NAME: PAWAN KUMAR

ROLL NO: 2414108237

ASSIGNMENT

SESSION JUL - AUG 2024

PROGRAM MASTER OF BUSINESS ADMINISTRATION
(MBA)
SEMESTER II
COURSE CODE & NAME DMBA202_FINANCIAL MANAGEMENT
CREDITS 04
NUMBER OF ASSIGNMENTS 02
& MARKS 30 MARKS EACH

Assignment Set – 1

1. Financial planning is essential for any organization or individual looking to achieve

financial stability and growth. The process involves a series of structured steps that help
in setting, monitoring, and adjusting financial goals”. Explain in detail the steps involved
in financial planning, highlighting how each step contributes to a successful financial
strategy of a company. Additionally, discuss the various factors that can impact the
financial plan of an organization.
Answer : Financial planning is a systematic process that helps an organization or an individual
manage their finances effectively to achieve financial stability, growth, and security. It involves
setting financial goals, creating strategies to achieve them, and continuously monitoring and
adjusting the plan as necessary. Here’s a detailed explanation of the steps involved in financial
planning and how each contributes to a successful financial strategy:

1. Establishing Financial Goals

Goal-setting is the first and most important step in financial planning. Financial goals act as
the guiding objectives for all the planning and decision-making processes. Clear goals help
provide direction and purpose.
How it contributes:
• Clarity: Setting specific, measurable, achievable, relevant, and time-bound (SMART)
goals ensures that the organization or individual knows exactly what they want to
achieve.
 • Motivation: Financial goals help prioritize efforts, keeping the organization focused on
achieving its mission (e.g., increasing profitability, expanding market share, or building
emergency reserves).
Example: For a company, a financial goal might be to increase revenue by 15% over the next
year or reduce debt levels by 10%.

2. Gathering and Analyzing Financial Data

Once the goals are set, it’s crucial to collect and analyze financial information to understand the
current financial situation. This includes reviewing historical financial data, assessing income
and expenses, analyzing assets and liabilities, and evaluating cash flow.
How it contributes:
• Reality Check: It provides a snapshot of where the organization stands financially,
helping to assess whether current resources are adequate to meet the goals.
• Informed Decisions: Analysis of past trends helps in identifying strengths and
weaknesses in the financial structure, enabling smarter planning.
Example: A company might analyze its balance sheet to understand asset utilization, debt levels,
and liquidity, providing insights into potential financial challenges.

3. Developing Financial Strategies and Plans

With the data gathered, the next step is to create a detailed financial strategy. This includes
determining how to allocate resources, manage cash flow, invest, and control costs in order to
meet financial goals.
How it contributes:
• Roadmap for Action: A financial strategy serves as a roadmap, detailing the actions
required to meet the financial goals.
• Resource Allocation: It helps prioritize where to allocate resources, such as investment
in assets, reducing liabilities, or increasing reserves for future growth.
Example: If the goal is to reduce debt, a strategy might involve refinancing existing loans,
cutting unnecessary expenses, and increasing cash reserves.

4. Implementing the Financial Plan

The next step is to execute the financial strategies developed in the previous step. This involves
taking actions such as setting budgets, making investments, and implementing cost-cutting
measures.
How it contributes:
• Action-Oriented Approach: Implementation ensures that strategies are not just
theoretical but are put into practice.
• Realization of Goals: The successful execution of plans leads to tangible results, such as
increased profits, improved liquidity, or reduced liabilities.
Example: The company may set up an automated system for budgeting, establish savings plans
for specific financial goals, or initiate investments based on the strategy.

5. Monitoring and Reviewing the Financial Plan

Financial plans are dynamic, and it’s essential to continuously monitor progress against the
goals. This involves tracking income and expenses, comparing actual performance with
forecasted figures, and identifying any deviations from the plan.
How it contributes:
• Course Correction: Monitoring helps identify issues early, allowing timely adjustments
to the plan.
• Ensuring Alignment: Regular reviews ensure that the financial strategy remains aligned
with the organization's goals and market conditions.
Example: A company might track its quarterly financial statements to evaluate whether it's
meeting revenue targets and adjust spending or pricing strategies if needed.

6. Adjusting the Financial Plan

Based on the monitoring and review process, the financial plan might need adjustments. This
step involves revisiting goals, re-assessing strategies, and making modifications to keep the
financial plan realistic and achievable.
How it contributes:
• Flexibility: Adjustments allow the plan to stay relevant in the face of changing market
conditions, new opportunities, or unforeseen financial challenges.
• Continuous Improvement: Regular adjustments help refine the strategy and improve
future planning processes.
Example: If a company faces unexpected market changes or economic downturns, it may need
to adjust its revenue targets, investment plans, or operational costs.

