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FIN ANC IA L MANA G E MEN T
TWO MARKS QUESTION AND ANSWERS
Chapter 1: Financial ManagementAn
overview
1. Define financial management.
Kenneth Midgley and Ronald Burns state "Financing is the
process of organizing the flow of funds so that a business can carry
out its objectives in the most efficient manner and meet its
obligations as they fall due."
2. Highlight the scope of financial management.
The Scope of financial management is dividend into two broadcategories: (a) Traditional Approach
(b) ModernApproach
3. Write a note on the traditional approach.
1. The approach equated finance function with raising and
administering of funds only. The limitation was that internal
decision-making was completely ignored.2. The focus was on financing problems of corporate enterprises(i.e.
Companies). Non corporate organizations lay outside itsscope.
3. The approach laid over emphasis on the problems of long
term financing. Hence day to day financial problems and
working capital management of a business did not receive anyattention.
4. Write a note on the modern approach.
The modern approach views the term 'Financial management' in a
broad sense and providesa conceptual and analytical frame work
for financial decision making. According to
it Finance function covers both
acquisitions of funds as well as their allocations. Thus the
Financial Management, in the modern sense of the term, can be
broken down in to
3 major decisions as functions of
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Finance.
1. The investmentDecision
2. The FinancingDecision
3. The Dividend PolicyDecision.
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5. What are the basic financial
decisions? (1) Investment decision
(2) Financingdecision
(3) Dividenddecision
6. What is meant by investment decision?
The investment decision relates to the selection of Assets in which
funds will be invested by a firm. The Assets which can be acquired
fall in to two broad categories.
(a) Long Term or Fixed Assets, which yield a return over a period of
time in future.(b) Short term or Current Assets which in the normal course of
business are convertible in to cash usually within a year.
7. Write a note on financing decision.
The financing decision of a firm relates to the choice of the
proportion of these sources to finance the investment requirements
8. What do you mean by dividend decision?
It is the decision relating to divide nd policy. Two alternatives are
available in dealing with the profits of the firm. They can be
distributed to the share holders in the form of dividends or they
can be retained in the business itself. The final decision will
depend upon the preference of the share holders and the
investment opportunities available within the firm.
9. What are the objectives of financialmanagement? (1) Profit Maximization
Approach
(2) Wealth MaximizationApproach
10. Write a note on profit maximisation approach.
According to this approach, actions that increase profits
should be undertaken and that decrease profits should beavoided. The Company should select those assets, projects, and
decisions which are profitable
and reject those which are
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not.
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11. Is profit maximisation an operationally feasible criterion? What
are its limitations?
No, profit maximisation is not an operationally feasible criterion
because of its following limitations:
(1)Ambiguity,
(2) Timing of benefitsand
(3) Quality ofbenefits.
12. Objective of a finan ce manager is to maximize the wealth ofthe owners
of the organisation comment.
Wealth maximization means maximizing the Net Present
Value (or wealth) of a course of action. A financial action which
has a positive Net Present Value creates wealth and therefore it is
desirable. The objective of wealth maximisation takes care of the
questions ofthe timing and risk of expected benefits.
13. Comment on the emerging role of the finance manager in India(1) To look after the cash and bank account (2) Investment
decisions (3) Tax and insurance (4) Credit and collection and (5)
investors relation.
14. What do you mean by agency problem?
Agency problem is the likelihood that managers may place
personal goals ahead of corporate goals.
15. How to reslove the agency problem?
The agency problem can be minimised byacts of
(1). MarketForces
(2). AgencyCosts.
Chapter 2: Time Value of Money
1. What is meant by time value of money?
Time Value of Money means that the value of money changes
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over a period of time. A rupee received today has more value
than a rupee
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receivable after a year. The time value of money can also be
referred to as time preference for money.
2. Why does money have value? Or General ly individuals show a
timepreference for money
. Give reasons forsuch preference. Or List outthe reasons for time value of money.
(a) Money can be employed productively to generate real returns;
(b) In an inflationary period, a rupee today has higher purchasing
power than a rupee in the future;
(c) Due to uncertainties in the future, current consumption is
preferred to future consumption.
3. List out the techniques or methods of adjusting the cash flows
for time value of money.
(1) Compounding
(2) Present Value or Discounting.
4. What do you mean by compounding?
Compounding is the process of finding the future values of cash
flows by applying the concept of compound interest. Compoundinterest is the interest that is received on the original amount
(Principal) as well as on any interest earned byt not withdrawn
during earlier periods.
