Mcs 035 IgnouAssignmentGuru 2017 2018

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Q.1.
A.1.
Definition:
One needs money to make money. Finance is the life-blood of business and there must be 3
a continuous flow of funds in and out of a business enterprise. Money makes the wheels of
business run smoothly. Sound plans, efficient production system and excellent marketing
network are all hampered in the absence of an adequate and timely supply of funds.
Sound financial management is as important in business as production and marketing. A
business firm requires finance to commence its operations, to continue operations and for
expansion or growth. Finance is, therefore, an important operative function of business.
Meaning of Financial Management:

Financial management may be defined as planning, organising, directing and controlling
the financial activities of an organisation. According to Guthman and Dougal, financial
management means, “the activity concerned with the planning, raising, controlling and
administering of funds used in the business.” It is concerned with the procurement and
utilisation of funds in the proper manner.
Objectives of Financial Management:
Financial management is one of the functional areas of business. Therefore, its objectives must
be consistent with the overall objectives of business. The overall objective of financial
management is to provide maximum return to the owners on their investment in the long- term.
This is known as wealth maximisation. Maximisation of owners’ wealth is possible when the
capital invested initially increases over a period of time. Wealth maximisation means
maximising the market value of investment in shares of the company.
Wealth of shareholders = Number of shares held ×Market price per share.
In order to maximise wealth, financial management must achieve the

following specific objectives:
(a) To ensure availability of sufficient funds at reasonable cost (liquidity).
(b) To ensure effective utilisation of funds (financial control). 4