Factors That Can Impact the Financial Plan of an Organization

There are several internal and external factors that can influence the financial plan of an
organization. These factors can cause deviations from the plan, so it's important to take them into
consideration when developing and adjusting financial strategies.
1. Market Conditions
• Economic factors like inflation, interest rates, and market demand can influence pricing,
investment strategies, and revenue forecasts.
Example: An economic downturn may lead to lower sales and necessitate adjustments in
the financial plan to reduce costs.
2. Regulatory Changes
• Government policies, tax laws, and industry regulations can impact profitability, costs,
and investment strategies.
Example: A change in tax laws that increases corporate taxes may require the company to
adjust its budget or rethink its investment decisions.
3. Competitor Actions
• The strategies adopted by competitors, such as price reductions, product innovations, or
aggressive marketing campaigns, can affect market share and revenue projections.
Example: If a competitor introduces a disruptive product at a lower price, the organization
may need to lower its prices or increase marketing spending.
4. Technological Advancements
• Technological innovations can create new opportunities or challenges. Adoption of new
technology might require investments or lead to operational efficiency improvements.
Example: A company may need to adjust its financial plan to include investment in new
technology or retraining of employees.
5. Internal Organizational Factors
• Changes within the company, such as leadership, organizational structure, or employee
skills, can affect its financial stability and growth.
Example: If a company undergoes a merger or acquisition, the financial plan may need to
be revised to integrate new operations and costs.
6. Global and Geopolitical Events
 • Global events like natural disasters, pandemics, or political instability can have a
significant impact on supply chains, revenue generation, and operating costs.
Example: The COVID-19 pandemic led to a global economic slowdown, causing many
companies to reassess their financial strategies.

Conclusion
Financial planning is a vital process for achieving long-term financial stability and growth for an
organization. The steps involved in financial planning — from goal setting to strategy
implementation and continuous monitoring — ensure that an organization stays on track to meet
its financial objectives. However, external and internal factors such as market conditions,
regulation changes, competition, technological advancements, and geopolitical events can
influence the success of the financial plan. By regularly reviewing and adjusting the plan,
organizations can adapt to these changes and continue on the path to financial success.
a)XYZ India Ltd.’s share is expected to be Rs.450 one year from now. The company is expected
to declare a dividend of Rs. 25 per share. What is the price at which an investor would be willing
to buy if his or her required rate of return is 15%?
Answer : Price of the Share Using the Dividend Discount Model (DDM)
To calculate the price at which an investor would be willing to buy XYZ India Ltd.’s share, we
can use the Dividend Discount Model (DDM). This model calculates the present value of a stock
based on the expected dividend and the expected price one year from now.
The formula for calculating the price of the share is:
P0=D1+P1(1+r)P_0 = \frac{D_1 + P_1}{(1 + r)}P0=(1+r)D1+P1
Where:
• P0P_0P0 is the current price of the share (what the investor is willing to pay today).
• D1D_1D1 is the dividend expected in the next period (Rs. 25).
• P1P_1P1 is the price of the share expected one year from now (Rs. 450).
• rrr is the required rate of return (15% or 0.15).
Step-by-step calculation:
P0=25+450(1+0.15)P_0 = \frac{25 + 450}{(1 + 0.15)}P0=(1+0.15)25+450 P0=4751.15P_0 =
\frac{475}{1.15}P0=1.15475 P0≈413.04P_0 \approx 413.04P0≈413.04
So, the price at which an investor would be willing to buy the share is approximately Rs. 413.04.
b) Difference Between Operating Leverage and Financial Leverage
Operating Leverage and Financial Leverage both refer to how a company’s fixed costs (in
operations or financing) can amplify changes in profitability, but they differ in terms of the type
of costs involved.
Operating Leverage:
Operating leverage refers to the proportion of fixed costs in a company’s total cost structure, which
impacts how changes in sales affect operating income (EBIT - Earnings Before Interest and Taxes).
When a company has high operating leverage, a small change in sales can lead to a large change
in profit due to fixed operational costs.
• Formula:
Degree of Operating Leverage (DOL)=% Change in EBIT% Change in Sales\text{Degre
e of Operating Leverage (DOL)} = \frac{\% \text{ Change in EBIT}}{\% \text{ Change
in Sales}}Degree of Operating Leverage (DOL)=% Change in Sales% Change in EBIT
• Impact:
o Companies with high operating leverage have higher fixed costs (e.g., machinery,
rent, salaries), meaning they must generate a significant level of sales to cover these
fixed costs.
o Once fixed costs are covered, additional sales lead to higher profits.
Example: A manufacturing company with expensive machinery and high fixed costs. If sales rise,
profits will increase disproportionately because the fixed costs do not change.
Financial Leverage:
Financial leverage refers to the use of debt (borrowed capital) to finance a company's operations.
When a company has high financial leverage, it uses more debt in its capital structure. The use of
debt increases the potential return on equity, but it also increases financial risk, as debt obligations
must be met regardless of how the company’s performance fluctuates.
• Formula:
Degree of Financial Leverage (DFL)=% Change in EPS% Change in EBIT\text{Degree of
Financial Leverage (DFL)} = \frac{\% \text{ Change in EPS}}{\% \text{ Change in
EBIT}}Degree of Financial Leverage (DFL)=% Change in EBIT% Change in EPS
• Impact:
o When a company uses debt, it incurs interest expenses. These interest payments are
fixed costs. If the company’s EBIT increases, financial leverage helps to amplify
the impact on the company’s earnings per share (EPS).
 o However, if the company’s earnings drop, financial leverage magnifies the decline
due to the fixed nature of debt repayments.
Example: A company that borrows money to finance new projects. If the projects are successful,
profits (and EPS) can increase significantly, but if they are unsuccessful, the company still needs
to pay the debt interest, leading to potential losses.

