NATINAL AVIATION COLLEGE

Financial management Final Examination

Name Solomon Abera ID GBLR/049/12 SECTION Regular

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PartI:Discussionall Questionsbelow

1. You as a (future) business administrator, how do you explain the value of finance
knowledge in managing your organization?
The value of finance knowledge in managing his organization is he have done properly
1. Raising of Funds: In order to meet the obligation of the institutions it is important to have enough
cash and liquidity. A firm can raise funds by the way of equity and debt It is the responsibility of a
financial manager to decide the ratio between debt and equity. It is important to maintain a good
balance between equity and debt.
2. Allocation of Funds: Once the funds are raised through different channels the next important function
is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In
order to allocate funds in the best possible manner the it is to be considered that the size of the firm and
its growth capability, Status of assets whether they are long term or short term and Mode by which the
funds are raised. These financial decisions directly and indirectly influence other managerial activities.
Hence formation of a good asset mix and proper allocation of funds is one of the most important
activities.
3. Forecasting Financial Requirements: It is the primary function of the Finance Manager. Be
responsible to estimate the financial requirement of the concern. He should estimate, how much
finances required to acquire fixed assets and forecast the amount needed to meet the working capital
requirements in future.
4. Acquiring Necessary Capital: After deciding the financial requirement, the finance manager should
concentrate how the finance is mobilized and where it will be available. It is also highly critical in
nature.
5. Investment Decision: The finance manager must carefully select best investment alternatives and
consider the reasonable and stable return from the investment. He must be well versed in the field of
capital budgeting techniques to determine the effective utilization of investment. The finance manager
must concentrate to principles of safety, liquidity and profitability while investing capital.
6. Cash Management: Present days cash management plays a major role in the area of finance because
proper cash management is not only essential for effective utilization of cash but it also helps to meet
the short-term liquidity position of the concern.
7. Interrelation with Other Departments: Finance manager deals with various functional departments
such as marketing, production, personnel, system, research, development, etc. Finance manager should
have sound knowledge not only in finance related area but also well versed in other areas. He must
maintain a good relationship with all the functional departments of the business organization. The
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 financial manager performs important activities in connection with each of the general functions of the
management. He groups activities in such a way that areas of responsibility and accountability are
cleared defined. The profit centre is a technique by which activities are decentralized for the
development of strategic control points.® The determination of the nature and extent of staffing is aided
by financial budget programme. Direction is based, to a considerable extent, on instruments of financial
reporting. Planning involves heavy reliance on financial tools and analysis. Control requires the use of
the techniques of financial ratios and standards. Briefly, an informed and enlightened use of financial
information is necessary for the purpose of coordinating the activities of an enterprise. Every business,
irrespective of its size, should, therefore, have a financial manager who has to take key decisions on the
allocation and use of money by various departments. Specifically the financial manager should
anticipate financial needs; acquire financial resources; and allocate funds to various departments of the
business. If the financial manager handles each of these tasks well, Ms firm is on the road to good
financial health.
Define finance
Finance is the life blood of business. It is required by all types of institutions. It is required for starting, it is
required for running, it is required for the survival, stability and growth of an institutions. It is required for
expansion and diversification of a business. An institution cannot survive without finance. It requires
promotional finance to start the activities. It requires long-term finance to purchase fixed assets. It requires
development finance for growth, expansion and diversification of business.
Finance is the management of money and includes activities such as investing , borrowing, lending,
budgeting, saving, and forecasting. On the other hand Finance is describes activities associated with banking,
leverage or debt, credit, capital markets, money, and investments. Basically, finance represents money
management and the process of acquiring needed funds. Finance also encompasses the oversight, creation,
and study of money, banking, credit, investments, assets, and liabilities that make up financial systems
, Discus major areas of finance,
There are three major area of finance
This are 1. Corporate finance, 2. Investments, and 3. Financial markets and institutions
1. Corporate finance has three main areas of concern:
A. Capital Budgeting: What long-term investments should the firm take?

