Financial Management: Notes, Questions

Financial Management: Notes, Questions

Finance is a study of trade off between the present and the future value of money. Corporate can raise capital by using various options. There are various financial instruments available in the market. Broadly, most of the companies in the industry raise financial instruments like bonds, Commercial papers and other instruments on the basis of their requirement as it is industry/company specific.

Questions and Answers

Question: Introduction to Financial Instruments: (Submission in Excel only)

A. Identify the types of financial instruments issued by your company as well as for two peers in the same industry. The peer company can be any company’s data available in the public domain. Provide a brief note on the characteristics of these financial instruments. (8 m)

B. Identify the interest paid on these instruments and the term for which the instrument is issued. (6 m)

C. From the past records (you can check the last 5 years), recognize if any financial instruments have been repaid and new instruments have been raised like bonds and the effect in the capital structure. (6 m)

Points to note before attempting the exercise:

In case your company is debt free, work on the assumption that if your company was to borrow, what would be the cost of debt. Even if the management of the company follows a no-debt policy, please work out an optimal debt equity position.

Question:

A. “The basic rationale for the objective of shareholder’s wealth maximization is that it reflects the most efficient use of society’s economic resources and thus leads to a maximization of society’s economic wealth”(Ezra Solomon).Comment critically.
B. Exactly 10 years from now sri chand will start receiving a pension of Rs 3,000 a year .The payment will continue for sixteen years .How much is the pension worth now,if srichand’s interest rate is 10 per cent.

Question:

a) A company is using a machine the original cost of which was Rs 3,70,000 . the machine is 2 years old and has a remaining useful life of 10 years . It is expected that scrapping the old amchine in 10 years from now will fetch Rs 10,000 but if it is sold now to another firm in the industry it would receive Rs 1,00,000 : the straight line method of depreciation is in effect.

The management is contemplating replacing it with a newer and more efficient machine which costs Rs 420000 and has an estimated salvage value of Rs 20000 after its useful life of 10 years. The new machine will have a greater capacity and annual returns are expected to go up by Rs 40,000 per year. The operatinf efficiency of the new machine will also produce an expected savings of Rs 50,000 a year. The company’s tax rate 55%. A 25% investment allowance will apply if the new machine is purchased. Additionally , if the new machine is purchased, inventories will increase by Rs 50,000 receivables by Rs 25000 and payables by Rs 20000 during the life of the project. Determine the economic desirability of the purchase of the machine, assuming the cost of capital to be 12 %.

b) What is meant by the term “leverage”? What are its types? With what type of risk is each leverage generally associated ? why is the increasing leverage ratio indicative of increasing risk? State the situation when there is neither a financial risk nor business risk.

Question:

A company is considering the possibility of raising Rs 100 million, by issuing debt, preference capital, and equity and retaining earnings. The book values and the market values of the issues are as follows:

Ordinary Shares: 40, 60. Preference Shares: 20, 24. Debt: 40, 36

The following costs are expected to be associated with the above mentioned issues of capital. (Assume a 30 per cent tax rate.)
i The debt is in the form of Rs 1,000 face value debenture with a 16 per cent rate of interest.
ii The 11 per cent Rs 100 face value preference shares currently sell at Rs 120 per share.
iii The firm’s ordinary share is currently selling for Rs 150. It is expected that the firm will pay a dividend of Rs 12 per share at the end of the next year, which is expected to grow at a rate of 7 per cent.

Compute the weighted average cost of capital using (i) book value weights (ii) market value weights.

Question:

a) Explain fully the concept of modified IRR? Under what circumstances is it useful? Compare NPV and IRR methods of project evaluation.

b) Management of Talash Ltd. Has the option to buy either Machine A or Machine B. Machine A has cost of 75,000. Its expected life is 6 years with no salvage value at the end. It would generate net cash flows of Rs. 20,000per year. Machine B on the other hand would cost Rs. 50,000. Its expected life is 6 year with no salvage value at the end. It would generate net cash flows of Rs.15,000 per year. Assuming that the cost of capital of both the machine is 10 percent, you are required to calculate:
a. Net present value for each Machine.
b. Internal rate of each Machine.
c. Which machine should be recommended and why?
d. What is the Profitability Index and the Pay Back of the machine.

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