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MB0045_MBA_Sem2_Fall/August 2012

Master of Business Administration - MBA Semester 2


MB0045 Financial Management - 4 Credits
Assignment Set- 1 (60 Marks)
Note: Each question carries 10 Marks. Answer all the questions.
Q.1 Considering the following information, what is the price of the
share as per Gordons Model?
Details of the Company
Net sales
Net profit margin
Outstanding preference
shares
No. of equity shares
Cost of equity shares
Retention ratio
Rate of interest (ROI)

Rs.120 lakhs
12.5%
Rs.50 lakhs@ 12%
dividend
25, 000
12%
40%
16%

Answer :

Q.2 Examine the components of working capital & also explain the
concepts of working capital.
Answer : There are two important concepts of Working Capital gross
and net

Gross Working Capital: Gross Working Capital refers to the amounts


invested in the various components of current assets. This concept has the
following practical relevance.
a. Management of current assets is the crucial aspect of Working Capital
Management.
b. It is an important component of operating capital. Therefore, for improving
the profitability on its investment a finance manager of a company must give
top priority to efficient management of current assets.
c. The need to plan and monitor the utilization of funds of a firm demands
working capital management as applied to current assets.

d. It helps in the fixation of various areas of financial responsibility.

Net Working Capital


Net Working Capital is the excess of current assets over current liabilities and
provisions. Net Working Capital is positive. when current assets exceed current
liabilities and negative when current liabilities exceed current assets. This
concept has the following practical relevance.
1. It indicates the ability of the firm to effectively use the spontaneous finance in
managing the firms Working Capital requirements.
2. A firms short term solvency is measured through the net Working Capital
position it commands.
Permanent Working Capital
Permanent Working Capital is the minimum amount of investment required to be
made in current assets at all times to carry on the day to day operation of firms
business. This minimum level of current asset has been given the name of core
current assets by the Tendon Committee. It is also known as fixed Working
Capital.

Temporary Working Capital


It is also known as Variable Working Capital or fluctuating Working Capital. The
firms working capital requirements vary depending upon the seasonal and
cyclical changes in demands for a firms products. The extra Working Capital
required as per the changing production and sales levels of a firm is known as
Temporary Working Capital.

The main components of working capital are :

Cash. Cash is one of the most liquid and important components of


working capital. Holding cash involves cost because the worth of cash
held, after a year will be less than the value of cash as on today. Excess of
cash balance should not be kept in business because cash is a non-earning
asset.-Hence, a proper and judicious cash management is of utmost
importance in business.
Marketable Securities. These securities also don't give much yield to
the business because of two reasons, (I) Marketable securities act as a
substitute for cash, (ii) These are used are temporary investments. These
are held not for speculative balances, but only as a guard against possible
shortage of bank credit.

Accounts Receivable. Too many debtors always lock up the firm's


resources especially during inflationary tendencies. This is a two step
account. When goods are sold, inventories are reduced and accounts
receivables are created. When payment is made, debtors reduce and cash
level increases. Thus, quantum of debtors depends on two things, (I)
volume of Credit sales (ii) average length of time between sales and
collections. The entrepreneur should determine the optimal credit
standards. An optimal credit policy should be established and the firm's
operations should be continuously monitored to achieve higher sales and
minimum bad debt losses.
Inventory. Inventories represent a substantial amount of firm's assets.
Inventories must be properly managed so that this investment doesn't
become too large, as it would result in blocked capital which could be put
to productive use elsewhere. On the other hand, having too little or small
inventory could result in loss of sales or loss of customer goodwill. An
optimum level of inventory, therefore, should be maintained.

Q.3 Internal capital rationing is used by firms for exercising financial


control. How does a firm achieve this?

Q.4 What are the objectives of working capital management? Briefly


explain the various elements of operating cycle.
Q.5 Define risk. Examine the need for assessing the risks in a project.

Q.6 Briefly examine the significance of identification of investment


opportunities in capital budgeting process

MB0045_MBA_Sem2_Fall/August 2012
Master of Business Administration - MBA Semester 2
MB0045 Financial Management - 4 Credits
Assignment Set- 2 (60 Marks)
Note: Each question carries 10 Marks. Answer all the questions.
Q.1 Examine the reasons for holding inventories by a firm & also
discuss the techniques of inventory control.

Answer : Whether a business is in retailing or manufacturing, there are several


cogent reasons for holding inventory. Businesses may hold stocks of raw
materials, spare parts for machinery, work in progress or finished goods. Given
that there are costs involved with purchases, orders and carriage inwards, a firm
might want to minimize its order costs and utilize storage space efficiently. While
a business would incur holding costs when storing inventory, these costs can be
offset if there are good business reasons for so doing.

== To meet expected demand ==

A business must ensure that it has adequate supplies to meet expected demand
for its goods, regardless of whether it is a retailing or production environment.
Particularly where a business has a high demand and rapid turnover, having
stock in storage ensures that the firm can comfortably meet anticipated demand.

== To guard against shortages ==


Holding inventory can act as insurance against future shortages. Unexpected
shortages in the supply of raw materials or finished goods can affect the
production run of a business or its ability to meet demand. Holding inventories
allows a degree of continuity for the activities of an enterprise.