(c) To ensure safety of funds by creating reserves, re-investing profits, etc. (minimisation of
risk).
(d) To ensure adequate return on investment (profitability).
(e) To generate and build-up surplus for expansion and growth (growth).
(f) To minimise cost of capital by developing a sound and economical combination of corporate
securities (economy).
(g) To coordinate the activities of the finance department with the activities of other departments
of the firm (cooperation).
Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will depend
upon expected costs and profits and future programmes and policies of a concern.
Estimations have to be made in an adequate manner which increases earning
capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made,
the capital structure have to be decided. This involves short- term and long- term debt
equity analysis. This will depend upon the proportion of equity capital a company is
possessing and additional funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company
has many choices like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of
financing.
4. Investment of funds: The finance manager has to decide to allocate funds into
profitable ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance
manager. This can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
b. Retained profits - The volume has to be decided which will depend upon
expansional, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to
cash management. Cash is required for many purposes like payment of wages and
salaries, payment of electricity and water bills, payment to creditors, meeting current
liabilities, maintainance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances. This can be done
through many techniques like ratio analysis, financial forecasting, cost and profit control,
etc.
5
Q.1.
A.1.(b)
There are 3 methods used in ranking investment proposals. The payback method, internalrate
of return and net present value. The net present value method is the most acceptableand
commonly used approach. Of the many methods for ranking investment proposals(1)The
payback period methods, being the number of years (or time periods) required toreturn the
original investment. The payback period is usually determined on anundiscounted basis, but
discounted payback periods must also be established for aproject. The net present value (NPV)
method: being the present value of future benefitsdiscounted at the appropriate cost of capital,
minus the present value of the capital cost ofthe investment. The internal rate of return (IRR)
method: being the discount rate whichequates the present value of benefits to the present value
of the capital expenditure.5.The payback period shows the number of years required to recover
the project’s cost orhow long it takes to get the entity’s money back.6.The payback method is
easy to understand. The focus is on liquidity. If the initialinvestment cannot be recouped soon, it
will not qualify. This method is preferred byindustries involved in technological developments.
The downside of this method is that isfails to discern the most economic solution to the capital
budgeting problem.7.
Let’s review a problem.Assume a $100,000 investment and the following cash flows fortwo
alternatives. In year 1 Investment A has a $30,000 cash flow and Investment Bshows a $40,000
cash flow. In year 2 Investment A’s cash flow is $50,000 and B is$30,000. Year 3 shows
$20,000 and $15,000 respectively, year 4 $60,000 and $15,000. Inyear 5 investment A does not
show a cash flow but investment B shows a $50,000 cashflow. Which of the two alternatives
would you select under the payback method?8.As shown in the solution Investment X will have
a payback in 3 years versus the 4 yearpayback in Investment Y. Using the payback method,
Investment X would be selected.9.The higher the discount rate the lower the net present value.
NPV discounts back theinflows over the life of the investment to determine whether they equal
or exceed therequired investment.Basic discount rate is usually the cost of the capital to the
firm.Inflows must provide a return that at least equals the cost of financing those returns.
A.2.
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7
8
A.3(i)
Fixed assets are long-term, tangible assets such as land, equipment, buildings,
furniture and vehicles. Fixed assets are parts of the company that help with
production and are components that last over time in the company. They
are physical assets that can be seen. They are not used for liquidation purposes
to contain debt within a business or cashed out in any way to aid a business
financially.
Current assets are the general inventory of a company, including cash, accounts
receivable, insurance claims, investments, and intangible or non-physical items.
Current assets account for the worth of a company, showing the earnings-to-debt
ratio by the year's end. Each current asset has the ability to be cashed out to
financially help the business or liquidated to save the company from debt
or bankruptcy.
Fixed and current assets are recorded on a balance sheet, which is a statement
showing the worth of a company at a certain point in time. The balance sheet
shows the company's spending habits and inventory compared to its income.
This helps the company determine where to cut back expenses and how to plan
future budgets.
The three main categories to fill out on a balance sheet are assets, liabilities and
owner's equity. The assets are the fixed and current assets. Liabilities are items
causing debt to the company, and equity is the value of shares issued by a
company. Each balance sheet is filled out annually so that potential investors or
banks know if the company as a whole is a liability or investment opportunity.
A.3.(ii)
A spot exchange rate is the price to exchange one currency for another for
immediate delivery. The spot rates represent the prices buyers pay in
one currency to purchase a second currency. Although the spot exchange rate is
for delivery on the earliest value date, the standard settlement date for most spot
transactions is two business days after the transaction date.
The spot exchange rate is the price paid to sell one currency for another for
delivery on the earliest possible value date.
Background
The foreign exchange market is the largest and most liquid market in the world,
with over $5 billion changing hands daily. The most actively traded currencies 9
are the U.S. dollar; the euro, which is used in many continental European
countries including Germany, France, and Italy; the British pound; Japanese yen;
and Canadian dollar.
Trading takes place electronically around the world between large, multinational
banks. Other active market participants include corporations, mutual
funds, hedge funds, insurance companies and government entities. Transactions
are for a wide range of purposes, including import and export payments, short-
and long-term investments, loans and speculation.
A.3.(iii)
Hurdal rate
In capital budgeting, hurdle rate is the minimum rate that a company expects to earn when investing
in a project. Hence the hurdle rate is also referred to as the company's required rate of return or
target rate. In order for a project to be accepted, its internal rate of return must equal or exceed the
hurdle rate.
The hurdle rate is also used to discount a project's cash flows in the calculation of net present value.
The minimum hurdle rate is usually the company's cost of capital (a blend of the cost of debt and the
cost of equity). However, the hurdle rate will be increased for projects with greater risk and when the
company has an abundance of investment opportunities.
BREAKING DOWN 'Hurdle Rate'

