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 TABLE OF CONTENT

Chapter 1: Introduction to Financial Management.......................................................6

Question 1........................................................................................................................6

Question 2........................................................................................................................7

Question 3........................................................................................................................7

Question 4........................................................................................................................8

Chapter 3: Capital Budgeting.........................................................................................10

Question 5......................................................................................................................10

Chapter 4: Cost of Capital..............................................................................................12

Question 6......................................................................................................................12

Question 7......................................................................................................................14

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GROUP
PHOTO

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 Chapter 1: Introduction to Financial Management

Question 1 (6m)

a. Define financial management (3m)

Financial management is the process of applying general management concepts

to the many projecting financial resources. Planning, organizing, leading, and
controlling financial activities are all included in this. Setting goals, rules, pro-
cesses, strategies, and budgets for financial operations is the process of financial
planning. The preparation of growth and expansion programs that aid in the
long-term survival of the company, the reduction of uncertainties with regard to
changing market trends that the company may be faced with, the assurance of
stability and profitability, the assurance of effective and adequate financial and
investment policies, the assurance of adequate funds, the assurance of a reason-
able balance between outflow and inflow of funds, the assurance of suppliers of
funds, and the preparation of growth and expansion programs are all made pos-
sible.

b. Explain three main goals of a firm. (3m)

1. Profit maximization
 An assumption in classical economics is that firms seek to maximise profits.
 Profit = Total Revenue (TR) – Total Costs (TC).
 Therefore, profit maximisation occurs at the biggest gap between total rev -
enue and total costs.
 A firm can maximise profits if it produces at an output where marginal rev -
enue (MR) = marginal cost (MC)

2. Sales maximisation
Even when it results in lower profit, businesses frequently want to grow their
market share. There are several causes for this to happen:
• Growing the market share gives the company more monopolistic power,
which might eventually allow it to raise prices and generate more profit.
• Managers like working for larger organizations because they enjoy greater
status and higher pay.

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 • Gaining market share might drive competitors out of business. For instance,
the rise of supermarkets has caused the closure of numerous small local busi-
nesses. Some businesses could genuinely use predatory pricing, which entails
suffering a loss to drive a competitor out of business.

3. Long run profit maximisation

In some circumstances, businesses will forgo short-term revenues in order to
boost long-term profitability. For instance, businesses may experience a short-
term loss when investing extensively in additional capacity, but do so in order to
permit bigger earnings down the road.

Question 2 (2m)

Explain why “wealth maximization” preferred than “profit maximization” by a firm?

Profit and wealth maximization are the two types of objectives that financial
management seeks to achieve. One is focused on making money, whilst the
other is focused on creating value. Because it is short-term in nature and places
more emphasis on what earnings are produced than on value maximization,
which conforms to shareholders wealth maximization, profit maximization is an
improper aim. Profit maximizing has restrictions, whereas wealth maximization
does not. Profit maximization may pursue such actions that may be negative in
the long run in the near term. On the other hand, while wealth maximization
may not appear advantageous in the near term, it ultimately achieves the
shareholders' objective of adding value.

Question 3 (3m)

What are the three questions addressed by financial management?

The three basic questions with which a financial manager must be concerned
with are
1. Capital budgeting
Capital budgeting is the process where the financial manager tries to
identify investment opportunities that are worth more to the firm than
they cost to acquire.

2. Capital structure
A firms capital structure refers to the specific mixture of long-term debt
and equity the firm uses to finance its operations. The financial manager
has two concerns in this area. First: How much should the firm borrow?
Second: What are the least expensive sources of funds for the firm?

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 3. Working capital management.
Working capital refers to a firm's short-term assets, such as inventory,
and its short-term liabilities, such as money owed to suppliers.

Question 4 (9m)

With using diagram explain the trade-off between risk and return.

Risk-return tradeoff states that the potential return rises with an increase in risk.
Using this principle, individuals associate low levels of uncertainty with low
potential returns, and high levels of uncertainty or risk with high potential
returns.