B. Capital structure: Where will the firm get the long-term financing to pay for its investments? Also, what
mixture of debt and equity should it used to fund operations?

C. Working capital management: How should the firm manage its everyday financial activities?

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2. Investments An investment is an asset or item acquired with the goal of generating income or
appreciation. Appreciation refers to an increase in the value of an asset over time. When an individual
purchases a good as an investment, the intent is not to consume the good but rather to use it in the future
to create wealth. An investment always concerns the outlay of some asset today time, money, or effort in
hopes of a greater payoff in the future than what was originally put in.
The Objectives of Investment is
 To Keep Money Safe. Capital preservation is one of the primary reasons people invest their money
 To Help Money Grow
 To Earn a Steady Stream of Income
 To Minimize the Burden of Tax
 To Save up for Retirement.
 To Meet the Financial Goals
3. Financial markets and institutions are component of the financial systeme
A financial system refers to a system which enables the transfer of money between investors and borrowers.
A financial system could be defined at an international, regional or organizational level. The term “system”
in the Financial Syste indicates a group of complex and closely linked institutions, agents, procedures,
markets, transactions, claims and liabilities within an economy. There are five components of Financial
System which is discussed below:
1. Financial Institutions: It ensures smooth working of the financial system by making investors and
borrowers meet. They mobilize the savings of investors either directly or indirectly via financial markets
by making use of different financial instruments as well as in the process using the services of numerous
financial services providers. They could be categorized into Regulatory, Intermediaries, Non-
intermediaries and Others. They offer services to organizations looking for advises on different problems
including restructuring to diversification strategies. They offer complete series of services to the
organizations who want to raise funds from the markets and take care of financial assets, for example
deposits, securities, loans, etc.
2. Financial Markets: A Financial Market can be defined as the market in which financial assets are
created or transferred. As against a real transaction that involves exchange of money for real goods or
services, a financial transaction involves creation or transfer of a financial asset. Financial Assets or
Financial Instruments represent a claim to the payment of a sum of money sometime in the future and /or
periodic payment in the form of interest or dividend.
There are components of financial market are
1. Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term
instrument. Funds are available in this market for periods ranging from a single day up to a year. This
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 market is dominated mostly by government, banks and financial institutions.
2. Capital Market - The capital market is designed to finance the long-term investments. The transactions
taking place in this market will be for periods over a year.
3. Forex Market - The Forex market deals with the multicurrency requirements, which are met by the
exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes
place in this market. This is one of the most developed and integrated market across the globe.Credit
Market- Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to
corporate and individuals.

Financial decisions,
Types of financial Decision
a. Capital budgeting
b. Capital stricture or financing
c. Dividend
d. Working capital management
There are four main financial decisions capital Budgeting or Long term Investment decision which application
of funds, Capital Structure or Financing decision that also Procurement of funds, Dividend decision which
distribution of funds and Working Capital Management Decision in order to accomplish goal of the firm to
maximize shareholder’s or owner’s wealth.

Explain how knowledge of finance in general

The knowledge of Finance is knowing of associated with banking, leverage or debt, credit, capital
markets, money, and investments. So it helps to to operate or knowledge of creation, and study of money,
banking, credit, investments, assets, and liabilities that make the over all of financial systems.
Financial management in particular,
Financial Management is a vital activity in any organization. It is the process of planning, organizing,
controlling and monitoring financial resources with a view to achieve organizational goals and objectives
of the organization. It helps that to analysis for giving of finance related decisions .
The financial management the discharging basic management functions are
1. Financial Planning: Financial management helps to determine the financial requirement of the
business concern and leads to take financial planning of the concern. Financial planning is an important
part of the business concern
example :- helps to promotion of an enterprise products .

