Answer any FIVE questions. Each question carries FIVE marks.

(5×5=25)
1. Define primary market. What are the features of primary
market?
The primary market is a financial market where companies and
governments sell new securities to investors for the first
time. It's a crucial part of the financial system, providing capital
for businesses to grow and expand.
Here are some features of the primary market:
 Securities
New securities, such as stocks and bonds, are sold to investors
directly by the issuing company.
 Types of issues
Primary market issues include initial public offerings (IPOs),
private placements, rights issues, and preferred allotments.
 Purpose
Companies and governments use the primary market to raise
funds for various purposes, such as expansion, research and
development, or debt repayment.
 Proceeds
The proceeds from sales in the primary market go to the issuer
of the securities.
 Instruments
Primary markets typically deal with primary instruments, such
as company stocks, bonds, and currencies.
 Regulation
The primary market is regulated by SEBI.
The primary market differs from the secondary market, where
investors buy and sell securities that have already been issued.

2. How wealth maximization goal is superior to profit

maximization?
Wealth maximization is generally considered a better goal than
profit maximization because it focuses on long-term growth and
value creation, while profit maximization can prioritize short-
term gains:
 Long-term focus
 Wealth maximization encourages strategic investments and
sustainable practices that can help a company grow and provide
returns over the long term. Profit maximization, on the other
hand, can lead to practices that are not sustainable and risk the
company's future.
 Risk assessment
Wealth maximization incorporates risk assessment into
decision-making, while profit maximization often overlooks
risk.
 Shareholder value
Wealth maximization aligns management with shareholder
interests and considers stockholder preferences. Stockholders
prefer steady growth over the long term to profits and
uncertainty in the short term.
 Resource allocation
Wealth maximization encourages better resource allocation.

3. Mention the acceptance and rejection criteria of all the capital

budgeting techniques.
In capital budgeting, the acceptance criteria generally states that
a project should be accepted if its calculated value using a
specific technique is greater than a predetermined threshold,
while the rejection criteria means the project should be rejected
if the calculated value falls below that threshold; for example,
with Net Present Value (NPV), a project is accepted if its NPV
is positive and rejected if it's negative, and with Internal Rate of
Return (IRR), a project is accepted if its IRR is higher than the
cost of capital and rejected if it's lower.
Here's a breakdown of acceptance and rejection criteria for
common capital budgeting techniques:
 Net Present Value (NPV):
o Accept: If NPV is positive.
o Reject: If NPV is negative.
 Internal Rate of Return (IRR):
o Accept: If IRR is greater than the cost of capital.
o Reject: If IRR is less than the cost of capital.
 Profitability Index (PI):
 o Accept: If PI is greater than 1.
o Reject: If PI is less than 1.
 Payback Period:
o Accept: If payback period is less than a predetermined
maximum acceptable payback period.
o Reject: If payback period is greater than a predetermined
maximum acceptable payback period.
Important points to remember:
 Time Value of Money:
Most capital budgeting techniques, like NPV and IRR, take into
account the time value of money by discounting future cash
flows to their present value.
 Risk Consideration:
While the acceptance/rejection criteria are based on the
calculated values, it's important to consider the risk associated
with each project when making final investment decisions.

4. Briefly explain different types of leverages.

The three main types of leverage in finance are:
 Operating leverage: Compares a company's fixed costs to its
total costs. It's also called the Degree of Operating Leverage
(DOL), which is a financial ratio that measures how well a
company uses fixed costs to generate operating income.
 Financial leverage: Uses debt financing to fund a company's
operations and investments. It increases the potential return on
equity, but also increases the risk of financial distress.
 Working capital leverage: Another type of leverage in
finance.
Other types of leverage include:


Debt-to-equity ratio
Compares a company's total debt to its shareholders' equity. It's
also known as the Equity Multiplier.
 
Consumer leverage ratio
Determines how much debt the average American consumer has
relative to their disposable income.


Margin trading
A sub-type of leverage trading where you borrow money from a
broker to trade assets.
Leverage is a tool that finance managers use to balance a
company's debt and equity to optimize its financial structure.

5. What is time value of money? What is its relevance in financial

decision making?
The time value of money (TVM) is a fundamental financial
principle that states that money is worth more today than the
same amount of money in the future. This is because money can
earn interest and grow in value over time.
TVM is a core concept in finance that influences many financial
decisions, including:
 Investing
TVM helps investors decide how to allocate their resources and
make the best financial decisions.
 Borrowing and lending
TVM can help individuals and businesses make informed
decisions about how to pay off debts or manage cash flow.
 Project management
TVM can help project managers make decisions about project
schedules and return on investment.
 Business decisions
TVM can help businesses decide whether to invest in new
equipment or expand into new markets.
 TVM is based on the idea that money can generate income
through investment, so delaying investment means missing out
on potential earnings. For example, if you have a choice
between receiving ₹1,000 today or one year from now, you
should take it today. You can invest that money and increase its
value over the year.
TVM is also related to inflation and purchasing power. Inflation
erodes the value of money over time, so it's important to factor
that in when investing.