Key Differences Between Operating and Financial Leverage:

Aspect Operating Leverage Financial Leverage

Related to the company’s cost Related to the company’s capital structure,

Nature
structure, particularly fixed costs. particularly debt.

Impact on Amplifies the effect of changes in Amplifies the effect of changes in operating
Profit sales on operating income (EBIT). income (EBIT) on earnings per share (EPS).

High operating leverage increases risk High financial leverage increases financial
Risk
due to high fixed costs. risk due to fixed debt obligations.

Focus on sales volume and cost Focus on debt financing and interest
Focus
structure. payments.

Manufacturing companies with high Companies using debt to finance projects or

Example
fixed costs (e.g., machinery). operations.

Both types of leverage can be useful for a company to maximize profitability, but they also increase
risks, particularly if the company faces unexpected changes in sales or profits.

b) Differentiate between Operating and Financial leverage.

Answer : Difference Between Operating and Financial Leverage
Operating leverage and financial leverage are both important concepts in finance that refer to
how different factors (cost structure and financing decisions) can impact a company's
profitability. While both involve the use of fixed costs, they differ in what those fixed costs relate
to and how they affect the company's financial performance.
1. Definition:
• Operating Leverage refers to the degree to which a company uses fixed costs in its
operations. It measures the effect of sales changes on operating income (EBIT - Earnings
 Before Interest and Taxes). A company with high operating leverage has a higher
proportion of fixed costs, which can amplify the impact of changes in sales on
profitability.
• Financial Leverage refers to the use of debt (borrowed money) to finance the company’s
operations. It measures how the use of debt can amplify the effect of changes in operating
income (EBIT) on the company’s earnings per share (EPS). A company with high
financial leverage has a higher proportion of debt in its capital structure, which can
magnify both profits and risks.
2. Cost Structure:
• Operating Leverage: Involves fixed operating costs like rent, salaries, and machinery.
These costs remain constant regardless of the level of production or sales.
• Financial Leverage: Involves fixed financial costs, primarily interest expenses on
borrowed funds. These costs remain constant, regardless of how much profit the company
generates.
3. Impact on Profitability:
• Operating Leverage: A company with high operating leverage will see a larger change
in operating income (EBIT) with a small change in sales. This is because fixed costs do
not change with sales volume, so higher sales translate to much higher profits.
• Financial Leverage: A company with high financial leverage will see a larger change
in EPS (earnings per share) with a change in EBIT. Higher debt can increase profitability
if the company generates sufficient revenue, but also magnifies the risks if the company
doesn’t meet its debt obligations.
4. Risk:
• Operating Leverage: Higher operating leverage increases the risk because fixed costs
remain the same even if sales decline, which can hurt profitability. A small drop in sales
can lead to a significant decline in profits.
• Financial Leverage: Higher financial leverage increases financial risk because the
company must meet its interest payments regardless of profitability. If EBIT is low, the
company still has to pay interest on its debt, which can reduce profits and increase the
chance of financial distress.
5. Formula:
• Operating Leverage:
Degree of Operating Leverage (DOL)=% Change in EBIT% Change in Sales\text{Degree of
Operating Leverage (DOL)} = \frac{\% \text{ Change in EBIT}}{\% \text{ Change in
Sales}}Degree of Operating Leverage (DOL)=% Change in Sales% Change in EBIT
It reflects the sensitivity of EBIT to changes in sales.
 • Financial Leverage:
Degree of Financial Leverage (DFL)=% Change in EPS% Change in EBIT\text{Degree of
Financial Leverage (DFL)} = \frac{\% \text{ Change in EPS}}{\% \text{ Change in
EBIT}}Degree of Financial Leverage (DFL)=% Change in EBIT% Change in EPS
It reflects the sensitivity of EPS to changes in EBIT.
6. Example:
• Operating Leverage Example: A company with a large number of fixed assets and high
fixed operating costs (such as machinery or factory space) may experience a significant
increase in profit when sales increase, but if sales decline, it will struggle to cover its
fixed costs, leading to losses.
• Financial Leverage Example: A company that borrows a large amount of money to
finance its operations or expansion will need to pay interest on that debt. If the company
performs well (high EBIT), financial leverage will boost its profits (EPS). However, if
the company doesn’t generate enough EBIT, the interest expense will reduce profits and
increase the risk of financial distress.