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 2. Acquisition of Funds: Financial management involves the acquisition of required finance to the
business concern. Acquiring needed funds play a major part of the financial management,
Example it apply in involve possible source of finance at minimum cost.
3. Proper Use of Funds: Proper use and allocation of fund leads to improve the operational efficiency of
the business concern. When the finance manager uses the funds properly, they can reduce the cost of
capital and increase the value of the firm.
4. Financial Decision: Financial management helps to take sound financial decision in the business
concern. Financial decision will affect the entire business operation of the concern. Because there is a
direct relationship with various department functions.
5. Increase the Value: Financial management is very important in the field of increasing the wealth of the
investors and the business concern. Ultimate aim of any business concern will achieve the maximum
profit and higher profitability leads to maximize the wealth of the investors as well as the nation.
2. What is the goal of financial management?
The goal of financial management is
a) Maximize profit
b) Minimize costs
c) Maximize market share
d) Maximize the current value of the company’s stock

Argumentative essay on profit maximization and wealth maximization as a goal .

The firm always to have the long and short term plane that plan specialy the long term plane clearly to state
the goal of the firms A firm with no set goals or one that doesn’t have good managers is set to fail in its bid to
make profit and hence employees and share holders . the clear goal and plan to have copatative advantage of
the firm. The goal of all firms are to maximize market share and business expunction to by prodact expancion
and market area expansions . The last achievement of the managers and employees to be success by profit
maximizations. And business concern is also functioning mainly for earning profit. Profit is the measuring
techniques to understand the business efficiency of the company.

Lastly Shareholder wealth maximization is the best choice for the main goal of a business because the effects
of all financial decisions are included in these decisions. The primary goal of the firm is to maximize
shareholder wealth.

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The firm to achieve its objectives firs to have

 Financial plan and budget to finance the projects

 The quality of management team

 The firm operates system satisfy and motivated employees

 Business supporting Government policy

 Low Risks that the firm faces.

Evry firm on the strategic or yearly planning time to do SWOT analysis that to help evaluating of strangthin
weaknes oprtunity of the business and treat. So that after doing the SWOT analysis to be plan the target of
market for to do business. On the business we have to consider or as opportunity to be guidelines the ten
principles that form the foundation of financial management

1. Risk-Return tradeoff

2. Time value of money

3. Cash is King not only profits which is liquidity

4. Incremental Cash Flows,

5. The curse of competitive markets,

6. Efficient capital markets

7. The agency problem,

8. Taxes bias business decisions

9. All risk is not equal, and

10. Ethical behavior.

The firm receives cash flows and is able to reinvest them rather than accounting profits. In effect, accounting
profits are shown when they are earned rather than when the money is actually in hand. Unfortunately, a firm's
accounting profits and cash flows may not be timed to occur together. For example, capital expenses, such as
the purchase of a new plant or piece of equipment, are depreciated over several years, with the annual
depreciation subtracted from profits. However, the cash flow associated with these expenses generally occurs
immediately. It is the cash inflows that can be reinvested and cash outflows that involve paying out money.
Therefore, cash flows correctly reflect the true timing of the benefits and costs.

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.In an efficient market, information is impounded into security prices with such speed that there are no
opportunities for investors to profit from publicly available information. Actually, what types of information
are immediately reflected in security prices and how quickly that information is reflected determine how
efficient the market actually is. The implications for us are, first, that stock prices reflect all publicly available
information regarding the value of the company. This means we can implement our goal of maximization of
shareholder wealth by focusing on the effect each decision should have on the stock price all else held constant.
It also means that earnings manipulations through accounting changes should not result in price changes. In
effect our preoccupation with cash flows is validated.
All of these principles are important in the grand scheme of things. Whether a market is efficient has to do with
the speed with which information is impounded into security prices. Investors adjust to new information in
immediately buying or selling security until they feel the market price correctly reflects the information. The
goal of the firm is the maximization of shareholder wealth. Stock prices reflect publicly available information
that has to do with the value of the company. This means companies can focus on the effect that each decision
should have on stock prices if things are held constant. In the long run good decisions result in higher stock
prices

