NAME- SIDHARTH KUMAR

ROLL - 2314106770

PROGRAM-BACHELOR OF BUSINESS ADMINISTRATION (BBA)

COURSE CODE & NAME -DBB2104 Financial management

Q.1 Explain the functions of a financial manager in any organization.

Ans. A financial manager plays a crucial role in an organization by overseeing its financial
health and guiding strategic financial decisions. Here are the key functions of a financial
manager:

Financial Planning and Analysis:

Budgeting: Developing and managing budgets to ensure resources are allocated effectively
and align with organizational goals.

Forecasting: Predicting future financial trends and performance to prepare for potential
opportunities and risks.

Investment Decisions:

Capital Budgeting: Evaluating investment opportunities, such as new projects or acquisitions,

to determine their potential returns and risks.

Asset Management: Deciding how to allocate funds across various assets and investments to
optimize returns.

Financing Decisions:

Funding Strategies: Determining the best sources of financing (e.g., equity, debt) to support
organizational activities and growth.

Cost of Capital: Analyzing the cost of different financing options to minimize overall costs
and maximize profitability.

Financial Reporting:

Internal Reporting: Providing management with accurate and timely financial reports to
support decision-making.

External Reporting: Ensuring compliance with regulatory requirements by preparing and

presenting financial statements to external stakeholders like investors and regulators.

Risk Management:

Identifying Risks: Assessing financial risks related to investments, market fluctuations, and
operational changes.

Mitigating Risks: Developing strategies to minimize or manage financial risks, such as using
hedging techniques or insurance.

Cash Flow Management:

Monitoring Cash Flow: Ensuring that the organization has sufficient liquidity to meet its
short-term obligations.

Optimizing Cash Flow: Managing receivables, payables, and inventory to enhance cash flow
and reduce financial strain.

Strategic Planning:

Long-term Strategy: Aligning financial strategies with the overall strategic goals of the
organization to support growth and competitiveness.

Performance Metrics: Developing and analyzing key financial metrics to gauge performance
and guide strategic decisions.

Compliance and Governance:

Regulatory Compliance: Ensuring adherence to financial regulations and accounting

standards.

Internal Controls: Establishing and maintaining internal controls to prevent fraud and ensure
accuracy in financial reporting.

Stakeholder Communication:

Investor Relations: Communicating financial performance and strategy to investors and

analysts.

Management Support: Advising senior management on financial implications of business

decisions and strategies.

Overall, financial managers are essential for maintaining the financial stability and growth of
an organization, balancing risk with opportunity, and ensuring that financial resources are
used effectively to achieve strategic objectives.

Q.2 Calculate the present value of the following cash flows assuming a discount rate of 10%
per annum.

Year Cash flows [₹]

1 10000

2 20000

3 30000

4 40000

5 50000
Ans. To calculate the present value (PV) of cash flows given a discount rate, we use the
formula for present value:

\[ \text{PV} = \frac{C}{(1 + r)^t} \]

where:

- \( C \) is the cash flow in a given year,

- \( r \) is the discount rate (expressed as a decimal),

- \( t \) is the year of the cash flow.

Let's calculate the present value of each cash flow given a discount rate of 10% (or 0.10) per
annum.

1. **Year 1: Cash Flow = ₹10,000**

\[

\text{PV}_1 = \frac{10{,}000}{(1 + 0.10)^1} = \frac{10{,}000}{1.10} \approx 9{,}090.91

\]

2. **Year 2: Cash Flow = ₹20,000**

\[

\text{PV}_2 = \frac{20{,}000}{(1 + 0.10)^2} = \frac{20{,}000}{1.21} \approx

16{,}528.93

\]

3. **Year 3: Cash Flow = ₹30,000**

\[
 \text{PV}_3 = \frac{30{,}000}{(1 + 0.10)^3} = \frac{30{,}000}{1.331} \approx
22{,}558.09

\]

4. **Year 4: Cash Flow = ₹40,000**

\[

\text{PV}_4 = \frac{40{,}000}{(1 + 0.10)^4} = \frac{40{,}000}{1.4641} \approx

27{,}333.87

\]

5. **Year 5: Cash Flow = ₹50,000**

\[

\text{PV}_5 = \frac{50{,}000}{(1 + 0.10)^5} = \frac{50{,}000}{1.61051} \approx

31{,}030.42

\]

To find the total present value, sum up the present values of all cash flows:

\[

\text{Total PV} = \text{PV}_1 + \text{PV}_2 + \text{PV}_3 + \text{PV}_4 + \text{PV}_5

\]

\[

\text{Total PV} \approx 9{,}090.91 + 16{,}528.93 + 22{,}558.09 + 27{,}333.87 +

31{,}030.42

\]
\[

\text{Total PV} \approx 106{,}542.22

\]

So, the present value of the cash flows at a 10% discount rate is approximately ₹106,542.22.

