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Master of Business Administration- MBA Semester 2 Spring 2015

MB0045: FINANCIAL MANAGEMENT
Q1. Explain the liquidity decisions and its important elements. Write complete information on dividend
decisions.
Answer: Liquidity decisions
The liquidity decision is concerned with the management of the current assets, which is a pre-requisite to longterm success of any business firm. The main objective of the current assets management is the trade-off between
profitability and liquidity, and there is a conflict between these two concepts. If a firm does not have adequate

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Q2. Explain about the doubling period and present value. Solve the below given problem:
Under the ABC Banks Cash Multiplier Scheme, deposits can be made for periods ranging from 3 months
to 5 years and for every quarter, interest is added to the principal. The applicable rate of interest is 9%
for deposits less than 23 months and 10% for periods more than 24 months. What will be the amount of
Rs. 1000 after 2 years?
Answer:Doubling period
A very common question arising in the minds of an investor is how long will it take for the amount invested to
double for a given rate of interest. There are 2 ways of answering this question:

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Q3. Write short notes on:
a) Operating Leverage
b) Financial leverage
c) Combined leverage
Answer: a) Operating Leverage
Operating leverage arises due to the presence of fixed operating expenses in the firms income flows. It has a
close relationship to business risk. Operating leverage affects business risk factors, which can be viewed as the
uncertainty inherent in estimates of future operating income.

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Q4. Explain the factors affecting Capital Structure. Solve the below given problem:
Given below are two firms, A and B, which are identical in all aspects except the degree of leverage
employed by them. What is the average cost of capital of both firms?
Details of Firms A and B
Net operating income EBIT
Interest on debentures I
Equity earnings E
Cost of equity Ke
Cost of debentures Kd
Market value of equity S =
E/Ke
Market value of debt B
Total value of firm V
Answer:

Firm A
Rs 1,00,000
Nil
Rs. 1, 00, 000
15%
10%
Rs. 6, 66, 667

Firm B
Rs 1,00,000
Rs 25,000
Rs. 75, 000
15%
10%
Rs. 5,00, 000

Nil
Rs. 6, 66, 667

Rs. 2, 50, 000

Rs. 7, 50, 000

Factors Affecting Capital Structure

Capital structure should be planned at the time a company is promoted. The initial capital structure should be
designed very carefully. The management of the company should set a target capital structure, and the
subsequent financing decisions should be made with a view to achieve the target capital structure.

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Q5. Explain all the sources of risk in capital budgeting with examples.
Solve the below given problem:
An investment will have an initial outlay of Rs 100,000. It is expected to generate cash inflows. Cash
inflow for four years.
Year
1
2
3
4

Cash Inflow
40000
50000
15000
30000

If the risk free rate and the risk premium is 10%,

a) Compute the NPV using the risk free rate
b) Compute NPV using risk-adjusted discount rate.
Answer:
Sources of risk
The five different sources of risk are:

Project-specific risk
Competitive or competition risk
Industry-specific risk
International risk
Market risk

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Q6. Explain the objectives of Cash Management. Write about the Baumol model with their assumptions.
Answer:
Objectives of Cash Management
The major objectives of cash management in a firm are:

Meeting payments schedule

Minimizing funds held in the form of cash balances

Meeting payments schedule

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