There will be agency problems in achieving a goal

The agency problem is the result of the separation of management and the ownership of the firm. As a result
managers may make decisions that are not in line with the goal of maximization of shareholder wealth.
The Agency problems are
2. Focus on short-time performance at the expense of Long-time growth
3. Horizon Problem: remuneration intrinsically linked to short-time goal
4. Differences in attitudes towards risk
1. Excessive remuneration or unjustified
5. Deteriorate controlling power of directors
6. Conflict between controlling and minority shareholders
Define agency relationship, agency problem and
In simple words, Agency problem is the relationship of potential conflict between shareholders and Management of a
company. It has long been known that in the large companies, the interest of managers may be different from the
Interest of the shareholders profit maximization. In such these companies, shareholders appoint the managers who will
be worked on behalf of their interest. And managers act as the agent for the shareholders and is supposed to make
decisions that will maximize shareholder wealth though their best interest to maximize his own wealth. And at this point
of time, Agency problem is occurred. Or, more specifically, the agency problem is a disagreement of interest inherent in
any relationship where one party is expected to act in another's best interests
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 The Ways to minimize agency problems.
To control this problem we monitor managers and try to align the interests of shareholders and managers. The
interests of shareholders and managers can be aligned by setting up stock options, bonuses, and perquisites
that are directly tied to how closely management decisions coincide with the interest of shareholders.
To solve and to control this problem certain measures can be taken likewise
1. Monitoring by board of Directors
2. Compensation Package
3. Monitoring by outside Bondholders
4. Efficient outside managerial labor market
5. Active outside takeover market
6. By threat of firing & Takeovers
7. Audited Financial statements
8. Promotion Tournament & career paths
9. Reinforce and Develop a Code of ethics
10.Stewardship theory
To minimize the agency problem regulators have been recognizing this problem and trying to safeguard listed
companies by requiring them to comply with numerous regulations designed to promote the independence of the board
of directors. However, such compliance with regulations is not sufficient to ensure that directors would act in the best
interests of the company and its.
3. Define capital structure
Capital structure is the mix of securities and financing sources used to finance real investment A firms
management, to improve firm value is always searching for positive NPV projects, but to implement the project
is necessary to have liquidity, and this could be a problem too.
Modigliani and Miller Theories
Modigliani and Miller theories of capital structure (also called MM or M&M theories) say that (a) when there
are no taxes, (i) a company’s value is not affected by its capital structure and (ii) its cost of equity increases
linearly as a function of its debt to equity ratio but when (b) there are taxes, (i) the value of a levered company
is always higher than an unlevered company and (ii) cost of equity increases as a function of debt to equity
ratio and tax rate. Modigliani and Miller’s (M&M) theories about capital structure offer a good starting point in
a company’s quest for optimal capital structure. This is even though they require certain unrealistic
assumptions such as: (a) existence of a totally efficient market with no transaction costs, (b) no financial
distress and agency costs, (b) ability to borrow and lend at the risk-free rate, etc. M&M theories offer two
propositions in two environments: (a) without tax and (b) with tax.

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Trade-off Theory

The trade-off theory of capital structure is the idea that a company chooses how much debt finance and how
much equity finance to use by balancing the costs and benefits. The classical version of the hypothesis goes
back to Kraus and Litzenbergernsidered a balance between the dead-weight costs of bankruptcy and the tax
saving benefits of debt. Often agency costs are also included in the balance. This theory is often set up as a
competitor theory to the pecking order theory of capital structure. A review of the literature is provided by
Frank and Goyal.

An important purpose of the theory is to explain the fact that corporations usually are financed partly
with debt and partly with equity. It states that there is an advantage to financing with debt, the tax benefits of
debt and there is a cost of financing with debt, the costs of financial distress including bankruptcy costs of
debt and non-bankruptcy costs (e.g. staff leaving, suppliers demanding disadvantageous payment terms,
bondholder/stockholder infighting, etc.). The marginal benefit of further increases in debt declines as debt
increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this
trade-off when choosing how much debt and equity to use for financing.

