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Amit KulshresthaRoll No: 571014385

Master of Business Administration MBA Semester 2

Subject Code- MB0045

Subject Name- Financial Management

Assignment Set-1

Q.1: A company has issued a bond with face value of Rs.1000 , with10% pa coupon rate payable annually and a tenure of 10 years tomaturity. At the end of 10 years, the bond will be redeemed at apremium of 10% to face value .

a) At what price would you buy the bond if the prevailing interest

rate is 12% pa on investments of similar risk?b) What is the YTM of the bond if the prevailing price is same ascalculated in a) above.

c) What is the current yield of the bond at the given price?

d) If the coupon rate is paid semi-annually, at what price would youbuy the bond at the 12% pa prevailing interest rate?

A.1: a) PVIFA(Kd,n) = [(1 + Kd)n - 1 ] / [Kd (1 + Kd) n]

PVIFA(12%,10) = [(1+0.12)10 -1] / [0.12(1+0.12) 10]

= [(1.12) 10 -1] / [0.12(1.12) 10]

= 2.11 / 0.37

= 5.70

coupon rate I = 10%

face value = 1000

So, I = 1000 * 10 % = Rs 100

Value of Bond Vo = I * PVIFA(Kd,n) + F/(1+Kd) n

= 100 * 5.70 + 1000/ (1.12)10= 570 + 1000/ 3.10

= 570 + 322.58

= 892.58

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b) {I+ (F- P)/n} / {(F+P)/2}

I = 100 , F = 1120 , P= 892

= { 100 + (1000 892) / 10} / {(1000+892) / 2}= 110.8 / 946

= 11.7 %

c) Current Yield = coupan Interest / current market price

Coupan Interest= 1000 * 10% = 100

Current market price = 892

Current Yield = 100 / 892

= 11.21 %

d) Vo = (I / 2) / (1 + Kd/2)n + F / (1 + Kd/2)2n

= ( 100 /2 ) / (1+ 0.12/2)10 + 1000 / (1+ 0.12/2)2*10

= 50 / 1.79 + 1000 / 3.20

= 27.93 + 312.5

= 340.43

Q.2: Given the following details for a company:

Net operating income 200,000Overall cost of capital 20%Value of the firm 1000,000Cost of debt 15%Interest 75,000Market value of debt 500,000Market value of equity 500,000

a) Given the assumptions of the net operating income approach,what will be the cost of equity, if the market value of debt is200,000.

b) Given the assumptions of the net income approach, what willbe the overall cost of capital with Market value of debt of200,000.

A.2: a)

Cost of equity Ke = K0 + (K0-Kd)(B/S)Here: K0 = 0.2; Kd = 0.15; B = 200000 S=800000

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Ke = 0.2 + (0.2 - 0.15) (200000/800000)

Ke = 0.2125

B. K0 = [B/(B+S)]Kd + [S/(B+S)] Ke

= [200000/(200000+800000)]*0.15 + [800000/(200000+800000)]*0.2125

= 0.03+ 0.17

K0 = 0.20

Q.3: Given the following projects , rank them on the basis of NPV,MIRR and Payback period if the cost of capital is 10% pa.

Project A Project B Project CYear Cash flow Year Cash flow Year Cash flow

0 -10000 0 -10000 0 -10000

1 5000 1 5000 1 5000

2 7000 2 8000 2 8500

3 8000 3 6500 3 9000

4 15000 4 11000 4 12000

A.3

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PROJECT-A

Year Cash flow PV factor @10% PV of cash flows

0 -10000 1

1 5000 0.909 4545

2 7000 0.826 5782

3 8000 0.751 6008

4 15000 0.683 10245

TOTAL 26580

NPV 1580

PROJECT-B


0 -10000 1

1 5000 0.909 4545

2 8000 0.826 6608

3 6500 0.751 4881.5

4 11000 0.683 7513

TOTAL 23547.5

NPV 3047.5

PROJECT-C


0 -10000 1

1 5000 0.909 4545

2 8500 0.826 7021

3 9000 0.751 6759

4 12000 0.683 8196

TOTAL 26521

NPV 2021

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Q.4: Given the following information, calculate Degree of operatingleverage, Degree of Financial leverage, Degree of total leverage.

