Financial management 2nd Assignment

1.Briefly Explain the Concept of Financial Management?

Ans:Financial management refers to the strategic planning, organizing, directing, and controlling
of financial activities within an organization. It involves managing the company's financial
resources to achieve its goals and objectives effectively. The key aspects of financial
management include:

1. Investment Decisions: Determining where to allocate funds for the best returns, which
involves evaluating potential investment opportunities and assessing risks.

2. Financing Decisions: Deciding how to raise capital, whether through equity, debt, or internal
financing. This includes evaluating the cost of capital and the impact of financing on the
company's financial structure.

3. Dividend Decisions: Determining how much profit should be distributed to shareholders as

dividends and how much should be reinvested in the business for growth.

4. Working Capital Management: Managing the company's short-term assets and liabilities to
ensure it has sufficient liquidity to meet its operational needs.

Overall, financial management aims to maximize the value of the organization for its
stakeholders by making informed financial decisions and effectively managing financial risks.

3.Write a short note on Dividend Policy.

Ans: Dividend policy refers to the strategy a company uses to decide how much it will pay out to
shareholders in dividends versus how much it will retain for reinvestment in the business. It
plays a crucial role in financial management and can significantly impact the company's stock
price and investor perception.

Key considerations in dividend policy include:

1. Types of Dividends: Companies can distribute dividends in various forms, such as cash
dividends, stock dividends, or property dividends. The choice depends on the company’s
financial health and market conditions.

2. Retention Ratio: This is the proportion of earnings that is retained in the company rather than
paid out as dividends. A higher retention ratio indicates that the company is reinvesting more in
growth opportunities, while a lower ratio suggests a focus on returning profits to shareholders.

3. Stability: Many companies aim for a stable dividend policy, where dividends are paid
consistently, even during economic downturns. This stability can attract investors looking for
reliable income.

4. Factors Influencing Dividend Policy: These include the company's profitability, cash flow,
growth prospects, and the overall economic environment. Companies may also consider the
preferences of their shareholders, as some investors prefer dividends for income, while others
might favor reinvestment for capital gains.

In summary, a sound dividend policy balances the need to reward shareholders with the need to
invest in the company's future growth.

2. The following information of ABC Co. Ltd.

Earnings per share – Rs. 9, Internal Rate of Return – 18%, Cost of Capital – 12%, Payout Ratio –
33.33%. Calculate the market price under Walters Model.

Ans:To calculate the market price of ABC Co. Ltd. under Walters Model, we can use the formula:

P = (D / (k - r)) + (E / (k - r))

Where:

- P = Market price of the share

- D = Dividend per share

- k = Cost of capital

- r = Internal rate of return

- E = Earnings per share

First, we need to calculate the dividend per share (D):

Payout Ratio = Dividend per share / Earnings per share

Given the payout ratio is 33.33% (or 1/3) and the earnings per share (E) is Rs. 9:

D = Payout Ratio × Earnings per share

D = (1/3) × 9 = Rs. 3

Now we can substitute the values into the formula.

Given:

- D = Rs. 3

- k = 12% or 0.12

- r = 18% or 0.18

Now, we can calculate the market price (P):

P = (3 / (0.12 - 0.18)) + (9 / (0.12 - 0.18))

Since (0.12 - 0.18) = -0.06, we need to be careful with the calculations:

P = (3 / -0.06) + (9 / -0.06)
Calculating each part:

P = -50 + -150

P = -200

In this case, the result indicates that under Walters Model, the market price would be negative,
which suggests that the assumptions or inputs may not be realistic or applicable for this
particular company. This could imply that the internal rate of return exceeds the cost of capital
significantly, leading to potential concerns about sustainability or market perceptions.

Therefore, based on the calculations, the market price under Walters Model is not feasible in
this scenario.

Section:B

4.Discuss the Functions of Financial Management?

Ans:Financial management plays a crucial role in the overall management of a company. Here
are the key functions of financial management:

1. Financial Planning: This involves estimating the capital requirements of the business and
determining the best sources of funds. Financial planning ensures that the company has
enough funds to meet its operational needs and future growth.

2. Capital Structure Management: Financial management involves deciding the right mix of debt
and equity financing. It is essential to find a balance that minimizes the cost of capital while
maximizing shareholder value.

3. Investment Decisions: Financial managers must evaluate potential investment opportunities

and decide where to allocate resources. This includes assessing the risk and return of different
projects and investments to ensure optimal use of funds.
4. Working Capital Management: This function focuses on managing the company’s short-term
assets and liabilities to ensure liquidity. It involves monitoring cash flow, inventory levels, and
receivables to maintain smooth operations.