Pecking Order Theory

The pecking order theory states that a company should prefer to finance itself first internally through retained
earnings. If this source of financing is unavailable, a company should then finance itself through debt. Finally,
and as a last resort, a company should finance itself through the issuing of new equity.

This pecking order is important because it signals to the public how the company is performing. If a company
finances itself internally, that means it is strong. If a company finances itself through debt, it is a signal that
management is confident the company can meet its monthly obligations. If a company finances itself through
issuing new stock, it is normally a negative signal, as the company thinks its stock is overvalued and it seeks to
make money prior to its share price falling.

Which one do you think is appropriate in the Ethiopian context?

Because our finance is so small so olly to follew the Animportant trad theory purpose of the theory is to
explain the fact that corporations usually are financed partly with debt and partly with equity. It states that there
is an advantage to financing with debt, the tax benefits of debt and there is a cost of financing with debt, the
costs of financial distress including bankruptcy costs of debt and non-bankruptcy costs (e.g. staff leaving,
suppliers demanding disadvantageous payment terms, bondholder/stockholder infighting, etc.). The marginal
benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm
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that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use
for financing.

4. Explain Dividend theories (Birds in the hand, Tax preference) and write an argumentative
essay whether Bird in the hand or Tax preference theory is practical in your view.
Dividends and share price growth are the two ways in which wealth can be provided to shareholders. There is
an interaction between dividends and share price growth: if all earnings are paid out as dividends, none can be
reinvested to create growth, so all profitable companies have to decide on what fraction of earnings they
should pay out to investors as dividends and what fraction of earnings should be retained.
Dividend policy theories are propositions put in place to explain the rationale and major arguments relating to
payment of dividends by company. The firms are often torn in between paying dividends or reinvesting their
profits on the new or existing business. Dividends are periodic payments to holders of equity which together
with capital gains are the returns for investing in a firm's stock. The prospect of earning periodic dividends and
sustained capital appreciation are therefore the main drivers of investors' decisions to invest in equity. At the
heart of the dividend policy theories discussion are two opposing Ideas of thought are there : One side holds
that whether firms pay dividends or not is irrelevant in determining the stock price and hence the market value
of the firm and ultimately its weighted cost of capital. In retrospect, the opposing side holds that firms which
pay periodic dividends eventually tend to have higher stock prices, market values and cheaper WACCs. The
existence of these two opposing sides has spawned vast amounts of empirical and theoretical research.
Scholars on both sides of the divide appear relentless on showcasing the case for their arguments.
this theory argue that proposers of the dividend irrelevance theory made unrealistic assumptions in crafting
their respective theories.

The M&M theorem holds that capital gains and dividends are equivalent as returns in the eyes of the investor.
The value of the firm is therefore dependent on the firm's earnings which result from its investment policy and
the lucrativeness of its industry. When a firm's investment policy is known (its industry is public information),
investors will need only this information to make an investment decision.
The theory further explains that investors can indeed create their own cash inflows from their stocks according
to their cash needs regardless of whether the stocks they own pay dividends or not. If an investor in a dividend
paying stock doesn't have a current use of the money availed by a particular stock's dividend, he will simply
reinvest it in the stock.