5. What do you mean by future value of money?
It means determining the future value of a lump sum amount
invested at one point of time.
6. What is meant by an annuity?
An annuity is a stream of equal annual cash flows.
7. What is meant by present value of money?
Present value is the current value of a future amount to be
received. The present value of a rupee that will be received in the
future will be less than the value of a rupee in hand today. It is for
this reason theprocedure of finding Present values is commonly called discounting.
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8. Explain briefly the effective rate of interest.
If compounding is done more than once a year, the actual
annualised rate of interest would be higher than the nominal
interest rate and it is called as the Effective Interest Rate.
9. What is rule 72? Or Rules of thumb?
The length of period which an amount is going to take to double
at a certain given rate of interest is known as Rule of 72 or Rules
of thumb. Doubling period can be calculated by adopting the
rules of thumb.
Rule of 72: Doubling period = 72 / rate of
interest
Chapter 3: Valuation of Bonds and shares
1. What is meant by Valuation?
Valuation is the process that links risk and return to
determine the worth of an asset / security.
2. What is meant by valuation of security?
The value of a security is the present value of all future
cashflows (returns) associated with it over the specified
period. The expected returns are discounted, using the required
return commensurate with the risk of the asset as the appropriate
discount rate.
3. What are the features of
bond? (1) Face Value
(2) Interestrate
(3)Maturity
4. List out the categories of bonds.
Bonds withMaturity
Pure discountbonds
Perpetualbonds.
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5. What do you mean by bond with maturity?
The government and companies issue bonds that specify the
interest rate and the maturity period. The present value of a
bond is the discounted
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value of its cash flows; that is, the annual interest payme nts plus bonds
terminal or maturityvalue.
6. Write a note on Pure discount bond.
Pure discount bond do not carry an explicit rate of interest. It
provides for the payment of lump sum amount at a future date in
exchange for the current price of the bond. The difference
between the face value of the bond and its purchase price gives
the return or YTM to the investor. It is also called as deep-discount
bonds or Zero interest bonds or Zero coupon bonds. The market
interest rate is also called as market yield, is used as the discount
rate.7. Define Perpetual bond.
It is also called as consols. It has an indefinite life and therefore it
has no maturity period.
8. What is meant by Yield to Maturity (YTM)?
The yield to maturity (YTM) is the rate of return that investors
earn if they buy a bond at a specified price and hold it until
maturity. It assumes that the issuer of the bond makes all due
interest payments and repayment of principal as promised.
9. What is meant by amortisation of Principal?
It means repayment of principal every year rather atmaturity.
10. List out the categories of preference
shares. (i) Redeemable preference
shares
(ii) Irredeemable preferenceshares
1. DefineReturn.
Chapter 4: Risk and Return
Return is the actual income received plus any change in market
price of an asset / investment. Total return comprises of both
dividend and
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capital gain.
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2. Define risk.
Risk is the variability of actual return from the expected
return associated with a given asset.
3. How a risk associated with an asset is measured?
The risk associated with asingle asset is assessed from both
a behavioural and a quantitative /statistical point of view.
4. What are the various methods used under behavioural view tomeasure
risk?
(1) Sensitivity analysis and (2)
Probability5. Define Sensitivity analysis.
Sensitivity analysis takes into account a number of possible
returns estimates while evaluating an asset risk. In order to have
a sense of the variability among return estimates, a possible
approach is to estimate the worst, the expected and the best
return associated with the asset.
6. Define Probability.
Probability is the chance that a given outcome (return) willoccur.
7. What are the various methods used under statistical view to
measure risk?
(1) Standard deviation and (2) Coefficient ofvariation.
8. Define Standard deviation.
Standard deviation measures the dispersion around the expected
value. It represents the square root of the average squared
deviation of the individual returns from the expected returns. The
greater the standard deviation of returns, the greater the
variability of returns and the investment is considered risky.
9. Define Coefficient of variation.
Coefficient of variation is a measure of risk per unit of expected
return. It converts standard deviation of expected values into
relative values to
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enable comparision of risk associated with assets havingdifferent
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expected values. The larger the CV, the larger the relative risk of
the asset.
10. What is meant by Portfolio?
A Portfolio means a combination of two or more securities(assets).
11. Define Portfolio expected return.
The expected rate of return on a portfolio is the weighted average
of the expected rate of return on assets comprising the portfolio.
12. Define Portfolio risk.
Portfolio risk consists of the risk of individual securities plus
the covariance between securities.