5. Financial Control: Financial management includes monitoring and controlling financial

performance through budgeting and variance analysis. This helps in identifying deviations from
planned performance and taking corrective actions.

6. Risk Management: Financial managers must identify, analyze, and mitigate financial risks that
the company may face. This includes market risk, credit risk, and operational risk, among others.

7. Financial Reporting: This function involves preparing financial statements and reports that
provide stakeholders with insights into the company's financial health. Accurate reporting is
essential for transparency and informed decision-making.

8. Dividend Decisions: Financial management involves determining the amount of profit to be

distributed to shareholders as dividends versus reinvesting in the business for growth. This
decision affects the company’s capital structure and shareholder satisfaction.

These functions collectively contribute to the financial health and sustainability of a company,
ensuring that it can achieve its objectives and create value for its stakeholders.

5.Discuss the Forms or Types of Dividend?

Ans:Financial management plays a crucial role in the overall management of a company. Here
are the key functions of financial management:

1. Financial Planning: This involves estimating the capital requirements of the business and
determining the best sources of funds. Financial planning ensures that the company has
enough funds to meet its operational needs and future growth.

2. Capital Structure Management: Financial management involves deciding the right mix of debt
and equity financing. It is essential to find a balance that minimizes the cost of capital while
maximizing shareholder value.

3. Investment Decisions: Financial managers must evaluate potential investment opportunities

and decide where to allocate resources. This includes assessing the risk and return of different
projects and investments to ensure optimal use of funds.

4. Working Capital Management: This function focuses on managing the company’s short-term
assets and liabilities to ensure liquidity. It involves monitoring cash flow, inventory levels, and
receivables to maintain smooth operations.

5. Financial Control: Financial management includes monitoring and controlling financial

performance through budgeting and variance analysis. This helps in identifying deviations from
planned performance and taking corrective actions.

6. Risk Management: Financial managers must identify, analyze, and mitigate financial risks that
the company may face. This includes market risk, credit risk, and operational risk, among others.

7. Financial Reporting: This function involves preparing financial statements and reports that
provide stakeholders with insights into the company's financial health. Accurate reporting is
essential for transparency and informed decision-making.

8. Dividend Decisions: Financial management involves determining the amount of profit to be

distributed to shareholders as dividends versus reinvesting in the business for growth. This
decision affects the company’s capital structure and shareholder satisfaction.

These functions collectively contribute to the financial health and sustainability of a company,
ensuring that it can achieve its objectives and create value for its stakeholders.

Section:C

If Ke – 11%, EPS – 15, Calculate the stock value of Sun Shine Ltd. Using Gordon’s Model.
r – 12%, r – 11% and r – 10%

The various levels of DP Ratios are as follows.

DP Ratios Retention Ratios

10 % 90 %

20 % 80 %

Ans:To calculate the stock value of Sun Shine Ltd. using Gordon's Growth Model (also known as
the Dividend Discount Model), we need to follow these steps:

1. Identify the given values:

- Earnings Per Share (EPS) = 15

- Cost of Equity (Ke) = 11%

- Retention Ratios and Dividend Payout Ratios:

- For a DP Ratio of 10%, the Retention Ratio is 90%.

- For a DP Ratio of 20%, the Retention Ratio is 80%.

2. Calculate the Dividends:

- The Dividend (D) can be calculated using the formula:

D = EPS * DP Ratio

- For a DP Ratio of 10%:

D = 15 * 0.10 = 1.5
 - For a DP Ratio of 20%:

D = 15 * 0.20 = 3.0

3. Calculate the Growth Rate (g):

- The growth rate (g) can be calculated using the formula:

g = EPS * Retention Ratio

- For a DP Ratio of 10% (Retention Ratio = 90%):

g = 15 * 0.90 = 13.5

- For a DP Ratio of 20% (Retention Ratio = 80%):

g = 15 * 0.80 = 12.0

4. Calculate the Stock Value (P):

- The stock value can be calculated using Gordon's Model:

P = D / (Ke - g)

- For a DP Ratio of 10%:

P = 1.5 / (0.11 - 0.135) = 1.5 / (-0.025)

Since the result is negative, it indicates that the growth rate exceeds the cost of equity,
making the model inapplicable in this scenario.

- For a DP Ratio of 20%:

P = 3.0 / (0.11 - 0.12) = 3.0 / (-0.01)

Again, this results in a negative value, indicating the same issue as above.
Since the calculated growth rates are higher than the cost of equity in both scenarios, the
Gordon Growth Model cannot provide a valid stock value. In practical terms, this means that the
expected growth is unsustainable at the given return rates.

Therefore, the stock value cannot be determined using Gordon's Model under these conditions.