Key Differences in Summary:

Aspect Operating Leverage Financial Leverage

Refers to the use of fixed operating costs Refers to the use of debt (borrowed
Definition to magnify the impact of sales changes funds) to magnify the effect of changes
on operating income (EBIT). in EBIT on earnings per share (EPS).

On fixed operating costs (e.g., salaries, On fixed financial costs (interest

Focus
rent, machinery). payments on debt).

Higher financial risk due to the

Higher risk of loss due to high fixed
Risk obligation to pay interest, regardless of
costs and dependency on sales volume.
profits.

Impact of Small changes in sales lead to large Small changes in EBIT lead to larger
Sales changes in operating income (EBIT). changes in EPS.

Cost High proportion of fixed costs in High proportion of debt in capital

Structure operations. structure.

A manufacturing company with high A company using debt to finance new

Example
fixed costs for machinery. product development.

In conclusion, both operating and financial leverage can be useful tools for companies to
maximize profitability, but they also increase risk. High operating leverage makes a company
sensitive to sales changes, while high financial leverage makes a company sensitive to its ability
to cover debt obligations.

3. A company has the following capital structure:

Equity Capital: 10 crore shares of Rs.10 each, fully paid up.

9% Preference Capital: 1 lakh shares of Rs.100 each, fully paid up, redeemable after 8 years.
15% Debentures: 2 lakh debentures of Rs.100 each, redeemable after 5 years.
12% Term Loans: Rs.20 crores.

Additional information:

The next expected dividend on equity shares is Rs.4 per share, with an annual growth rate of 6%.
The market price per equity share is Rs.50.
The market price of the preference shares is Rs.90 per share.
The market price of debentures is Rs.85 per debenture.
The company’s income tax rate is 35%.
Answer : To analyze the capital structure and compute the Weighted Average Cost of
Capital (WACC), we need to calculate the costs of each of the components (Equity,
Preference Capital, Debentures, and Term Loans) and then compute the WACC using the
formula:
WACC=EV×Re+PV×Rp+DV×Rd×(1−Tc)WACC = \frac{E}{V} \times Re + \frac{P}{V}
\times Rp + \frac{D}{V} \times Rd \times (1 - Tc)WACC=VE×Re+VP×Rp+VD×Rd×(1−Tc)
Where:
• EEE = Market value of equity
• PPP = Market value of preference capital
• DDD = Market value of debt (debentures + term loans)
• VVV = Total market value of the company's capital (E + P + D)
• ReReRe = Cost of equity
• RpRpRp = Cost of preference capital
 • RdRdRd = Cost of debt
• TcTcTc = Corporate tax rate
Let's go step-by-step to compute the individual components:

1. Cost of Equity (Re):

To compute the cost of equity, we use the Dividend Discount Model (DDM). The formula is:
Re=D1P0+gRe = \frac{D1}{P0} + gRe=P0D1+g
Where:
• D1D1D1 = Next expected dividend per share = Rs. 4
• P0P0P0 = Market price per equity share = Rs. 50
• ggg = Growth rate of dividend = 6% or 0.06
Substituting the values:
Re=450+0.06=0.08+0.06=0.14 or 14%Re = \frac{4}{50} + 0.06 = 0.08 + 0.06 = 0.14 \text{ or }
14\%Re=504+0.06=0.08+0.06=0.14 or 14%
So, the cost of equity ReReRe is 14%.

2. Cost of Preference Capital (Rp):

The cost of preference capital can be calculated using the formula:
Rp=DividendMarketPriceRp = \frac{Dividend}{Market Price}Rp=MarketPriceDividend
Where:
• Dividend = 9% of Rs. 100 = Rs. 9 per preference share
• Market Price = Rs. 90 per preference share
Rp=990=0.10 or 10%Rp = \frac{9}{90} = 0.10 \text{ or } 10\%Rp=909=0.10 or 10%
So, the cost of preference capital RpRpRp is 10%.

3. Cost of Debt (Rd):

The cost of debt is calculated using the effective interest rate of the debt, adjusted for tax
savings due to interest expense.
Rd=CouponPaymentMarketPriceofDebentureRd = \frac{Coupon Payment}{Market Price of
Debenture}Rd=MarketPriceofDebentureCouponPayment
For Debentures:
• Coupon Payment = 15% of Rs. 100 = Rs. 15 per debenture
• Market Price of Debenture = Rs. 85
Rd=1585=0.1765 or 17.65%Rd = \frac{15}{85} = 0.1765 \text{ or } 17.65\%Rd=8515
=0.1765 or 17.65%
After tax adjustment (tax rate is 35%):
Rdafter−tax=0.1765×(1−0.35)=0.1765×0.65=0.1147 or 11.47%Rd_{after-tax} = 0.1765 \times
(1 - 0.35) = 0.1765 \times 0.65 = 0.1147 \text{ or } 11.47\%Rdafter−tax
=0.1765×(1−0.35)=0.1765×0.65=0.1147 or 11.47%
So, the cost of debt RdRdRd is 11.47%.