6. Briefly explain the challenges of modern financial manager.

Modern financial managers face challenges like managing
complex data from diverse sources, navigating rapidly changing
regulations, integrating new technologies, ensuring
cybersecurity, balancing short-term needs with long-term
strategic goals, making data-driven decisions in uncertain
economic environments, and fostering collaboration with other
departments to achieve optimal financial outcomes.
Key points about these challenges:
 Technological complexity:
The need to adopt and leverage advanced analytics tools, cloud
computing, and automation to process large volumes of data
efficiently.
 Regulatory compliance:
Keeping up with evolving financial regulations and ensuring
adherence across different jurisdictions.
 Risk management:
Identifying and mitigating potential financial risks like market
volatility, credit risk, and cyber threats.
 Strategic decision-making:
Balancing financial goals with broader business strategies and
considering long-term sustainability factors.
 Data analysis and interpretation:
Extracting meaningful insights from complex data sets to inform
financial decisions.
 Communication and collaboration:
 Effectively communicating financial information to stakeholders
across different departments and levels of the organization.
 Talent acquisition and development:
Finding and retaining skilled financial professionals with the
necessary technical and soft skills to navigate a changing
landscape.

7. Explain different forms of dividend.

Here are some different types of dividends:
 Cash dividends
A company pays a fixed amount of cash to shareholders per
share. This is a popular form of dividend in India.
 Stock dividends
A company gives shareholders additional shares instead of
cash. This increases ownership but can dilute share value.
 Special dividends
A company makes a one-time payment outside of the regular
dividend schedule. This can happen after strong earnings or
asset sales.
 Property dividends
A company distributes non-cash assets, like real estate or
inventory, to shareholders.
 Scrip dividends
A company pays out promissory notes or IOUs that can be
redeemed for stock or cash at a later date.
 Liquidating dividends
A company liquidates all its assets and pays the sum to
shareholders as a dividend. This is usually done when the
company is about to shut down.
Dividends are not considered an expense, but rather an
allocation of a company's accumulated earnings.

8. What is working capital management?

Working capital management is a business strategy that involves
managing a company's short-term assets and liabilities to ensure
the business has enough money to run smoothly:
 What it is
 Working capital management is the process of ensuring a
company has enough cash flow to meet its day-to-day operating
costs and short-term debt obligations. It involves balancing a
company's available money with its short-term bills.
 What it includes
Working capital management primarily involves managing cash,
accounts receivable, inventory, and accounts payable.
 What it aims to do
Working capital management aims to ensure that a company
operates efficiently by using its current assets and liabilities to
their most effective use.
 How to measure
The efficiency of working capital management can be quantified
using ratio analysis. Some important working capital metrics
include the working capital ratio, the collection ratio, and the
inventory ratio.
 How to improve
Some ways to improve working capital management include:
 Monitoring receivables
 Negotiating favorable payment terms
 Optimizing inventory management
 Utilizing short-term financing
 Leveraging technology

9. What is time value of money?

10. What is secondary market?

 The secondary market is a financial market where investors buy
and sell financial instruments that have already been issued,
such as stocks, bonds, options, and derivatives. It's also known
as the aftermarket or follow-on public offering.
The secondary market differs from the primary market, where
new securities are first issued and sold to the public. In the
secondary market, investors trade with each other, rather than
directly with the company that issued the securities.
The secondary market is where most trading takes place.
National exchanges like the New York Stock Exchange (NYSE)
and the Nasdaq are examples of secondary markets.
11. A firm does not pay any dividend for the first 4 years and
thereafter it will pay a dividend of A 5 at the growth rate of 10%.
The required rate of return is 12%. Find the value of share.
12. Distinguish between cost of debt and cost of equity.
13. What is WACC?

14. Define capital budgeting

Capital budgeting is a process that businesses use to evaluate
and prioritize large-scale investments that can significantly
impact a company's financial standing. It involves analyzing the
potential profitability of projects to determine which ones are
worth pursuing and allocating financial resources accordingly.
Capital budgeting is a crucial part of a business's strategy for
spending money on big projects or purchases that will help it
grow and improve operations. Capital budgeting decisions can
impact the company's future growth and profitability.
The capital budgeting process includes: Identifying investment
opportunities, Evaluating investment proposals, Choosing a
profitable investment, and Apportioning the project.
Some techniques used in capital budgeting include: Payback
period method, Net present value, Accounting rate of return,
Internal rate of return (IRR), and Profitability index.
The choice of which technique to use is based on the priorities
and goals of the company.
15. Briefly Explain the mechanics of calculating the present
value of cash flows.
16. Illustrate the concept of the Internal rate of return.
The internal rate of return (IRR) is a metric used to estimate the
expected return on an investment. It's the discount rate that makes the
net present value (NPV) of an investment equal to zero.
Here's how the IRR concept works:
 Calculation
The IRR is calculated by discounting a project's cash flows at
different rates until the NPV is zero. The IRR is the discount rate that
produces this result.
 Comparison
The IRR is compared to a pre-set target or the investor's minimum
acceptable rate of return. If the IRR is greater than the target, the
project is accepted.
 Use
The IRR is used to analyze capital budgeting projects and compare
potential rates of annual return. It's also used to compare different
projects within a company.
 Benefits
The higher the IRR, the higher the profit from the
investment. However, a company might prefer a project with a lower
IRR if it has other potential benefits.
Here's an example of how the IRR can be used to compare lump-sum
investments versus payments over time:
 Monthly payments
If you invest $50 every month in the stock market over a 10-year
period, that money would turn into $7,764 at the end of the 10 years
with a 5% IRR.
 Lump-sum investment
To get the same future value of $7,764 with an IRR of 5%, you would
have to invest $4,714 today.
Q4) What are ordinary shares? What are their features?
Ordinary shares, also known as common stock, are a type of equity
that gives shareholders certain rights and benefits:
 Voting rights: Shareholders can vote on company matters, such
as board elections, mergers, and bylaws.
 Dividends: Shareholders may receive a portion of the
company's profits, but companies aren't required to distribute
them.
 Residual claims: In the event of a company's liquidation,
shareholders receive any remaining assets after debts and
liabilities are paid.
  Ownership: Shareholders are considered part owners of the
company.
 Tradability: Ordinary shares are typically listed and traded on
stock exchanges.
Here are some other things to know about ordinary shares:
 Types: There are different types of ordinary shares, each with
unique characteristics. For example, some shares are non-voting,
while others are sweat equity shares given to staff or
management.
 Risk: Ordinary shareholders can lose money if the price of the
shares decreases.
 Benefits for companies: Issuing ordinary shares is a way for
companies to raise capital without taking on too much debt.