13. Why the correlation between securities return in a portfolio isimportant?
The magnitude of the portfolio risk depends on the correlation
between the securities.
14. What is the significance of getting perfect negative correlation
between two securities?
When the correlation coefficient between asset returns is
negative, it is possible to combine them in a manner that will
eliminate all risk. The portfolio risk can be reduced to zero.
15. What are the two types of risk?
(1) Systematicrisk
(2) Unsystematic
risk
16. Define systematic risk.
Systematic risk arises on account of the economy wide
uncertainties and the tendency of individual securities to move
together with changes in the market. This risk cannot be
reduced through diversification os securities. E.g. Increase in
inflation rate, changes in interest rate etc.
17. Define unsystematic risk.
Unsystematic risk arises from the unique uncertainties of
individual securities. These uncertainties are diversifiable if a
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large numbers of
securities are combined to form well diversifiedportfolio.
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Chapter 5: Capital Budgeting
1. Define Capital budgeting.
Capital budgeting is a process of making decisions regarding
investments in fixed assets.2. Highlight the nature / features of capital
budgeting. (i) It involves huge capital
(ii) Long terminvestment
(iii) Involves forecasting of several years profit in advance to
judge the profitability of project.
3. What are the significance of capital budgeting?
(i) Indirect forecast ofsales
(ii) Comparative study of alternativeprojects
(iii) Timing of asset acqusition
(iv) Cashforecast
(v) Wealth maximisation ofshareholders
4. What are the various types of
projects? (i) Mutually exclusive
investments
(ii) Independent
investments
(iii) Contigentinvestments
5. What are mutually exclusive projects?
Mutually exclusive investments compete with each other. If one
investment is undertaken, other investments will have to be
excluded. Such investment proposals are known as mutually
exclusive projects.
6. What are independent investments?
Independent investments do not compete with each others.
Depending on the profitability and availability of funds, the
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company can undertake all investments.
7. What are contingent investments?
Contingent investments are dependent projects; the choice of
one investment necessitates undertaking one or more
other investments.
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8. List the phases of capital budgeting.
(1) Organisation of investment
(2) Screening the proposal
(3) Evaluation of projects
(4) Establishing priorities
(5) Final approval
(6) Evaluation.
9. What are the components / techniques of capital
budgeting? (1) Traditional method
(a) Pay back period
(b) Accounting Rate of Return
(2) Discounted Cash Flowmethod
(a) Net Present Value
(b) Profitability Index
(c) Internal Rate of Return
10. Write a note on discounted cash flow method.The meth od is also known as 'Time adjusted rate ofretur nmethod. The
method is based on the assumption that future rupee value
cannot be taken as equivalent to the rupee value in the present.
When we compare the returns or cash inflows with the amount
of investment or cash outflows, both must be stated on a present
value basis. The time value of money is to be given due
importance.
11. List out the merits of discounted cash flow method.
(1) The method takes into account the entire economic life of the
project investment and income.
(2) It gives due weightage to time factor offinancing
(3) It produces a measure which is precisely comparably among
projects, regardless of the character and time shape of
their receipts an
outlays.
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(4) This approach provides for uncertainty and risk by
recognizing the time factor. It measures the profitability of
capital expenditure by reducing the earnings to the present
value.
(5) It is the best method of evaluating project where the cashflows are
uneven.
12. List out the demerits of discounted cash flow method.
It is quite difficult to obtain estimates of cash flows
due to uncertainty.
It is also difficult to measure discount rate.
At times fails to indicate correct choice between mutually
exclusive projects.
13. What is Net Present Value? What are its merits?
This method takes into account time value of money. In this
method present value of cash flows is calculated for which
cash flows are discounted. The rate of interest is called cost of
capital and is equal to minimum rate of return which must
accrue from the project. Later, present value of cash out
flows is calculated in same manner and subtracted from
present value of cash inflows. This difference is called Net Present
value or NPV.
Merits
1) It takes into account time value of
money.
2) It considers cash inflows form project throughout itslife.
3) In this method variable discount rates can be used for the
projects with longer life period.
4) This method is more closely related to firm s objective of
maximising wealth of shareholders.
5) True measure ofprofitability.
14. What are the limitations of Net Present Value
method? (1) Difficult to use, calculate &
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understand.
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(2) To determine the required rate of return which is called
cost of capital is a difficult task.
(3) At times fails to indicate correct choice between mutually
exclusive projects.15. What is Profitability Index? What are its merits?
