Académique Documents
Professionnel Documents
Culture Documents
(3 credits)
Set 1
ROLL NO :
L C CODE: 02782
DDE
MBA – II Semester
MB0029 - Set 1
Financial Management
1. Explicit cost and implicit cost are the two dimensions of cost. What role
does cost play in financial decisions.
Ans.
The cost of debt has two parts – explicit cost and implicit cost. Explicit cost is the given rate
of interest. The firm is assumed to borrow irrespective of the degree of leverage. This can
mean that the increasing proportion of debt does not affect the financial risk of lenders and
they do not charge higher interest. Implicit cost is increase in Ke attributable to Kd. Thus
the advantage of use of debt is completely neutralized by the implicit cost resulting in Ke
and Kd being the same.
4. Never ignore the need for financial capital maintenance in units of constant
purchasing power.
6. Give due weightage to cost and risk in using debt and equity.
7. Keeping the need for finance for expansion of business, formulate plough
back policy of earnings.
9. Seasonal peak requirements to be met from short term borrowings from banks.
4a. Mr. Avinash aged 40 years, needs 50000 after 5 years. If the interest
rate is 10% how much should he save now to get Rs.50000 at the end
of 5 years
Ans.
FVn=PV (1+i/m)m*n
Where
i = annual nominal interest rate (as a decimal)=0.1
m = number of times the interest is compounded per year=1
n = number of years = 5
FVn = amount after time t ie 5 yrs = 50,000
PV = principal amount (initial investment=Present Value) =?
= PV (1.1)5
= PV * 1.61051
PV = 50,000/1.61051
PV = Rs. 31,046.07
Amount at the end of 3 years with 10% rate of interest = Deposit * FVIFA(10%, 3y)
Where, FVIFA = Future Value of Interest Factor for Annuity
= 1,000 * 3.310
= Rs. 3,310
Bonds are of three types: (a) Irredeemable Bonds (also called perpetual bonds) (b)
Redeemable
Bonds (i.e., Bonds with finite maturity period) and (c) Zero Coupon Bonds.
Bonds which will never mature are known as irredeemable or perpetual bonds. Indian
Companies Acts restricts the issue of such bonds and therefore these are very rarely issued
by corporates these days. In case of these bonds the terminal value or maturity value does
not exist because they are not redeemable. The face value is known; the interest received
on such bonds is constant and received at regular intervals and hence the interest receipts
resemble a perpetuity. The present value (the intrinsic value) is calculated as:
V0=I/id
If a company offers to pay Rs. 70 as interest on a bond of Rs. 1000 par value, and the
current yield is 8%, the value of the bond is 70/0.08 which is equal to Rs. 875
2) Redeemable Bonds :
There are two types viz.,bonds with annual interest payments and bonds with semiannual
Interest payments.
Bonds with annual interest payments;
The holder of a bond receives a fixed annual interest for a specified number of years and a
fixed
principal repayment at the time of maturity. The intrinsic value or the present value of bond
can be expressed as:
V0 or P0=Σ n
t=1 I/(I+kd) n +F/(I+kd) n
Which can also be stated as folloows
V0=I*PVIFA(kd, n) + F*PVIF(kd, n)
In reality, it is quite common to pay interest on bonds semiannually. the value of bonds with
semiannual interest is much more than the ones with annual interest payments. Hence, the
bond valuation equation can be modified as:
V0 or P0=Σ n
t=1 I/2/(I+id/2) n +F/(I+id/2) 2n
In India Zero coupon bonds are alternatively known as Deep Discount Bonds. For close to a
decade, these bonds became very popular in India because of issuance of such bonds at
regular intervals by IDBI and ICICI. Zero coupon bonds have no coupon rate, i.e. there is no
interest to be paid out. Instead, these bonds are issued at a discount to their face value,
and the face value is the amount payable to the holder of the instrument on maturity. The
difference between the discounted issue price and face value is effective interest earned by
the investor. They are called deep discount bonds because these bonds are long term bonds
whose maturity
some time extends up to 25 to 30 years.
6. Sushma Industries wishes to issue bonds with Rs.100 as par value, 5 years
to maturity, coupon rate 11% and YTM of 11%.
a. What is the value of the bond?
Ans.
F = Rs. 100
n = 5 years
V0 = Value of Bond = ?
(a) If kd is 11%,
V0=I*PVIFA(kd, n) + F*PVIF(kd, n)
=11*PVIFA(11%, 5) + 100*PVIF(11%, 5)
=11*3.6959 + 100*0.593
=40.6549+59.3
=Rs. 99.95
(b) If kd is 10%,
V0=I*PVIFA(kd, n) + F*PVIF(kd, n)
=11*PVIFA(10%, 5) + 100*PVIF(10%, 5)
=11*3.7908 + 100*0.621
=41.6988+62.1
=Rs. 103.79
(c) If kd is 13%,
V0=I*PVIFA(Kd, n) + F*PVIF(kd, n)
=11*PVIFA(13%, 5) + 100*PVIF(13%, 5)
=11*3.5172 + 100*0.543
=40.6549+54.3
=Rs. 94.95