In capital budgeting, projects are evaluated either by discounting futurecash flows to the present by
the hurdle rate, so as to ascertain the net present value of the project, or by computing the internal
rate of return (IRR) on the project and comparing this to the hurdle rate. If the IRR exceeds the
hurdle rate, the project would most likely go ahead.
For example, a company with a hurdle rate of 10% for acceptable projects, would most likely accept
a project if it has an internal rate of return of 14% and does not have a significantly higher degree of
risk. Alternately, discounting the future cash flows of this project by the hurdle rate of 10% would
lead to a large and positive net present value, which would also lead to the project's acceptance.
Discount Rate
The interest rate charged to commercial banks and other depository institutions for loans received
from the Federal Reserve Bank’s discount window. The discount rate also refers to the interest rate
used in discounted cash flow (DCF) analysis to determine the present value of future cash flows.
The discount rate in DCF analysis takes into account not just the time value of money, but also the
risk or uncertainty of future cash flows; the greater the uncertainty of future cash flows, the higher
the discount rate. A third meaning of the term “discount rate” is the rate used by pension plans and
insurance companies for discounting their liabilities.
A.3.(iv) nternal rate of return (IRR) is the interest rate at which the net present value of all
the cash flows (both positive and negative) from a project or investment equal zero.
10
Internal rate of return is used to evaluate the attractiveness of a project or investment. If the
IRR of a new project exceeds a company’s required rate of return, that project is desirable.
If IRR falls below the required rate of return, the project should be rejected.
HOW IT WORKS (EXAMPLE):

The formula for IRR is:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively; and
IRR equals the project's internal rate of return.
Let's look at an example to illustrate how to use IRR.
Assume Company XYZ must decide whether to purchase a piece of factory equipment for
$300,000. The equipment would only last three years, but it is expected to generate
$150,000 of additional annual profit during those years. Company XYZ also thinks it can
sell the equipment for scrap afterward for about $10,000. Using IRR, Company XYZ can
determine whether the equipment purchase is a better use of its cash than its other
investment options, which should return about 10%.
Here is how the IRR equation looks in this scenario:
0 = -$300,000 + ($150,000)/(1+.2431) + ($150,000)/(1+.2431)2 + ($150,000)/(1+.2431)3 +

$10,000/(1+.2431)4
The investment's IRR is 24.31%, which is the rate that makes the present value of the
investment's cash flows equal to zero. From a purely financial standpoint, Company XYZ
should purchase the equipment since this generates a 24.31% return for the Company --
much higher than the 10% return available from other investments.
Under payback method, an investment project is accepted or rejected on the basis of

payback period. Payback period means the period of time that a project requires to recover
the money invested in it. It is mostly expressed in years.
Unlike net present value and internal rate of return method, payback method does not take
into account the time value of money.
According to payback method, the project that promises a quick recovery of initial
investment is considered desirable. If the payback period of a project is shorter than or
equal to the management’s maximum desired payback period, the project is accepted,
otherwise rejected. For example, if a company wants to recoup the cost of a machine within
5 years of purchase, the maximum desired payback period of the company would be 5
years. The purchase of machine would be desirable if it promises a payback period of 5
years or less.
Q.4.
A.4.(i) 11
What is 'Capital Budgeting'
Capital budgeting is the process in which a business determines and evaluates

potential expenses or investments that are large in nature. These expenditures
and investments include projects such as building a new plant or investing in a
long-term venture. Often times, a prospective project's lifetime cash inflows and
outflows are assessed in order to determine whether the potential returns
generated meet a sufficient target benchmark, also known as
"investment appraisal."
Ideally, businesses should pursue all projects and opportunities that