Quantity sold Q 100,000 unitsVariable cost per unit V 200Selling price S 800Fixed cost F 10,000Number of equity shares 50,000Debt 1000,000 @ 15%paPreference shares 10,000 of Rs.100 each @ 10% Tax rate 30%.A.4:DTL=Q(S-V)/(QS-V-F-I-(Dp1-T)

DTL = 100000 ( 800-200)

100000 (800-200)-10000-100000 (150000/1-0.30)

DTL = 60000000/59675714.29

Degree of total leverage=1.0054

Degree of operating leverage

DOL=(QS-V)/(QS-V-F)

DOL = 60000000/60000000-10000Degree of operating leverage =1.000167

Degree of financial leverage

DFL=EBIT/(EBIT-I-(Dp1-T)

EBIT= Q(S-V)-F= 59990000

DFL = 59990000/59990000-100000-(150000/(1-0.3))

Degree of financial leverage =1.0053

Q.5: Explain the following concepts :

a) Operating cycle

b) Total inventory cost

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c) Price earnings ratio

d) Financial risk

A.5: Operating Cycle: The Operating Cycle of a business is ametric that calculates the average number of days it takes torecover via a final debtor collections, the cash initially outlaid forresource inputs. The Operating Cycle includes raw materialpurchases, inventories, conversions, sales, debtor accounts anddebtor collections.The operating cycle of a business is also known as the "CashOperating Cycle", the "Cash to Cash Cycle", the"Cash Conversion Cycle" or simply the "Cash Cycle".The Operating Cycle for a manufacturing based business can

involve many stages, namely:1. Purchase - the receipt of raw materials from suppliers on

account.

2. Conversion - the conversion of these raw materials intofinished goods

3. Inventory - the holding and storage of raw materials,Work-In-Progress (WIP) and Finished Goods.

4. Payment - the payment of the supplier's account for theraw materials received earlier.

5. Sale - the sale of finished goods to customers on account6. Collection - the collection of money from these customers

in payment of their account

b) Total inventory cost : The economic order quantity (EOQ)

refers to the optimal order size that will result in the lowest total of

order and carrying costs for an item of inventory given its expected

usage, carrying costs and ordering cost. By calculating an economic

order quantity, the firm attempts to determine the order size that

will minimize the total inventory costs.

Total inventory cost = Ordering cost + Carrying costTotal ordering costs = Number of orders x Cost per order= $ U / Q X FWhereU = Annual usageQ = Quantity orderedF = Fixed cost per orderThe total carrying costs = Average level of inventory x Price per unitx Carrying cost (percentage)

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Total carrying costs= $ Q / 2 x P x C= $ QPC over 2

WhereQ = Quantity orderedP = Purchase price per unitC = Carrying cost as %As the lead-time (i.e., time required for procurement of material) isassumed to be zero an order for replenishment is made when theinventory level reduces to zero.The level of inventory will be equal to the order quantity (Q units) tostart with. It progressively declines (though in a discrete manner) tolevel O by the end of period 1. At that point an order forreplenishment will be made for Q units. In view of zero lead-time,the inventory level jumps to Q and a similar procedure occurs in thesubsequent periods. As a result of this the average level ofinventory will remain at (Q/2) units, the simple average of the twoend points Q and Zero.From the above discussion the average level of inventory is knownto be (Q/2) units.From the previous discussion, we know that as order quantity (Q)increases the total ordering costs will decrease while the total

carrying costs will increase. The economic order quantity, denotedby Q*, is that value at which the total cost of both ordering andcarrying will be minimized. It should be noted that total costsassociated with inventoryT= $ UF / Q + $QPC / 2

c) Price Earnings RatioThe price earnings ratio reflects the amount investors are willing topay for each rupee of earnings.Expected earnings per share = (Expected PAT) (Preferencedividend) / Number of outstanding shares.

Expected PAT is dependent on a number of factors like sales, grossprofit margin, depreciation and interest and tax rate. The priceearnings ratio has to consider factors like growth rate, stability ofearnings, company size, company management team and dividendpay-out ratio.