17. Suppose on investor is considering the purchase of a 6 year `

2,000 per value bond, bearing a nominal rate of interest of 6%
The investor’s required rate of return is 8%. What should be
the willing to pay now to purchase the bond if it metures at
per?
18. What is the difference between NPV and PI methods?
As NPV and PI techniques of capital investment decisions are closely
related to each other, both provide the same result as far as accept-
reject decisions are concerned. This is so because under NPV method
a proposal is acceptable if it gives positive net present value and
under PI method a proposal is acceptable it the profitability index is
greater than one.
The P.I. will be greater than one only when the NPV is positive and
hence they give identical accept-reject decisions. However, in case of
mutually exclusive proposals having different scales of investment,
i.e. where the initial investment in the alternative proposals is not the
same, a conflict in NPV and PI rankings may occur.

19. Define cost of capital. Explain its significance in financial

decision making.
Cost of Capital:
The cost of capital is the rate of return a company must earn on its
investments to maintain its market value and attract funds. It
represents the opportunity cost of using funds for a specific purpose
rather than investing them elsewhere. In essence, it reflects the
minimum return required by the company’s investors—both equity
and debt holders.

Components of Cost of Capital:

1. Cost of Debt:
o The effective interest rate a company pays on its borrowed
funds.
o Adjusted for tax savings since interest expenses are tax-
deductible.
2. Cost of Equity:
o The return required by equity shareholders.
o Calculated using models like the Capital Asset Pricing
Model (CAPM).
 3. Weighted Average Cost of Capital (WACC):
o The overall cost of capital for the company, combining the
costs of debt and equity, weighted by their respective
proportions in the capital structure.

Significance of Cost of Capital in Financial Decision-Making:

1. Investment Decisions:
o Serves as the discount rate in evaluating investment
opportunities using methods like Net Present Value (NPV)
or Internal Rate of Return (IRR).
o Projects with expected returns exceeding the cost of
capital are typically accepted.
2. Capital Structure Decisions:
o Helps in determining the optimal mix of debt and equity
financing to minimize the WACC and maximize the firm's
value.
3. Performance Evaluation:
o Acts as a benchmark for evaluating a company’s financial
performance.
o If the company earns a return greater than its cost of
capital, it creates value for shareholders.
4. Valuation of Companies:
o Used as the discount rate in Discounted Cash Flow (DCF)
analysis for valuing companies or projects.
5. Risk Assessment:
o Reflects the risk perception of investors.
o A higher cost of capital indicates higher perceived risk,
influencing funding and project feasibility.
6. Dividend Policy Decisions:
 o Impacts decisions regarding dividend payments versus
reinvesting profits in the business.
7. Strategic Planning:
o Provides insights into the viability of expansion,
acquisitions, and other long-term strategic initiatives.

Practical Example:
A company with a cost of capital of 10% would only consider
projects expected to generate returns higher than 10%. If a project
offers a 12% return, it creates a 2% value surplus. Conversely, a
project with an 8% return would reduce the firm's value.
In summary, the cost of capital is a vital benchmark for making sound
financial decisions that ensure the company’s growth, profitability,
and sustainability.
4o

20. Briefly explain the relevance of agency theory.

Agency Theory:
Agency theory addresses the relationship between principals
(owners, shareholders) and agents (managers, executives) in a
business context. It focuses on resolving conflicts that arise due to
differing goals, risk tolerances, and levels of information between
these two parties.

