FM Revision 3rd Year

Bhalotia Classes (9883034569): Admission Going for Crash Course
[Red: 90 %, Blue: 60 %, Green: 30 %]
[Practical: 62 Marks Approx]

Practical: Working Capital Management 10 Marks
Practical: Leverage 6 Marks
Practical: Cost of Capital 10 Marks
Practical: Basic Concept 5 + 5 = 10 Marks
Practical: Dividend policies 10 Marks
Practical: Capital Budgeting 6 + 10 = 16 Marks
[Compulsory Theory: 38 Marks]

Theory: Introduction: 6 Marks
Theory: Working Capital Management 6 Marks
Theory: Financial Control 6 Marks
Objectives 20 Marks
[OPtional Theory: 30 Marks]

Theory: Basic Concept: 5 Marks
Theory: Capital Structure 10 Marks
Theory: Dividend policies 10 Marks
Theory: Capital Budgeting 5 Marks
- 1 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

Working Capital Management

[10 Marks]
1. Working Capital management [B.com 1995 Honours] [RKB]*
From the following informations of Sunshine Paints Ltd. You are required to determine the Working
Capital Requirements :
(i) Annual (expected) Sales ₹ 3,60,000
(ii) Analysis of Sales :-
Raw materials 50%
Expenses 30%
Profit 20%
(iii) Credit allowed to Debtors 2 ½ months
Credit allowed by Creditors l ½ months
Raw Materials in store 1 month
Processing period 2 months
Finished goods in Store 4 months
Bank Overdraft ₹ 1,00,000
Cash in hand for contingencies ₹ 6,000
Production is carried out evenly during the year and expenses accrue similarly.
[Ans. Net working capital (including Cash) ₹ 2,08,500; Monthly Production and Sale ₹ 30,000;
Collected ₹ 1,00,000 from Bank Overdraft and balance from other sources.]
2. Working Capital management [B.com 1988 Honours] [RKB]*

From the following information of Bright Ltd., you are required to determine working capital requirement.
(a) Annual expected sales —₹ 1,20,000
(b) Analysis of sales :—
Material—60 %, Expenses—15 %; Profit—25 %;
(c) Credit allowed to Debtors —2 ½ months
(d) Credit allowed by Creditors — 1 ½ months
(e) Raw materials in store—1 month
(f) Processing Period—2 months
(g) Finished goods in store—3 months
(h) Bank overdraft —₹ 80,000
(i) Cash in hand for contingencies—₹ 5,000
(j) Production is carried on evenly during the year and expenses accrued similarly.
[Ans. Net working Capital (including Cash) ₹ 63,000; Monthly Production ₹ 10,000; Only Bank
Overdraft of ₹ 63,000 Can be withdrawn and to be used.]

3. Working Capital management [B.com 2013 Pass]
From the following information prepare a statement showing estimated working capital requirement of
Woodpecker Ltd.:
Projected Annual Sales 5200 units
Selling price per unit ₹ 60
Analysis of selling price:
Material: 40%; Labour: 30%; Overhead: 20%; profit: 10%
Time lag on an average:
Raw material in stock 3 weeks
Production process 4 weeks
Credit to debtors 5 weeks
Credit from suppliers 3 weeks
Lag in payment of wages and overhead 2 weeks
Finished goods are in warehouse 2 weeks
Cash in hand is expected to be 10% of net working capital.
[Ans. Net working capital (including Cash) ₹ 56,000]

From the following information extracted from the books of Rubies Ltd, prepare a statement showing
the working capital requirement needed to finance a level of activity of 5200 units of output per annum:
Amount per unit (₹)
Raw materials 8
Direct labour 2
Overheads 6
Total Cost 16
Profit 4
Selling price
20
Raw materials are in stock on an average for-1 month
Materials are in process- month
Finished goods are in stock-6 weeks
Credit allowed by creditors-1 month
Credit allowed by debtors- 2 months
Log in Payment of wages-1 month
Cash in hand and at bank-₹ 7300
The production is carried on evenly during the year and wages and overheads accrue similarly.
[Ans. Net working capital (including Cash) ₹ 36,311]

From the following particulars of Moon Ltd. Determine the working capital requirement:
(a) Monthly Sales (expected): 10,000 units of ₹ 10 each.
(b) Analysis of Sales: Materials 40%, Labour 30%, Overhead ₹ 8,000 per week.
(c) Stock will include raw materials of ₹ 48,000 and 8,000 units of finished goods.
(d) Processing period – 2 weeks
(e) Credit to debtors – 5 weeks
(f) Credit from creditors – 1 month.
(g) Lag in payment of overhead – 2 weeks.
Production is carried on evenly during the year and expenses accrue similarly.
[Ans. Net working capital (excluding Cash) ₹ 2,34,100]

Leverage [6 Marks]
1. Leverage [Compiled by Ravi Bhalotia]*
D Limited Furnishes the following results for the year 2004-05:
Sales 2,00,000 units @ ₹ 100 per unit
Variable cost ₹ 40 per unit
Operating fixed cost (i.e. Depreciation, rent, salary etc.) ₹ 60,00,000
Financial Fixed cost (i.e. interest on borrowed capital) ₹ 20,00000
Compute (a) DOL ; (b) DFL; (c) DCL
2. Leverage Compiled by Ravi Bhalotia]*

The particulars of three firms X, Y and Z are given below. Calculate DOL; DFL and DCL
X Y Z
Sales Value (₹) 50,000 50,000 50,000
Variable cost (₹) 30,000 20,000 15,000
Fixed cost (operating) (₹) 10,000 20,000 25,000
Fixed Financial Cost (₹) 3,500 2,000 1,000
3. Leverage [B.com 2018 Pass]*

From the following information calculate Degree of operating Leverage (DOL), Degree of Financial
Leverage (DFL) and Degree of Combined Leverage (DCL):
a) Sales Rs. 9,60,000
b) Variable Cost Rs. 5,60,000
c) Fixed Cost Rs. 2,40,000
d) Interest Rs. 60,000

Megabyte Ltd made a sale of ₹ 20, 00,000. Variable cost was ₹ 14, 00,000. Fixed cost was ₹ 4, 00,000
and Debt ₹ 1, 00,000 @ 10% interest per annum. Determine the degree of operating and financial
leverage of the company.

A simplified income statement of Fortune Ltd. Is given below:
Sales ₹ 12, 00,000
Variable cost ₹ 9, 00,000
Fixed cost ₹ 1, 00,000
EBIT ₹ 2, 00,000
Interest ₹ 70,000
Tax (30%) ₹ 39,000
Net Income ₹ 91,000
Calculate the following:
i. Degree of Operating Leverage
ii. Degree of Financial Leverage
iii. Degree of Combined Leverage

Calculate different types of Leverages and EPS of ABC Ltd. from the following information:
Equity share capital (12,000 shares @ Rs. 10 each) Rs. 1,20,000
Retained Earnings Rs. 40,000
10% Debentures Rs. 1,60,000
Turnover Rs. 12,00,000
Fixed operating cost Rs. 1,00,000
Variable operating cost ratio 40%
Income tax rate 40%
7. Leverage [B.com 2013 Hons Old]*

Calculate different types of Leverages from the following data:
Sales : 50,000 units @ ₹ 40 per unit
Variable cost per unit : ₹ 12
Operating Fixed Costs : ₹ 5, 00,000
Shareholders‘ fund : ₹ 20, 00,000
Debt equity Ratio : 1.5:1
Rate of Interest : 10%
9. Leverage [Compiled by Ravi Bhalotia]****

Calculate the PBT and Financial Leverage if
Net Worth = Rs 25 lakhs ;
Debt / Equity = 3:1;
Interest rate = 12% ;
Operating Profit = Rs 20 lakhs.
19. Leverage [B.com 2014 Pass]******

A company is expanding its activity for which it needs ₹ 20, 00,000. It has the following three
alternative financial plans:
i. It can issue 20,000 equity shares of ₹ 100 each
ii. It can issue 10,000 equity shares and 10,000 preference shares, both of ₹ 100 each. The
preference shares will carry 12% dividend.
iii. It can issue 10,000 equity shares of ₹ 100 each and raise term loan of ₹ 10, 00,000 at 14%
rate of interest.
Show the earnings per shares under the three different financing plans when EBIT levels are ₹ 1,
00,000, ₹ 2, 00,000, ₹ 3, 00,000, ₹ 4, 00,000. Which plan would you recommend and why? The
present corporate income tax rate is 50%.
22. Leverage [B.com 2006] ***

A firm has sales of ₹ 5,00,000, variable cost of ₹ 3,50,000 and fixed cost of ₹ 1,00,000 and debt of
₹ 2,50,000 at 10% rate of interest. What is Combined Leverage ?
26. Leverage [B.com 2016 Pass]

A company provides you with the following information: Capital structure –
Rs.
10,000 equity shares of Rs. 10 each 1, 00,000
Debenture ---------
EBIT 2, 00,000
Tax Rate 50%
Change in EBIT 20%
Show the effects of proposed change in EBIT on EPS and comment on it.
Cost of capital [10 Marks]

1. Cost of capital [Cost of Equity Shares] [B.com Honours 2006, 2018 Pass]*
A company's share is currently quoted in the market at ₹ 20. The company pays a dividend of ₹ 2
per share and the investors expect a growth rate of 5% per year. You are required to calculate (a)
Cost of equity capital of the company and (b) the market price per share, if the anticipated growth
rate dividend is 7%. [Answer: (a) 15 %; (b) ₹ 25]
11. Cost of capital [Cost of Redeemable Pref. Shares] [B.com 06]*

A company issues 12% redeemable preference shares of ₹ 100 each at 5 % premium redeemable
after 15 years at 10% premium. If the floatation cost of each share is ₹ 2, what is the value of K p
(Cost of Preference share) to the company?
[Answer: 11.71 %]
12. Cost of capital [Cost of Redeemable Preference Shares] [2015 Pass]*

JK Ltd. Issues – 10,000, 10% preference shares of ₹ 100 each at a premium of 10% but redeemable at a
premium of 15% after 5 years The cost of issue is ₹ 5 per share. You are required to determine the cost
of preference share capital.
[Answer: 10.91 %]
14. Cost of Capital [Redeemable P. Share Capital] [B.com Honours 17]****

Z Ltd. issued 10,000, 12% preference shares of Rs. 100 each at a premium of 10%. The flotation cost
was 5% on issue price. The preference shares will be redeemed at a premium of 20% after five years.
The tax rate applicable to the company is 30%. The corporate dividend tax is 10%. Compute cost of
preference shares of Z Ltd.
17. Cost of capital [Redeemable debenture] [B.com 2007]***

Rima & Co. has issued 12% Debenture of face value ₹ 100 for ₹ 10 lakh. The debenture is expected to
be sold at 5% discount. It will also involve floatation costs of ₹ 5 per debenture. The debentures are
redeemable at a premium of 5% after 10 years Calculate the cost of debenture if the tax rate is 50%.
[Ans. 7.69 %]
18. Cost of Capital [Cost of retained Earning] [B.com 2018 Pass]*

