KRISHNA KANTA HANDIQUI STATE OPEN UNIVERSITY

(Maniram Dewan School of Management)

Home Assignment
MBA 2nd Semester, 2024
PGBA S1 04: Financial Management
Total Marks: 50

Q1. Define Capital Rationing. Discuss and explain the factors that lead to capital rationing also
outline the advantages of Capital rationing.
Ans - MEANING AND RATIONING CONCEPT OF CAPITAL
In simple words Capital Rationing is a form of Capital budgeting. in this we change the
unlimited capital assumption of capital budgeting and thereby we try to choose projects with
the finite capital that we have in hand. Capital rationing technique is used when a company has
limited funds for investing in profitable investment proposals. It is of two types Soft Capital
Rationing and Hard Capital Rationing.
Capital rationing can be further defined as a process of distributing available capital
among the various investment proposals in such a manner that a firm achieves maximum
increase in its value. It is the process of putting restrictions on the projects that can be
undertaken by the company or the capital that can be invested by the company.
In other words, Capital Rationing refers to the situation where an organisation cannot
undertake all the projects which are having positive net present value because of shortage of
capital. It can also be mentioned as a strategy that firms implement to put certain limitation on
the cost of new investments. It is also believed that Capital rationing is engaged when a firm
has a low return in investment from its current investment due to high investment costs.

Discuss and explain the factors that lead to capital rationing-

There are various reasons or factors leading to capital rationing, same of which are
described below
a. Increase in Cost of capital: The companies want to avaid the direct as well as indirect costs
in order to issue new capital and after a limit, the cost of raising further capital will increase
because companies have limited assets to secure loans.
b. Lack of reliable forecast: This is another important factor which leads to capital rationing.
Companies believe that the project's manager forecast a high cash flow estimates
unreasonably so companies filter out the projects and a few are accepted.
c. Lack of managerial abilities and skilful employees might also be one of the reasons for
capital rationing.
d. Unwillingness to broaden the equity share base for fear of losing control.
e. In order to avoid further risk, the company may be reluctant to take resort to financing by
external equities.
Besides some internal factors there are some external factors which can lead to capital
rationing, they are mentioned below
a. Imperfection of capital market or deficiency in market information for making the required
capital available.
b. Generally the government or the capital market itself will not supply unlimited amounts of
capital to a company, even though the company has identified investment opportunities which
would be able to produce the required return. Because of these reasons the company may not
get sufficient amount of funds to carry out all the profitable projects.

The various advantages of capital rationing are as follows

a. Eradicating wastages: Capital rationing prevents wastages of resources by not by not
investing in each and every new project available for investment
b. Budget: Capital rationing introduces a sense of strict budgeting of corporate resources
of a company. Whenever there is increase of capital in the form of more borrowings, the
resources are properly handled and invested in profitable projects.
c. Fewer projects: It ensures that less number of projects are selected by imposing capital
restrictions which ultimately helps in keeping the number of active projects to a
minimum and manage them all well.
 d. Higher Returns: Companies invest only in the projects where the expected return is high
and eliminating projects with lower returns on capital, which is possible through capital
rationing.
e. More stability: As the company is not investing in every project, it helps in having
adequate finances for tough times and ensures stability and increase in the stock price
of the company.

Q. 2. Discuss the implications of the Modigliani and Miller (MM) dividend irrelevance model for
shareholders and companies. How does this model challenge traditional views on dividend
policy, and what are its key assumptions and criticisms?

Ans –
DIVIDEND IRRELEVANCE MODEL/ APPROACH
Modigliani and Miller (MM) model maintain that dividend policy has no effect on the
market price of the shares and the value of the firm is determined by the earning capacity of
the firm or its investment policy. As observed by the MM, "Under conditions of perfect capital
markets, rational investors, absence of tax discrimination between dividend income and capital
appreciation, given the firm's investment policy, its dividend policy may have no influence on
the market price of the shares.

Challenges to Traditional Views

1. Traditional View on Dividends:

o Traditionally, dividends were seen as a signal of a firm's profitability and a way to
return cash to shareholders.
o Investors typically viewed a stable or increasing dividend as a positive signal
about the company's future prospects.
2. Dividend Preference:
o Some theories, such as the "bird-in-the-hand" theory, suggest that investors
prefer certain dividends over potential future capital gains due to risk aversion.
3. Clientele Effect:
o Different groups of investors (clienteles) may prefer different dividend policies
based on their tax situations or income needs.