P/E Ratio = (1-b) / r ROE * b

Where, 1-b is dividend pay-out ratio

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r is required rate of returnROE*b is expected growth rate

d) Financial risk: Financial risk is an umbrella term for any riskassociated with any form of financing. Risk may be taken asdownside risk, the difference between the actual return and theexpected return (when the actual return is less), or theuncertainty of that return. Risk related to an investment is oftencalled investment risk. Risk related to a company's cash flow iscalled business risk.

Credit risk : Credit risk, also called default risk, is the risk

associated with a borrower going into default (not making paymentsas promised). Investor losses include lost principal and interest,decreased cash flow, and increased collection costs. Investment riskhas been shown to be particularly large and particularly damagingfor very large, one-off investment projects, so-called"megaprojects". This is because such projects are especially proneto end up in what has been called the "debt trap," i.e., a situationwhere due to cost overruns, schedule delays, etc. the costs ofservicing debt becomes larger than the revenues available to payinterest on and bring down the debt

Market risk : This is the risk that the value of a portfolio, either aninvestment portfolio or a trading portfolio, will decrease due to thechange in value of the market risk factors. The four standardmarket risk factors are stock prices, interest rates, foreignexchange rates, and commodity prices

Liquidity risk : This is the risk that a given security or asset cannot betraded quickly enough in the market to prevent a loss (or make therequired profit). There are two types of liquidity risk:

Asset liquidity- An asset cannot be sold due to lack of liquidity inthe market - essentially a sub-set of market risk. This can beaccounted for by:

Widening bid-offer spread

Making explicit liquidity reserves

Lengthening holding period for VaR calculations

Funding liquidity- Risk that liabilities:

Cannot be met when they fall due

Can only be met at an uneconomic price

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Can be name-specific or systemic

Operational risk

Reputational risk

Legal risk

IT risk

Diversification: Financial risk, market risk, and even inflation risk,can at least partially be moderated by forms of diversification. Thereturns from different assets are highly unlikely to be perfectlycorrelated and the correlation may sometimes be negative. A keyissue in diversification is the correlation between assets, thebenefits increasing with lower correlation. Diversification has costs.Correlations must be identified and understood, and since they arenot constant it may be necessary to rebalance the portfolio whichincurs transaction costs due to buying and selling assets. The is alsothe risk that as an investor or fund manager diversifies their abilityto monitor and understand the assets may decline leading to thepossibility of losses due to poor decisions or unforeseen correlations

Hedging : Hedging is a method for reducing risk where acombination of assets are selected to offset the movements of eachother. For instance when investing in a stock it is possible to buy anoption to sell that stock at a defined price at some point in thefuture. The combined portfolio of stock and option is now much less

likely to move below a given value. As in diversification there is acost, this time in buying the option for which there is a premium.

Q.6: Explain the Net operating income approach to capital structuretheories

A.6: Net operating income approach (NOI) : Net operatingincome approach is propounded by Durand and is totally opposite ofthe Net Income Approach. Durand says that any change in leveragewill not lead to any change in the total value of the firm, marketprice of shares and overall cost of capital. The overall capitalisationrate is the same for all degrees of leverage. We know that:

K0 = [B/(B+S)]Kd + [S/(B+S)]Ke

As per the NOI approach the overall capitalisation rate remainsconstant for all degrees of leverage. The market values the firm asa whole and the split in the capitalisation rates between debt andequity is not very significant.

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The increase in the ratio of debt in the capital structure increasesthe financial risk of equity shareholders and to compensate this,they expect a higher return on their investments. Thus the cost ofequity is

Ke = K0 +[ (K0 Kd)(B/S)]

Cost of debt

The cost of debt has two parts as shown in the figure

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Explicit cost can be considered as the given rate of interest. Thefirm is assumed to borrow irrespective of the degree of leverage.This can result to a conclusion that the increasing proportion of debtdoes not affect the financial risk of lenders and they do not chargehigher interest.Implicit cost is nothing but increase in Ke attributable to Kd. Thus the

advantage of use of debt is completely neutralised by the implicitcost resulting in Ke and Kd being the same.Graphical representation of the debts is shown in figure