Q.3 X ltd issued Rs 100, equity shares at a premium of 10%. At the end of the year, the
expected dividend is 15% which is expected to grow 8% p.a.

Calculate the cost of equity.

If dividends are constant, then what will be the cost of equity?

Ans. To calculate the cost of equity for X Ltd, we'll use the Dividend Discount Model
(DDM). There are two scenarios to consider:

1. When dividends are expected to grow at a constant rate:

We'll use the Gordon Growth Model (also known as the Dividend Growth Model) for
this calculation. The formula is:

Cost of Equity(re)=D1P0+gCost of Equity(re)=P0D1+g

where:

oD1D1 = Expected dividend at the end of the year

oP0P0 = Current price of the equity share
ogg = Growth rate of dividends
2. When dividends are constant:

In this case, we'll use a simpler formula:

Cost of Equity(re)=DP0Cost of Equity(re)=P0D

where:

o DD = Dividend per share

o P0P0 = Current price of the equity share

Given Data:

• Face value of equity share: ₹100

• Premium: 10%
• Price of equity share (P_0): ₹100 + 10% of ₹100 = ₹110
 • Expected dividend: 15% of ₹100 = ₹15
• Growth rate (g): 8% per annum

1. Cost of Equity with Constant Growth

First, we calculate the cost of equity using the Gordon Growth Model.

1. Calculate D1D1 (expected dividend at the end of the year):

o D1=₹15D1=₹15 (the dividend expected this year)
2. Current price of equity share P0P0:
o P0=₹110P0=₹110
3. Growth rate gg:
o g=8% or 0.08g=8% or 0.08

Now, apply the Gordon Growth Model:

re=D1P0+gre=P0D1+gre=15110+0.08re=11015+0.08re≈0.13636+0.08re
≈0.13636+0.08re≈0.21636 or 21.64%re≈0.21636 or 21.64%

2. Cost of Equity with Constant Dividends

In this scenario, the growth rate gg is not applicable because dividends are constant.

re=DP0re=P0Dre=15110re=11015re≈0.13636 or 13.64%re≈0.13636 or 13.64%

Summary:

• Cost of Equity with constant growth: Approximately 21.64%

• Cost of Equity with constant dividends: Approximately 13.64%

SET-2

Q.5 What are the sources of finance? Discuss the short term and long term sources of finance
for the firm.

Ans. Sources of finance for a firm can be broadly classified into two categories: short-term
and long-term sources. Each type has its own characteristics and suitability depending on the
firm's needs, financial goals, and the nature of the investment.

Short-Term Sources of Finance

Short-term finance typically refers to funding that is required for a period of less than one
year. These sources are usually used to meet immediate or short-term financial needs, such as
working capital requirements. Here are common short-term sources of finance:

Trade Credit:

Definition: A form of credit extended by suppliers allowing the firm to purchase goods and
services and pay for them at a later date.

Characteristics: Interest-free if paid within the agreed period, but may involve discounts for
early payments.

Bank Overdraft:

Definition: A facility provided by banks allowing firms to withdraw more money than is
available in their current account.

Characteristics: Short-term borrowing that usually incurs higher interest rates compared to
other forms of debt.

Commercial Paper:

Definition: Unsecured, short-term promissory notes issued by companies to raise funds.

Characteristics: Typically issued at a discount and repaid at face value upon maturity, usually
within 1 to 270 days.

Factoring:

Definition: Selling accounts receivable to a third party (factor) at a discount to get immediate
cash.

Characteristics: Provides immediate cash flow but at a cost (discount).

Trade Credit:

Definition: Credit extended by suppliers allowing the firm to purchase goods or services and
pay later.

Characteristics: Typically involves no interest if paid within the agreed terms.

Short-Term Loans:

Definition: Loans from banks or financial institutions with a maturity period of less than one
year.

Characteristics: Often used for specific purposes like seasonal inventory purchases or urgent
cash needs.
Long-Term Sources of Finance

Long-term finance refers to funding that is needed for a period exceeding one year. These
sources are used to finance long-term investments, such as capital expenditure, expansion, or
strategic projects. Common long-term sources include:

Equity Financing:

Definition: Raising funds by issuing shares to investors.

Characteristics: Does not require repayment like debt financing but dilutes ownership and
control.

Types:

Common Shares: Provides voting rights and dividend income based on profitability.

Preferred Shares: Typically offers fixed dividends and priority over common shares in
dividend payments and liquidation.

Debt Financing:

Definition: Borrowing funds that need to be repaid with interest over a longer period.

Characteristics: Includes obligations such as bonds, debentures, and long-term loans.

Types:

Bonds: Long-term debt securities issued by companies to raise capital. Investors receive
regular interest payments and repayment of principal at maturity.

