent
3. W-&&
Cy dividing 8@P- with 4nvest$ent2 we get returns in !ercentage. Fro$ this2 we deduct -W&&
which is also in !ercentageD the difference would show E!rofit !er ru!ee. Cy $ulti!lying this
with total ca!ital2 we ca!ture ',- in ru!ee>ter$s.
1. '*!lain the ter$ value added.
2. (ow can an entity increase its value addition)
3. Descri#e with for$ula2 how is value addition calculated)
". (ow do we get returns in !ercentage)
%. Read and su$$arise the case in a#out %6 words.