Risk-Return Trade Off

LOW RISK
Return
LOW POTENTIAL RETURN

HIGH RISK
HIGH POTENTIAL RETURN

Risk

This graph illustrates the fundamental connection between risk and return,
although it should be noted that both the expected returns and the risk levels for
different investments are continually shifting, thus this connection is never static.
As a result, this chart should only be used as an example. The link between risk
and return is not linear, and taking on greater risk does not necessarily translate
into a larger predicted return.

The trading theory known as the risk-return tradeoff connects high risk and high
profit. The right risk-return trade-off depends on a number of variables, including
as the investor's risk tolerance, the number of years till retirement, and the
possibility of recovering lost cash.

In order to create a portfolio with the right balance of risk and return, time is also
crucial. Investing in equities over a long period of time, for instance, gives a person

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the chance to recover from the risks associated with bear markets and take part in
bull markets. On the other hand, if a person can only invest for a short period of
time, the same equities carry a higher risk.

Risk-return tradeoff is one of the crucial factors that investors consider when
making investment decisions and when evaluating their portfolios as a whole.
Risk-return tradeoff at the portfolio level might involve evaluations of holding
concentration or variety, as well as whether the combination poses too much risk
or a lower-than-desired potential for returns.

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 Chapter 3: Capital Budgeting
Question 5 (20m)

Goldrums Ltd s trying to decide which project should be taken up, out of three possible
investments. The initial investment would amount RM25,000. Scrap value at end of use
would be nil.
Cost of capital is 12%. The net cash inflows from three projects under consideration are:

Year Project N (RM) Project V (RM) Project Q (RM)

1 7,000 12,000 10,000
2 6,000 12,000 10,000
3 8,000 15,000 10,000
4 10,000 - 11,000
5 12,000 - 11,000

For each possible project you are required to calculate capital budgeting and choose the
best project under:
a. Payback (7m)

a) Project N :
Cumulative cash flows for first 3 Years = 7000 + 6000 + 8000 = 21,000
Amount to be recovered in year 4 = 25000 - 21000 = 4000
Pay back Period = 3 + (4000 / 10000)
Payback Period = 3.4 Years

Project V :
Cumulative cash flows for first 2 Years = 12000 + 12000 = 24000
Amount to be recovered in year 3 = 25000 - 24000 = 1000
Pay back Period = 2 + (1000 / 15000)
Payback Period = 2.07 Years

Project Q :
Cumulative cash flows for first 2 Years = 10000 + 10000 = 20000
Amount to be recovered in year 3 = 25000 - 20000 = 5000
Pay back Period = 2 + (5000 / 10000)
Payback Period = 2.5 Years

According to these calculations, project V has lower payback periods. Thus, it

should be selected.

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b. Net Present Value (11m)
NPV = Present value of future cash flows - Initial cash out flow Present value =
Future cash flow / (1+r)^n

r = interest rate
n = Year of cash flow

Project N :
NPV = [7000 / (1+12%) + 6000 / (1+12%)^2 + 8000 / (1+12%)^3 + 10000 /
(1+12%)^4 + 12000 / (1+12%)^5] - 25000
NPV = RM4,891.71

Project V :
NPV = [12000 / (1+12%) + 12000 / (1+12%)^2 + 15000 / (1+12%)^3] - 25000
NPV = RM5957.32

Project Q :
NPV = [10,000 / (1+12%) + 10,000 / (1+12%)^2 + 10,000 / (1+12%)^3 + 11000 /
(1+12%)^4 + 11000 / (1+12%)^5] - 25000
NPV = RM12,250.71

From this calculation, we can see that Project Q has higher NPV. Thus, it is the
best project to be selected.

c. State one advantage and one disadvantage of payback period (2m)

Advantage - it is very simple method to calculate the period required and

because of its simplicity it does not involve much complexity and helps to
analyze the reliability of project

Disadvantage - it completely ignores the time value of money, fails to depict the
detailed picture and ignore other factors too.