It is Benefit Cost ratio (B/C Ratio) or Profitability Index (P1). It is
the ratio of value of future cash benefits at required rate or
return to the initial cash outflow of the investment.
Merits
1. Considers all cash
flows.
2. This method considers all benefits during the life time of theproject.
This method takes into account the time value ofmoney.
3. Pl method is considered better to NPV in case when the initial
costs of projects are different for eg. The NPV of two project is
equal ie, Rs5000. The initial cost of project is Rs 40,000 and that of projectB Rs
20,000. Project should be selected on the basis of profitability
index, whereas under NPV method both the projects will be
considered equally profitable.
4. Generally consistent with the wealth maximisation
principle.16. What are the limitations of PI method?
1). It is difficult to understand and implement this method.
2). Requires estimates of the cash flows which is a tedious task.
3). At times fails to indicate correct choice between mutually
exclusive projects.
17. What is meant by Internal Rate of return? What are its merits?
Internal rate of return is the rate of interest or discount at which
the present value of expected cash flows is equal to the total
investment outlay.
Merits
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1. IRR attempts to find the maximum rate of interest at which
funds invested in the project could be repaid out of cash inflows
arising from that project.
2. It considers the time value ofmoney
3. It considers cash flows throught out the life of theproject
4. It is consistent with the objective of shareholders wealth
maximisation.
18. What are the limitations of IRR method?
(1) Calculation of IRR is quite tedious and it is difficult tounderstand
(2) It implies that profits can be reinvested at internal rate of
return, which is not logical
(3) It produces multiple rate of return which can be confusing
(4) It may fail to indicate a correct choice between mutually
exclusive projects undercertain situation.
19. What is meant by Pay back period? What are its merits?
Pay Back Period is the number of year requir ed for the original
investment to be
recouped. Merits
1. Easy to understand andcompute.
2. This method follows short terms view point, as a result,
the obsolescence are minimum.
3. Emphasis liquidility, therefore useful for the company whichfaces
the problem of liquidity. Such companies will invest their funds in
such projects in which investment can be recovered in minimum
time.
4. Suitable for those organisations which emphasise on
short-term investments rather than long terms development.
5. Uses cash flowinformation.
6. Easy and crude way to cope with
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risk.
20. What are the limitations of pay back period
method? (1) Ignores the time value of money.
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(2) Ignores the cash flows occurring after the pay back
period. (3) No objective way to determine the
standard payback.
(4) No relation with the wealth maximisationprinciple. (5) Not a measure of profitability.
21. What is meant by Accounting rate of return? What are itsadvantages?
This method is also called Accounting Rate of Return Method.
This method is based on accounting information rather than cash
flows. Advantages
(1) Easy to understand.
(2) Give more weightage to future receipts.
(3) Uses accounting data with which executives are familiar.
22. What the limitations of ARR
method? (1) Ignore the time
value of money.
(2) It uses accounting profits, not cash flow.
(3) No objective way to determine the minimum acceptable
rate of return.
(4) ARR method does not consider the size of investment for each
project.
23. Define Capital Rationing.
Capital rationing implies the choice of investment unde
financial constraints of capital expenditure budget.
24. Define indivisible project.
It is a project which can be accepted / rejected in its entirely.
25. Define divisible project.
It is a project which can be accepted / rejected in part.
Chapter 6: Cost ofCapital
1. Define Cost of capital.
According to Solomon Ezr a, Cost of Capital is the minimum
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required rate of earnings or the cut-offrate ofcapital expendi tures.
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2. What are the significance of cost of capital?
(1) As an Acceptance Criterion in Capitalbudgeting
(2) As a Determinant of Capital Mix in Capital StructureDecisions
(3) As a Basis for Evaluating the FinancialPerformance
(4) As a Basis for taking other FinancialDecisions
3. Define marginal cost of capital.
The current rate of interest on longterm debts or current rate of
return is treated as the marginal cost of capital. Marginal cost or
explicit cost tends to increase proportionately as the amount of
debt increases.
4. What is meant by cost of debt?
The cost of debt is the rate of return required by thelenders.
5. What is cost of preference?
The cost of preference capital may be defined as the dividend
expected by the preference shareholders.
6. What is cost of equity?
The cost of equity capital indicates the minimum rate which
must be earned on projects before their acceptance and the raising
of equity funds to finance those projects.