4. Market Value of Debt:

The market value of debt is the sum of the market value of the debentures and the term loans.
• Debentures:
o Number of debentures = 2 lakh
o Market price per debenture = Rs. 85
o Total market value of debentures = 2,00,000 ×\times× 85 = Rs. 1,70,00,000 or Rs.
17 crores
• Term Loans: Rs. 20 crores (Term loans are typically taken at face value since their
market price is not provided).
So, the total debt DDD = Rs. 17 crores (debentures) + Rs. 20 crores (term loans) = Rs. 37
crores.

5. Market Value of Preference Capital:

• Preference Shares:
o Number of preference shares = 1 lakh shares
o Market price per preference share = Rs. 90
o Total market value of preference shares = 1,00,000 ×\times× 90 = Rs. 90,00,000
or Rs. 9 crores
So, the market value of preference capital PPP = Rs. 9 crores.

6. Market Value of Equity:

• Equity Capital:
o Number of equity shares = 10 crore shares
o Market price per equity share = Rs. 50
o Total market value of equity = 10,00,00,000 ×\times× 50 = Rs. 500 crores
So, the market value of equity EEE = Rs. 500 crores.

7. Total Market Value of the Company (V):

V=E+P+D=500+9+37=Rs.546 croresV = E + P + D = 500 + 9 + 37 = Rs. 546 \text{
crores}V=E+P+D=500+9+37=Rs.546 crores

8. Weighted Average Cost of Capital (WACC):

Now, we can calculate the WACC using the formula:
WACC=(EV×Re)+(PV×Rp)+(DV×Rd×(1−Tc))WACC = \left( \frac{E}{V} \times Re \right) +
\left( \frac{P}{V} \times Rp \right) + \left( \frac{D}{V} \times Rd \times (1 - Tc)
\right)WACC=(VE×Re)+(VP×Rp)+(VD×Rd×(1−Tc))
Substituting the values:
WACC=(500546×0.14)+(9546×0.10)+(37546×0.1147)WACC = \left( \frac{500}{546} \times
0.14 \right) + \left( \frac{9}{546} \times 0.10 \right) + \left( \frac{37}{546} \times 0.1147
\right)WACC=(546500×0.14)+(5469×0.10)+(54637×0.1147)
WACC=(0.915×0.14)+(0.0165×0.10)+(0.0677×0.1147)WACC = (0.915 \times 0.14) + (0.0165
\times 0.10) + (0.0677 \times 0.1147)WACC=(0.915×0.14)+(0.0165×0.10)+(0.0677×0.1147)
WACC=0.1281+0.00165+0.0078=0.1376 or 13.76%WACC = 0.1281 + 0.00165 + 0.0078 =
0.1376 \text{ or } 13.76\%WACC=0.1281+0.00165+0.0078=0.1376 or 13.76%
Conclusion:
The Weighted Average Cost of Capital (WACC) for the company is approximately 13.76%.

4. A company is considering, the following mutually exclusive projects:

 Cash Flows (in ₹) Projects
Q R S
𝐶0 -25000 -25000 -25000
𝐶1 10000 7000 10000
𝐶2 13000 11000 10000
𝐶3 11000 13000 10000
𝐶4 7000 10000 10000
C0 represents initial investment and C1, C2, C3, and C4 are annual cash inflows in the year 1,2,3
and 4 respectively.
Assuming a 12% discount factor, estimate the net present value of projects Q, R, and S. Which
project should be recommended under the net present value (NPV)method?

The present value factor (PVF) @ 12% is as follows:

Year 1 2 3 4
12% 0.893 0.797 0.712 0.636

Answer : To evaluate the Net Present Value (NPV) of the given projects, we will use the
following formula:
NPV=∑(Ct(1+r)t)−C0NPV = \sum \left( \frac{C_t}{(1 + r)^t} \right) - C_0NPV=∑((1+r)tCt
)−C0
Where:
• CtC_tCt = Cash inflow at time ttt
• rrr = Discount rate (in this case, 12% or 0.12)
• ttt = Year (1, 2, 3, 4)
• C0C_0C0 = Initial investment (which is negative since it's an outflow)
Given:
• Discount factor at 12% for Year 1 to Year 4:
o Year 1: 0.893
o Year 2: 0.797
o Year 3: 0.712
o Year 4: 0.636
Let's compute the NPV for each project.
Project Q:
The cash flows for Project Q are:
• Initial Investment C0=−25,000C_0 = -25,000C0=−25,000
• Year 1 cash inflow C1=10,000C_1 = 10,000C1=10,000
• Year 2 cash inflow C2=13,000C_2 = 13,000C2=13,000
• Year 3 cash inflow C3=11,000C_3 = 11,000C3=11,000
• Year 4 cash inflow C4=7,000C_4 = 7,000C4=7,000
Now, calculate the NPV:
NPVQ=−25000+(10000×0.893)+(13000×0.797)+(11000×0.712)+(7000×0.636)NPV_Q = -
25000 + (10000 \times 0.893) + (13000 \times 0.797) + (11000 \times 0.712) + (7000 \times
0.636)NPVQ=−25000+(10000×0.893)+(13000×0.797)+(11000×0.712)+(7000×0.636)
NPVQ=−25000+8930+10361+7832+4452NPV_Q = -25000 + 8930 + 10361 + 7832 +
4452NPVQ=−25000+8930+10361+7832+4452 NPVQ=−25000+32475=7475NPV_Q = -25000
+ 32475 = 7475NPVQ=−25000+32475=7475
So, the NPV of Project Q is ₹7,475.