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The Gordon / Lintner (Bird-in-the-Hand) Theory. The bird-in-the-hand theory, hypothesized independently by
Gordon (1963) and by Lintner (1962) states that dividends are relevant to determining of the value of the firm.
In a popular common stock valuation model developed by Gordon, The determinants of the value of a firm's
cost of equity financing are the dividends the firm is expected to pay to perpetuity the expected annual growth
rate of dividends and the firm's current stock price. Where: k is the return on equity to equity investors
d1 is the forward looking yearend dividend payout p is the current stock price of the firm's stock g is the
expected future annual growth rate of the firm's dividend The dividend yield and the future growth of the
dividends provide the total return to the equity investor. This model insists that dividend yield is a more
important measure of the total return to the equity investor than the future growth rate of the dividends (which
is the rate at which the net earnings and the capital gains of the firm will grow at in the future). Future growth,
and hence capital gains cannot be estimated with accuracy and are not guaranteed at all as firms might lose
even their entire market value in the stock exchange and go bankrupt.
If firm does not pay dividends therefore, its forward looking market value is severely affected by the
uncertainty surrounding the possibility of the investors' ever booking the capital gains.
Assumptions of the Bird-in-the-Hand theory . This theory is based on a number of assumptions, as enumerate
below. This happens then the returns of the firm is equal to the earnings of the shareholders if the dividends
were paid. Thus, it's clear that if r, is more than the cost of capital ke, then the returns from investments is more
than returns shareholders receive from further investments.
Walter's model says that if r<ke then the firm should distribute the profits in the form of dividends to give the
shareholders higher returns. However, if r>ke then the investment opportunities reap better returns for the firm
and thus, the firm should invest the retained earnings. The relationship between r and ke are extremely
important to determine the dividend policy. The M&M assumption of a perfect capital market excludes any
possible tax effect. It has been assumed by Modigliani and Miller that there is no difference in tax treatment
between dividends and capital gains. However, in the real world taxes exist and may have significant influence
on dividend policy and the value of the firm. In general, there is often a differential in tax treatment between
dividends and capital gains, and, because most investors are interested in after tax return, the influence of taxes
might affect their demand for dividends. the tax-preference hypothesis suggests that low dividend payout ratios
lower the cost of capital and increase the stock price. By extension, low dividend payout ratios contribute to
maximizing the firm's value. This argument is based on the assumption that dividends are taxed at higher rates
than capital gains. In addition, dividends are taxed immediately, while taxes on capital gains are deferred until
the stock is actually sold. These tax advantages of capital gains over dividends tend to predispose investors,
who have favorable tax treatment on capital gains, to prefer companies that retain most of their earnings rather
than pay them out as dividends, and are willing to pay a premium for low-payout companies.
Another important tax consideration is that in an estate situation; where an heir is entitled to shares after the
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death of a benefactor, no capital gains taxes will be due from the heir in such a situation. The Signaling
Hypothesis. Another hypothesis for why M&M's dividend Irrelevance theory is inadequate as an explanation of
financial market practice is the existence of asymmetric information between insiders (managers and directors)
and outsiders (shareholders). M&M assumed that managers and outside investors have free, equal and
instantaneous access to the same information regarding a firm's prospects and performance. But managers who
look after the firm usually possess information about its current and future prospects that is not available to
outsiders.This informational gap between insiders and outsiders may cause the true intrinsic value of the firm to
be unavailable to the market. If so, share price may not always be an accurate measure of the firm's value. In an
attempt to close this gap, managers may need to share their knowledge with outsiders so they can more
accurately understand the real value of the firm. Historically, due to a lack of complete and accurate
information available to shareholders, the cash flow provided by a security to an investor often formed the
basis for its market valuation (Baskin and Miranti, 1997). In this way dividends came to provide a useful tool
for managers in which to convey their private information to the market because investors used visible (or
actual) cash flows to equity as a way of valuing a firm. Many scholars also suggest that dividends might have
implicit information about a firm's prospects. Even M&M (1961) suggest that when markets are imperfect
share prices may respond to changes in dividends. In other words, dividend announcements may be seen to
convey implicit information about the firm's future earnings potential. This proposition has since become
known as the 'information content of dividends' or signaling hypothesis. According to the signaling hypothesis,
investors can infer information about a firm's future earnings through the signal coming from dividend
announcements, both in terms of the stability of, and changes in, dividends. However, for this hypothesis to
hold, managers should firstly possess private information about a firm's prospects, and have incentives to
convey this information to the market. Secondly, a signal should be true; that is, a firm with poor future
prospects should not be able to mimic and send false signals to the market by increasing dividend payments.