Key Aspects of Agency Theory:

1. Principal-Agent Relationship:
o Principals delegate decision-making authority to agents to
manage the business on their behalf.
o Example: Shareholders (principals) hire managers (agents)
to run a company.
 2. Conflict of Interest (Agency Problem):
o Managers may act in their self-interest rather than in the
best interest of shareholders.
o Example: Managers might prioritize personal benefits
(e.g., bonuses, perks) over long-term shareholder value.
3. Information Asymmetry:
o Agents often possess more information about the business
than principals, making it difficult for principals to
monitor agents effectively.
4. Agency Costs:
o Costs incurred to align the interests of principals and
agents, such as:
 Monitoring costs (e.g., audits, performance reviews).
 Bonding costs (e.g., incentives to align goals).
 Residual loss (costs from divergent actions not fully
mitigated).

Relevance of Agency Theory:

1. Corporate Governance:
o Establishes frameworks, such as boards of directors and
performance-based compensation, to align management's
interests with shareholders.
2. Incentive Structures:
o Helps design reward systems (e.g., stock options, profit-
sharing) to encourage managers to act in shareholders’
best interests.
3. Decision-Making:
o Guides shareholders and boards in monitoring managerial
actions to minimize opportunistic behavior.
4. Risk Management:
 o Balances the risk preferences of shareholders (who may
favor higher risks for higher returns) with those of
managers (who may prefer lower risks to safeguard their
positions).
5. Mergers and Acquisitions:
o Informs strategies to prevent managerial overreach or
empire-building tendencies, which can lead to inefficient
resource allocation.
6. Financial Policy:
o Provides insights into dividend policies, capital structure
decisions, and investment choices, ensuring they align
with shareholder wealth maximization.

Practical Example:
In a publicly traded company, shareholders might implement
performance-based bonuses for executives to incentivize them to
increase the company's stock price, reducing the risk of self-serving
actions.

21. Distinguish between primary market and secondary

market.

22. Briefly explain different capital budgeting techniques with

their acceptance andrejection criteria.
Capital budgeting techniques are methods used to evaluate and select
investment projects based on their profitability and feasibility. These
methods help

in making decisions about long-term investments in fixed assets like

machinery, infrastructure, or new projects.
23. “Leverage is double-edged sword” comment.
The phrase "Leverage is a double-edged sword" aptly describes the
dual nature of leverage in finance. Leverage refers to the use of
borrowed funds (debt) or fixed costs to enhance the potential returns
of a business or investment. While leverage can amplify gains, it also
increases the potential for losses, making it both beneficial and risky.

Why Leverage is a Double-Edged Sword?

1. Amplification of Gains:
o Leverage magnifies profits when the returns on
investments or operations exceed the cost of borrowed
funds or fixed obligations.
o Example: If a company borrows at 5% interest and earns a
return of 10% on the borrowed amount, the additional
profit boosts the company's equity return.
2. Amplification of Losses:
o When returns fall below the cost of debt or fixed
obligations, leverage magnifies losses, putting greater
pressure on the company's financial stability.
o Example: If the return is only 3% but the cost of debt is
5%, the company incurs losses, reducing equity value
more severely.
3. Risk of Insolvency:
o Excessive leverage increases the risk of default on debt
payments, especially during economic downturns or
periods of reduced profitability.
4. Volatility in Earnings:
o Leverage increases the variability of returns, making a
company's performance more sensitive to changes in
revenue or operating conditions.

Illustration of Leverage's Impact:

Financial Leverage (Debt):
  A firm with no debt bears no interest expense and retains
flexibility, but its returns may be limited due to reliance solely
on equity.
 A firm with high debt benefits from increased returns when
business conditions are favorable but faces higher fixed interest
payments during downturns, risking bankruptcy.
Operating Leverage (Fixed Costs):
 High fixed costs can increase profits during periods of high sales
volume.
 Conversely, if sales decline, fixed costs remain constant, leading
to a steep drop in profitability.

Benefits of Leverage:
1. Higher Potential Returns:
o Leverage allows firms or investors to control larger assets
or projects, increasing profit potential.
2. Tax Advantage:
o Interest payments on debt are tax-deductible, reducing the
effective cost of borrowing.
3. Ownership Retention:
o Borrowing instead of issuing new equity helps maintain
control over the company.

Drawbacks of Leverage:
1. Financial Risk:
o High leverage can lead to insolvency if cash flows are
insufficient to meet fixed obligations.
2. Reduced Flexibility:
o Debt covenants and repayment obligations limit
managerial freedom.
 3. Increased Volatility:
o Earnings and returns become more unpredictable.

24. Why wealth maximization is widely accepted goal of

financial Management?
Wealth Maximization as a Goal of Financial Management
Wealth maximization is the process of increasing the long-term
value of the firm for its shareholders. It is considered the most
appropriate and widely accepted goal of financial management due to
its focus on sustainable value creation.