Project R:
The cash flows for Project R are:
• Initial Investment C0=−25,000C_0 = -25,000C0=−25,000
• Year 1 cash inflow C1=7,000C_1 = 7,000C1=7,000
• Year 2 cash inflow C2=11,000C_2 = 11,000C2=11,000
• Year 3 cash inflow C3=13,000C_3 = 13,000C3=13,000
• Year 4 cash inflow C4=10,000C_4 = 10,000C4=10,000
Now, calculate the NPV:
NPVR=−25000+(7000×0.893)+(11000×0.797)+(13000×0.712)+(10000×0.636)NPV_R = -
25000 + (7000 \times 0.893) + (11000 \times 0.797) + (13000 \times 0.712) + (10000 \times
0.636)NPVR=−25000+(7000×0.893)+(11000×0.797)+(13000×0.712)+(10000×0.636)
NPVR=−25000+6251+8767+9256+6360NPV_R = -25000 + 6251 + 8767 + 9256 + 6360NPVR
=−25000+6251+8767+9256+6360 NPVR=−25000+26334=1334NPV_R = -25000 + 26334 =
1334NPVR=−25000+26334=1334
So, the NPV of Project R is ₹1,334.
Project S:
The cash flows for Project S are:
• Initial Investment C0=−25,000C_0 = -25,000C0=−25,000
• Year 1 cash inflow C1=10,000C_1 = 10,000C1=10,000
• Year 2 cash inflow C2=10,000C_2 = 10,000C2=10,000
• Year 3 cash inflow C3=10,000C_3 = 10,000C3=10,000
• Year 4 cash inflow C4=10,000C_4 = 10,000C4=10,000
Now, calculate the NPV:
NPVS=−25000+(10000×0.893)+(10000×0.797)+(10000×0.712)+(10000×0.636)NPV_S = -
25000 + (10000 \times 0.893) + (10000 \times 0.797) + (10000 \times 0.712) + (10000 \times
0.636)NPVS=−25000+(10000×0.893)+(10000×0.797)+(10000×0.712)+(10000×0.636)
NPVS=−25000+8930+7970+7120+6360NPV_S = -25000 + 8930 + 7970 + 7120 + 6360NPVS
=−25000+8930+7970+7120+6360 NPVS=−25000+30380=5380NPV_S = -25000 + 30380 =
5380NPVS=−25000+30380=5380
So, the NPV of Project S is ₹5,380.

Comparison and Recommendation:

• NPV of Project Q: ₹7,475
• NPV of Project R: ₹1,334
• NPV of Project S: ₹5,380
The NPV of Project Q is the highest at ₹7,475. According to the NPV method, the project with
the highest NPV is the most profitable and should be recommended.
Conclusion:
Project Q should be recommended, as it has the highest NPV among the three projects.