Thus the market must be able to rely on the signal to differentiate among firms. If these conditions are fulfilled,
the market should react favorably to the announcements of dividend increase and unfavorably otherwise (Ang,
1987, and Koch and Shenoy, 1999).

As managers are likely to have more information about the firm's future prospects than outside investors, they
may be able to use changes in dividends as a vehicle to communicate information to the financial market about
a firm's future earnings and growth. Outside investors may perceive dividend announcements as a reflection of
the managers' assessment of a firm's performance and prospects. An increase in dividend payout may be
interpreted as the firm having good future profitability (good news), and therefore its share price will react
positively. Similarly, dividend cuts may be considered as a signal that the firm has poor future prospects (bad
news), and the share price may then react unfavorably. Accordingly, it would not be surprising to find that
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managers are reluctant to announce a reduction in dividends.
Lintner (1956) argued that firms tend to increase dividends when managers believe that earnings have
permanently increased. This suggests that dividend increases imply long-run sustainable earnings. Lipson,
Maquieira and Megginson (1998) also observed that, 'managers do not initiate dividends until they believe
those dividends can be sustained by future earnings'.

Due to its logic and more favorable empirical support, I favor the dividend relevance theory. This hypothesis
has more realistic assumptions that the M&M hypothesis and therefore is more probable to be tenable in a
realistic world. The assumption that shareholders tend to be indifferent to current dividends or prospective
future capital gains cannot go unchallenged. Inasmuch as we assume businesses are going concerns, a
probability of bankruptcy, loss of market value or financial distress cannot be ruled out for any particular firm
in the future.

This means that which do not pay dividends might actually end up paying nothing to their shareholders. This
uncertainty should not be compared with the return on investment actualized by a periodic dividend. The
subsidiary theories supporting the dividend relevance hypothesis are all based on observed phenomena across
different domains. Hence it's likely that indeed in the real world, dividends policy is relevant in determining the
value of a firm's stock and by extension its market value

Dividends and dividend policy will be a continuing cause of debate and comment. The theoretical position is
clear: provided retained earnings are reinvested at the cost of equity, or higher, shareholder wealth is increased
by cutting dividends. However, in the real world, where not necessarily all investors are logical and where
transaction costs and other market imperfections intervene, determining a successful and popular dividend
policy is rather more difficult.

PartII:Workout

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 Capital budgeting decisions
AA Company is considering a new product line to supplement its range line. It is anticipated
that the new product line will involve a cash investment of ETB 3,000,000 at time
zero(initial) and ETB 2,000,000 in year 1, ETB500,000 in year 2, ETB 600,000 in year 3,
ETB 800,000 in year 4.
Calculate the payback period
TIME OR ANNUAL CASH COMULATIVE
YEAR FLOWES CASH FLOW
0 (3000000) (3000000)
1 2000000 1000000
2 500000 500000
3 600000 500000
4
PBP= 2+ 500000 = 2.8333 YEARE
600000

THE payback period is shorter than the plan so acceptable

a) If the required rate of return is 10%, what is the net present value (NPV) of the
project? Is it acceptable? Why?

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 b) What is its internal rate of return (IRR)?Is it acceptable? Why?

Calculate the payback period

TIME OR ANNUAL CASH COMULATIVE
YEAR FLOWES CASH FLOW
0 (3000000) (3000000)
1 2000000 1000000
2 500000 500000
3 600000 500000
4 NPV=0 IRR= 14.362%

The IRR=14.362 and the r =10% so the IRR > r

Which mean by that the 14.362% > 10%

I conclude that the project is acceptable If IR greater than the cost of capital r , accept the project
that is whey GREAT from the initial capital

c) What would be the case if the required rate of return is 5%? (calculate NPV) and comment on it)

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The end
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