Find out the cost of retained earnings from the following information
Cost of capital=10%, brokerage cost =2% and tax rate =50%

19. Cost of capital [WACC] [2014 Pass]
The following information is extracted from the books of A Ltd:
Capital structure---
Source ₹ After tax cost
Equity Shares Capital 4,00,000 16%
Retained Earning 1,00,000 16.5%
Preference Share Capital 3,00,000 12%
Debenture 2,00,000 10%
10,00,000
Calculate the weighted average cost of capital on the basis of book value weights. [Ans. 13.65 %]
20. Cost of capital [WACC] [2016 Pass]

ABC Ltd has the following capital structure:
₹
Equity share Capital (expected dividends 15%) 8,00,000
12% Preference Share Capital 5,00,000
10% Debenture 4,00,000
8% Long-Term Loan 3,00,000
You are required to calculate the weighted average cost of capital before and after tax, assuming 40% as
the rate of income tax.
21. Cost of Capital [WACC] [B.com Honours 2009]***

The Capital structure and specific cost of capita! (after tax) of a company are given below:
Sources Book Value After Tax
Rs. in lakh Cost %
Equity Share Capital (Share of ₹ 10 each) 200 18
Retained Earnings 100 18
Long-term Debt 200 6
500
The present market value of equity is ₹ 90 per share. Corporate tax rate is 40%.
(1) Calculate weighted average cost of capital using:
(i) Book values as weights
(ii) Market values as weights.
[Ans. Weighted Average Cost of Capital (i) Using Book Value as Weight 13.20% and (ii) Using
Market Value as Weight 16.80%]
22. Cost of Capital [WACC] [B.com Honours 2008, 2018 Honours type]***
RIL Ltd", opts for the following capital structure:
Equity Shares (1,00,000 shares) ₹ 50,00,000
15% Debenture ₹ 50,00,000
Total ₹ 1,00,00,000
The company is expected to declare a dividend of ₹ 5 per share. The market price per share is ₹ 50. The
Dividend is expected to grow at 10 %. Compute weighted average cost of capital of RIL Ltd. assuming
50 % tax rate.
[Weighted Average Cost of Capital 13.75%; cost of Equity 20% and cost of Debenture (after tax)
= 7.5%]

Basic Concept [10 Marks]

1. Basic concept [Future value of one time deposit] [B.com 2007]****
Shubha invested ₹ 10,000 at an interest of 12% p.a. for 3 years Compute future value of investments
assuming interest is compounded quarterly. Given FVIF (3, 12) = 1.4262
[Answer ₹ 14,262]
2. Basic concept [F. Value] [2013 Honours old, 2015 Hons, 2016 P]****
Compute the compound value when ₹ 5000 is invested for 3 years and the interest on it is compounded
at 12% p.a. quarterly.
[Answer: ₹ 7,129]
3. Basic concept [Future value of one time deposit] [2013 Pass]****

A trader deposited ₹ 4, 00,000 in a bank @8% p.a. compounded interest for 5 years How much will he
get at the end of 5 years? [Compounded value of Re.1 for 5 years @ 8% p.a.=1.469]
[Answer: ₹ 5,87,600]
5. Basic concept [Present value] [B.com 2018 Honours]****

A fixed deposit receipt has a maturity value of Rs. 1,33,100. What is the amount at which the fixed
deposit has been initially purchased if compound interest rate is 10% p.a. and the maturity period is 3
years
6. Basic concept [Present value] [B.com 2007]****

Naba is offered either to receive ₹ 5,000 one year from now or ₹ 7,000 five years from now. Which one
Naba will accept and why if discount rate is 10 %? Given, present value of Re 1 at 10 % are .909 and
.621 for 1st and 5th year respectively.
[₹ 4,545, ₹ 4347 Option I]
9. Basic concept [Present value] [B.com 2017 Honours]****

X borrows Rs. 59,36,000 from Y at a compound interest rate of 12% p.a. it is agreed that the loan shall
be payable in two equal instalments, which shall be payable at the end of the 1st year and 2nd year
respectively. Calculate the amount of instalments.
12. Basic concept [B.com 2014 Pass]****

Mrs. Dasgupta has two options at the time of her retirement:
Option A: Receive ₹ 10, 00,000 as on the date of retirement.
Option B: Receive ₹ 1, 00,000 as an annual pension over 20 years.
If the discount rate is 12%, which option should she choose?
[Present value of 1 rupee @12% over 20 years is 7.469].
[Answer: Option A ₹ 10,00,000; Option B ₹ 7,46,900]

The present value of certain sum of money is more valuable than the future value of the same amount. –
Explain with reasons.
Dr. Kanjilal is given the following two options by his employer at the time of his retirement:
Option I –An annual pension of Rs. 50,000 as long as he lives
Option II – A lump sum payment of Rs. 3,00,000
If he expects to live for 15 years and his time preference for money is 12%, which option should he
choose
[Given PVIF12,15 =6.811]
15. Basic concept [B.com 2018 Honours]****

Mr. Sen estimates that he needs to withdraw Rs. 2, 40,000 every year from his bank for the next three
years. He wants to know the amount of deposit he should have in his bank today to meet the above
requirement if the rate of interest is 4% p.a. (Given PVIFA4%,3=2.775).

Mr. Bhattacharya borrows ₹ 15, 00,000 to buy a bungalow in Rajarhat. He wants to repay this amount in
15 equal annual instalments. The loan has been taken from a commercial bank which charges interest @
10% p.a. What is the amount of each annual instalment? [PVIFA10, 15 = 7.606]
[Answer: ₹ 1,97,212.73]
17. Basic concept [B.com 2014 Honours]****

If the loan amount is ₹ 10 lakhs, tenure is for 3 years and rate of interest is 12%, find out equated annual
instalment. (PVIFA 12%. 3=2.40).
[Answer: ₹ 4,16,667]
18. Basic concept [Compiled by Ravi Bhalotia]*

₹ 5,000 is paid every year for 10 years to pay off a loan. What is the loan amount if interest rate be
14% per annum compounded annually? Given PV (10, 0.14) = 5.21611
[Answer ₹ 26,080.55]
19. Basic concept [Compiled by Ravi Bhalotia]*

Y bought a TV costing ₹ 13,000 by making a down payment of ₹ 3,000 and agreeing to make equal
annual payment for 4 years How much would be each payment if the interest on unpaid amount be
14% compounded annually? Given PV (4, 0.14) = 2.9137
[Answer Rs 3,432.05]

Dividend policies [10 Marks]

1. Dividend policy [Gordon‘s Model] [2015 Pass]
From the following information, calculate value per equity share on the basis of Gordon‘s Model.
Earnings per share ₹ 6, Internal rate of return is 30 percent and cost of capital is 10 percent. Dividend
payout ratios are 60% and 100%.
[Answer: (i) Not Possible, (ii) ₹ 60]
2. Dividend policy [Gordon‘s Model] [08 Hons, 2013 Pass, 2013 Hons. old]**
The following information is acquired from XYZ Ltd. Net earnings -₹ 1,00,000. Equity Capital 5,000
shares of ₹ 10 each, cost of capital 10%, expected rate of return (i) 9 %, (ii) 10 % (iii) 12 %
Assuming the dividend payout ratios are 0%, 50% and 100% respectively determine the, effect of
different dividend policies on the share price of XYZ Ltd. for the above mentioned three alternatives
levels of return using Gordon's model.
3. Dividend policy [Gordon‘s Model] [B.com 2018 Honours]**

The earning per share of a company is Rs. 8 and the rate of capitalization applicable is 10 %. The
company has before it, an option of adopting (a) 50%, (b) 75%, and (c) 100% dividend payout ratio.
Compute the market price of the company‘s quoted shares as per Gorden‘s Model if the company can
earn a return of (a) 15% (b) 10% and (c) 5%.
4. Dividend policy [Gordon‘s Model] [B.com 2017 Pass]***

From the following particulars relating to R Limited determine the market price of a share using
Gordon‘s Model:
Total Investment in shares ₹ 10,00,000
No. of shares 50,000
Total earning ₹ 2,00,000
Cost of capital 16 %
Dividend Payout ratio 40 %
[Answer: ₹ 40]
8. Dividend policy [Walter‘s Model] [B.com 2009 Honours]*

Z Co. Ltd. has an investment of ₹ 10,00,000 in equity share of ₹ 100 each. The profitability rate of the
Company is 16%. Pay out ratio is 80 %. Cost of Capital is 10 %. What will be the price per share as per
Walters Model ? Do you consider the given payout ratio as optimum ?
[Ans. Price per share at 80 % Pay out - ₹ 179.20 and Price at optimum Fay out Ratio = ₹ 256]
9. Dividend policy [Walter‘s Model] [B.com 2014 Pass]*

The following data are available for N Ltd:-
Earning per share ₹ 3.00
Internal rate of Return 15 %
Cost of capital 12 %

If Walter‘s valuation formula holds, what will be the price per share when dividend pay-out ratio is (a)
50 %, (b) 75% & (c) 100 %.
[Answer: (a) ₹ 28.13; ₹ 26.56; ₹ 25]
10. Dividend policy [Walter‘s Model] [B.com 2016 Pass]*

Determine the market value of equity shares of N Limited as per Walter‘s Model:
Earnings of the company ₹ 5,00,000
Dividend Paid ₹ 3,00,000
No. of shares outstanding 1,00,000
Price earning ratio 8
Rate of return on investment 15%
Are you satisfied with the current dividend policy of the firm? If Not what should be the optimal
dividend pay-out ratio?
[Answer: Market value per share = ₹ 43.20; As r > Ke, the company is not following the optimal
dividend policy. The optimal dividend pay-out is nil, i.e. 0 %; In this case Market value per share
will be ₹ 48]
13. Dividend policy [M-M Model] [Compiled by Ravi Bhalotia]*

SRK limited currently has 1,00,000 shares. The company needs ₹ 10,00,000 to finance its new
investments. The total earnings of the firm during the current year would be ₹ 10,00,000 and ₹ 5,00,000
would be paid by way of dividends. The market price per share at the end of the current year is expected
to be ₹ 110. If the cost of capital is 15%, ascertain the present value of a share under the Modigliani-
Miller Model. [Answer: ₹ 100]
15. Dividend policy [M-M Model] [B.com 2017 Honours]*

XYZ Ltd. has a capital of Rs. 10,00,000 in equity shares of Rs. 100 each. The shares are currently
quoted at par. The company proposes to declare a dividend of Rs. 10 per share at the end of the current
financial year. The capitalization rate for the risk class to which the company belongs is 12%. What will
be the market price of the share at the end of the year, if—
(a) Dividend is not declared?
(b) Dividend is declared?
16. Dividend policy [M-M Model] [B.com 2013 Honours]*