7. List out the various methods of computing cost of equity.
(1) Dividend priceapproach
(2) Constant dividend growthapproach
(3) Earnings priceapproach
(4) Realised yieldapproach
8. Define cost of retained earnings.
The cost of retained earnings may be defined as opportunity cost in
terms of dividends forgone by the equity shareholders.
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9. What is meant by weighted average cost of capital / overall
cost of capital?
Weighted average is an average of the costs of specific source of
Capital employed in a business, properly weighted by theproportion, they hold in
the firm's capital structure.
1. What isleverage?
Chapter 7: Leverage
Leverage is the employment of an asset / source of finance for
which the firm pays fixed cost / fixed return.
2. List out the types of
leverages. (1) Operating
leverage
(2) Financial leverage
(3) Combined leverage
3. What is operating leverage?
The leverage associated with investment (asset acquisition)
activities is referred to as operating leverage.
4. What is financial leverage?
The leverage associated with financiang activities is called
financial leverage.5. What type of risk is associated with each type of leverage?
High operating leverage increases the operating risk. The
Operating risk is the risk of the firm not being able to cover its
operating costs.
High financial leverage increases the financial risk. The financialrisk
refers to the risk of the firm not being able to cover its fixed
financial cost.
6. What is EBITEPS analysis?
The EBIT EPS analysis is a method to study the effect of
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leverage. It involves the comparison of alternative methods of
financing under
various assumptions of EBIT.
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7. What is indifference point?
The EBIT level at which the EPS is the same for two
alternative financial plans is referred to as the indifference
point/level.
Chapter 8: Capital Structure
1. What is Capital structure?
Capital structure is the proportion of debt, preference and equityshares
on a firm s balance sheet.
2. What is optimal capital structure?
The optimum or balanced capital structure means an ideal
combination of borrowed and owned capital that may attain the
maximum value of the firm
3. Different between capital strucutre and financial structure.
Financial structure refers to the left hand side of the balance
sheet, represented as total liabilities. Therefore Financial
structure includes current liabilities, long term debt, preference
shares and equity share capital.
Capital structure is a part of financial structure, which representsonly
long term debt, preference share and equity sharecapital.
4. What is meant by trading on equity?
A company may raise funds either by issue of shares or by
debentures. In case if the rate of return (ROI)
on the total capital employed (shareholders' funds plus
long-term borrowed funds) is more than the rate of interest on
debentures or rate of dividend on preference shares, it is said that
the company is trading on equity.
5. Name various theories of capital structure. Net Income Approach
Net Operating Income Approach
The Traditional Approach
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Modigliani and Miller Approch
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Chapter 9: DividendPolicy
1. Define dividend.
Dividends refer to the corporate net profits distributed
among shareholders.
2. List out the various types of dividend policies.
a) Constant dividend per share, b) Constant payout ratio and c)
Stable rupee dividend plus extra dividend.
3. What are the various forms of dividend?
(a) Scrip, (b) bond, (c) Property, and (d) Stockdividend
4. Define scrip dividend.
In this form of dividend, the equity share holders are issued
transferable promissory notes for a shorter maturity period that
may or may not bear interest.
5. What is bond dividend?
The equity shareholders are issued bonds that carries longer
maturity period with interest.
6. What is property dividend?
It means payment of dividend in the form of asset. This form of
dividend takes place only when a firm has assets that are no
longer necessary in the operation of business and share holders
are ready to accept dividend in the form of Assets.7. Define stock dividend.
Stock dividend is payment of additional shares of common stocks
to the ordinary shareholders. Bonus shares are
issued to the existing shareholders.
8. What are the reasons / objectives for stock dividend?
It tends to bring the market price per share within a more
popular range.
It promotes more active trading
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It reduces the nominal rate of dividend, which may
attract the impression of profiteering
It increases the paid up share capital
It improves prospects of raising additional funds.
9. Define stock split.
It is a method commonly used to lower the market price of
shares by increasing thenumber of shares belonging to each share
holder.
10. Differentiate between bonus shares and stock split.
Par value of share: Is unchanged in issue of bonus share,
whereas it is reduced in stock split.
Capitalization of reserves: Capitalization takes place in
issue of bonus share, whereas there is no capitalization in
stock split.
Share holders proportion: There is no change in the shareholders
proportion; it remains unchanged in both the cases.
Book value, earnings and market price per share: In both the
cases book value,earnings and market price per share decline.
Market price per share: The market price is bought within a
popular trading range, where as in stock split it is bought
within a more popular trading range.
11. What are the reasons for stock split?
To make trading attractive Indication of higher profits in the future
To give higher dividends to shareholders.
