FINANCIAL

MANAGEMENT II

SECTION A

1.What are the important decisions in financial Management?

  Investment decisions

Investment choices reveal the overall amount of assets the

company will own. In order to maximize wealth, appropriate
utilization of the restricted amount of finances that include costs
is necessary.

 Financial Decision

The quantity of money that needs to be raised from diverse long-

term sources is what it is most concerned with. In another sense,
it is a choice about the capital structure of the business (owners'
funds versus borrowed funds).
Financial risk is the possibility of missing a payment of interest
on a loaned sum of money.

 Dividend decisions

The distribution of extra funds is the major issue at hand in this

choice. These extra money are either paid out as dividends to the
shareholders or are set aside as retained earnings.
The financial manager will choose how much money should be
set aside and how to spend dividends. Greater money is set aside
and less money is distributed to shareholders if there are more
investment opportunities and expansion plans for the company.
Remaining decision is another name for this choice.

2.What are the goals of financial Management?

 Profit Maximization
 Profitability Maximization
 EPS maximization
 Minimize cost
3. When do you think there will be a conflict between stockholders and
bondholders?
Conflicts may occur if there are no regulations for share transfers or if one party
sells their shares to a third party that the other shareholders find difficult to
work with. However, conflicts can also occur if parties feel unable to leave the
company and imprisoned therein.

4. Explain agency costs and the different costs associated with it?
Agency cost is the cost paid to mediate a quarrel and maintain amicable
relations in a typical company setting including arguments between
shareholders and managers.

SECTION B

5.Name the different capital budgeting techniques. Highlight the advantages and
disadvantages of each of them.
Payback period method
• It is the amount of time required for an investment to generate cash
flows sufficient to recover its initial cost.
• Based on the payback rule an investment is acceptable if its calculated
payback period is less than some prespecified number of years.

Disadvantages
• Ignores time value of money
• Not all cash flows covered
• Not realistic
• Ignores profitability
 Advantages

• Simple to use and easy to understand

• Preference for liquidity
• Useful in case of uncertainity
• Quick Solution

Average Accounting return method

• Average accounting return (AAR) is an investment’s average net
income divided by its average book value
• ARR method is based on accounting profit hence measures the
profitability of investment

Disadvantages
• Results by different methods are inconsistent.
•  Ignores the time factor (time value of money) which is very
crucial in business decision
• Does not adjust for the risk to longer term forecasts.
Advantages

• simple and easy to understand

• consider the total earnings from the project
• Gives due weight to the profitability of the project.
 more frequently used by novice investors to evaluate their investment
choices

Internal rate of return

Disadvantages
• Ignores the size of the project
• Ignores new rates of investment
• Ignores future-related costs
• A mix of Positive and Negative Future Cash Flows

Advantages

• Required Rate of Return is a Rough Estimate

• Time Value of Money
•  Better corporate decision making
• Maximizing net present values
• Better capital management

NET PRESENT VALUE

Disadvantages
• Estimation of opportunity cost
• Ignoring sunk cost
• Optimistic projections
• Difference in size of projects

Advantages
 • Assumption of reinvestment
• Accepts conventional cash flow patterns
• Consideration of all cash flows
• Factor risks

Profitability Index
Disadvantages

• Ignoring Sunk cost

• Difficulty in determining the required rate of return
• Estimating opportunity cost
Advantages

• It indicates whether a particular investment creates value or not.

• It considers both the time value of money and the risk of future
cash flows
• It can be used to choose between numerous projects for
allocation of capital.
• Assist in choosing project that fits within the budjet

SECTION C

6 What is the payback period for the following set of cash flows?

1900 + 3000 = 4900

4900 + 2300 = 7200
7200 + 500 = 7700
 Payback period = 500 / 1700
= 0.29411
= 0.2 = 3.2 years

7 You’re trying to determine whether to expand your business by building a

new manufacturing plant. The plant has an installation cost of $12.6
million, which will be depreciated straight-line to zero over its four-year
life. If the plant has projected net income of $1,430,000, $1,523,460,
$1,716,300, and $1,097,400 over these four years, respectively, what is
the project’s average accounting return (AAR)?

Average net income = ($1430000 + $1523460 + $1716300 + $1097400)/4

= 5767160/4
= $1441790
Given , Average book value = $12.6 million
Therefore , Average accounting return(ARR) =Average net income÷ Average book value
($1441790) / ($12.6 million)

8 A firm evaluates all of its projects by applying the IRR rule. If the
required return is 14 percent, should the firm accept the following project?
9 For the cash flows in the 8th problem, suppose the firm uses the NPV
decision rule. At a required return of 11 percent, should the firm accept
this project? What if the required return is 24 percent?

Given ,
Rate = 11%
NPV = Cash inflow – Cash outflow
0 = 20000 ÷ (1+14%) + 23000 ÷ (1+14%)^2 + 14000 ÷ (1+14%)^3 - 41000
= 18018.01+18667.31+10236.67– 41000
= 46921.99 – 41000
= 5921.99

Given ,
Rate = 24%
NPV = Cash inflow – Cash outflow
0 = 20000÷(1+24%) + 23000 ÷ (1+24%)^2 + 14000 ÷ (1+24%)^3 - 41000
=16129.03+14958.37+7342.82-41000
=38430 – 41000
= -2569.78