5. Explain in detail the theory of the MM approach to capital structure in the presence of taxes
and absence of taxes?
Answer : The Modigliani-Miller (MM) approach to capital structure, developed by Franco
Modigliani and Merton Miller in the 1950s, is a foundational theory in corporate finance that
suggests how a company's capital structure (the mix of debt and equity) affects its overall value.
The MM approach has two key propositions: one in the absence of taxes and one in the
presence of taxes.
1. MM Approach in the Absence of Taxes (1958):
In the absence of taxes, Modigliani and Miller argue that the capital structure of a company does
not affect its overall value. They put forward the irrelevance theorem, which states that a firm's
value is determined by its earning power and the risk of its underlying assets, and is not
influenced by how it is financed (whether with debt or equity).
Key Assumptions in the Absence of Taxes:
1. Perfect Capital Markets: No transaction costs, no taxes, and investors can borrow or
lend at the same rate as the company.
2. Homogeneous Expectations: All investors have the same expectations regarding future
cash flows and risk of the firm.
3. No bankruptcy costs: There are no costs associated with financial distress.
4. No agency costs: There are no conflicts of interest between managers and shareholders.
MM Proposition I (Capital Structure Irrelevance):
• The total value of a company is unaffected by its capital structure.
• The value of a leveraged firm (a company that uses debt) is the same as that of an
unleveraged firm (a company that uses only equity).
Mathematically:
VL=VUV_L = V_UVL=VU
Where:
• VLV_LVL = Value of the leveraged firm (firm with debt)
• VUV_UVU = Value of the unleveraged firm (firm with no debt)
In other words, whether a company is financed entirely by equity or has a mix of debt and equity,
its total value remains unchanged. This result occurs because the gain from using debt (the
interest tax shield) is offset by the increased risk to equity holders.
MM Proposition II (Cost of Equity and Capital Structure):
• The cost of equity increases as the firm takes on more debt.
• While debt financing is cheaper than equity (because debt is tax-deductible), the
increased risk to equity holders raises the required return on equity.
Mathematically:
Re=Ru+(Ru−Rd)×DERe = Ru + (Ru - Rd) \times \frac{D}{E}Re=Ru+(Ru−Rd)×ED
Where:
• ReReRe = Cost of equity for the leveraged firm
• RuRuRu = Cost of equity for the unleveraged firm (i.e., the cost of equity if the firm has
no debt)
• RdRdRd = Cost of debt
• DDD = Total debt
• EEE = Total equity
Thus, as the firm increases its debt, the cost of equity rises in proportion to the amount of debt.
The overall weighted average cost of capital (WACC) remains constant.
2. MM Approach in the Presence of Taxes (1963):
In their later work, Modigliani and Miller recognized that taxes do exist, and interest payments
on debt are tax-deductible. This leads to a tax shield that reduces the firm's overall tax liability,
making debt financing more attractive than equity financing.
Key Assumptions in the Presence of Taxes:
1. Corporate Taxes: Companies face taxes on their income.
2. Debt Interest Tax Shield: Interest payments on debt are tax-deductible, which reduces
the overall tax burden of the company.
3. Other assumptions (e.g., perfect capital markets, no bankruptcy costs) remain the same.
MM Proposition I with Taxes (Value of Leveraged Firm):
• In the presence of taxes, the value of a leveraged firm increases due to the tax shield on
debt. The more debt a company uses, the more tax savings it gets, increasing its value.
Mathematically:
VL=VU+(Tc×D)V_L = V_U + (Tc \times D)VL=VU+(Tc×D)
Where:
• VLV_LVL = Value of the leveraged firm (with debt)
• VUV_UVU = Value of the unleveraged firm (without debt)
• TcTcTc = Corporate tax rate
• DDD = Amount of debt
This means the value of the leveraged firm is equal to the value of the unleveraged firm plus the
tax shield benefits. The tax shield is the reduction in taxes due to the deductibility of interest
payments on debt.
MM Proposition II with Taxes (Cost of Equity and Capital Structure):
• In the presence of taxes, the cost of equity increases with leverage, but not by as much as
in the absence of taxes. This is because the firm benefits from the tax shield, which
reduces the overall cost of capital.
• The cost of equity for a leveraged firm is still higher than that for an unleveraged firm,
but the overall WACC decreases with more debt because the tax shield makes debt
cheaper.
Mathematically:
Re=Ru+(Ru−Rd)×DE×(1−Tc)Re = Ru + (Ru - Rd) \times \frac{D}{E} \times (1 -
Tc)Re=Ru+(Ru−Rd)×ED×(1−Tc)
Where:
• ReReRe = Cost of equity for the leveraged firm
• RuRuRu = Cost of equity for the unleveraged firm
• RdRdRd = Cost of debt
• DDD = Total debt
• EEE = Total equity
• TcTcTc = Corporate tax rate
The more debt a firm uses, the lower its WACC, but there is a limit. As the firm becomes highly
leveraged, the risk of financial distress increases, and the tax shield benefit might be
overshadowed by bankruptcy costs.
Summary of MM Approach with and without Taxes:

Feature Without Taxes With Taxes

Capital structure does not affect

Firm Value Value increases with more debt due to tax shield
firm value

Cost of
Does not affect cost of capital Debt is cheaper due to tax deductibility
Debt

Cost of Increases with leverage, but not as much due to

Increases as debt increases
Equity tax shield

Remains constant regardless of Decreases as more debt is used (until financial

WACC
leverage distress risks arise)

Conclusion:
 • Without taxes, Modigliani and Miller's theory suggests that capital structure does not
affect the firm's value or cost of capital.
• With taxes, the presence of a tax shield makes debt financing attractive, and using more
debt increases the firm's value due to tax savings on interest payments. However, as the
firm becomes more leveraged, the risk of bankruptcy and other costs associated with high
leverage must also be considered.
In practice, firms use a balance of debt and equity financing, factoring in tax benefits, the risk of
financial distress, and the costs of issuing new securities.