Chapter 10: Working Capital Management
1. Define Working capital.
Working Capital is the funds required to meet day-to-day
operations of a business firm.
2. List out the kinds of working capital.
(1) Concept based
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(i) Gross Working Capital
(ii) Net Working Capital
(2) Time based
(i) Permanent or Fixed Working Capital
(ii) Fluctuating or Variable Working Capital.
3. Define permanent working capital.
This minimum level of investment in current assets that is
required to continue the business without interruption is referred
to as permanent working capital.
4. Define variable working capital.
It is also known as the circulating or transitory working
capital. is required to maintain additional current assets
temporarily over and above permanent working capital to satisfy
cyclical demands. Additional working capital is required to meet
unforeseen events like floods, strikes, fire, price hike tendencies
and contingencies.
5. What is meant by operating cycle?The time between purchase of inventory items (raw material or
merchandise) for the production and their conversion into cash is
known as operating cycle or working capital cycle.
6. What is manufacturing cycle?
The Manufacturing Cycle is conversion of raw material into
work-in- process into finished goods, is a component of
operating cycle, and therefore, it is a major determinant of
working capital requirement. Manufac turing cycle depends on the
firm s choice of technology and production policy.
7. Define Cash management.
Cash is the basic input that keeps business running continuously
and smoothly. Too much cash and too little cash will have a
negative impact on the overall profitability of the firm as too muchcash would mean cash
remaining idle and too less cash would hamper the smoothrunning of
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the operations of the firm.Therfore the trade-off between liquidity
and cost is known as Cash Management.
8. What are the objectives of cash management?
To meet payment scheduleTo minimize funds committed to cash balance.
9. List out the motives for holding cash.
Transaction Motive
Precautionary Motive
SpeculativeMotives
Compensating Motive10. What is transaction motive?
This refers to holding of cash to meet routine cash requirements to
finance the transaction in the normal course of business.
11. What is meant by precautionary motive?
This refers to holding of cash to meet unpredictableobligations.
12. What is a speculative motive?
It refers to holding of cash to quickly take advantage of opportunity
typically beside the normal course of business. Eg., Opportunity to
purchase raw material at a reduced price on payment of immediate
cash.
13. What is compensating motive?
It refers to holding of cash to compensate banks for providing certain
services or loans.
14. What are the cash management strategies followed in an organisation?
CashPlanning
Managing the cashflows
Optimum cashlevel
Investing surpluscash
15. Define Float.
The term Float refers to the amount of money tied up in cheques that have
been written, but yet to be collected and encashed. There are two ways
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of doing it: They are (a) Paying from a distant bank (b) Cheque
encashment analysis.
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16. Define optimum cash level.
The firm should decide about the appropriate level of cash balances.
The cost of excess cash and danger of cash deficiency should be
matched to determine the optimum level of cash balances.
17. Define Receivables Management.Management of account receivables may be defined as the
process of making decisions relating to the investment of funds
in this asset which will result in maximising the over all return of
the investment ofthe firm.
18. What are the objectives of receivables management?
The trade-off between the benefits and cost associated with the
extension of credit. The benefits are increased sales and anticipated
increased profits.
19. What are the costs associated with receivables management?
CapitalCosts
AdministrativeCost.
CollectingCost
DefaultingCost
20. Define capital cost.
Maintenance of A/C receivables results in blocking of the firms
financial resources. This is because there is a time lag between the
sale of goods to customers and the payments by them. Thefirm has to arrange for additional funds to meet its own
obligations, such as payment to employees, suppliers of raw
materials, etc while awaiting for payments from its customers.
21. Write a note on administrative cost.
The firm has to incur additional administrative cost for
maintaining Account Receivables in the form of salaries to
the staff kept for maintaining accounting records relating to
customers, cost of conducting
investigation regarding customers creditworthiness etc.
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22. What is meant by collecting cost?
The firm has to incur costs for collecting payments from its
credit customers. Some times additional steps may have to be
taken to recover money from defaulting customers.
23. Define defaulting cost.
The firm has to incur costs for collecting payments from its
credit customers. Some times additional steps may have to be
taken to recover money from defaulting customers.
24. What are the various crucial decisions involved in
receivables management?
1) Credit Policies (2) Credit terms (3) CollectionPolicies.
25. What is meant by credit policies?
The credit policy provides a framework to determine whether to extend
credit or not and how much to extend credit. The two broad dimensions
are (a) Credit standards (b) Credit analysis.