A company belongs to a risk class for which the appropriate capitalisation rate is 10%. It currently has
outstanding 25,000 shares selling at ₹ 100 each. The firm is contemplating the declaration of dividend of
₹ 5 per share at the end of current financial year. The company expects to have a net income of ₹ 2.5
lakh and has a proposal for making new investment of ₹ 5 lakh.
Answer the following questions based on M-M Model (assume there is no tax):
(a) What will be the price per share at the end of the year if dividend is paid?
(b) What will be the price per share at the end of the year if dividend is not paid?
[Ans: (a) ₹ 105 (b) ₹ 110]

Capital Budgeting [10 + 6]

3. Capital Budgeting [ARR Method] [B.com 2016 Honours]****
A company is considering an investment proposal to install a new machine at a cost of Rs. 50,000.
The facility has a life expectancy of 5 years with Rs. 5,000 salvage value. For the project additional
working capital of Rs. 10,000 will also be required. The applicable income tax rate is 30 %.
Estimated EBDIT from the proposal are: Rs. 20,000; Rs. 22,000; Rs. 19,000; Rs. 17,000 and
Rs.24, 000 respectively for 5 years. Compute the Accounting rate of return for the proposal.
4. Capital Budgeting [ARR Method] [B.com 2014 Honours]****

The cost of a plant is ₹ 60,000. The expected life of the plant is 3 years It is expected to generate
EBDIT (Earnings before depreciation, interest and taxes) ₹ 26,000, ₹ 30,000, and ₹ 34,000
respectively. Compute Accounting Rate of Return assuming 30% tax and straight line meth od of
depreciation.
[23.33 %]
7. Capital Budgeting [Payback Period] [B.com 2014 Pass]****

A project requires an initial cash outlay of ₹ 20,00,000 having a life of 6 years The expected
average annual profit from the project before tax is ₹ 545454. Compute the payback period of the
project assuming tax rate at 45% and the rate of depreciation at 10% p.a. on straight line basis.
[4 Years]
8. Capital Budgeting [Payback] [B.com 2017 honours] *

A project of Rs. 3,00,000 is supposed to yield Rs. 40,000 after depreciation @ 12.5% and is subject to
income tax @ 40%. Calculate the payback period of the project.
10. Capital Budgeting [Payback] [B.com 2017 Pass] *

Compute the pay-back period for the project from the following information:
Cost of Assets – Rs. 100
Depreciation – 15% under straight line method
Profit after tax for the five years-
Year 1 – Rs. 15, Year 2 – Rs. 20, Year 3 – Rs. 25, Year 4 – Rs. 30, Year 5 – Rs. 35
11. Capital Budgeting [Payback] [B.com 06] *

Compute the payback period for the project:
End of Year: 1 2 3 4 5
Book value of fixed assets: 90 80 70 60 50
Profit after Tax: 20 22 24 26 28
[Answer: Payback period 3.11 years]

14. Capital Budgeting [Payback & ARR] [Compiled by Ravi Bhalotia]*
CO. CLOUDY LTD. desires to invest in a project which requires an initial investment of ₹ 50,00,000.
The useful life of the project is 10 years with a salvage value ₹ 5,00,000 and will be depreciated on
straight line method. The profit before charging depreciation is ₹ 10,00,000 p.a. The income tax rate is
35%. Compute:
(i) Payback period (PBP) (ii) Average rate of return (ARR)
[ (i) 6.19 year (ii) ARR = 13 %]
16. Capital Budgeting [Discounted Pay-Back] [B.com 2013 PASS]*

B.T. Ltd. Wants to replace an obsolete machine to increase its productivity. There are two machines
under its consideration. The cost of machine I is ₹ 1, 40,000 and that of machine II is ₹ 2,20,000. The
company‘s cost of capital is 16% and it expects the following cash inflow from each of the machines-
Year Machine-I Machine II Discounting
1 (₹) (₹) factor at 16%
1 - 60,000 0.862
2 40,000 72,000 0.743
3 95,000 85,000 0.641
4 80,000 80,000 0.552
5 50,000 60,000 0.476
On the basis of discounted pay-back period, which machine the company should purchase?
[Answer: 4.22 Years & 4.57 Years]
17. Capital Budgeting [Discounted Pay-Back] [B.com 2008 Honours]*

Using the information given below compute the Pay-Back Period under Discounted Pay-Back Method
Initial outlay ₹ 80,000
Estimated life 5 Years
Profit after Tax
End of year 1 ₹ 6,000
End of year 5 Nil
Depreciation has been calculated under straight line method. The cost of capital may be taken at 20%
p.a. and the P.V. Re. 1 at 20% p.a. is given below:
Year 1 2 3 4 5
P.V Factor .83 .69 .58 .48 .40
[Ans. Discounted payback period = 4.39 years.]
18. Capital Budgeting [Discounted Pay-Back] [B.com 2018 Honours]*

L Ltd. provides you the following information. Calculate the Discounted Payback Period.
a) Purchase price of machine Rs. 1,73,500
b) Useful life of machine 3 years
c) Salvage value at the end of useful life Nil
d) Cost of Capital 10%
e) Cash Flow after Tax (CFAT)
Year - 1 1,00,000
Year - 2 1,00,000
Year - 3 80,000
Note: Present Value factors @ 10% are as follows:
Year: 1 2 3
PV Factor: 0.909 0.826 0.751
20. Capital Budgeting [P.I Method] [2015 Pass]
Madhumita Ltd. Desires to invest in a project which requires an initial investment of ₹ 50, 00,000.
The useful life of the project is 10 years with a salvage value of ₹ 5, 00,000 and will be depreciated
on straight line method. The profit before charging depreciation is ₹ 10, 00,000 p.a. The income tax
rate is 35%. Compute:
(a) NPV at 10% p.a. and
(b) P.I.
[Ans. (a) 154434 (b) 1.031]
23. Capital Budgeting [NPV Method] [B.com Honours 2014 Honours]****

A machines costing ₹ 12, 00,000 is required in order to undertake a proposed project. The effective
life of the machines is expected to be 5 years with a residual value of ₹ 2, 00,000. The company
follows straight line method of charging depreciation. The estimated earnings before tax of the project
are as follows:
Year 1st 2nd 3rd 4th 5th
Earnings (₹) 4,80,000 5,60,000 6,40,000 4,00,000 3,20,000
before tax
If the tax rate is 40%, cost of capital is 15%, calculate the net present value and suggest whether the
machines would be acquired or not.
Given: The present value factors at a discount rate of 15% rate are:
Year 1 2 3 4 5
P. V. Factor 0.8696 0.7561 0.6575 0.5718 0.4975
[₹ 559727]
27. Capital Budgeting [NPV Method] [B.com Honours 2007, 2017 Pass]****
R. Ltd presently considering two machines for possible purchase. Other information related to the machines
are as follows:
Machine 1 Machine 2
Purchase price ₹ 50,000 ₹ 60,000
Estimated life 4 years 4 years
Method of Depreciation Straight line Straight line
Estimated Scrap Value NIL NIL
Cash Flow before Depreciation & Tax
Year 1 ₹ 25,000 ₹ 45,000
Year 2 ₹ 25,000 ₹ 19,000
Year 3 ₹ 25,000 ₹ 25,000
Year 4 ₹ 25,000 ₹ 27,000
Rate of Tax 40 %.
Compute net present value of each machine assuming Cost of Capital is 8 %. Which machine the company
should buy?
The present value of Re 1 at 8 % is as follows:
Year 1: 0.926; Year 2: 0.857; Year 3: 0.794; Year 4: 0.735
[₹ 16240 & ₹ 18461]

30. Capital Budgeting [NPV & PI] [B.com 2014 Pass]
A company has ₹ 40 lakh to invest at the cost of capital 15%. The following proposals are under its
consideration. Rank the projects on the basis of (a) NPV and (b) PI methods.
Project Initial outlay Annual Cash flow Life span
₹ ₹ ₹
A 2,00,000 50,000 10
B 1,40,000 40,000 8
C 60,000 16,000 10
D 1,20,000 30,000 12
E 1,00,000 24,000 8
Given that the present value of annuity of ₹ 1 at 15% are as under:
Year Present Value
8 4.6586
10 5.1790
12 6.1230
33. Capital Budgeting [IRR] [Compiled by Ravi Bhalotia] ****

From the information given below, determine the highest opportunity cost (IRR) that the project can bear :
(i) Required initial investment in fixed facilities : ₹ 10,000.
(ii) Profit before depreciation & Tax expected to generate by the project during the 4 years of its economic
life:
End of
1st year : ₹ 4,000
2nd year : ₹ 6,000
3rd year : ₹ 8,000
4th year : ₹ 2,000
(iii) No scrap value at the end
(iv) Appropriate tax rate : 40%.
(v) Fixed facilities are allowed to be depreciated on straight-line basis for tax purposes, (vi) Relevant
Year : 1 2 3 4
P.V. factor @ 20 % : 0.833 0.694 0.579 0.482
P.V. factor @ 22 % : 0.820 0.672 0.551 0.451
@ 23 % : 0.813 0.661 0.537 0.437
@ 25 % : 0.800 0.640 0.512 0.410
40. Capital Budgeting [ROI, PBP & PI] [B.com 2016 Pass]*
An enterprise can make either of the two investments at the beginning of 2016. Assuming a required
rate of return at 10% p.a., evaluate the investment proposals under each one of the following criteria;
a) Return on Investment
b) Discounted payback period
c) Profitability Index.
The forecasted figures are:
Investment Cost of Estimated Scrap Net Income (after Depreciation and tax at
Proposals Investment Life Value the end of year)
Year Rs. 2016 2017 2018 2019 2020
Rs. Rs. Rs. Rs. Rs.
P Rs. 40,000 4 NIL 1,000 4,000 7,000 5,000 --
Q Rs. 56,000 5 NIL NIL 6,800 6,800 6,800 6,800
It is estimated that each of the alternative projects would require an additional working capital of Rs.
4,000, which would be received back in full after the expiry of each project. Depreciation is provided
under straight line method.
Financial Management [Theories]

[Introduction 5 + 5 = 10 Marks]
2. Discuss the importance of Financial Management. [B.com 2015 Pass]
Finance is the lifeblood of business organization. It needs to meet the requirement of the business
concern. Each and every business concern must maintain adequate amount of finance for their smooth
running of the business concern and also maintain the business carefully to achieve the goal of the
business concern. The business goal can be achieved only with the help of effective management of
finance. We can‘t neglect the importance of finance at any time at and at any situation.
Some of the importance of the financial management is as follows:
(a) Financial Planning: Financial management helps to determine the financial requirement of the
business concern and leads to take financial planning of the concern. Financial planning is an
important part of the business concern, which helps to promotion of an enterprise
(b) Acquisition of Funds: Financial management involves the acquisition of required finance to the
business concern. Acquiring needed funds play a major part of the financial management, which
involve possible source of finance at minimum cost.
(c) Proper Use of Funds: Proper use and allocation of funds leads to improve the operational
efficiency of the business concern. When the finance manager uses the funds properly, they can
reduce the cost of capital and increase the value of the firm.
(d) Financial Decision: Financial management helps to take sound financial decision in the business
concern. Financial decision will affect the entire business operation of the concern. Because there
is a direct relationship with various department functions such as marketing, production
personnel, etc.
(e) Improve Profitability: Profitability of the concern purely depends on the effectiveness and
proper utilization of funds by the business concern. Financial management helps to improve the
profitability position of the concern with the help of strong financial control devices such as
budgetary control, ratio analysis and cost volume profit analysis.
(f) Increase the Value of the Firm: Financial management is very important in the field of
increasing the wealth of the investors and the business concern. Ultimate aim of any business
concern will achieve the maximum profit and higher profitability leads to maximize the wealth of
the investors as well as the nation.
(g) Promoting Savings: Savings are possible only when the business concern earns higher
profitability and maximizing wealth. Effective financial management helps to promoting and
mobilizing individual and corporate savings.
Now days financial management is also popularly known as business finance or corporate finances. The
business concern or corporate sectors cannot function without the importance of the financial
management.