Why Wealth Maximization is Widely Accepted:

1. Focus on Long-Term Value:
o Wealth maximization emphasizes long-term growth and
sustainability rather than short-term profits.
o It ensures that the firm's decisions contribute to increasing
the market value of equity, reflecting the overall health of
the business.
2. Alignment with Shareholder Interests:
o Shareholders invest to maximize their wealth, and this goal
aligns the objectives of financial management with those
of shareholders.
3. Time Value of Money Consideration:
o Wealth maximization takes into account the time value of
money, recognizing that a rupee today is worth more than
a rupee tomorrow.
o Discounted Cash Flow (DCF) techniques, like Net
Present Value (NPV), help evaluate projects based on
future cash flows.
4. Comprehensive Measure of Performance:
 o Unlike profit maximization, which focuses solely on
accounting profits, wealth maximization considers cash
flows, risk, and the overall impact of decisions on the
firm's value.
5. Risk-Return Trade-Off:
o Wealth maximization incorporates the risk-return trade-
off, ensuring that investments are evaluated based on their
potential returns and associated risks.
6. Market Perception and Credibility:
o A firm that focuses on maximizing shareholder wealth
gains credibility and trust in the financial markets,
improving its ability to raise capital at favorable terms.
7. Social and Economic Benefits:
o By maximizing wealth, firms can contribute to economic
growth, create employment, and improve stakeholder well-
being.
o Higher shareholder wealth often translates into higher tax
revenues for governments and increased social
investments.

Comparison: Wealth Maximization vs. Profit Maximization

Aspect Wealth Maximization Profit Maximization
Long-term value
Objective Short-term profits
creation
Time Horizon Long-term Short-term
Risk Accounts for risk and
Ignores risk
Consideration uncertainty
Cash Flow Focuses on cash flows Focuses on accounting
Focus and their timing profits
Aspect Wealth Maximization Profit Maximization
Stakeholder Limited to shareholders
Benefits all stakeholders
Impact in the short term

Practical Example:
A company considering an investment project that generates
consistent cash flows over 10 years might choose to proceed based on
its positive NPV, even if the project does not yield immediate profits.
This decision supports wealth maximization by increasing the firm's
long-term value.

25. What is time value of money? Why it is necessary to

consider time value of money in capital budgeting.
Why Time Value of Money is Necessary in Capital Budgeting:
Capital budgeting involves evaluating long-term investment projects,
and considering the time value of money is essential for making
sound decisions.
1. Cash Flow Comparability:
o Capital projects generate cash flows over multiple years.
o Discounting future cash flows to their present value
ensures all cash flows are evaluated on the same time
scale.
2. Risk and Opportunity Cost:
o Future cash flows are uncertain and risky.
o TVM reflects the opportunity cost of investing capital in
a project versus alternative investments.
3. Accurate Project Evaluation:
o Ignoring TVM may overestimate the attractiveness of
projects with significant future cash inflows.
 o Methods like Net Present Value (NPV) and Internal
Rate of Return (IRR) incorporate TVM for precise
evaluation.
4. Maximizing Shareholder Wealth:
o TVM ensures that investment decisions align with the goal
of maximizing the firm's value by prioritizing projects
with higher present values.
5. Inflation and Purchasing Power:
o TVM accounts for the erosion of money's value over time
due to inflation.
o This ensures that projects deliver real, not nominal, value.

Capital Budgeting Techniques Using TVM:

1. Net Present Value (NPV):
o Considers TVM by discounting cash flows.
o Projects with positive NPV add value.
2. Internal Rate of Return (IRR):
o Calculates the discount rate at which NPV is zero.
o Incorporates TVM for profitability assessment.
3. Discounted Payback Period:
o Accounts for TVM while determining how long it takes to
recover the investment.

Example:
 Without TVM: Receiving ₹10,000 today and ₹10,000 five
years later would be considered equal.
 With TVM: Receiving ₹10,000 today is more valuable because
it can be invested to grow over five years.
26. What are the challenges of financial manager in the global
scenario?
Currency Fluctuations
 Issue: Exchange rate volatility affects the value of international
transactions, investments, and earnings.
 Impact:
o Increases risk in cross-border transactions.
o Affects pricing, profits, and cost management.
 Example: A company exporting goods may earn less revenue if
the local currency depreciates against the foreign buyer’s
currency.

2. Regulatory and Legal Compliance

 Issue: Navigating diverse tax codes, financial regulations, and
legal systems across countries.
 Impact:
o Non-compliance can result in penalties, legal disputes, and
reputational damage.
 Example: A multinational corporation must comply with the
General Data Protection Regulation (GDPR) in the EU and
different tax laws in each operating country.

3. Political and Economic Risks

 Issue: Political instability, economic downturns, and
government interventions can disrupt operations and
investments.
 Impact:
o Sudden policy changes (e.g., tariffs, sanctions) can
increase costs or limit market access.
  Example: A financial manager must assess risks of investing in
countries with unstable governments or protectionist policies.

4. Managing Diverse Stakeholders

 Issue: Financial managers must align the interests of diverse
stakeholders, including international investors, employees, and
governments.
 Impact:
o Differing priorities complicate decision-making.
 Example: Balancing shareholder expectations for profits with
local community demands for sustainable practices.

5. Cultural and Communication Barriers

 Issue: Cultural differences and language barriers affect
negotiations, contracts, and teamwork.
 Impact:
o Misunderstandings can lead to financial errors or strained
relationships.
 Example: Variations in accounting practices between countries
using GAAP versus IFRS standards.

6. Capital Availability and Cost

 Issue: Access to affordable financing differs across global
markets.
 Impact:
o High borrowing costs in certain regions can affect global
operations.
 Example: A company operating in an emerging market may
face higher interest rates or limited access to international
capital markets.
7. Inflation and Interest Rate Differences
 Issue: Varying inflation rates and monetary policies impact
purchasing power, costs, and returns.
 Impact:
o Unstable inflation can erode profitability in high-inflation
countries.
 Example: High inflation in a country like Argentina may
necessitate frequent price adjustments and hedging strategies.

