Financial Management Chapter 1 Summary Financial management "is the operational activity of a business that is responsible for obtaining and effectively • utilising the funds necessary for efficient operations. Wealth maximisation refers to maximising the net wealth of the company's share holders. • Financial Planning is a process by which funds required for each course of action is decided. • A financial plan has to consider capital structure, capital expenditure and cash flow. • Capitalisation of a firm refers to the composition of its long-term funds. It refers to the capital structure of the • firm. It has two components, viz., debt and equity. The earnings theory of capitalisation recognises the fact that the true value (capitalisation) of an enterprise • depends upon its earnings and earning capacity. A company is said to be overcapitalised, when its total capital exceeds the true value of its assets. Self Assessment Wealth maximisation refers to maximising the ___________ of the company's share holders 1. profit a. net wealth b. assets c. liabilities d. A company is said to be ____________, when its total capital exceeds the true value of its assets. 2. under-capitalised a. capitalised b. overcapitalised c. profit maximisation d. Which of the following statements is false? 3. Capitalisation of a firm refers the composition of its short-term funds. a. A financial plan has to consider Capital structure, Capital expenditure and cash flow. b. Wealth maximisation refers to maximising the net wealth of the company's share holders c. Goal of financial management of a firm is maximisation of economic welfare of its shareholders d. The earnings theory of Capitalisation recognises the fact that the _________ of an enterprise depends upon its 4. earnings and earning capacity. false value a. total value b. true value c. half value d. Which of the following cost is not visible but it may seriously affect the company's operations especially when 5. it is exposed to business and financial risk. Explicit cost a. Implicit cost b. Direct cost c. Indirect cost d. Match the following 6. Concept Description A. Explicit cost 1. A process by which funds required for each course of action is decided B. Financial Planning 2. This involves huge investment and yield a return over a period of time in future. C. Long-term assets 3. The current assets that can be converted into cash within a financial year without diminution in value D. Short-term assets 4. The cost in the form of coupon rate, cost of floating and issuing the securities A-2, B-1, C-4, D-3 a. A-4, B-3, C-1, D-2 b. A-4, B-1, C-2, D-3 c. A-1, B-2, C-3, D-4 Financial Management 10/JNU OLE ___________ is the operational activity of a business that is responsible for obtaining and effectively utilising 7. the funds necessary for efficient operations. Financial planning a. Financial management b. Asset management c. Budget management d. ______________is a major decision made by the finance manager on the formulation of dividend policy. 8. Investment decision a. Financing decision b. Dividend decision c. Accounting decision d. Financing decisions relate to the acquisition of funds at the _________ cost. 9. maximum a. less b. more c. least d. Which among the following is the primary goal of financial management of a firm? 10. Maximisation of economic welfare of its shareholders a. Encouragement to competition b. Fall in dividend rates c. Effective utilisation of funds chapter 2 Summary One of the most fundamental concepts in finance is that money has a “time value.” That is to say that money • in hand today is worth more than money that is expected to be received in the future. Simple interest is the interest paid on only the original amount, or principle borrowed. • Simple amount is a function of three components such as principle amount borrowed or lent, interest per annum • and the number of years for which the interest rate is calculated. Doubling period is the period required to double the amount invested at a given rate of interest. • The present value of a future cash inflow (or outflow) is the amount of current cash that is of equivalent value • to the present value. Effective and nominal rate are equal only when the compounding is done yearly once, but there will be a • difference, that is effective rate is greater than the nominal rate for shorter compounding periods. Loan is an amount raised from outsiders at an interest and repayable at a specified period. Payment of loan is • known as amortisation. Self Assessment Individual prefers ________opportunity to receive money now rather than waiting for one or more years to 1. receive the same value a. money b. interest c. principle d. ________ is an amount raised from outsiders at an interest and repayable at a specified period 2. Money a. Loan b. Principle c. Value d. ________ rate of interest or rate of interest per year is equal 3. Sinking a. Present value b. Nominal c. Principle d. The present value of a future cash inflow (or outflow) is the amount of _________ cash that is of equivalent 4. value to the present value current a. future b. past c. lost d. Which of the following statements is false? 