P

E

R

C

E

N

T

A

G

E

C

O

S

Ko

Kd

Ke

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T

Leverage (B/S)

Master of Business Administration MBA Semester 2

Subject Code- MB0045

Subject Name- Financial Management

Assignment Set-2

Q.1: Given the following information, prepare a cash budget:Month Sales Purchase

sWages Producti

onoverheads

Sellingoverheads

Jan 100000 40000 10000 6000 6000Feb 120000 45000 15000 6500 6500March 150000 35000 18000 7000 6600April 160000 30000 20000 7700 6800

May 175000 25000 22000 8000 6200 June 200000 20000 24000 8500 6300

The company has a policy of selling its goods at 50% cash and thebalance on credit. On credit sales, 50% is paid in the followingmonth and balance 50% two months from the sale. Purchases arepaid one month from the month of purchase. Wages are paid in thefollowing month and overheads are also paid in the followingmonth. The company plans a capital expenditure, in the month ofApril, for Rs. 25,000.The company has a opening balance of cash of Rs. 40,000 on 1st

Jan 2010. Prepare a cash budget for Jan to June.A.1:

Jan Feb Mar Apr May JunOperating cashbalance

40000 90000

113000

170000 225900 326400

Cash receipts

Cash sales5000

0 600007500

0 80000 87500 100000

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Credit Sales 250005500

0 67500 77500 83750Total CashAvailable

90000

175000

243000

317500 390900 510150

Cash payments

Materials 400004500

0 35000 30000 25000

Wages10000 1500

018000 20000 22000

Productionoverheads

6000 6500 7000 7700 8000

Selling overheads 6000 6500 6600 6800 6200

Sales commission

Purchase of asset 25000 Payment ofadvance ITTotal cashpayments 0 62000

73000 91600 64500 61200

Closing cashbalance

90000

113000

170000

225900 326400 448950

WORKING NOTE:The credit sales are calculated in followingtable:

Jan Feb Mar Apr May Jun

Current month 0 0 0 0 0 0

previous month 0 250003000

0 37500 40000 43750one month beforethat 0 0

25000 30000 37500 40000

0 250005500

0 67500 77500 83750

Q.2 : Given the following information in terms of per unit costs,

prepare a statement showing the working capital requirement.

Raw material 60Direct labour 22Overheads 44Total cost 126Profit 18Selling price 140

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The following additional information is available:Average raw material in stock one monthAverage materials in process 15 daysCredit allowed by suppliers one monthCredit allowed to debtors two monthsTime lag in payment of wages 15 daysTime lag in payment of overheads one monthSales on cash basis 20%Cash balance to be maintained 80,000

You are required to prepare a statement showing the workingcapital required to finance a level of activity of 100,000 units ofoutput. You may assume production is carried out evenlythroughout the year and payments occur similarly. Assume 360days in a year.

A.2: Estimation of working capital:

A 1. Raw Material

Formula(RMC/360)*RMCP

((100000*60)/360)*3050000

0

2. Work-in process inventory

Formula(COP/360)*WIIPCP

((100000*126)/360)*1552500

0

3. Finished goods inventory

Formula(COS/360)*FGCP

((100000*126/360)*30)10500

00

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B Investment in debtors

Formula(Cost of creditsales/360)*DCP

((80000/360)*126)*6016800

00

C Cash Balance8000

0

D Total current assets

A + B + C

3835000

E Current Liabilities

1. Creditors

Purchase of Raw Material * PDP/360

(100000* 60*30)/360

500000

2.Wages

(100000*22*15)/360

91666.67

3. Overheads

(100000* 40 *30)/360

333333.3

F Total Current Liabilities

925000

Net Working Capital

D-F

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2910000

Net Working Capital 2910000

Q.3. Given the following information, calculate the weightedaverage cost of capital.