8. Technological and Cybersecurity Challenges

 Issue: Adopting global financial technologies and safeguarding
data.
 Impact:
o Financial fraud or data breaches can result in significant
losses.
 Example: Implementing secure systems for global payment
processing while mitigating cyber threats.

9. Ethical and Environmental Concerns

 Issue: Addressing global calls for corporate social responsibility
(CSR) and sustainability.
 Impact:
o Ignoring these concerns can harm reputation and lead to
regulatory scrutiny.
 Example: Financial managers need to integrate environmental,
social, and governance (ESG) factors into decision-making.

10. Complexity of Global Taxation

  Issue: Managing tax obligations across multiple jurisdictions.
 Impact:
o Double taxation or tax avoidance disputes can arise.
 Example: Navigating tax treaties and optimizing global tax
liability through transfer pricing strategies.

11. Supply Chain Disruptions

 Issue: Global supply chain volatility due to natural disasters,
pandemics, or geopolitical tensions.
 Impact:
o Disruptions affect cash flow, inventory costs, and financial
planning.
 Example: The COVID-19 pandemic highlighted vulnerabilities
in global supply chains.

12. Exchange Controls and Repatriation Restrictions

 Issue: Restrictions on currency transfers imposed by some
countries.
 Impact:
o Limits on repatriating profits can create liquidity
challenges.
 Example: Restrictions in countries like Nigeria and Venezuela
complicate cash management.

Strategies to Overcome Challenges:

1. Hedging Against Currency Risks:
o Use derivatives like forward contracts and options to
mitigate exchange rate volatility.
2. Diversified Investments:
 o Spread investments across geographies to reduce reliance
on any single market.
3. Compliance Frameworks:
o Develop robust systems for adhering to international
regulations.
4. Technology Adoption:
o Invest in secure and efficient global financial management
systems.
5. Scenario Planning:
o Use stress testing and contingency planning to prepare for
economic and political uncertainties.

SECTION - B
Answer any four questions. Each question carries ten marks : [4 × 10
= 40]
1. The following in the information of two proposals. If A is
selected then X will be rejected, evaluate and rank the
proposals by NPV and IRR techniques. The minimum
required rate of return is 10%. The life of the projectes is 3
years and
Cash flows are as follows.
Year Cash flow A (`) Cash flow X(`)
0 –10,00,000 –20,00,000
1 5,00,000 10,00,000
2 6,00,000 15,00,000
3 4,00,000 10,00,000
2. What is capital budgeting? Discuss its main features?
3. Find payback time of the two machines. Suggest which is better
a) Machine A costs ` 50,000 and generates a cash flow of ` 18,000
for 4 years.
b) Machine B costs ` 75,000 and generates ` 20,000 for 6 years.
c) A project requires on investment of 5 lakh and yields an annual
cash flow of 6 lakhs for 10 years what is the payback period of the
project?
4. What is the meaning of cost of capital? What is its significance
in financial decision
- making.
5. A company declared a dividend of ` 2 per share last year. The
shareholders have
a required rate of return of 15%. What would be the market
price of the share if
the growth rate of the dividend is expected to be
a) 9% b) 11%
c) 14% d) 10%
6. Discuss the assumptions and limitations of Walter’s approach
to dividend decisions.

Assumptions of Walter’s Approach:

1. Constant Rate of Return (r):
 o The firm’s internal rate of return on retained earnings
remains constant, irrespective of the scale of investment.
2. Constant Cost of Capital (k):
o The cost of equity remains the same, regardless of the
firm’s risk profile or capital structure.
3. All Financing Through Retained Earnings:
o Walter’s model assumes the firm relies solely on retained
earnings for financing investments, ignoring external
financing.
4. Single Investment Opportunity:
o The firm has only one type of investment opportunity with
a fixed return.
5. No Taxes or Market Imperfections:
o The model operates under the assumption of no taxes,
transaction costs, or market imperfections.
6. 100% Payout or Retention:
o Profits are either fully distributed as dividends or fully
retained for reinvestment.
7. Infinite Time Horizon:
o The firm has an indefinite life, allowing returns to be
perpetually earned.

Limitations of Walter’s Approach:

1. Unrealistic Assumptions:
o The assumptions of constant rrr, constant kkk, and reliance
only on retained earnings are impractical in real-world
scenarios.
2. Neglects Market Dynamics:
 o The model does not account for market reactions to
dividend announcements or other external factors affecting
share prices.
3. No External Financing:
o Excluding external sources of funding limits the
applicability of the model, especially for firms that require
significant capital for growth.
4. Ignores Tax Implications:
o In reality, taxes on dividends and capital gains influence
investor preferences and decisions.
5. Single Rate of Return:
o Assuming all retained earnings yield the same return
disregards diminishing returns on large-scale investments.
6. Risk-Return Trade-Off Ignored:
o The model does not consider the increasing risk associated
with higher retention of earnings for investment purposes.
7. Applicability Limited to Specific Cases:
o The model is most relevant for firms where r>kr > kr>k or
r<kr < kr<k. In cases where r=kr = kr=k, dividend
decisions do not impact the firm's value, limiting the
practical insight of the model.