3. What are the functions of financial manager/Financial Management?
[2014 Hons, 2016 Hons] [Important]********
Financial Management means planning, organizing, directing and controlling the financial activities
such as procurement and utilization of funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.
(a) Estimation of capital requirements: A finance manager has to make estimation with regards
to capital requirements of the company. This will depend upon expected costs and profits and
future programmes and policies of a concern. Estimations have to be made in an adequate
manner which increases earning capacity of enterprise.
(b) Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short- term and long- term debt equity analysis. This
will depend upon the proportion of equity capital a company is possessing and additional funds
which have to be raised from outside parties.
(c) Choice of sources of funds: For additional funds to be procured, a company has many choices
like-
 Issue of shares and debentures
 Loans to be taken from banks and financial institutions
 Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of
financing.
(d) Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
(e) Disposal of surplus: The net profits decision have to be made by the finance manager. This can
be done in two ways:
(f) Dividend declaration - It includes identifying the rate of dividends and other benefits like
bonus.
(g) Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
(h) Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries, payment
of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of
enough stock, purchase of raw materials, etc.
(i) Financial controls: The finance manager has not only to plan, procure and utilize the funds but
he also has to exercise control over finances. This can be done through many techniques like
ratio analysis, financial forecasting, cost and profit control, etc.

7. Why it is inappropriate to seek profit maximisation as the goal of financial
decision making? [2013 H]
Though, there could be little controversy over profit maximisation, as the basic objective of financial
management – yet, in the modern times, several authorities on financial management criticise this
objectives, on the following grounds:
(i) Profit is a vague concept, in that; it is not clear whether profit means –
short-run or long-run profits.
OR
– Profit before tax or profits after tax or
– Rate of profits or the amount of profits.
(ii) The profit maximisation objective ignores, what financial experts call the time value of money‘. To
illustrate, this concept, let us assume that two financial courses of action provide equal benefits (i.e.
profits) over a certain period of time. However, one alternative gives more profits in earlier years; while
the other one gives more profits in later years.
Based on profit maximization criterion, both alternatives are equally well. However, the first alternative
i.e. the one which gives more profits in earlier years is better; as some part of the profits received earlier
could be reinvested also.
Modern financial experts call this philosophy, ‗the earlier the better principle‘. The second alternative
which gives more profits only in later years is inferior; as the time-value of profits is more in the case of
the first alternative.
(iii) The profit maximization objective ignores the quality of benefits (i.e. profits). The factor implicit
here, is the risk element associated with profits. Quality of benefits (profits) is the most when risk
associated with their occurrence is the least. According to modern financial experts, less profit with less
risk are superior to more profits with more risk.
(iv) Profit-maximisation objective is lop-sided. This objective considers or rather over-emphasizes only
on the interests of owners. Interests of other parties like, workers, consumers, the Government and the
society as a whole are ignored, under this concept of profit-maximisation.
8. Why value maximisation (wealth maximisation) objective is called better

than profit maximisation objectives? [2017 H]
The wealth maximisation objective is held to be superior to the profit maximisation objective, because
of the following reasons:
(a) It is based on the concept of cash flows; which is more definite than the concept of profits.
Moreover, management is more interested in immediate cash flows than the profits a large part
of which might be hidden in credit sales- still to be realized.
(b) Through discounting the cash flows arising from a financial course of action over a period of
time at an appropriate discount rate; the wealth maximisation approach considers both- the time
value of money and the quality of benefits.
(c) Wealth maximisation objective is consistent with the long term profitability of the company.

9. Give an idea about ‗wealth maximisation‘ & Profit Maximisation objective
of financial management?*
Wealth Maximization
Wealth Maximization is considered as the appropriate objective of an enterprise. When the firms
maximizes the stock holder‘s wealth, the individual stockholder can use this wealth to maximize his
individual utility. Wealth Maximization is the single substitute for a stock holder‘s utility.
A Stock holder’s wealth is shown by:
Stock holder‘s wealth = No. of shares owned x Current stock price per share
Higher the stock price per share, the greater will be the stock holder‘s wealth.
Arguments in favour of Wealth Maximization:
(i) Due to wealth maximization, the short term money lenders get their payments in time.
(ii) The long time lenders too get a fixed rate of interest on their investments.
(iii) The employees share in the wealth gets increased.
(iv) The various resources are put to economical and efficient use.
Argument against Wealth Maximization:
(i) It is socially undesirable.
(ii) It is not a descriptive idea.
(iii) Only stock holders wealth maximization does not lead to firm‘s wealth maximization.
(iv) The objective of wealth maximization is endangered when ownership and management are
separated.
Inspite of the arguments against wealth maximization, it is the most appropriative objective of a firm
‗Profit Maximization‘
Profit Maximization is the main objective of business because:
(i) Profit acts as a measure of efficiency and
(ii) It serves as a protection against risk.
Agreements in favour of Profit Maximization:
(a) When profit earning is the main aim of business the ultimate objective should be profit
maximization.
(b) Future is uncertain. A firm should earn more and more profit to meet the future contingencies.
(c) The main source of finance for growth of a business is profit. Hence, profit maximization is
required.
(d) Profit maximization is justified on the grounds of rationality as profits act as a measure of efficiency
and economic prosperity.
Arguments against Profit Maximization:
(a) It leads to exploitation of workers and consumers.
(b) It Ignores the risk factors associated with profit.
(c) Profit in itself is a vague concept and means differently to different prople.
(d) It is narrow concept at the cost of social and moral obligations.
Thus, profit maximization as an objective of Financial Management has been considered inadequate.

Basic Concept [In Option]

19. Discuss the basic components of the financial environment under which a
firm has to operate. [2015 H]
The complete system of financial environment comprises of four important components. These
include (1) financial managers (2) investors (3) financial markets and 4) Financial instruments.
(1) Financial Managers:
Decision of investing funds lies with financial managers. Financial managers are responsible for taking
decision on acquiring the funds for business and appropriately investing those funds. Finance manager
is accountable on the issue of how to obtain funds (financing) and where to invest a company‘s funds to
expand its business. The actions taken by financial managers to make financial decisions for their
respective firms are referred to as financial management (or managerial finance). Financial managers
are expected to make financial decisions in such a way to optimize risk return trade off so as to ensure
maximum value of the firm and ultimately maximize the value of the firm‘s stock price. Hence, the final
focus of finance manager is to take financial decisions in a way that may ensure maximum wealth to the
shareholders.
(2) Investors :
Investors may be individuals or institutions who have surplus funds and are willing to provide these
funds to borrowers such as firms, government agencies, individuals or other institutions. This section
provides a brief insight on investors and how do they create provision of funds? Individual investors are
generally small investors who commonly provide funds to firms by purchasing their securities (equity
shares or debt securities). Second category of investors includes institutional investors. The financial
institutions that provide funds are referred to as institutional investors. Some of these institutions focus
on providing loans, whereas others commonly purchase securities that are issued by firms.
(3) The Financial Markets:
Financial markets represent place/ market that facilitate the flow of funds among investors and
borrowers. In financial markets investors and borrowers trade financial securities, commodities and
other fungible items at a price determined by demand and supply. Financial markets are typically
defined by having transparent pricing, basic regulations on trading, costs and fees and market forces
determining the prices of securities that trade. Hence, financial markets refer to an organized
institutional structure or mechanism for creating and exchanging financial assets. An important
component of these financial markets is financial institutions that act as intermediaries. Financial
markets can be a) Capital markets b) Money market
(4) Financial Instruments:
Financial instruments refer to tradable securities of financial markets. These financial instruments may
represent cash, ownership interest or contractual right to pay/receive money. Broadly, financial
instruments can be of two types: a) Cash instruments b) Derivative instruments Cash instruments are the
one whose value is directly determined by the market e.g. deposits and loans. Whereas value of
derivative instrument is derived from underlying asset e.g. forward, options, swap etc.

Working Capital Management

(6 Marks)
30. What are the different Strategies (policies) of financing?**
There are four different approaches or policies to take this decision relating to financing mix of the
working capital. These are discussed as follows:
(1) Hedging or Matching Policy: Under this policy of financing working capital, each asset in the
balance sheet would be off set with a financing instrument of the same approximate maturity. The
hedging principle states that the financing maturity should follow the cash flow features of the
assets being financed. For this reason, this policy is known as ‗matching policy‘. This policy
suggests that the permanent or hardcore component of current assets should be financed with the
funds from long-term sources while the temporary component of current assets should be financed
with short term sources
(2) Conservative Policy: As the name itself suggests, the finance manager does not take any risk under
this approach. As a result, all the current assets are primarily financed by long-term sources and the
short-term sources should be used for unexpected and emergency requirements. The larger the
portion of long-term sources used for financing the current assets, the more conservative is said to
be the financing policy of the firm. Under this policy, a firm can avoid the risk of liquidity and
insolvency. Following are the main features of this policy:
(a) Greater liquidity;
(b) Minimum risk; and
(c) More costly.
(3) Aggressive Policy: This policy is just the opposite of the conservative policy. Under this policy, a
firm decides to finance a larger portion of estimated requirement of permanent current assets from
short-term sources. But too much reliance on short-term sources is more risky, since these sources
have to be renewed by the firm on a continuous basic for financing a major part of the hardcore
current assets. Therefore, this policy makes the finance-mix more risky, less costly and thus more
profitable to the firm.
(4) Highly Aggressive Policy: Under this policy, entire current assets (i.e., permanent and temporary)
even a part of fixed assets may be financed from short-term sources. Hence, this policy makes the
financing mix highly risky as the short term sources is to be renewed by the firm on a continuous
basis for financing not only the entire current assets but also a part of the fixed assets. Working
capital position under this policy will always be negative and this will lead the firm toward liquidity
crunch and towards insolvency.
32. Bank financing: recommendations of Tandon committee*

In July 1974, an expert committee was set up by the RBI under the chairmanship of Sri P.L Tandon
to frame guidelines for the follow-up of bank credit to industries.
The terms of reference of this committee are shown below:

(i) To suggest necessary guidelines for commercial banks to follow-up and supervise credit for
ensuring proper end-use of funds;
(ii) To suggest the type of operational data and other information which may be obtained by the
commercial banks from their borrowers, and by the RBI from the lending banks;
(iii) To make suggestions for prescribing inventory norms for both public sector and private
sector industries, and indicate broad criteria for deviations, if any, from such norms;
(iv) To suggest criteria for satisfactory capital structure and sound financial basis of the
borrowers;
(v) To make recommendation regarding the source for financing the minimum working capital
requirements of the borrowe₹
(vi) To suggest whether the existing pattern of working capital requirements by the cash credit/
overdrafts has to be modified and, if so, to suggest necessary modifications.
One of the important features of the report of the Tandon Committee is the fixation of some
specific norms for bank lending to the industry. These norms can be divided into two parts:
(a) Norms regarding inventories and receivable, and
(b) Norms regarding bank lending.
(A) Inventory and receivables norms covering 15 major industries for (i) Raw material; (ii) Stocks in
process; (iii) Finished Goods; and (iv) Receivables and bills discounted.
(B) Lending norms of which there are three alternatives, (i) the method under which the borrower will
have to contribute a minimum of 25% of the working capital gap from long-term funds, i.e., owned
funds and term borrowings. This will give a ratio of 1.17:1 (ii) second, method under which the
borrower has to provide the minimum of 25% of the total current assets and that will give a current ratio
of 1.33:1; (iii) third method, under which the borrower‘s contribution from long-term funds will be to
the extent of the entire core current assets and a minimum of 25% of the balance of the current assets
33. Bank financing: recommendations of Chore committee*

Having implemented the recommendations of the Tandon Committee, the Reserve Bank of India in
March, 1979, appointed another committee under the chairmanship of Shri K.B.Chore, Chief Officer,
Department of Banking Operation and Development, Reserve Bank of India. The important points in the
findings of the committee are as follows:
(a) To review operation of cash credit system in recent years, particularly with reference to the gap
between the sanctioned cash credit limits and the extent of their utilization;
(b) To suggest alternative types of credit facilities which would ensure greater credit discipline and
enable the banks to correlate the credit limits to an increase in output and other productive
activities of the borrower;
(c) To suggest necessary modifications in the system to make it more amenable to rational
management of funds by the commercial banks; and
(d) To make recommendations on any other related manner.

Capital Structure [In option]

38. What do you mean by Optimum Capital Structure? Discuss the features
of an optimum capital structure.****
The theory of optimal capital structure deals with the issue of the right mix of debt and equity in the
long term capital structure of a firm. This theory states that if a company takes on debt, the value of
the firm increases up to a point. Beyond that point if debt continues to increase then the value of the
firm will start to decrease. Similarly if the company is unable to repay the debt within the specified
period then it will affect the goodwill of the company in the market and may create problems for
collecting further debt. Therefore, the company should select its optimum capital structure.
The main features of an optimum capital structure are:
(a) Profitability: The capital structure of the company should be most profitable. The most profitable
capital structure is one that tends to minimize cost of financing and maximize earnings per equity
share.
(b) Solvency: The pattern of capital structure should be so devised as to ensure that the firm does not
run the risk of becoming insolvent. Excess use of debt threatens the solvency of the company. The
debt content should not, therefore, be such that which increases risk beyond manageable limits.
(c) Flexibility: The capital structure should be flexible to meet the requirements of changing
conditions. Moreover, it should also be possible for the company to provide funds whenever needed
to finance its profitable activities.
(d) Conservatism: The capital structure should be conservative in the sense that the debt content in the
total capital structure does not exceed the limit which the company can bear. In other words, it
should be such as is commensurate with the company‘s ability to generate future cash flows.
(e) Control: The capital structure should be so devised that it involves minimum risk of loss of control
of the company

39. Mention the factors that ate to be considered in determining capital
structure?*
(a) Trading on equity or financial leverage: Through this device, the capital is highly-geared. In this
case, the company issues more debentures and preference shares with fixed rate of interest and
dividend. As a result, the dividend rate of equity shares can be substantially raised.
(b) Risk, income and control of the enterprise: Risk, income and control move together, Greater
income and control may cover greater risk. Equity shareholders undertake greater risk than the fixed
interest-bearing securities. The control is also concentrated in their hands. So this aspect should be
considered in capital structure.
(c) Operating leverage: It indicates the vulnerability of operating profit of change in volume of sales
and depends on operating fixed cost of the company. It reflects the operating risk. If operating
leverage is high, the company should introduce relatively small amount of debt capital.
(d) EBIT-EPS analysis: To maximise earnings per share (EPS) of equity shareholders, while planning
capital structure the behaviour of EPS at varying levels of earnings before interest and tax (EBIT) under
alternative financial plans should be studied.
(e) Cost of capital: Lower cost of capital increases the value of the firm. Cost of capital is influenced by
capital structure. Debt capital is usually cheaper because of lower risk and tax deductibility. So debt-
equity mix has to be made in such a way that overall cost of capital becomes minimum.
(f) Control: Capital structure is affected by the extent to which the promoters desire to maintain control
over the affairs of the company. If the company issues more equity shares, there will be dilution of control.
To avoid loss of control, the company should use more debt capital and preference capital.
(g) Cash flow analysis: The Company should prepare a projected cash flow statement for the next 5-6 years
to get an idea of cash inflows. If future cash inflows position is steady or stable, more debt capital can be
employed. But if future cash inflows position is unstable, debt capital should be avoided.
(h) Stability of sales: If the company's sales are stable, it can employ more debt capital because there will
be no difficulty in meeting fixed obligations.
(i) Size of the company: If the size of the company is large, it can raise fund easily from different
sources. So its capital structure can be suitably designed.
(j) Legal requirements or restrictions: The finance manager has to comply with the legal
requirements or restrictions while deciding about the capital structure.
(k) Corporate taxation: Corporate taxation is an important factor in determining the choice between
different sources of financing, e.g., dividend on shares is not deductible but interest on borrowed
capital and cost of raising finance are allowed as deduction for taxation purpose. So capital structure
planning needs to consider corporate taxation factor.
(l) Government policies: Lending policies of financial institutions, SEBI rules and regulations,
government's monetary and fiscal policies affect capital structure decisions.
(m) Purpose of financing: If the funds are required for manufacturing or productive purposes, funds
should be raised from long-term sources. If the funds are needed for welfare facilities to
employees of the company, internal sources should be tapped.
(n) Period of finance: When permanent funds are needed, equity shares should be issued but when
finance is required for 8-10 years, it is appropriate to raise borrowed funds.

Capital Budgeting (6 Marks)

54. What is capital Budgeting? What are the Purposes of Capital
Expenditure Decisions: **
Capital budgeting decision may be defined as ―Firms decisions to invest its current funds most
efficiently in long term activities in anticipation of an expected flow of future benefits over a series of
year. The firm‘s capital budgeting decisions will include addition, disposition, modification and
replacement of fixed assets‖.
Definitions:
Charles. T. Horngreen defined capital budgeting as ―Long term planning for making and financing
proposed capital out lay‖.
According to Keller and Ferrara, ―Capital Budgeting represents the plans for the appropriation and
expenditure for fixed asset during the budget period‖.
Robert N. Anthony defined as ―Capital Budget is essentially a list of what management believes to be
worthwhile projects for the acquisition of new capital assets together with the estimated cost of each
product‖.
Need of capital budgeting decision
The selection of the most profitable project of capital investment is the key function of Financial
Manager. The decisions taken by the management in this area affect the operations of the firm for many
years Capital budgeting decisions may be generally needed for the following purposes:
Hence, following may be considered as major or specific objectives in respect of investment in fixed
assets under long-term basis:
(a) Modification and Replacement of existing facilities.
(b) Quality improvement in the present projects.
(c) Expansion of business through creating additional facilities.
(d) Creation of new product and improving the quality of existing products.
(e) Product diversification for survival under the competitive market scenario.
(f) Cost reduction initiatives which may require the purchase of most sophisticated and modern
equipments.
(g) Exploration of new ideas through Research and Development.
(h) Replacement of manual work by automation process.
(i) Maximization of wealth of the shareholde₹
(j) Achievement of various social objectives complying with statutory obligations. (say, setting up
of waste treatment plant to reduce environmental pollution).

61. Examine the rationality of the Payback Period Method in the context of
capital expenditure decisions.****
Payback Period
It is the most popular and widely recognized traditional methods of evaluating the investment
proposals. It can be defined as ―the number of years to recover the original capital invested in a
project‖. According to Weston and Brigham, ―the pay back period is the number of years it takes for
the firm to recover its original investment by net returns before depreciation, but after taxes:
When cash flows are uniform:
If the proposed project‘s cash inflows are uniform the following formula can be used to calculate the
payback period.
Payback period = Annual Cash inflows/Initial Investment
When cash flows are not uniform
When the project‘s cash inflows are not uniform, but vary from year to year pay back period is
calculated by the process of cumulating cash inflows till the time when cumulative cash flows
become equal to the original investment outlay.
Discounted payback period‘
Some Accountants calculate payback period after discounting the cash flows by a predetermined rate
and the payback period so calculated is called, ‗Discounted payback period‘.
Advantages of Payback period:
Merits: The following are the merits of the pay back period method:
(a) Easy to calculate: It is one of the easiest methods of evaluating the investment projects. It is simple
to understand and easy to compute.
(b) Knowledge: The knowledge of payback period is useful in decision-making, the shorter the period
better the project.
(c) Protection from loss due to obsolescence: This method is very suitable to such industries where
mechanical and technical changes are routine practice and hence, shorter payback period practice
avoids such losses.
(d) Easily availability of information: It can be computed on the basis of accounting information,
what is available from the books
Limitations of Payback period:
However, the payback period method has certain demerits:
(a) Failure in taking cash flows after payback period: This methods is not taking into account the
cash flows received by the company after the payback period.
(b) Not considering the time value of money: It does not take into account the time value of
money.
(c) Non-considering of interest factor: It does not take into account the interest factor involved in
the capital outlay.
(d) Maximisation of market value not possible: It is not consistent with the objective of
maximizing the market value of share.
(e) Failure in taking magnitude and timing of cash inflows: It fails to consider the pattern of cash
inflows i.e. the magnitude and timing of cash inflows.