26. What is meant by credit terms?
Credit terms specify the repayment terms. The credit terms have
three components: (a) Credit period (b) Cash discount (c) Cash discount
period.
27. Define cash discount.
Cash discount is the incentive to customers to make earlypayments.
28. Write a note on collection policies.
Collection policies refer to the procedure followed to collect the
receipts when they become due. The collection policy can be classified
into strict and liberal. The effect of tightening the credit policy would
be decline in debts, decline in collection period resulting to lower
interest costs, increase in collection costs and decline in sales. The
effect of lenient policy would be exactly the opposite.
29. Define inventory.
Inventory refers to the stockpile of the products a firm would sell in
future in the normal course of business operation and the components
that make up the
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product. The firm stores three types of inventories, namely, Raw
materials, work-in-progress, finished goods, consumables and spares.
30. What are the objectives of inventory management?
The objective of inventory management consists of two
counterbalancing parts: (1) to minimize investments in inventory and
(2) to meet the demand for products by efficiently organizing the
production and sales operations.
31. List out the costs involved in inventory management.
(i) Orderingcost
(ii) Carrying
cost32. Define ordering cost.
Ordering costs are associated with the ordering of inventory
such as dispatching of orders and issuance of reminders, costs
incurred by the goods received bay, inspection and handling.
33. Define carrying cost.
Carrying cost arises due to the storing ofinventory.
34. Define factoring.
Factoring may be defined as an arrangement between the financial
institution and the business concerns which is selling goods on credit.
35. List out the benefits of factoring.
It provides liquidity to the suppliers as the tied up receivable isreleased
The funds released by the factoring agencies facilitate more
investment in fixed assets
Factoring agreement minimizes bad debts as the factor chooses thecorrect
party
Supplier is relieved of the botheration of administering sales ledger
and control of debts
36. What is meant by trade credit?
Trade credit is the credit extended by one trader to another for
the purchase of goods and services. Trade credit facilitates the
purchase of supplies without immediate payment. Such credit
appears in the records
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of the buyer of goods as sundry credito rs or accounts payable .
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37. Define commercial paper.
Commercial paper is an unsecured promissory note issued by a
firm to raise funds for a short period, varying from 90 days to
364 days. It is issued by one firm to other business firms,insurance companies, pension funds and banks. CP carries a fixed
rate of interest.
38. What is meant by overdraft?
When a bank allows its depositors or account holders to withdraw
money in excess of the balance in his account upto a specified
limit, it is known as overdraft facility. This limit is granted purely
on the basis of credit- worthiness of the borrower.
Chapter 11: CapitalMarket
1. What is meant by financial system?
All those activities related to finance and organized into a system
are called as Financial System. A financial system comprises of
financial institutions, financial services, financial markets and
financial instruments.
2. Define financial market.
Financial market facilitate buying and selling of financial
assets / securities. It consists of capital market, money market,
foreign exchange market and government securities market.
3. Define capital market.
Capital market deals with shares and debentures. It can be
further classified as Primary market and Secondary market.
4. Define money market.
Money market deals with short term funds. There is no fixed
place as money market. It refers to all institutions which are
dealing short term funds.
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5. What are financial instruments?
A financial instrument / securities / assets are (1) direct (shares
and debentures) (2) indirect (Mutual funds) and (3) derivatives
(futures and options).
6. List out the functions of new market.
(1) Origination, (2) underwriting and (3)distribution.
7. What are the methods available to float securities?
(1) Public issue through prospectus (2) Offer for sale (3)
Private placement (4) Right issue and (5) Book building.
8. Define offer for sale.
It involves two stages. In first stage, the securities are issued to
stock brokers or issuing houses at an agreed fixed price. In the
second stage, the issuing houses sell the securities to the ultimate
investors.
9. What is meant by private placement?
It also involves two stages. In the first stage, shares are issued to
issuing houses or stock brokers. In the second stage, they are
made available to their investors-clients.
10. Define Right issue.
In this method the shares are offered to the existing share
holders. They can subscribe to new shares in proportion to the
number of shares they already hold. This offer is made by circularto
existing shareholders only.
11. What is meant by book building?
It is price discovery and investors response mechanism. The
issuing company incorporates all the details of the proposals
in the offer document including the minimum price. The
investors are required to quote the number of securities and
the price at which they wish to acquire. The book runners and
the issuing company determine the issue
price based on the bids recei ved through syndic ate member s .