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 Chapter 4: Cost of Capital
Question 6 (10m)

Mukesh Corporation needs RM8 million for its long-term expansion projects. As the
financial manager of the company, you are required to evaluate the costs of the
following financing alternatives:
Calculate the cost of each alternative and choose the best alternative.

a. Issue common stock. The price of the existing shares of the company is RM50. The
expected dividend for the next year is RM3.50 and the growth rate will remain at
10%. The flotation cost is 5% of the issue price.

Current Market Price ( MP ) per share = RM 50 ,

Expected dividend (D1 ) = RM 3.50 per share
Growth rate ( g ) = 10 %
Floatation Cost (FC) = 5 % of the Issue Price = 5 % x RM 50 = RM 2.50
Thus, Cost of Common Stock ( Ke ) = [ D1 / ( MP - FC) ] + g = [ ( 3.50 / ( 50 - 2.50 ) ] +
0.10
= ( 3.50 / 47.50 ) + 0.10 = 0.07368 + 0.10 = 0.1737
= 17.37 % is the Ke

b. Issue 8% coupon interest bond of 10 years. The market price of a similar bond is
RM1,000. The current tax bracket of the firm is 40%.

8 % coupon 10 year Bonds with Market Price of similar bonds = RM 1,000 .

Let Face Value be = RM 1,000
This means that the YTM of the Bond = 8 %
So, Cost of Debt ( Kd ) = 8 %
thus after tax cost of debt = 8 % x ( 1 - tax ) = 8 % x ( 1 - 0.40 )
= 4.8 % is the Kd

c. Issue a 15% preferred stock with a par value of RM90. The flotation cost is 3% of the
par value and the market price is RM140.

15 % Preferred Stock with par value = RM 90 ,

Floatation Cost ( FC ) = 3 % of RM 90 ( Par Value ) = RM 2.70
Market Price ( MP ) = RM 140 .
Now Preferred dividend ( PD ) = 15 % x RM 90 = RM 13.50
Cost of Preferred Debt ( Kp) = PD / (MP - FC ) = 13.50 / ( 140 - 2.70 ) = 13.50 / 137.30
= 0.09832

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=9.83 %

Since among all the alternatives cost of Debt ( Kd ) is minimum, Mukesh Corporation
should raise RM 8 Million through issue of 8 % coupon interest Bonds for 10 years
and take advantage of leverage effect.

Thus, Issue of 8 % coupon Interest Bonds for 10 years is the best alternative with
least cost of financing ( Kd ) = 4.8 %

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Question 7 (10m)

You are considering two financing proposals. The first proposal that you are analyzing is
a preferred stock that sells for RM100 and pays annual dividend of RM15. The second
proposal is a common stock that recently paid a RM6 dividend and the stock is selling
for RM50. The rate of growth in earnings for this common stock is 5%.

a. Calculate the cost of issuing common stock.

Let g be the growth rate

Let P0 be the current stock price
Let D0 be the dividend paid
D1 = Dividend in year 1 = D0 * (1+g)
= 6 * (1+5%) = 6.30
As per dividend growth model,
Cost of common stock = (D1/P0) + g
= (6.3/50) + 5% = 17.60%

b. Calculate the cost of issuing preferred stock.

= Preference Dividend / Price of preference share

= 15/100 = 15%

c. Which financing proposal to be accepted and why?

Due to cost considerations, it is the best to issue preference shares. In addition,

there will be no dilution of control.
(10 m)

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 GOOD LUCK

THE END

Prepared by: R.Rajamohan B.Econs (Hons), MBA (Acct)

REFERENCES

Al Breiki, M., & Nobanee, H. (2019). The Role of Financial Management in Promoting
Sustainable Business Practices and Development. SSRN Electronic Journal. Published.
https://doi.org/10.2139/ssrn.3472404

Azam, G. (2018, October 27). What is financial management? Explain its functions and
importance? StartUp Plan. https://startupaplan.com/what-is-financial-management/

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