62. Write short note on Accounting Rate of Return Method.****
Accounting Rate of Return
This technique uses the accounting information revealed by the financial statements to measure the
profitability of an investment proposal. It can be determined by dividing the average income after
taxes by the average investment. According to Soloman, Accounting Rate of Return can be
calculated as the ratio, of average net income to the initial investment.
On the basis of this method, the company can select all those projects whose ARR is higher than the
minimum rate established by the company. It can reject the projects with an ARR lower than the
expected rate of return. This method also helps the management to rank the proposal on the basis of
ARR.
Accounting Rate of Return (ARR) = Original Investment/Average Net Income
Acceptance Rule:
The project which gives the highest rate of return over the minimum required rate of return is
acceptable
Merits:
The following are the merits of ARR method:
(i) It is very simple to understand and calculate;
(ii) It can be readily computed with the help of the available accounting data;
(iii) It uses the entire stream of earnings to calculate the ARR.
Demerits:
This method has the following demerits:
(i) It is not based on cash flows generated by a project;
(ii) This method does not consider the objective of wealth maximization;
(iii) It ignore the length of the projects useful life;
(iv) If does not take into account the fact that the profile can be re-invested; and
(v) It ignores the time value of money.
63. Write short note on Profitability Index Method.*

This method is also known as ‗Benefit Cost Ratio‘. According to Van Horne, the profitability Index
of a project is ―the ratio of the present value of future net cash inflows to the present value of cash
outflows‖.
Profitability Index = Present value of cash inflows/Present value of cash outflows
Advantages
Decision criteria: If the Profitability Index is greater than or equal to one, the project should be
accepted otherwise reject.
Merits:
The merits of this method are:
(i) It takes into account the time value of money
(ii) It helps to accept / reject investment proposal on the basis of value of the index.
(iii) It is useful to rank the proposals on the basis of the highest /lowest value of the index.
(iv) It takes into consideration the entire stream of cash flows generated during the life of the asset.
Demerits:
However, this technique suffers from the following limitations:
(i) It is some what difficult to compute.
(ii) It is difficult to understand the analytical of the decision on the basis of profitability index.

Dividend policies [In option]

70. What factors determine the dividend policy of a firm/Discuss the
determinants of dividend policies.****
There are many firms that pay dividends and also issue stock from time to time. They could avoid
the stock issues (where costs are highest for the firm) by paying lower dividends. Many other firms
restrict dividends so that they do not have issue shares. They on the other hand could occasionally
issue stock and increase dividends. Thus both firms face dividend policy trade-off.
There are many reasons for paying dividends and there are many reasons for not paying any
dividends. As a result, dividend policy is always controversial.
Many factors determine the dividend policy of a company. The factors determining the dividend
policy are as follows:
Each of the above points are further discussed as given here in below:
(i) Dividend Payout ratio: A certain share of earnings to be distributed as dividend has to be
worked out. This involves the decision to pay out or to retain. The payment of dividends results in
the reduction of cash and, therefore, depletion of assets. In order to maintain the desired level of
assets as well as to finance the investment opportunities, the company has to decide upon the payout
ratio. D/P ratio should be determined with two bold objectives – maximising the wealth of the firms‘
owners and providing sufficient funds to finance growth.
(ii) Stability of Dividends: Generally investors favour a stable dividend policy. The policy should
be consistent and there should be a certain minimum dividend that should be paid regularly. The
liability can take any form, namely, constant dividend per share; stable D/P ratio and constant
dividend per share plus something extra. Because this entails – the investor‘s desire for current
income, it contains the information content about the profitability or efficient working of the
company; creating interest for institutional investor‘s etc.
(iii) Legal, contractual and internal constraints and restriction: Legal and Contractual
requirements have to be followed. All requirements of Companies Act, SEBI guidelines, capital
impairment guidelines, net profit and insolvency etc., have to be kept in mind while declaring
dividend. For example, insolvent firm is prohibited from paying dividends; before paying dividend
accumulated losses have to be set off, however, the dividends can be paid out of current or previous
years‘ profit. Also there may be some contractual requirements which are to be honoured.
Maintenance of certain debt equity ratio may be such requirements. In addition, there may be certain
internal constraints which are unique to the firm concerned. There may be growth prospects,
financial requirements, availability of funds, earning stability and control etc.
(iv) Owner‘s considerations: This may include the tax status of shareholders, their opportunities for
investment dilution of ownership etc.
(v) Capital market conditions and inflation: Capital market conditions and rate of inflation also
play a dominant role in determining the dividend policy. The extent to which a firm has access to
capital market, also affects the dividend policy. A firm having easy access to capital market will
follow a liberal dividend policy as compared to the firm having limited access. Sometime dividends
are paid to keep the firms ‗eligible‘ for certain things in the capital market. In inflation, rising prices
eat into the value of money of investors which they are receiving as dividends. Good companies will
try to compensate for rate of inflation by paying higher dividends. Replacement decision of the
companies also affects the dividend policy.

Financial Control [10 Marks]

71. Discuss the concept of financial control? What are its objectives?*
The term 'Financial Control' is formed by the combination of two words — one is 'Financial' and the other
is 'Control.' The term 'Financial' means relating to money i.e., something which relates to money is called
Financial. Control refers to evaluation of the performed activities with respect to planned activities. So,
Financial Control refers to the evaluation of the performed financial activities with respect to the planned
financial activities.
According to the Kootz & O'Donnel — "Financial control is the process of comparing actual financial
performance with that of the pre-established financial standards or norms to ascertain deviations, if any,
and to take remedial measures
Financial control imposes control over the financial factors of a firm. Finance is regarded as the life
blood of a business. As man becomes weak due to shortage of blood, similarly, a business also
becomes weak due to shortage of finance. So, sufficient amount of finance is needed in order to
make the business powerful and strong.
But use of finance is a difficult task than its collection. So, proper plan is required for the effective
use of finance. Again, sound financial control is needed in order to determine whether the finance
has been used according to the plan and if not, then taking necessary remedial steps. For this, a
sound and effective control system should be enforced.
Objective of Financial Control
The objectives and necessities of the financial control are as follows:
(a) Evaluation of Financial Activities: The financial managers prepare the financial plan for
performing the financial activities properly. Whether all the financial activities have been
performed properly according to predetermined plan or not can be verified through the financial
control. So, it is necessary to build-up sound financial control system for each firm in order to
verify the standard of the performed financial activities.
(b) Development of standard of financial activities: If any deviation is found out between the pre-
determined standards and the actual financial activities, then necessary remedial steps can be
taken through the financial control so that repetition of such deviation does not take place. So, it
is necessary for every firm to build up a sound financial control system in order to develop the
standard of the financial activities.
(c) Prevention of misuse of money: The misuse of money can be prevented through the sound
financial control system. As a result of it, optimum use of money is possible. So, financial
control is necessary in order to ensure optimum utilisation of the money by preventing its
misuse.
(d) Optimum utilisation of Financial Resources: The misuse of the financial resources can be
prevented through the financial control. As a result of it, optimum use of those resources is
possible. So, financial control is necessary in order to ensure optimum utilisation of the financial
resources.
(e) Decline in possibility of misappropriation of funds: If a proper financial control system is
implemented in each department of a firm, then the possibility of misappropriation of funds will

be reduced to the minimum. So, it is necessary to build up an effective control system in every
firm in order to minimise the misappropriation of funds
(f) Ensuring financial stability: The financial control prevents the misuse of money, ensures the
optimum utilisation of financial resources and declines the possibility of misappropriation of
funds. As a result of these, the financial position of the firm is improved. If the financial position
is improved then the financial stability is ensured. So, it is necessary to maintain a sound
financial control system in each firm in order to ensure the financial stability.
(g) Increasing in profitability: A sound financial control system prevents all types of wastages and
ensures optimum utilisation of the financial resources. As a result of it, the amount of profit is
increased due to reduction of the cost. So, it is necessary to build up an effective control system
so that the amount of profit of the firm is increased.
(h) Fair return on investment: It is necessary to bear the cost of capital whatever may be the
source of financing. So, the collected capital is to be invested in such a way so that it is possible
to bear that cost by the earnings from the investment. For this, it is necessary to impose an
effective control over the investment.
(i) Creation of confidence among the investors: If it is possible to impose proper control on the
investment, then returns can be obtained at a fair rate. As a result of it, it is possible to fulfil the
expectations of the investors as cost of capital. As a result, confidence is created in the minds of
the investors to the firm. So, it is necessary to build up a sound financial control system to be
reliable to the investors.
(j) Timely collection of debt and payment of liabilities: If proper method is adopted for the
financial control, it will become easy to realise the amount due from customers timely and on the
other hand it is possible to pay liabilities of the creditors within the stipulated time. So, it is
necessary to build up a suitable financial control system in order to maintain sound credit policy.
(k) Creation of Goodwill: If it is possible to implement a proper financial control system in a firm,
then confidence is created in the minds of the shareholders about the firm, and it is possible to
repay the claims of the creditors in appropriate time and the financial position of the firm is
strengthen. As a result, the goodwill of the firm is increased.
(l) Financial Liquidity: If the possibility of misappropriation of funds is reduced, then it is
possible to realise the debts from the customers in appropriate time and proper maintenance of
cash is possible through the sound financial control system. As a result of these, the financial
liquidity of the firm remains in force. So, it is necessary to build up a proper financial control
system in order to maintain the financial liquidity.
(m) Fulfillment of objective of financial management: The primary objective of the financial
management is to maximise the wealth of the firm. Optimum use of scarce and valuable
resources is possible through the proper financial control system. As a result of it, the objective
of maximisation of wealth is fulfilled.
(n) Financial discipline: The financial managers allocate the financial responsibilities among the
officers and along with this they are given necessary authorities in order to perform the financial
activities properly. If the officers do not perform the duties according to their respective
responsibilities, then their inability can be identified through the financial control. So, the officers
try to perform their respective duties sincerely. So, it is necessary to build up a sound financial
control system in order to bring discipline among the officers.

73. Discuss in brief the major tools of financial control.***
Financial control is exercised with the help of some tools or techniques and mechanisms to control
specific financial activities and performance of an enterprise. A brief discussion of the major tools of
financial control is made below:
(a) Budgetary control : Perhaps the most important tool of financial control is budgetary control.
When budget is used as a tool of control it is known as budgetary control. Budgetary control
extends to monitoring, measurement, evaluation, regulation and correction of financial activities
along the directions specified in the budget.
(b) Break-even analysis : Break-even analysis shows the level of production where both the
revenue and expenditure are equal, i.e., there is "no profit, no loss" position. Break-even analysis
helps planning of profit. This tool helps greatly to size up the costs behaviour, revenues and
profits at different levels of activity.
(c) Ratio analysis : Ratio analysis is a handy tool of financial control through which the key aspects
of financial health, profitability, liquidity and solvency position of the firm at a particular point
of time or over a period of time can be understood. This tool is also used for inter-firm
comparison to assess the financial soundness of the firm in relation to other comparable
enterprises.
(d) Profit and loss control : Profit and Loss Account is a powerful tool of financial control. It
summarizes the relations between revenues and expenses of the firm's operations during a
specified period. This tool greatly helps in controlling expenditures to maximise profits. It is
used to monitor and regulate financial events and transactions.
(e) Funds flow statement : In fact it is a statement which shows the sources and application of
funds. This tool helps to know the causes of change in working capital position, how fixed assets
are acquired, what should be the rational dividend policy, how optimum allocation of fund can
be made, how to manage working capital, etc.
(f) Cash flow statement: It reveals the impact of all business transactions over a period of time on
the cash or liquidity position of the firm by summarising the amount of cash inflows and cash
outflows over a period. The object of cash flow statement is to highlight the cash earning
capacity and liquidity position of the firm.
(g) Return on investment (ROI) : This is another tool of financial control which highlights how
much profit is earned in relation to the amount of capital invested by the firm. ROI is an overall
measure of the financial performance of the firm.
(h) Internal audit : Internal audit is tool of financial control in the sense that it assures the
management that the accounting system and the internal check are effective as well as
economical. Internal audit refers to a review of operations and records, sometimes continuous,
undertaken within a business by a specially assigned staff. Internal audit detects errors and
frauds and corrections can be made instantly. A separate department is assigned with the job of
internal audit.
(i) Standard costing : Standard costing is a tool of financial control. It is a means of performance
evaluation. It highlights those activities which do not conform to plan in order to draw the
attention of management to take corrective action. Performance evaluation and cost control are
its main objectives.