enhance shareholder value. However, because the amount of capital available at
any given time for new projects is limited, management needs to use capital
budgeting techniques to determine which projects will yield the most return over
an applicable period of time. Various methods of capital budgeting can
include throughput analysis, net present value (NPV), internal rate of return
(IRR), discounted cash flow (DCF) and payback period.
There are three popular methods for deciding which projects should
receive investment funds over other projects. These methods are throughput
analysis, DCF analysis and payback period analysis.
A.4.(ii) Cash management has changed significantly over the past 2 decades for two
reasons. First, from the early 1970s to the late 1980s, there was an upward trend in interest
rate that increased the opportunity cost of holding cash. This encouraged financial manager
to search for more efficient ways of managing cash. Second, technological developments,
particularly computrised electronic funds transfer mechanism changed the way cash is
managed.
Most cash management activities are performed jointly by the firm and its banks. Effective
cah management encompasses proper management of cah inflow, and outflows, which
entails (1) improving forecasts of cash flows, (2) synchronizing cash inflows and outflows,
(3) usinig floats, (4) accelearing collections, (5) getting available funds to where they are
needed, and (6) controlling disbursement. Most businesses are conducted by large firms,
many sources and make payments from a number of different cities or even countries. For
example, companies such as IBM, General Motros, and Hewlett-Packard have
manufacturing plants all around the world, even more sales offices, but most of the
payments are made from the cities where manufacturing occurs, or else from the
headoffice. Thus a major corporation mightnhave hundreads of bank accounts, and since
there is no reason to think that inflows and outflows will balance in each account, a system
must be in place to transfer funds from where they come into where they are needed, to
arrange loans to cover net corporate shortfalls, and to invest net corporate surpluses
without delay.
12
A.4.(iii)
Net present value (NPV) is defined as an investment measure that tells an investor
whether the investment is achieving a target yield at a given initial investment. NPV also
quantifies the adjustment to the initial investment needed to achieve the target yield
assuming everything else remains the same. Formally, the net present value is simply the
summation of cash flows (C) for each period (n) in the holding period (N), discounted at the
investor’s required rate of return (r):
If all of this math scares you don’t worry, we’ll walk through some detailed examples next
that will leave you with a solid intuition and understanding of NPV.
NPV Intuition
What’s the intuition behind NPV? Here’s a simple way to think about the net present value:
NPV = Present Value – Cost
The net present value is simply the present value of all future cash flows, discounted back
to the present time at the appropriate discount rate, less the cost to acquire those cash
flows. In other words NPV is simply value minus cost.
A.4.(iv)
Many real estate investors determine the value of an income property by using the
capitalization rate, aka cap rate. It is probably the one most misused concept in real estate
investing.
While brokers, sellers, and lenders are fond of quoting deals based on the cap rate, the
way it is typically used, they really shortcut the true use of a valuable tool. A broker prices a
property by taking the Net Operating Income (NOI), dividing it by the sales price, and voila!-
-there's the cap rate.
Example:
Say the property has an NOI of $125,000, and the price is $1,125,000.
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$125,000/ $1,125,000 = 11.1% cap rate
But what does that number tell you? Does it tell you what your return will be if you use
financing? No. Does it take into account the different finance terms available to different
investors? No. Then just what does it show?
What the cap rate above represents is merely the projected return for one year as if the
property were bought with all cash. Not many of us buy property for all cash, so we have to
break the deal down, usually by trial and error, to find the cash on cash return on our actual
investment using leverage (debt).
Then we calculate the debt service, subtract it from the NOI, and calculate our return. If the
debt terms, loan-to-value, or our return requirement change, then the whole calculation
must be performed again. That's not exactly an efficient use of time or knowledge.
Q.5.
A.5.(i) Outstanding Expenses

Outstanding expenses are those expenses which have been incurred and consumed during
an accounting period and are due to be paid, but are not paid. Examples include
outstanding salary, outstanding rent, etc. Outstanding expenses are recorded in the books
at the end of an accounting period to show true numbers of a business.
Outstanding expense is a personal account and is shown on the liability side of a

balance sheet.
Expenses are amounts paid for goods or services purchased. According to the accrual
concept of accounting, transactions are recorded in the books of accounts at the time of
their occurrence and not when the actual cash or a cash equivalent is received or
paid. Therefore, payments are not necessarily made immediately, they may be late or in
advance. Outstanding expenses and prepaid expenses are both a result of this.
A.5.(ii)
Master Budget Definition
The master budget is the aggregation of all lower-level budgets produced by a