Assumptions of MM Hypothesis-
The MM Hypothesis of irrelevance of dividends is based on the following assumptions
a. There are capital markets.
b. Investors behave rationally.
c. There are no floatation and transaction costs.
d. Information about the company is available to all without any cost.
e. The firm has a rigid investment policy.
f. There are either no taxes or there are no differences in the tax rate applicable to
dividends.
g. No investor is large enough to affect the market price of shares. There is no risk or
uncertainty in regard to the future of the firm. (This assumption was dropped later)

Criticism of MM Approach
MM hypothesis has been criticised on account of various unrealistic assumptions as
given
a. Perfect capital market does not exist in reality.
b. The firms have to incur floating costs while issuing securities.
c. Information about the company is not available to the persons.
d. Taxes do exit and there is normally different tax treatment The firms do not follow a
rigid investment policy.
e. Shareholders may prefer current income as compared to further gains.

Q3: Discuss the different methods for accounting for the risk in capital budgeting.
Ans –
 Accounting for risk in capital budgeting is crucial to making informed investment
decisions. Various methods help quantify and manage the uncertainty inherent in future cash
flows. Here are some of the key methods:
1. Sensitivity Analysis
This method involves changing one key variable at a time (e.g., sales volume, cost of
materials) to see how sensitive the project's net present value (NPV) or internal rate of return
(IRR) is to that variable.
Advantages:-
- Identifies critical variables affecting project outcomes.
- Simple to implement and understand.
Disadvantages:-
- Does not account for the probability of changes in variables.
- Examines only one variable at a time, ignoring interactions between variables.
2. Probability Method
Probability Method examines the effects of different combinations of variables. It
typically includes best-case, worst-case, and most likely scenarios.
Advantages:
- Provides a range of possible outcomes.
- Considers multiple variables simultaneously.
Disadvantages:
- Requires estimation of scenarios, which can be subjective.
- May not capture the full range of possible outcomes.
3. Simulation Technique -
This method uses probability distributions for key variables and simulates a large
number of scenarios to produce a distribution of possible outcomes.
Advantages:
- Provides a comprehensive risk assessment.
- Accounts for the probability and interaction of multiple variables.
Disadvantages:
- Requires advanced statistical and computing skills.
- Data-intensive and can be time-consuming.
4. Risk-Adjusted Discount Rate (RADR)
Adjusting the discount rate used in NPV calculations to reflect the risk level of the
project. Higher risk projects use higher discount rates.
Advantages:
- Simple to apply.
- Intuitive adjustment for risk.
Disadvantages:
- Determining the appropriate risk premium can be challenging.
- May oversimplify complex risk profiles.
5. Certainty Equivalent Approach
Adjusts the expected cash flows to reflect risk by converting uncertain future cash flows
into their risk-free equivalents.
Advantages:
- Directly adjusts cash flows for risk.
- Can be more intuitive than adjusting the discount rate.
Disadvantages:
- Requires estimation of certainty equivalents, which can be subjective.
- Can be complex to implement.
6. Decision Tree Analysis
Maps out different decision paths and outcomes over time, incorporating probabilities
of various events and their impacts on cash flows.
Advantages:
- Visually represents different decision paths and their risks.
- Useful for projects with sequential decisions.
Disadvantages:
- Can become very complex for large projects with many decisions.
- Requires estimation of probabilities and outcomes at each decision point.
Q4. Analyse the causes and consequences of air pollution in urban areas. What strategies can
be implemented to reduce air pollution levels and improve public health?
Ans –
Causes of Air Pollution in Urban Areas
1. Vehicular Emissions:
- High density of cars, trucks, and buses, especially those running on diesel and gasoline,
release significant amounts of nitrogen oxides (NOx), carbon monoxide (CO), volatile organic
compounds (VOCs), and particulate matter (PM).

2. Industrial Activities:
- Factories and power plants emit large quantities of sulfur dioxide (SO2), NOx, CO, VOCs, and
PM from burning fossil fuels and other industrial processes.
3. Construction Activities:
- Construction sites generate dust and release PM and VOCs from machinery and materials.
4. Residential Heating and Cooking:
- Burning coal, wood, or other biomass for heating and cooking, especially in lower-income
areas, contributes to indoor and outdoor air pollution.
5. Waste Management:
- Open burning of waste, landfills, and incinerators release harmful pollutants, including
dioxins and furans.
6. Agricultural Activities:
- Urban farming and nearby agricultural activities can release ammonia, methane, and other
pollutants through the use of fertilizers and pesticides.