8. ) Debt is cheaper than equity. Comment.

The statement "Debt is cheaper than equity" reflects a fundamental
principle in corporate finance. Debt financing typically incurs lower
costs compared to equity financing, making it an attractive source of
capital for many firms. However, while debt has cost advantages, it
also comes with risks that need careful management.

Reasons Why Debt is Cheaper Than Equity:

 1. Lower Cost of Capital:
o Interest Rates: Debt typically involves fixed interest
payments that are generally lower than the returns
demanded by equity investors.
o Equity investors expect higher returns as compensation for
bearing greater risk (residual claims and lack of fixed
returns).
2. Tax Benefits:
o Interest on debt is tax-deductible, reducing the effective
cost of debt. In contrast, dividends paid to shareholders are
not tax-deductible.
o Example: A company with a 30% tax rate and 10%
interest rate effectively pays only 7% (10% × (1 - 0.30))
after tax.
3. Fixed Obligations:
o Debt involves fixed repayment obligations, which lenders
consider less risky than equity, where returns are
contingent on the firm's performance.
o As a result, lenders typically accept a lower return
compared to equity investors.
4. No Ownership Dilution:
o Raising capital through debt does not dilute ownership or
control, unlike equity, which requires sharing ownership
with new investors.
o This aligns managerial incentives with existing
shareholders.

Limitations and Risks of Debt Financing:

While debt is cheaper, it comes with significant risks that can
outweigh its cost advantages if mismanaged:
1. Financial Risk and Insolvency:
 o Fixed interest payments create financial leverage. If the
firm’s earnings are insufficient, it may default, leading to
bankruptcy.
2. Increased Cost with Higher Debt Levels:
o Excessive debt increases the risk of default, raising
borrowing costs and the cost of equity due to increased
risk perception (financial distress).
3. Impact on Flexibility:
o High debt levels restrict managerial flexibility, as
companies may face covenants or limitations imposed by
creditors.
4. No Tax Benefit in Some Cases:
o Firms with low or no taxable income (e.g., during losses)
cannot benefit from the tax-deductibility of interest
payments.
5. Macroeconomic Sensitivity:
o Rising interest rates in the economy can increase the cost
of debt, especially for variable-rate loans.

Comparison of Debt and Equity Costs:

Aspect Debt Equity
Lower (fixed interest rate, Higher (residual risk,
Cost
tax-deductible) opportunity cost)
Risk to Higher (fixed obligations, Lower (no obligation to
Company default risk) pay dividends)
Ownership
No Yes (dilutes control)
Dilution
Dividends are not tax-
Tax Treatment Interest is tax-deductible
deductible
Aspect Debt Equity
Restricted (due to
Flexibility More flexibility
covenants)

Conclusion:
Debt is indeed cheaper than equity due to its lower cost, tax benefits,
and fixed repayment obligations. However, the affordability of debt
must be balanced against the risks of financial distress and reduced
flexibility. For a firm, the optimal capital structure involves a
balanced mix of debt and equity that minimizes the overall cost of
capital while ensuring financial stability and operational flexibility.
4o

9. A share housing a face value of A 1 is expected to pay a

dividend of 15% at the end of year 1. Its growth rate in
dividends is estimated to be 5%. If the investor has a
required rate of return of 16%. What would be the value of
the equity share?
10. What is the significance of dividends for a shareholder?
Significance of Dividends for Shareholders
Dividends play a crucial role in a shareholder's investment strategy
and perception of a company. They represent a distribution of a
portion of a company's earnings to its shareholders and have both
financial and psychological importance.

1. Source of Regular Income:

 Dividends provide a steady and predictable cash flow for
shareholders, especially for those who rely on investments for
income (e.g., retirees).
  They are particularly significant for income-focused investors
who prioritize returns in the form of cash rather than capital
appreciation.

2. Indicator of Financial Health:

 Regular and consistent dividend payments are seen as a signal of
a company’s stability and financial strength.
 A history of increasing dividends suggests growth and strong
earnings potential.

3. Confidence and Trust:

 Dividends reflect management’s confidence in the company’s
profitability and cash flow.
 Paying dividends signals that the company generates enough
profits to meet operational needs and still has surplus for
distribution.

4. Total Return on Investment:

 Dividends contribute to the total return on a shareholder’s
investment, alongside capital gains.
 Even during periods of stagnant stock prices, dividends can
provide tangible returns.

5. Tax Benefits in Certain Jurisdictions:

 In some countries, dividends are taxed at a lower rate than
regular income, making them a tax-efficient way for
shareholders to receive returns.

6. Diversification of Returns:
  Shareholders can reinvest dividends to buy more shares
(dividend reinvestment plans or DRIPs), enhancing the
compounding effect.
 This strategy supports long-term growth, even in volatile
markets.

7. Psychological Assurance:
 Regular dividends provide reassurance to shareholders that their
investment is yielding tangible benefits, reducing the temptation
to sell shares during market downturns.