== To benefit from discounts ==


Suppliers often offer trade discounts for bulk purchases, once those purchases
are above a certain amount. A business can reduce the unit cost of materials and
its ordering costs (delivery, import duties) by purchasing a large amount of
goods/ raw materials to hold in stock.

== To deal with variations in usage or demand ==


"Usage" refers to production consumption in a manufacturing process. Increased
usage can increase the demand for materials. This is the result of either
increased inefficiency or increased production levels. Sometimes a business
might cater for special orders or have high seasonal demand that it must
address, requiring additional stock to facilitate such occurrences.

== To facilitate the production process ==

Stock can allow the manufacturing process to flow smoothly and help the
business to respond quickly and effectively to contingencies.

== In times of high inflation/ supply shortages ==


Holding vast supplies of inventories can be a deliberate strategy in response to
unusual or difficult economic circumstances. In times of high inflation, a business
might not wish to purchase stock at increasingly higher prices. Once the business
determines that it is feasible to hold additional inventory beyond the usual
levels, this is a very sensible strategy.

== Some processes require holding work in progress ==


Inventory can also include work in progress. Some products might have longer
production cycles than others (like wine or cheese for instance). It is necessary to
hold a high volume of inventory to cater for the inherent nature of production in
some business contexts.

Techniques of Inventory control


Naturally, there are restrictions on how much inventory a business could or
should hold. The nature of the product, regulations and maximum storage
capacity are some elements that limit or deter a business from holding too much
inventory. Once a business decides to hold inventory, then a proper inventory
management and control system is necessary to optimize both the stock levels
and inventory costs.

There are several techniques a person can use to increase profitability and
streamline workflow via proper inventory control. Through research, competitive
analysis and experience, an effective business leader can balance costs versus
benefits to storing and ordering the necessary supplies to ensure business
vitality. The supply chain is made of all materials that help you to produce,
market and supply your product. Inventory control means that you have
identified every facet of your supply chain and its logistics.

FIFO
If you deal in perishable items, FIFO (first in, first out) is an important concept to
understand and maintain throughout the supply chain. If a grocery store did not

rotate their stock, new stock coming in would get taken immediately and older
stock would expire, causing great loss. Stock must be arranged by date received.

Cutting Edge Control


For a great deal of stock that needs constant management, consider bar codes or
RFID (radio frequency identification) where hand-held readers can immediately
tell you where valuable merchandise is. Many IT inventory programs on the
market provide a wealth of features including tie-ins to USPS, Fed-Ex and/or UPS
to track merchandise and provide real-time logistics.

Costs versus Convenience


A business owner must balance space available for extra stock versus speed of
product turnover, fees for storage, cost in bulk versus regular ordering, and
whether clients/end users would be willing to wait.

Stock Levels
Defining your minimum stock level will allow you to set up regular inspections
and re-ordering of supplies. Take into account emergencies and vendors taking
longer than average to replenish stock. This will aid you in arriving at JIT (just in
time) ordering, where stock is held for a minimum amount of time before moving
on to the next stage in the supply chain.

Your Security
Stock security is a necessary cost. Many experts recommend separating staff
that is responsible for stock management from staff that has financial
responsibility. Many times, shoplifting and thievery is committed by employees
rather than a stranger. Security guards, cameras, bar codes and security devices
are used by most businesses since the cost of security is minimal compared to
the millions of dollars that U.S. businesses lose each year to stolen goods.
Training staff in identifying potential security issues and having a clear method of
reporting violations is important in reducing crime. Often, shoplifters and thieves
use standard techniques to distract employees and take stock.

Stock on Hand
Having a great deal of stock on hand has both positive and negative
consequences. Having an immediate supply means that end users get their
product that much sooner. Speed and immediate gratification for a client can

make the difference not only in a sale, but recommendations, repeat business
and client loyalty. In the modern business environment where every business is a
global business, an emergency or unforeseen circumstance anywhere in the
world can render competition without resources you have on hand. Of course,
one must take into account using capital in bulk buys, management and
insurance costs as well as goods perishing or becoming obsolete.

Q.2 a.) A bond of Rs. 1000 value carries a coupon rate of 10% and has a
maturity period of 6 years. Interest is payable semi-annually. If the
required rate of return is 12%, calculate the value of the bond.
( 5marks)

b.) A bond whose par value is Rs. 500 bearing a coupon rate of 10% and
has a maturity of 3 years. The required rate of return is 8%. What
should be the price of the bond? ( 5marks)
Answer :

Q.3 Examine the features & evaluation of decision-tree approaches.


Q.4 If the EPS is Rs.5, dividend pay-out ratio is 50%, cost of equity is
20% and growth rate in the ROI is 15%. What is the value of the stock
as per Gordons Dividend Equalisation Model?
Q.5 Critically examine the pay-back period as a technique of approval of
projects.
Q.6 Two companies are identical in all aspects except in the debt-equity
profile. Company X has 14% debentures worth Rs. 25,00,000 whereas
company Y does not have any debt. Both companies earn 20% before
interest and taxes on their total assets of Rs. 50,00,000. Assuming a
tax rate of 40% and cost of equity capital to be 22%, find out the value
of the companies X and Y using NOI approach.
Answer :