Consequences of Air Pollution

1. Health Impacts:
- Respiratory diseases (e.g., asthma, bronchitis, chronic obstructive pulmonary disease).
- Cardiovascular diseases (e.g., heart attacks, strokes).
- Increased mortality rates due to heart and lung diseases.
- Adverse effects on pregnant women and children, including low birth weight and
developmental issues.
2. Environmental Effects:
- Acid rain caused by SO2 and NOx damaging soil, water bodies, and vegetation.
- Reduced visibility and smog formation impacting natural landscapes and urban views.
- Harm to wildlife through contaminated water and soil.
3. Economic Costs:
- Increased healthcare costs due to pollution-related illnesses.
- Loss of productivity from sick days and reduced workforce efficiency.
- Damage to buildings and infrastructure from acidic pollutants.
4. Climate Change:
- Pollutants like black carbon and methane contribute to global warming.
- Ground-level ozone acts as a greenhouse gas, exacerbating climate change.

Strategies to Reduce Air Pollution and Improve Public Health

1. Improving Public Transportation:
- Investing in efficient, affordable, and extensive public transit systems to reduce the reliance
on private vehicles.
- Encouraging the use of bicycles and walking through better infrastructure and safety
measures.
2. Promoting Cleaner Vehicles:
- Implementing stricter emissions standards for vehicles.
- Providing incentives for electric vehicles (EVs) and hybrid cars.
- Phasing out older, more polluting vehicles.
3. Enhancing Industrial Regulations:
- Enforcing stricter emission standards for industries.
- Promoting the use of cleaner technologies and renewable energy sources in industrial
processes.
 - Implementing regular monitoring and penalties for non-compliance.
4. Controlling Construction Dust:
- Enforcing regulations on dust control measures at construction sites.
- Using water sprays and barriers to minimize dust emissions.
- Requiring the use of cleaner machinery and materials.
5. Improving Waste Management:
- Encouraging recycling and composting to reduce waste volume.
- Implementing strict regulations on waste burning and promoting cleaner waste disposal
methods.
- Developing efficient waste collection and processing systems.
6. Promoting Cleaner Residential Practices:
- Encouraging the use of cleaner fuels for heating and cooking, such as natural gas or
electricity.
- Providing subsidies or incentives for low-income households to transition to cleaner energy
sources.
- Raising awareness about the health impacts of indoor air pollution.
7. Green Urban Planning:
- Increasing green spaces and urban forests to absorb pollutants and improve air quality.
- Designing cities to reduce traffic congestion and promote natural ventilation.
- Implementing zoning laws that separate industrial activities from residential areas.
8. Public Awareness and Education:
- Educating the public about the sources and health impacts of air pollution.
- Encouraging community involvement in monitoring and reporting pollution sources.
- Promoting behavior changes, such as reducing car use and energy consumption.

Q5. What is financial management? Discuss the importance of financial management in an

organization.
Ans –
Financial Management: Definition and Importance
Financial management involves the strategic planning, organizing, directing, and
controlling of financial activities within an organization. It is crucial for ensuring that financial
resources are utilized effectively and efficiently to achieve the organization’s goals, maximize
shareholder wealth, and maintain long-term financial stability. Here’s an in-depth look at the
key aspects and importance of financial management:

Importance of Financial Management

1. Maximizing Shareholder Wealth:
- The primary goal of financial management is to increase the value of the firm for its
shareholders. By making sound financial decisions, the management can enhance the firm's
market value and, consequently, shareholder wealth.
2. Ensuring Financial Stability:
- Effective financial management ensures that the organization maintains sufficient liquidity to
meet its short-term and long-term obligations, avoiding financial distress and insolvency.
3. Facilitating Growth and Expansion:
- By efficiently allocating financial resources, financial management supports the
organization’s growth and expansion plans, enabling it to seize new opportunities and improve
its competitive position.
4. Optimizing Resource Utilization:
- Through careful budgeting and financial control, financial management ensures that
resources are utilized in the most efficient manner, reducing waste and increasing productivity.
5. Improving Profitability:
- Financial management focuses on cost control, revenue enhancement, and investment in
profitable ventures, which directly contribute to improving the organization’s profitability.
6. Ensuring Compliance and Governance:
- Adhering to regulatory requirements and implementing strong corporate governance
practices are integral parts of financial management, reducing the risk of legal and regulatory
issues and enhancing the organization’s reputation.
7. Enhancing Decision-Making:
 - Providing accurate and timely financial information helps managers make informed strategic
and operational decisions, supporting overall organizational effectiveness.
8. Managing Risks:
- Financial management identifies and mitigates various financial risks, such as market risk,
credit risk, and operational risk, thereby safeguarding the organization’s assets and ensuring
financial stability.
9. Attracting Investors and Lenders:
- Sound financial management practices enhance the organization’s credibility, making it
more attractive to potential investors and lenders. This facilitates access to capital, which is
essential for growth and development.
10. Sustaining Long-Term Viability:
- By balancing profitability, growth, and risk, financial management ensures the long-term
sustainability and viability of the organization, enabling it to thrive in a competitive and
dynamic environment.