Capital structure in millionsEquity capital ( Rs.10 par value) 214% preference share capital Rs.100 each 1.5Retained earnings 212% Debentures Rs.100 each 4

8% term loan 0.5 Total 10

The market price per equity share is Rs. 45. The company isexpected to declare a dividend per share of Rs.5 and dividends areexpected to grow at 15% pa. The preference shares are redeemableat Rs. 115 after 5 years and are currently traded at Rs. 90 in themarket. Debentures will be redeemed after 5 years at Rs.110. Thecorporate tax rate is 30%. Calculate the Weighted average cost ofcapital.

A.3 Step 1 is to determine the cost of each component:Ke = (D1/P0) + g

= (5/45) + 0.15

=0.261111111

=26.11%

Kp = (D + ((F -P)/n))/(F+P)/2)

=(14 + ((115-90)/5))/(115+90)/2)

=0.185365854

=18.53%

Kr = Ke i.e. 26.11%

Kd = (I(1-T) + ((F-P)/n)/(F+P)/2)

= (12(1-0.3) + ((110-100)/5)/(110+100)/2)

=0.099047619

=9.90%

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Kt = I (1-T)

= 0.08 ( 1-0 .3)

=0.056=5.60%

Step 2 is to calculate weights of each source

We = 2/10 = 0.2

Wp= 1.5/10= 0.15

Wr= 2/10=0.2

Wd = 4/10 = 0.4

Wt = 0.5/10 = 0.05

Step 3

WACC = We*Ke + Wp * Kp + Wr * Kr + Wd * Kd + Wt * Kt= 0.2*0.2611 + 0.15*0.1854 + 0.2*0.2611+ 0.4* 0.099

+ 0.05*0.056

=0.17465

=17.47%

WACC = 17.47%

Q.4. Calculate the present value of the following options:

a) Rs. 10,000 to be received after 5 years if the prevailing rate ofinterest is 10%pa

b) Rs. 10,000 to be received after 5 years if the prevailing rate ofinterest is 10%pa payable semi annually

c) Rs. 5000 to be received every year for 5 years if the prevailinginterest rate is 10% pa

d) Rs. 5000 to be received after 5 years and Rs. 10,000 to bereceived after 10 years

A.4: a) PV= 10000/(1+0.1)5

PV = 6209.2

b) PV= 10000/(1+0.05)10

PV = 6139.1

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c) PV = 5000(1/1.1) + 5000(1/1.1)2 + 5000(1/1.1)3 +5000(1/1.1)4 + 5000(1/1.1)5

= 4545.45 + 4132.23 + 3756.57 + 3415.06 + 3104.61

PV= 18953.92

d) PV = 5000/(1+0.1)5 + 10000/ (1+0.1)10

=3104.61 + 3855.43PV= 6960

Q.5: Explain each of the following:

a) Operating cycle

b) Shareholders wealth maximisationc) Capital rationing

d) Economic order quantity

A.5: a) Operating cycle :The Operating Cycle of a business is ametric that calculates the average number of days it takes torecover via a final debtor collections, the cash initially outlaid forresource inputs. The Operating Cycle includes raw materialpurchases, inventories, conversions, sales, debtor accounts anddebtor collections. The operating cycle of a business is also known as the "CashOperating Cycle", the "Cash to Cash Cycle", the"Cash Conversion Cycle" or simply the "Cash Cycle". The Operating Cycle for a manufacturing based business caninvolve many stages, namely:

1. Purchase - the receipt of raw materials from suppliers onaccount.

2. Conversion - the conversion of these raw materials intofinished goods

3. Inventory - the holding and storage of raw materials,Work-In-Progress (WIP) and Finished Goods.

4. Payment - the payment of the supplier's account for theraw materials received earlier.

5. Sale - the sale of finished goods to customers on account

6. Collection - the collection of money from these customers inpayment of their account

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b) Shareholders wealth maximisation: Suppose a stock

holder buys a stock at INR10 and in ten years time the market price

of stock shoots up to INR55.This is called maximizing shareholders

capital. Maximizing Shareholder Wealth refers to the process by

which executives in a publically-owned company, usually, (but also

to private companies with shareholders), undertake investing in

new projects, maximizing profits from existing products and

services, controlling costs, and adding "value" to the company

through the process, which hopefully gets reflected in the price of

the stock, but always in the increase in Net Asset Value and Equity

Per Share. Sometimes simply selling the company for a premium

over the existing price or Asset Value results in Maximizing

Shareholder Wealth.

c) Capital rationing: What Does Capital Rationing Mean?