(j) Cost control : A firm has to incur two types of costs for running its business. These two types of
costs are fixed costs (FC) and variable costs (VC).FC+VC = TC (Total Cost). The object of cost
control is to minimise the cost of creation so that profitability of the firm can be increased. Cost
control is made on re basis of pre-determined standard, quantity and time schedule of
production. Cost control system is a tool of financial control in the sense that it prescribes the
methods to be adopted for the reduction of costs.
74. Explain the concept of budgetary control as a tool of Financial Control

System.****
Budget refers to the work of preparing quantitative and reasonable plan in order to achieve a definite
goal in the future and control refers to the evaluation of the performed work with respect to the
planned work. Both these works are to perform through the budgetary control.
G. R. Terry says — "Budgetary control is a process of finding out what is being done and
comparing actual results with the corresponding budget data in order to approve accomplishments or
to remedy differences by either adjusting the budget estimates or correcting the causes of
differences."
On the basis of above discussion, it can be said that the process of verifying whether all the financial
activities of a firm have been performed according to the budget and if not, finding its causes and
taking necessary remedial steps, is called Budgetary Control
Advantages : The advantages of budgetary control are —
(a) Facilitates in co-ordination : Each and every firm prepares both functional budget and master
budget. It brings together the activities of various sections, departments in overall perspective.
The master budget takes into account the essence of different functional budgets. So, a proper
co-ordination is needed between the master and functional budgets.
(b) Workers' participation in Management: Various types of budgets are prepared for different
types of functions. As a result, it is possible to allocate duties and responsibilities among the
different workers and it offers an opportunity for the workers to participate in management
affairs. This will create inducement and enthusiasm among the workers.
(c) Improvement in communication : On account of implementation of budgetary control, the
communication system of the enterprise will be improved. The objectives, policies, authority and
responsibility are communicated to the subordinates at lower level, whereas submission of
reports of works performed, accountability, job evaluation and correction, etc. are communicated
to top-level management. Thus, a cordial relationship is formed and communication system is
improved.
(d) Identification of weak spots ; The weak spots of the performed works can be identified through
the budgetary control by comparing the actual performance with the budget.
(e) Taking corrective action : As the weak spots of managing the firm can be identified through the
budgetary control, it is possible to take necessary corrective actions in order to remove those
weaknesses.
(f) Creation of consciousness among the workers : Works are distributed among the workers
according to the pre-determined budget. If the workers do not perform their duties properly, then
these are detected through the budgetary control. So, the workers try to perform their duties

according to their respective assignment. Thus, the budgetary control system helps to create
consciousness among the workers
(g) Increase in profitability : Budgetary control system increases consciousness among the
workers, reduces wastages, rectifies deviations and ensures optimum use of resources. As a
result, the amount of profits of the firm increases.
(h) Helpful for fixing up future policy : If there is any deviation in the functions of the
management, then it is detected through the budgetary control. As a result, it is possible to take
necessary corrective actions so that such deviation does not take place in future. So, it can be
said that the budgetary control helps in determining future policies.
(i) Control of finance and functions : Budgetary control includes the financial matters of the firm
as well as functional aspects of every stage. As both these aspects of control are included in it, it
is regarded as a good system of financial control.
Disadvantages : The budgetary control suffers from certain limitations. These are —
(a) Negligence of other sections excepting finance : Only financial aspects are concerned in the
budgets. But there are other matters in the organisation, which are no less important than
financial matte₹ As for example, goodwill of a business, morale and satisfaction of the employees,
etc. These factors are to be duly considered in the preparation of budget.
(b) Effect on workers : Too much control will give bad results rather than good one. Bad effect
may be found on workers. The spontaneous attitude of the workers will go away, willingness to
work will disappear.
(c) Too costly : The introduction of budgetary control system and its effective use are very costly.
So, it is not possible for the small firm to apply this system.
(d) Optimum use of efficiency is impossible : If budgetary control system is introduced in a firm,
then the workers of that firm have to perform their duties according to the budget. As a result,
they have to do works within a particular limit. So, they can not apply excessive efficiency in the
performance of their duties even if they are able to do it.
(e) Inflexibility : Change and refining are needed in the budget in order to adapt with the changing
situations. If it is not done, then it will not be possible to achieve success. But, it is very difficult
and costly to change or rectify the budget, once it is prepared.
(f) Indulgence in past events : What happened in the past will be reflected repeatedly in the
budget. So, it is not certain that the similar incident will always happen in future. Therefore, it
may be said that by giving too much emphasis on the past events inefficiencies are indulged.
75. ―Return on investment is an important tool of financial control‖ –

Discuss*
Return on Investment is an important tool for the measurement of efficiency and financial control of
a firm. It is a yardstick with the help of which it is known how much a firm earn profit on the basis
of capital employed.
Advantages : The advantages of Return on Investment are —
(a) Realistic Approach : The actual profit earning capacity of a firm can be known with the help of
this technique. At the same time, it also can be known that what will be the effect on return, if
investment is changed.

(b) Comparative analysis of efficiency : This technique is not only applicable to the firms as a
whole, but equally applicable to various departments, sub-departments, products also. Thus, a
comparative picture relating to efficiency of different departments or products may be drawn.
(c) Proper allocation of resources : If any department claims more resources though it is not
necessary for it, this technique helps to prevent the department from their demand for assets with
ensuring the utilisation of resources according to the necessity in each case, this technique makes
it possible for rationale use of resources.
(d) Departmental Control: Every departmental manager is responsible for ensuring a certain rate
of return for his department. How far he has been successful in maintaining his responsibility
can be known with the help of return on investment technique. As a result, it is possible to
implement control in different departments according to the necessity.
(e) Indicator to overall control : This technique may be used as a method of overall control.
Because the objective of a firm is indicated through the rate of return. If this rate is satisfactory,
then other measures of control (viz. budget, cost, ratios, analysis, report etc.) may be possibly
regarded as satisfactory.
Disadvantages: The disadvantages of Return on Investment technique are—
(a) Problem for determining the standard rate : The success of a firm is justified with the help of
the Return on Investment technique. But, it is very difficult to determine the standard rate of
return on which a firm is operated successfully.
(b) Valuation Problem : Another problem arises as to the valuation of investment. There is dispute
about the basis of valuation of assets. Different experts differ in their opinions whether assets
should be valued at realisable value or historical cost or replacement cost.
(c) Other matters neglected : This technique lays more emphasis on financial factors only. As for
example, income and capital employed. Apart from those factors there are other matters which
have positive effect on the successful running of the business.
(d) Costly and laborious : This technique is costly as well as laborious task. A good deal of human
resources is needed for collection of relevant information relating to cost determination, sales,
assets and others. Moreover, this being much costly cannot be profitably applied to small firms.
(e) Detrimental to the development: The concept of the return on investment is sometimes used in
such a strict literal sense that the case of research for new inventions, growth and development
are not considered. Here too much emphasis is placed on enhancing profitability by reducing the
various types of expenses. Ultimately, it yields that this technique is quite detrimental to the
overall development.
76. Discuss the advantages of financial control.****

Finance is said to be the life blood of business. From the time of promotion of the business to the daily
operations of business activities, the need for finance cannot be overemphasized. If proper control is not
exercised on all financial matters, the business will face disaster and its existence may be in danger.
Efficient financial control is essential to reduce the cost of raising capital and increase earnings per
share (EPS), profitability and rate of dividend. Financial control helps to procure exact amount of
finance and make optimum utilization of funds. Absence of financial control, production is hampered,
costs are increased and profits and dividends are reduced which injure image and goodwill of the
company.

The advantages of financial control may be enumerated as follows:
a. Maximization of profit: Efficient financial control increases the profitability of the business and
helps to achieve the objective of profit maximization.
b. Wealth maximization: Efficient financial control ensures wealth maximization of the firm. As a
result, value of the firm is increased.
c. Improvement of financial condition: Proper financial control helps to improve the financial
position of the business.
d. Financial stability: Financial control brings financial stability of the business by improving the
financial standing of the firm.
e. Ability to repay debts: Financial control increases the ability of the company to repay its debts. As a
result, creditworthiness and reputation of the company are increased.
f. Return on investment: Sound financial control helps in yielding satisfactory return on investment
(ROI) and paying satisfactory rate of dividend.
g. Collection of debts: Financial control ensures that proper collection drive is made for realizing dues
from debtors in time and creditors are paid timely.
h. Prevention of misappropriation: Financial control helps to prevent defalcation of cash and
misappropriation of fund. It also helps to maintain adequate cash balance in hand to feed working
capital needs of the business.
i. Cost effectiveness: Financial control brings cost consciousness among the employees and brings
down the cost of operations.
j. Co-ordination: Financial control helps in co-ordination of financial activities of the business and
increases the morale of the members of the financial team.
k. Financial discipline: Financial control establishes financial discipline and helps in achieving the
objectives of the firm.
l. Higher rate of dividend: Financial control helps to increase the rate of dividend and earnings per
share (EPS) by improving the financial performance of the firm.
m. Optimum utilization of resources: Financial control helps to make optimum utilization of available
financial resources of the company. It reduces wastages and cost of production.
n. Conservation of financial assets: Financial control conserves financial assets of the firm and helps
to keep capital intact.
o. Prevention of wastages: Financial control prevents wastages of financial resources by adopting
preventive control measures.
p. Corrective measures: Financial control adopts ‗standards‘ or ‗norms‘ against which actual
performances are measures, deviations or variances are ascertains and corrective or remedial actions
are taken so that such deviations do not recur in future.