6. Efficient cash management will aim at maximizing the cash inflows and slowing cash
outflows. Discuss the statement in light of effective cash planning opted by the organizations ?
Answer : The statement that "efficient cash management will aim at maximizing the cash inflows
and slowing cash outflows" reflects a key objective of cash management strategies adopted by
organizations. Cash management plays a crucial role in ensuring that an organization has enough
liquidity to meet its short-term obligations while optimizing its financial resources for growth
and investment. Let’s break down how organizations achieve this through effective cash
planning:
1. Maximizing Cash Inflows:
Organizations aim to increase their cash inflows by adopting several strategies that improve
revenue generation and the timing of cash collections. Some key practices include:
• Optimizing Receivables Collection:
o Faster Collections: By setting clear credit terms and offering discounts for early
payments, organizations can accelerate cash inflows from customers. For
example, a company might offer a 2% discount if payment is made within 10
days.
o Effective Credit Policies: Companies may evaluate the creditworthiness of
customers carefully to minimize bad debts and ensure quicker payments.
Implementing stricter credit controls reduces the risk of delayed payments.
o Electronic Payments: Encouraging customers to make payments via electronic
methods such as bank transfers or credit cards can speed up collections, as
opposed to waiting for checks or cash.
• Enhancing Sales Revenue:
o Product or Service Innovation: By continuously improving and innovating
products or services, companies can attract more customers and increase sales,
which directly boosts cash inflows.
 o Sales Forecasting: Accurate sales forecasting helps organizations plan for
expected revenues, ensuring they can align cash flows with business needs.
• Reducing Refunds and Returns:
o Reducing product returns and refunds ensures that more of the revenue generated
stays with the company and does not go out as a cash outflow. This can be
achieved through quality control, customer satisfaction, and providing good after-
sales services.
• Investments and Assets:
o Organizations may also maximize inflows by efficiently managing their
investments. This could include earning interest on idle cash or liquidating non-
performing assets.
2. Slowing Cash Outflows:
On the other hand, effective cash management involves controlling and delaying cash outflows
without jeopardizing the company’s relationships with suppliers, employees, or creditors. Some
techniques for slowing cash outflows include:
• Negotiating Longer Payment Terms:
o Supplier Agreements: By negotiating longer payment terms with suppliers,
companies can delay cash outflows while still maintaining good relationships. For
instance, extending payment terms from 30 days to 60 or 90 days allows the
company more time to use its available cash before it needs to pay.
o Staggering Payments: For organizations with multiple suppliers, staggering the
payment schedules can help to manage cash flows more efficiently and avoid a
cash shortage.
• Control Over Operating Expenses:
o Cost-Cutting Measures: Monitoring and controlling costs such as utilities, office
supplies, and labor can help reduce outflows. For instance, renegotiating contracts
with service providers for better rates or optimizing the use of resources (like
energy savings) can lower operating expenses.
o Deferring Non-Essential Expenditures: By deferring non-essential expenditures
or capital projects to later periods, companies can preserve cash for more critical
needs.
• Optimizing Inventory Management:
o Just-in-Time (JIT) Inventory System: By adopting JIT inventory management,
companies can minimize cash tied up in inventory. This reduces storage costs and
the amount of cash tied up in unsold goods. Keeping inventory levels optimized
ensures that companies don’t over-purchase, leading to unnecessary outflows.
 • Effective Payroll Management:
o While payroll is a regular cash outflow, organizations can still manage the timing
of payments by paying salaries on a periodic basis, avoiding unnecessary bonuses
or perks when cash is low, and closely monitoring payroll expenses.
• Delaying Capital Expenditures:
o For larger expenditures, such as buying new machinery or upgrading technology,
companies can delay these capital expenditures during times when they are
focusing on conserving cash. This helps avoid large outflows when cash is needed
elsewhere.
3. Effective Cash Planning and Forecasting:
• Cash Flow Forecasting:
o Short-term and Long-term Forecasting: One of the main pillars of efficient
cash management is accurate cash flow forecasting. By predicting both cash
inflows and outflows over a short-term (monthly/weekly) and long-term
(quarterly/yearly) horizon, companies can anticipate any liquidity issues in
advance and take corrective actions.
o Scenario Analysis: Organizations can use scenario analysis to estimate cash
flows under different conditions (such as increased sales, supply chain
disruptions, or economic downturns). This helps prepare the company for various
situations that could impact cash flow.
• Cash Management Tools:
o Cash Budgeting: Organizations often prepare a detailed cash budget to estimate
how much cash they need at different points in time. By carefully planning for the
cash requirements of the business, they can avoid both cash surpluses and
shortages.
o Cash Flow Management Systems: Organizations may also invest in cash
management software that helps track real-time cash positions, schedule
payments, and forecast future cash needs more accurately.
Conclusion:
Efficient cash management aims at both maximizing cash inflows and slowing cash outflows to
ensure that the organization can maintain enough liquidity to meet its obligations and take
advantage of growth opportunities. It involves a balance of careful planning, strategic decision-
making, and operational efficiency. Organizations achieve this by managing receivables,
inventory, and expenses effectively while negotiating favorable terms with suppliers and
ensuring that cash flows are continuously monitored and forecasted.
By optimizing these areas, businesses can enhance their financial stability, reduce reliance on
external financing, and position themselves for long-term success.