The act of placing restrictions on the amount of new investments or

projects undertaken by a company. This is accomplished by

imposing a higher cost of capital for investment consideration or by

setting a ceiling on the specific sections of the budget.

Companies may want to implement capital rationing in situations

where past returns of investment were lower than expected. For

example, suppose ABC Corp. has a cost of capital of 10% but that

the company has undertaken too many projects, many of which are

incomplete. This causes the company's actual return on investment

to drop well below the 10% level. As a result, management decides

to place a cap on the number of new projects by raising the cost of

capital for these new projects to 15%. Starting fewer new projects

would give the company more time and resources to

complete existing projects.

d) Economic order quantity: Economic order quantity is the

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level of inventory that minimizes total inventory holding costs and

ordering costs. It is one of the oldest classical production scheduling

models.

EOQ applies only when demand for a product is constant over the

year and each new order is delivered in full when inventory reaches

zero. There is a fixed cost for each order placed, regardless of the

number of units ordered. There is also a cost for each unit held in

storage, sometimes expressed as a percentage of the purchase cost

of the item.

We want to determine the optimal number of units to order so that

we minimize the total cost associated with the purchase, delivery

and storage of the product.

The required parameters to the solution are the total demand for

the year, the purchase cost for each item, the fixed cost to place

the order and the storage cost for each item per year. Note that the

number of times an order is placed will also affect the total cost,

though this number can be determined from the other parameters.

Underlying assumptions

1. The ordering cost is constant.

2. The rate of demand is constant

3. The lead time is fixed

4. The purchase price of the item is constant i.e. no discount isavailable

5. The replenishment is made instantaneously, the whole batchis delivered at once.

Q.6: a) Discuss the advantages of ordering Economic order quantityof inventory.b) Discuss the Dividend discount model of measuring cost of equity.

A.6: a) Advantages of ordering Economic order quantity of

inventory:

Economic order quantity (EOQ) refers to the optimal order size thatwill result in the lowest ordering and carrying costs for an item ofinventory based on its expected usage.

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EOQ model answers the following key quantum of inventorymanagement. What should be the quantity ordered for each replenishment

of stock?

How many orders are to be placed in a year to ensureeffective inventory management?

EOQ is defined as the order quantity that minimises the total cost

associated with inventory management.

The advantage of the EOQ formula is that it provides a baseline for

getting the best deal. It helps you purchase what you're going to

use and keeps you from over purchasing to get 'deals' from

vendors.

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The disadvantages are very obvious if you've got a high periodicity

or seasonality to your consumption, or your usage is very minimal.

EOQ should only be applied to higher volume items that are worthinventorying; it's much safer to use VMI (Vendor Managed

Inventory) for items like bolts and screws that have a high volume

and aren't worth inventorying. For instance, I would never use EOQ

to order screws or bolts unless they were particularly expensive and

individually inventoried. I wouldn't use EOQ to order memory chips

for a retail computer store, because demand can vary greatly and

the risk that they'll become obsolete is high. However, I would use

EOQ to order steel L-brackets for an industrial production facility

where production is consistent and/or forecast.

b) The Dividend Discount Model is a way of valuing a company

based on the theory that a stock is worth the discounted sum of all

of its future dividend payments. In other words, it is used to

evaluate stocks based on the net present value of the future

dividends.

Dividend discount model is a tool that produces a number based on

the data provided. The equation can be written as

where P0 is the current stock price, D1 is the expected dividend, ris

the required rate of return, and g is the expected growth rate in

perpetuity.

This equation is also used to estimate cost of capital by solving for r

From the first equation, one might notice that in the long run, the

growth rate cannot exceed the cost of equity; r g cannot be

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negative, i.e., r> g. In the short run if g > r, then usually a two

stage DDM is used:

Therefore,

where g denotes the short-run expected growth rate, denotes the

long-run growth rate, and N is the period (number of years), over

which the short-run growth rate is applied.

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