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Chapter 12: Leasing and Hire Purchase Financing
1. Define lease.
Leasing is a contract between the owner of the asset(lessor) and the
user of the asset (lessee) where in the lessor gives the lessee the right to
use the asset for a particular period called the lease period and as a
consideration the lessee pays lease rental. At the end of the lease
period the lessee returns back the asset to the lessor.
2. What is meant by operating lease?
a). Short term cancelable lease
b). Lease period is around 3-5 years
c). Maintenance of the asset will be done by the
lessor d). Risk of obsolescence falls on the lessor
e). Lease rentals will be high
3. Write a note on financial lease.
a). Long term non-cancelable lease
b). Lease period is more than 5 years
c). Maintenance of the asset will be done by the
lessee d). Risk of obsolescence falls on the lessee
e). Lease rentals are moderate.
4. What is meant by sale and lease back?
It is a kind of financial arrangement. The owner of the asset in order to
manage a financial crunch will sell the asset to the lessor and takes it back
on lease. The lessor pays a huge amount for the cost of the asset. With
this huge amount received the financial crisis is settled.
5. What is update lease?
In an update lease the lessor promises to update the asset if a newtechnology arises and in return the lessee is expected to pay higher
lease rentals.
6. What is meant by direct lease?
In a direct lease the lessee chooses the asset directly from
manufacturer. The lessor buys that asset and gives it on lease to the
lessee.
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7. What is leveraged lease?
The lessor purchases the asset by borrowing from the financier,
lessor contribution may be around 25% of the asset only. The
remaining amount is provided by the financier. The lessor leases theasset to the lessee. The lessee pays installments to the financier.
8. Define cross border lease.
When the lessor and lessee belong to different countries the lease is said
to be a cross border lease.
9. What is meant by closed ended lease and open ended lease?
In a closed ended lease the lessee must return the asset to the lessor
after the lease period. In an open ended lease the choice is given tothe lessee to either purchase the asset or return back the asset.
10. List out the various advantages of leasing.
It avoids huge cash outlay
The time spent in negotiating for the asset is minimized
In an operating lease the maintenance and risk of obsolescence is
taken by the lessor
In a financial lease the lease rentals are moderate
In a sale and lease back lease financial crunch can be managed
In a direct lease the lessee can choose the asset from themanufacturer.
In an update lease the lessee gets the updated asset
In an open ended lease the lessee has got the choice to purchase theasset
The lease rent is a tax deductable expenses and hence there is
a tax advantage.
11. What are the disadvantages of leasing?
The pride of ownership is not available to lessee
Lessee cannot claim depreciation for the asset because he is not theowner.
So tax advantage on depreciation is notavailable
Acute care has to be taken in handling the assets. If damages
occur penalty has to be paid
Lease renewals may be difficult. It involves lot of paper work
In case of the financial lease the lessee takes up the risk of
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obsolescence.
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12. What are the various features of hire purchase financing?
The essence of the agreement between the seller and the buyer is
that the ownership of goods does not pass to the buyer until he
pays the last installment.There are two parties to the hire purchase agreement. Seller andthe
buyer
The buyer has to make a down payment of 20 to 25% of the cost
and the remaining amount has to be paid in equal monthly
installments.
The buyer may even return back the goods, if he is not satisfied
with their quality or performance
But this is different from installment sale, in which the ownership
of the goods passes to the buyer immediately on payment of the
first installment and the buyer has no option to return the goods.
Chapter 13: Venture Capital
1. Define Venture Capital.
A Venture capital can be defined as defined as a temporary
equity investment in a growth oriented small or medium business
managed by a highly motivated entrepreneur.The
investment is combined with managerial
assistance.
2. What are the features of venture capital?
It is basically financing of new companies which are
finding it difficult to go to the capital market at their early
stage of existence.
This finance can also be loan based or convertible debentures
so that they carry a fixed yield for the providers of venture
capital.
Those who provide venture capital aim at capital gain due to
the success achieved by the borrowing concern.
Venture capital is always a long term investment andmade in
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companies which have high growth potential. The
provision of venture capital will bring rapid growth for the
business.
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The venture capital provider will also take part in the business
of borrowing concern whereby the venture capital financier
not merely confines to finance but also provides managerial
skill.
3. What are the techniques followed by VCIs to achieve objectives?
Personal discussions
Plant visits
Feedback from nominee directors
Periodic reports
Commissioned studies
4. What are the methods available for VCIs to realise the investment?
Going public
Sale of shares to entrepreneurs
Trade sales to another company
selling to a new investor and
Liquidation.