FM: Objectives [10 Qn x 2 = 20 Marks] [For 3rd year Pass]

1. What do you mean by Financial Management?
Financial management is concerned with the planning and controlling of the financial resources of
the firm. It deals with the problems of capitalisation, choice of capital structure, sources of raising
funds, capital budgeting, working capital management, financial control, etc.
According to S.C.Kuchhal, "Financial management deals with procurement of funds and their
effective utilisation in the business."
According to Prof. Solomon, "Financial management is concerned with the efficient use of an
important economic resource, namely capital funds."
2. Mention any two objectives of Financial Management?
Efficient financial management requires the existence of some objectives or goals because
judgement as to whether or not a financial decision is efficient must be made in the light of some
objective. Although various objectives are possible but two main objectives of financial
management are as follows:
(A) Profit Maximisation: It has traditionally been argued that the objective of a company is to earn
profit; hence the objective of financial management is also profit maximisation.
(B) Wealth Maximisation: Maximisation of wealth implies that the financial objective of a firm
should be to maximise the market value of its shares. Wealth or value maximisation is the most
important goal of financial management.
3. Mention any two Functions of Financial Management?
The finance manager has to take careful decision in respect of the following:
(a) Investment decisions: These decisions determine how scarce resources in terms of funds
available are committed to projects which can range from acquiring a piece of plant to the
acquisition of another company. Funds procured from different sources have to be invested
in various kinds of assets.
(b) Financing decisions: These decisions relate to acquiring the optimum finance to meet
financial objectives and seeing that fixed and working capital are effectively managed. The
financial manager needs to possess a good knowledge of the sources of available funds and
their respective costs, and needs to ensure that the company has a sound capital structure, i.e.
a proper balance between equity capital and debt.
(c) Dividend decisions: These decisions relate to the determination as to how much and how
frequently cash can be paid out of the profits of an organisation as income for its
owners/shareholders.
4. What do you mean by time value of Money?
The time value of money (TVM) is one of the basic concepts of finance. We know that if we deposit
money in a bank account we will receive interest. Because of this, we prefer to receive money today
rather than the same amount in the future. Money we receive today is more valuable to us than
money received in the future by the amount of interest we can earn with the money. This is referred
to as the time value of money.
The term time value of money can be defined as ―The value derived from the use of money over
time as a result of investment and reinvestment.

5. What do you mean by Compounding and Discounting techniques?
Technique of discounting:
The present value of a sum of money to be received at a future date is determined by
discounting the future value at the interest rate that the money could earn over the period. This
process is known as Discounting. The present value interest factor declines as the interest rate
rises and as the length of time increases.
Techniques of compounding
The "time value of money" describes the effects of compounding. An amount invested today
has more value than the same amount invested at a later date because it can utilize the power of
compounding. Compounding is the process by which interest is earned on interest. When a
principal amount is invested, interest is earned on the principal during the first period or year.
In the second period or year, interest is earned on the original principal plus the interest earned
in the first period. Over time, this reinvestment process can help an account grow significantly.
6. What do you mean by Leverage?
In Financial Management the term 'leverage' means getting more benefit (in terms of profit) by
employment of the fixed asset or part of the capital employed which has a fixed rate of cost.
According to Van Horn—"Leverage refers to the use of fixed costs in an attempt to increase (or,
Lever up) profitability."
According to S. C. Kuchhal — "The term leverage is used to describe a firm's ability to use
fixed cost assets or funds to magnify the return to its owners."
7. What do you mean by Capital Gearing?
'Gearing' may be simply defined as the ratio between the various types of securities to total
capitalisation. When the term gearing is applied to the capital of a company, it is called capital
gearing. According to Prof. M. C. Shukla, "Capital rearing is the fixation of a proper ratio
between two or more types of securities and the ratio which each type of security bears to the
total capitalisation."
8. What do you mean by Trading on Equity?
"Trading on equity denotes the act of earning some additional net profit on the basis of strength
of equity without any extra pressure on sales or operating profit."
Trading' means taking advantage of and equity means stock or ownership. Thus trading on
equity denotes taking advantage of equity share capital to debt capital on reasonable basis.
According to Gerstenberg, "When a company uses both debt capital and owned capital in the
conduct of the business, it is called trading on equity."
9. What do you mean by Capital Structure?
Capital structure refers to the mix of a firm‘s capitalisation and includes long term sources of
funds such as debentures, preference share capital, equity share capital and retained earnings.
According to Gerstenberg capital structure is ―the make-up of a firm‘s capitalisation‖. The
decisions regarding the forms of financing, their requirements and their relative proportions in
total capitalisation are known as capital structure decisions.
10. Mention any three Strategies of financing
(a) Matching,
(b)Conservative, and
(c) Aggressive policies
11. What do you mean by Bank Financing?
Banks are the main constituents of money market. Money market is a highly organised market
where monetary transactions for short-term financing are effected through the process of
accepting deposits and lending money. Banks provide short-term financing to industry, trade
and commerce. In fact, a large part of working capital of the business is procured from bank
financing. Bank financing helps to float surplus cash and it contributes to financing the working
capital requirements of industry, trade, and commerce. Bank financing is related with floating
cash and its utilisation in industry, trade and commerce through banking system.
12. What are the Methods of Bank Financing?
Methods of Bank Financing:
The different methods of bank financing are discussed below:
1. Loans and Advances:
2. Cash Credit:
3. Overdraft
4. Discounting of Bills
5. Mortgage of Commercial Documents
13. What do you mean by Ploughing Back of Retained Earning?
Ploughing back of retrained earnings means re-investment of a part of profits retained or
undistributed. It is at. ideal method of financing for expansion and improvement. It is a self -
financing or auto-financing method. During prosperity, the management builds up reserves by
following a conservative dividend policy. Such reserves may be used for working capital or for
expansion and improvement. Retained earnings are the sources of fund This method is logical.
It constitutes internal capital. This method is becoming more popular and the government is
also encouraging this method.
14. What do you Mean by Capital Budgeting?
Financing and investment of funds are two crucial financial functions. The investment of funds
also termed as capital budgeting requires a number of decisions to be taken in a situation in
which funds are invested and benefits are expected over a long period. The term capital
budgeting means planning for capital assets. It involves proper project planning and commercial
evaluation of projects to know in advance technical feasibility and financial viability of the
project.
15. What are the objectives of capital Budgeting?
(a) It requires huge amount of investment in the initial stage for which the company will have
to bear high amount of cost, on the capital invested, in the nature of interest etc. So before
investing, selection of the project with respect to viability important.
(b) Generally capital investment decisions are not reversible. Capital investment means
investment in fixed assets like plant and machinery, office, building, furniture, etc. which
cannot be disposed off easily without incurring huge amount of loss. A few wrong decisions
may lead the company into insolvency or bankruptcy.
(c) Future is always uncertain as nobody has seen the future. So high degree of risk is, by its
very nature, attached to capital, budgeting decisions.

16. What do you mean by payback period?
The payback period of an investment is the length of time required for the cumulative total net
cash flows from the investment to equal the total initial cash outlays. At that point in time, the
investor has recovered the money invested in the project.
17. What do you mean by Accounting Rate of Return?
The accounting rate of return of an investment measures the average annual net income of the
project (incremental income) as a percentage of the investment.
Accounting rate of return = Average annual Net Income/Investment
The numerator is the average annual net income generated by the project over its useful life.
The denominator can be either the initial investment or the average investment over the useful
life of the project. Some organizations prefer the initial investment because it is objectively
determined and is not influenced by either the choice of the depreciation method or the
estimation of the salvage value. Either of these amounts is used in practice but it is important
that the same method be used for all investments under consideration.
18. What do you mean by Capital Rationing?
Sometimes a company may face the shortage of funds considering the number available projects
in hand. Acceptance of all the projects require significant amount of fund which the company
does not have. In such a situation the management makes the rationing or distribution of capital
to the projects in such a way that it gets maximum benefits from the projects selected. This
technique is
called capital rationing. The projects are ranked in order of their priority. They are ranked on
the basis of or Profitability index or sometimes on the basis of IRR. After that the most
profitable projects are selected. The best method of ranking is the NPV per rupee of investment
i.e. NPV / Investment.
19. What is dividend?
Every company has to determine the divisible profit before distributing dividend. The part of
the profit of a company, which can be distributed among its shareholders is called Divisible
Profit.
The part of the divisible profit of a company, which is distributed among its shareholders, is
called Dividend.
20. What are the different types of dividends declared by the companies?
(a) Final Dividend:
(b) Interim Dividend:
(c) Cash Dividend:
(d) Bonus Dividend:
(e) Scrip Dividend:
(f) Bond Dividend:
(g) Property Dividend:
(h) Composite Dividend:
(i) Optional Dividend:

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Bhalotia Classes (9883034569): Admission Going for Crash Course

[Red: 90 %, Blue: 60 %, Green: 30 %]

[Practical: 62 Marks Approx]

[Compulsory Theory: 38 Marks]

[OPtional Theory: 30 Marks]

- 1 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

Working Capital Management

2. Working Capital management [B.com 1988 Honours] [RKB]*

- 2 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

4. Working Capital management [B.com 2014 Pass]

5. Working Capital management [B.com 2015 Pass]

- 3 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

2. Leverage Compiled by Ravi Bhalotia]*

3. Leverage [B.com 2018 Pass]*

4. Leverage [B.com 2013 Pass]*

5. Leverage [B.com 2015 Pass]*

- 4 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

7. Leverage [B.com 2013 Hons Old]*

9. Leverage [Compiled by Ravi Bhalotia]****

19. Leverage [B.com 2014 Pass]******

22. Leverage [B.com 2006] ***

26. Leverage [B.com 2016 Pass]

Cost of capital [10 Marks]

11. Cost of capital [Cost of Redeemable Pref. Shares] [B.com 06]*

12. Cost of capital [Cost of Redeemable Preference Shares] [2015 Pass]*

14. Cost of Capital [Redeemable P. Share Capital] [B.com Honours 17]****

17. Cost of capital [Redeemable debenture] [B.com 2007]***

18. Cost of Capital [Cost of retained Earning] [B.com 2018 Pass]*

- 6 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

20. Cost of capital [WACC] [2016 Pass]

21. Cost of Capital [WACC] [B.com Honours 2009]***

- 7 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

Basic Concept [10 Marks]

3. Basic concept [Future value of one time deposit] [2013 Pass]****

5. Basic concept [Present value] [B.com 2018 Honours]****

6. Basic concept [Present value] [B.com 2007]****

9. Basic concept [Present value] [B.com 2017 Honours]****

12. Basic concept [B.com 2014 Pass]****

- 8 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

15. Basic concept [B.com 2018 Honours]****

16. Basic concept [B.com 2015 Pass]****

17. Basic concept [B.com 2014 Honours]****

18. Basic concept [Compiled by Ravi Bhalotia]*

19. Basic concept [Compiled by Ravi Bhalotia]*

- 9 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

Dividend policies [10 Marks]

3. Dividend policy [Gordon‘s Model] [B.com 2018 Honours]**

4. Dividend policy [Gordon‘s Model] [B.com 2017 Pass]***

8. Dividend policy [Walter‘s Model] [B.com 2009 Honours]*

9. Dividend policy [Walter‘s Model] [B.com 2014 Pass]*

- 10 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

10. Dividend policy [Walter‘s Model] [B.com 2016 Pass]*

13. Dividend policy [M-M Model] [Compiled by Ravi Bhalotia]*

15. Dividend policy [M-M Model] [B.com 2017 Honours]*

16. Dividend policy [M-M Model] [B.com 2013 Honours]*

- 11 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.

Capital Budgeting [10 + 6]

4. Capital Budgeting [ARR Method] [B.com 2014 Honours]****

7. Capital Budgeting [Payback Period] [B.com 2014 Pass]****

8. Capital Budgeting [Payback] [B.com 2017 honours] *

10. Capital Budgeting [Payback] [B.com 2017 Pass] *

11. Capital Budgeting [Payback] [B.com 06] *

- 12 –No Guarantee of any Question. Prepare as much as Possible. Best of Luck.