Debentures: Similar to bonds but unsecured, relying on the issuer’s creditworthiness.

Long-Term Loans: Loans from banks or financial institutions with a repayment term
exceeding one year.

Leasing:

Definition: Acquiring assets through leasing agreements rather than purchasing them
outright.

Characteristics: Helps avoid large upfront costs and can offer tax benefits, with the option to
purchase the asset at the end of the lease term.

Retained Earnings:

Definition: Using profits that have been reinvested in the business rather than distributed as
dividends.
Characteristics: No additional cost like interest or dilution, but depends on the availability of
sufficient profits.

Venture Capital:

Definition: Investment provided by venture capitalists to startups and small businesses with
high growth potential in exchange for equity or convertible debt.

Characteristics: Involves high-risk capital and may require giving up a significant equity
stake.

Public and Private Placements:

Definition: Issuing new securities to investors either through public offerings or private
placements with select institutional investors.

Characteristics: Public placements involve more regulatory scrutiny, while private

placements are often quicker and less regulated.

Summary

Short-Term Sources: Trade credit, bank overdraft, commercial paper, factoring, short-term
loans.

Long-Term Sources: Equity financing (common and preferred shares), debt financing (bonds,
debentures, long-term loans), leasing, retained earnings, venture capital, public and private
placements.

Each source of finance has its own advantages and disadvantages, and the choice depends on
factors such as the firm’s financial health, cost of capital, risk tolerance, and strategic
objectives.

Q.6 The details regarding three companies are given below:

X Ltd Y Ltd Z Ltd.

r = 12% r = 8% r = 10%

Ke = 10 % Ke = 10 % Ke = 10 %

E = Rs. 100 E = Rs. 100 E = Rs. 100

Compute the value of an equity share of each of these companies applying Walter’s formula
when the dividend pay-out ratio is (a) 0%, (b) 20%, (c) 40%,
Ans. Walter’s formula is used to determine the value of an equity share based on the dividend
payout ratio, the cost of equity, and the return on equity (r). The formula is:

P=D+r−KerKeP=KeD+rr−Ke

where:

• PP = Price of the equity share

• DD = Dividend per share
• rr = Return on equity
• KeKe = Cost of equity

Given:

• EE = Earnings per share (which is Rs. 100 for all companies)

• rr = Return on equity
• KeKe = Cost of equity

Let’s compute the value of an equity share for each company using different dividend payout
ratios.

1. Company X Ltd

• Return on equity (r): 12%

• Cost of equity (Ke): 10%
• Earnings per share (E): Rs. 100

(a) Dividend Payout Ratio = 0%

Here, the entire earnings are retained. Thus, D=0D=0, and the value of the share is:

P=D+r−KerKeP=KeD+rr−KeP=0+0.12−0.100.120.10P=0.100+0.120.12−0.10
P=0.020.120.10P=0.100.120.02P=0.16670.10=1.6667P=0.100.1667=1.6667

So,

P=1.6667×100=Rs.166.67P=1.6667×100=Rs.166.67

(b) Dividend Payout Ratio = 20%

Here, 20% of earnings are paid as dividends:

D=0.20×100=Rs.20D=0.20×100=Rs.20P=D+r−KerKeP=KeD+rr−Ke
P=20+0.12−0.100.120.10P=0.1020+0.120.12−0.10P=20+0.020.120.10P=0.1020+0.120.02
P=20+0.16670.10=20.16670.10=201.67P=0.1020+0.1667=0.1020.1667=201.67

So,

P=Rs.201.67P=Rs.201.67
(c) Dividend Payout Ratio = 40%

Here, 40% of earnings are paid as dividends:

D=0.40×100=Rs.40D=0.40×100=Rs.40P=D+r−KerKeP=KeD+rr−Ke
P=40+0.12−0.100.120.10P=0.1040+0.120.12−0.10
P=40+0.16670.10=40.16670.10=401.67P=0.1040+0.1667=0.1040.1667=401.67

So,

P=Rs.401.67P=Rs.401.67

2. Company Y Ltd

• Return on equity (r): 8%

• Cost of equity (Ke): 10%
• Earnings per share (E): Rs. 100

Since r<Ker<Ke, the value of the share will be negative or undefined according to Walter’s
formula. This is because if the return on equity is less than the cost of equity, the formula
indicates that the firm’s investments are not generating returns that justify the cost of equity,
which results in no feasible positive value for the share.

