Financial Management, Sonal.docx

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Student Name: Sonal Bhardwaj Course: MBA

Registration Number: 1308011363 LC Code: 2971

Subject Name: Financial Management Subject Code: MB 0045

Question 1. When a firm follows wealth maximization goal, it achieves maximization of market value

of a share. Do you agree? Substantiate your arguments.

Answer. The term wealth means shareholders wealth or the wealth of the persons those who are

involved in the business concern. Wealth maximization is also known as value maximization or net

present worth maximization. This objective is a universally accepted concept in the field of business.

Wealth maximization is possible only when the company pursues policies that would increase the

market value of shares of the company. It has been accepted by the finance managers as it

overcomes the limitations of profit maximization. The following arguments are in support of the

superiority of wealth maximization over profit maximization:

Wealth maximization is based on the concept of cash flows. Cash flows are a reality and notbased on any subjective interpretation. On the other hand, profit maximization is based on

accounting profit and it also contains many subjective elements.

Wealth maximization considers time value of money. Time value of money translates cash

flow occurring at different periods into a comparable value at zero periods. In this process,

the quality of cash flow is considered critical in all decision as it incorporates the risk

associated with the cash flow stream. It finally crystallizes into the rate of return that will

motivate investors to part with their hard earned savings. Maximizing the wealth of the

shareholders means positive net present value (the excess of present value of cash inflows of

any decision over the present value of cash out flow) of the decisions implemented.

Question 2.

A) If you deposit Rs. 10000 today in a bank that offers 8% interest, how many years will the

amount take to double?

B) What is the future value of a regular annuity of Re. 1.00 earning a rate of 12% interest p.a. for

5 Years?

Answer.

A) One way to answer it is by rule known as rule of 72. This rule states that the period within

which the amount doubles is obtained by dividing 72 by the rate of interest. Though it is a crude

way of calculating, this rule is followed by most. So, if the rate of interest is 8%, the doublingperiod is 8/10, that is, 9 year.A much accurate way of calculating doubling period is by using rule

of 69. By this method, doubling period = 0.35+69/interest rate. So if the rate of interest is 8%

then doubling period=0.35+69/8%=8.975years.

B) FVAn = A * FVIFA (12%, 5yrs)

= 1 * FVIFA (12%, 5y) = 1*6.353 = rs. 6.353

Question 3. The concept of financial leverage is a significant, as it has direct relation with capital

structure. Do you agree? If so, substantiate your arguments.


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Step 3. From the PVIFA table for 4years, the annuity factor very near 2.35 is 25%. Therefore, the first

initial, rate is 25% as shown in table

YEAR CASH FLOW PV FACTOR AT 25% PV OF CASH FLOWS1 50,000 0.800 40,0002 50,000 0.640 32,0003 30,000 0.512 15,3604 40,000 0.410 16,400

Total 1,03,760

As the initials investments of Rs. 1,00,000 is less than the computed value at 25% of Rs. 1,03, 760,

the next trial rate is 26%.

Hence, the changes in the calculations are as shown in table


Total 1,02,049

The next trial rate is 27%, the changes are as shown in table


Total 1,00,392

The next trial rate is 28%, the changes are as shown in table


Total 98,789

Because initial investment of Rs. 1,00,000 lies between 98789 (28%) and 1,00,392 (27%), the IRR byinterpolation is equal to:

27+1,00,392-1,00,000/1,00,392-98,789*1

=27+392/1603*1

=27+0.2445

=27.2445=27.24%

Question 5. Below table gives the complete details of sales and costs of the goods produced by XYZ

ltd for the year 31.03.12.


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TABLE-SALES AND COSTS PRODUCED BY XYZ Ltd.

Sales 80,000 InventoryCost of Goods 56,000 31.03.07 9,000

31.03.08 12,000Accounts Receivables

31.03.07 12,00031.03.08 16,000

Accounts Payables31.03.07 7,00031.03.08 10,000

What is the length of the operating cycle? What is the cash cycle? Assume 365 days in a year.

Answer. Operating Cycle = Inventory Conversion Period + Accounts Receivables Conversion Period

From the above formula we need to first calculate the individual conversion periods.

Inventory conversion period =

Average Inventory/Annual Cost of goods sold*365 = (9000 + 12000) / 2 / 56000*365

= 10500*365/56000 = 68.4 days

Receivables Conversion Period =

Average Accounts Receivables/Annual Sales*365 = (12000 + 16000)/2*365/80000 = 63.9 days

Payables Conversion Period

= Average Accounts Payables/Annual Cost of Goods Sold*365 = (7000 + 10000)/2/56000*365

= 8500*365/56000 = 55.4 days

Operating Cycle = ICP + RCP = 68.4 + 63.9 = 132.3days

Cash Conversion Cycle = OCPDP = 132.355.4 = 76.9 days

Question 6. Facebook bought WhatsApp on Feb, 19, 2014 for $19 billion. This was split between $4

billion in cash, $12 billion worth of facebook shares, and $3 billion in restricted stock units to be paid

in four years. Do you think the market capitalization has played a significant role in pricing the

valuation. Discuss the Walters model assumptions in this context.

Answer. Prof. James E. Walter considers that dividend pay-outs are relevant and have a bearing on

the share prices of the firm. He further states that investment policies of a firm. He further states that

investment policies of a firm cannot be separated from its dividend policy and both are interlinked.

The choice of an appropriate dividend policy affects the value of the firm. Walter model clearly

establishes a relationship between the firms rate of return r and its cost of capital k to give a

dividend policy that maximizes shareholders wealth. The firm would have the optimum dividend policy

that enhances the value of the firm.

Walter model can be studied with the relationship between r and k.

If r>k, the firms earnings can be retained, as the firm has better and profitable investment

opportunities and the firm can earn more than what the shareholders could earn by re-

investing, if earnings are distributed. Firms which have r>k are called growth firms and such

firms should have zero payout ratio.


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If r


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