company's various functional areas, and also includes budgeted financial statements, a
cash forecast, and a financing plan. The master budget is typical ly presented in either a
monthly or quarterly format, and usually covers a company's entire fiscal year. An
explanatory text may be included with the master budget, which explains the
company's strategic direction, how the master budget will assist in acco mplishing 14
specific goals, and the management actions needed to achieve the budget. There may
also be a discussion of the headcount changes that are required to achieve the budget.
A master budget is the central planning tool that a management team uses to direct the
activities of a corporation, as well as to judge the performance of its
various responsibility centers. It is customary for the senior management team to
review a number of iterations of the master budget and incorporate modifications until it
arrives at a budget that allocates funds to achieve the desired results. Hopefully, a
company uses participative budgeting to arrive at this final budget, but it may also be
imposed on the organization by senior management, with little input from other
employees.
A.5.(iii)
Dividend policy is the set of guidelines a company uses to decide how much of
its earnings it will pay out to shareholders. Some evidence suggests that
investors are not concerned with a company's dividend policy since they can sell
a portion of their portfolio of equities if they want cash. This evidence is called
the "dividend irrelevance theory," and it essentially indicates that an issuance of
dividends should have little to no impact on stock price. That being said, many
companies do pay dividends, so let's look at how they do it.
There are three main approaches to dividends: residual, stability or a hybrid of

the two.
Residual Dividend Policy

Companies using the residual dividend policy choose to rely on internally
generated equity to finance any new projects. As a result, dividend payments
can come out of the residual or leftover equity only after all project capital
requirements are met. These companies usually attempt to maintain balance in
their debt/equity ratios before making any dividend distributions, deciding on
dividends only if there is enough money left over after all operating and
expansion expenses are met.
A.5.(iv)
Profit and
Trading Account Loss
Account
It is the second 15
1 It is the first stage of final accounts. 1 stage of the final
accounts.
It shows the net

It shows the gross result (gross profit results (net profit
2 2
or gross loss) of the business. or net loss) of
the business.
All expenses
connected with
sales and
All direct expenses (expenses
administration
3 connected with purchase or production 3
(indirect
of goods) are considered in it.
expenses) of
business are
considered.
It always starts
with the balance
It does not start with the balance of of a trading
4 4
any account. account (gross
profit or gross
loss).
Its balance (N.P

or N.L) is
Its balance (G.P or G.L) is transferred
5 5 transferred to
to profit and loss account.
capital account
in balance sheet.
16

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BCA MCA BA MA BDP B.COM M.COM B.

Sound financial management is as important in business as production and marketing. A

expansion or growth. Finance is, therefore, an important operative function of business.

Meaning of Financial Management:

the financial activities of an organisation. According to Guthman and Dougal, financial

utilisation of funds in the proper manner.

Objectives of Financial Management:

maximising the market value of investment in shares of the company.

Wealth of shareholders = Number of shares held ×Market price per share.

In order to maximise wealth, financial management must achieve the

(a) To ensure availability of sufficient funds at reasonable cost (liquidity).

(b) To ensure effective utilisation of funds (financial control). 4

(d) To ensure adequate return on investment (profitability).

of the firm (cooperation).

Functions of Financial Management

BREAKING DOWN 'Hurdle Rate'

HOW IT WORKS (EXAMPLE):

0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n

Let's look at an example to illustrate how to use IRR.

Here is how the IRR equation looks in this scenario:

0 = -$300,000 + ($150,000)/(1+.2431) + ($150,000)/(1+.2431)2 + ($150,000)/(1+.2431)3 +

Under payback method, an investment project is accepted or rejected on the basis of

Capital budgeting is the process in which a business determines and evaluates

Ideally, businesses should pursue all projects and opportunities that

NPV = Present Value – Cost

A.5.(i) Outstanding Expenses

Outstanding expense is a personal account and is shown on the liability side of a

Master Budget Definition

The master budget is the aggregation of all lower-level budgets produced by a

There are three main approaches to dividends: residual, stability or a hybrid of

Residual Dividend Policy

It shows the net

Its balance (N.P

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