So, in this case:

P=Undefined or Negative ValueP=Undefined or Negative Value

3. Company Z Ltd

• Return on equity (r): 10%

• Cost of equity (Ke): 10%
• Earnings per share (E): Rs. 100

Similarly, since r=Ker=Ke, the value of the share is given by:

P=DKeP=KeD

(a) Dividend Payout Ratio = 0%

Here, D=0D=0:

P=00.10=0P=0.100=0

So,

P=Rs.0P=Rs.0

(b) Dividend Payout Ratio = 20%

Here, D=0.20×100=Rs.20D=0.20×100=Rs.20:
P=200.10=200P=0.1020=200

So,

P=Rs.200P=Rs.200

(c) Dividend Payout Ratio = 40%

Here, D=0.40×100=Rs.40D=0.40×100=Rs.40:

P=400.10=400P=0.1040=400

So,

P=Rs.400P=Rs.400

Summary of Values:

• X Ltd:
o Dividend Payout Ratio 0%: Rs. 166.67
o Dividend Payout Ratio 20%: Rs. 201.67
o Dividend Payout Ratio 40%: Rs. 401.67
• Y Ltd:
o All dividend payout ratios: Undefined or Negative Value
• Z Ltd:
o Dividend Payout Ratio 0%: Rs. 0
o Dividend Payout Ratio 20%: Rs. 200
o Dividend Payout Ratio 40%: Rs. 400

Q.6 What is Working capital management? Discuss various factors that affect working
capital requirement?

Ans. Working capital management is the process of managing a company's short-term assets
and liabilities to ensure it can continue its operations and meet its short-term obligations. It
involves monitoring and optimizing the levels of current assets (such as cash, inventory, and
receivables) and current liabilities (such as payables) to maintain operational efficiency and
liquidity.

Effective working capital management ensures that a company has sufficient cash flow to
meet its short-term liabilities and invest in its operations, while minimizing the cost of
holding excessive working capital.

Factors Affecting Working Capital Requirements

Nature of Business:

Industry Type: Businesses with seasonal demand or those that deal in perishable goods
generally require more working capital due to fluctuating inventory levels and receivables.
Conversely, service-based firms might have lower working capital needs.

Business Model: Companies with high inventory turnover (e.g., retail) or long production
cycles (e.g., manufacturing) will have different working capital requirements.

Business Cycle:

Operating Cycle: The time taken to convert raw materials into finished goods, and then sell
and collect receivables, affects working capital needs. A longer operating cycle typically
requires more working capital.

Sales Volume and Seasonality: Businesses with high sales volumes or significant seasonal
variations need more working capital to manage inventory and receivables during peak
periods.

Inventory Management:

Inventory Turnover Ratio: Companies with high inventory turnover require less working
capital since they sell goods quickly and do not need to hold large amounts of stock.

Stock Levels: Companies that hold large inventories to meet customer demand or prevent
stockouts will need more working capital.

Receivables Management:

Credit Policy: Firms offering longer credit terms or facing delays in receivables collection
will need more working capital to cover the gap between credit sales and cash inflow.

Collection Period: The time taken to collect accounts receivable affects working capital
requirements. Longer collection periods increase the need for working capital.

Payables Management:

Payment Terms: The credit terms extended by suppliers impact working capital. Longer
payment terms can reduce working capital needs by deferring cash outflows.

Negotiation Power: Firms with strong bargaining power can negotiate better payment terms,
thereby affecting their working capital requirements.

Cash Management:

Cash Flow Patterns: Irregular cash flows or seasonality in cash receipts and payments
influence working capital needs. Companies must maintain sufficient cash reserves to
manage fluctuations and avoid liquidity problems.
Cash Reserves: Maintaining an optimal level of cash reserves to handle unexpected expenses
or investment opportunities affects working capital.

Credit Availability:

Access to Short-Term Financing: The ability to secure short-term loans or lines of credit can
impact working capital. Firms with easier access to credit can operate with lower working
capital since they can borrow to meet short-term needs.

Growth and Expansion:

Business Growth: Rapid expansion or investment in new projects often requires additional
working capital to support increased inventory, receivables, and other operational costs.

Capital Expenditures: Significant investments in fixed assets may temporarily increase

working capital needs as the company shifts funds from current assets to long-term
investments.

Economic Conditions:

Inflation: Rising prices can increase the cost of inventory and reduce the real value of cash
reserves, affecting working capital needs.

Interest Rates: Higher interest rates can increase the cost of borrowing, impacting working
capital requirements and financial management.

Operational Efficiency:

Production Efficiency: Efficient production processes reduce the time required to convert raw
materials into finished goods, affecting working capital requirements.

Supply Chain Management: Effective supply chain management can reduce inventory levels
and enhance cash flow, influencing working capital needs.

Summary

Working capital management is essential for ensuring that a company can meet its short-term
obligations and invest in its operations efficiently. Factors affecting working capital
requirements include the nature of the business, business cycle, inventory and receivables
management, payables management, cash flow patterns, credit availability, growth and
expansion plans, economic conditions, and operational efficiency. Managing these factors
effectively helps maintain liquidity, optimize resource utilization, and support overall
business performance.