8. Impact on Share Valuation:

 Dividends influence stock valuation, as many investors use
dividend-based metrics (e.g., dividend yield or dividend
discount model) to assess a stock’s value.

9. Shareholder Preferences:
 Some investors, particularly institutional investors and retirees,
prefer dividend-paying stocks, making them a target market for
such companies.
 High-dividend stocks are often associated with lower volatility,
appealing to risk-averse shareholders.

10. Liquidity Without Selling:

 Dividends provide a way for shareholders to derive cash from
their investments without selling their shares, maintaining their
ownership and exposure to potential future capital gains.
 11. Consider A 1,000 bond issued with a maturity of five
years at par to yield 10%interest is paid annually and the
bond is newly issued. Find the present value of bond.
12. A computer costs A 60,000. The following are the cash
inflows calculate PBP.
Year CFAT
1 12,000
2 19,000
3 15,000
4 30,000
5 15,000
13. Explain the main features of capital budgeting.
14. Define dividend policy. Why do investors want dividends?
Explain the different types of
dividends.
16. Critically evaluate the MM approach to Capital Structure.
17.. Explain the determinants of working capital.
18. Calculate weighted average cost of capital from the following:
Source of capital Book Value of capital(Rs.) Specific
cost %
Equity shares 15,00,000 11
Preference shares 8,00,000 13
Bank loan 3,00,000 10

19. Given the following information about Sunrise Industries Ltd.

Show the effect of the dividend policy on the market price per
share, using Walter’s model.
EPS=Rs.8, Cost of capital (K)=12%
Assumed rate of return
a) 15%
b) 10%
c) 12%
13. The following are cash flows of XYZ Ltd.
Year Cash flows (Real)
0 -40,000
1 12,000
2 12,000
3 18,000
4 20,000
Calculate the NPV at 10% discount rate and Payback period.
20. Explain traditional trade off theory of capital structure.
The Traditional Trade-Off Theory of capital structure is a framework
that explains how firms decide on their optimal mix of debt and
equity. It suggests that firms balance the benefits of debt (e.g., tax
advantages) against the costs of debt (e.g., financial distress and
bankruptcy risks) to determine their capital structure.

Key Components of the Theory:

1. Benefits of Debt:
o Tax Shield: Interest payments on debt are tax-deductible,
reducing the overall taxable income and increasing the
value of the firm.
o Lower Cost: Debt is cheaper than equity due to lower risk
for lenders and the tax advantages of interest payments.
o No Ownership Dilution: Raising capital through debt does
not dilute shareholders' control over the firm.
2. Costs of Debt:
 o Financial Distress Costs: Excessive borrowing increases
the risk of default and bankruptcy, leading to direct (legal
fees) and indirect (reputational damage, loss of customer
confidence) costs.
o Agency Costs: Conflicts between debt holders and equity
holders may arise, such as over risk-taking or dividend
payouts.
o Cost of Borrowing Increases: As leverage increases,
creditors demand higher interest rates to compensate for
the higher risk of default.
3. Equity Considerations:
o Equity is more expensive than debt because shareholders
bear residual risk.
o However, equity has no repayment obligations, reducing
the firm's risk of financial distress.

The Trade-Off:
The theory posits that there is an optimal capital structure where the
marginal benefit of debt equals its marginal cost. This point
maximizes the firm's value and minimizes its weighted average cost
of capital (WACC).
1. At Low Levels of Debt:
o The tax shield benefits outweigh the financial distress
costs.
o Adding more debt reduces WACC and increases the firm's
value.
2. At High Levels of Debt:
o Financial distress costs and agency costs outweigh the tax
shield benefits.
o Adding more debt increases WACC and reduces the firm's
value.
Graphical Representation:
The relationship between leverage and firm value under the traditional
trade-off theory can be depicted as a curve:
 X-axis: Leverage (debt-to-equity ratio).
 Y-axis: Firm value or WACC.
 The curve shows an increase in firm value as debt is added
initially, followed by a decrease beyond the optimal level of
debt.

Strengths of the Traditional Trade-Off Theory:

1. Practical Framework: Provides a realistic explanation for why
firms use both debt and equity in their capital structures.
2. Tax Advantage Highlighted: Emphasizes the tax benefits of
debt, which is a key consideration in financial decision-making.
3. Flexibility: Explains differences in capital structure across
industries and firms with varying risk profiles.

Limitations:
1. Simplistic Assumptions: Assumes a clear-cut balance between
benefits and costs of debt, which may not hold in practice.
2. Ignores Market Conditions: Does not account for the impact of
market timing on capital structure decisions.
3. Static View: Assumes the firm’s risk profile and tax rate remain
constant, whereas they can change over time.
4. Behavioral Factors Excluded: Ignores managerial preferences
and investor behavior, which can influence capital structure
decisions.

23ŚSS. What is leverage? Explain different types of leverages.

21. Mention different forms of dividends. Briefly explain
determinants of dividend payout.
22. Given the following information about Raj Industries Ltd.
Show the effect of the dividend policy on the market price per
share, using Walter’s model. EPS=Rs.8,
Cost of capital (K)=12% Assumed rate of return
a) 15%
b) 10%
c) 12%