5. Annuity is a series of odd cash flows for a specified duration a. Simple interest is the interest paid on only the original amount b. Growing annuity means the cash flows that grow at a constant rate for a specified period of time c. The processes of determining present value of future cash flows are called discounting d. Compounding interest is also referred as __________. 6. future value a. current value b. asset value c. amount value d. ________ period is the period required to double the amount invested at a given rate of interest. 7. Compounding a. Growth b. Discounting c. Doubling 23/JNU OLE If cash flows happen at the beginning of the year, it is called as an? 8. Annuity due a. Deferred annuity b. Regular annuity c. Mixed annuity d. A rupee, which is received today, is more valuable than a rupee receivable in ______. 9. past a. present b. future c. today d. The process of determining present value of future cash flows is called? 10. Sinking a. Billing b. Discounting c. Amounting chapter 3 Summary Valuation is the process of linking risk with returns to determine the worth of an asset. The value of an asset • depends on the cash flow it is expected to provide over the holding period. Book value is an accounting concept. Assets are recorded in balance sheet at their book values. Book value of • an asset is cost of acquisition less accumulated depreciation. Market value of an asset is the price at which the asset is bought or sold in the market. Market value per share • is generally higher than the book value per share for profitable and growing firms. Liquidation value of a equity stock is the actual amount that would be received if all of the firm's assets were • sold at their market value, liabilities were paid, and the remaining proceeds were by number of equity shares outstanding. A bond is a legal document issued by the issuing company under is common seal acknowledging a debt and • setting forth the terms under which they are issued and are to be paid. Irredeemable bond is the bond which is not repaid till closing of the firm. It is the bond without maturity • period. Self Assessment _________ is divided by the number of equity shows outstanding to get book value per share. 1. Net worth a. Yield b. Equity stock c. Premium bond d. Value of bond equals to __________ value when required rate equals to interest rate. 2. present a. current b. par c. net d. Which of the following statements is false? 3. Preference stock is also known as hybrid security. a. Liquidation value equals to value of assets minus value of liabilities b. Value of bond is less than par value when required rate of return than interest rate. c. Cash inflows, timing and required return are the three inputs required to value any asset. d. Bond value equals to par value when it reaches to __________ period. 4. maturity a. premium b. value c. completion d. Current yield relates to the annual interest to the current________. 5. cost price a. asset price b. market price c. specific price d. A bond is said to be premium bond when its value is: 6. Higher than the par value a. Less than the par value b. Equal to than the par value c. Higher than the present value d. Intrinsic value is the __________ value of cash flows expected over a series years of holding an asset. 7. coming a. going b. present c. net d. 8. Equity stock a. Ordinary stock b. Hybrid security c. Security stock d. When required rate of return is different from the interest rate the length of time to maturity effects _______ 9. values. bond a. equity b. share c. net d. Value of bond is less than par value when required rate of return higher than ________ rate. 10. interest a. return b. required c. present d. Summary Cost of capital is an integral part of investment decision as it is used to measure the worth of investment proposal • provided by the business concern. Cost of capital is the rate of return that a firm must earn on its project investments to maintain its market value • and attract funds. Cost of capital is the required rate of return on its investments which belongs to equity, debt and retained • earnings. Computation of cost of capital is a very important part of the financial management to decide the capital structure • of the business concern. Following points illustrates the importance of cost of capital. The cost of equity or the returns required by the equity shareholders is the same in both the cases shareholders • are providing funds to the firm to finance firm's investment proposals. Shareholders could receive the earnings as dividends and invest the same in alternative investments of comparable • risk to earn returns. Retained earnings are those parts of net earnings that are retained by the firm for investing in capital budgeting • proposals instead of paying them as dividends to shareholders Self Assessment Existence of perfect capital market is one of the assumptions of ______. 1. WACC a. CAPM b. equity c. debentures d. Cost of the capital is the ___________ required rate of return expected by investors. 2. minimum a. maximum b. higher c. reduced d. Which of the following statements is false? 3. Cost of capital comprises of three components a. Cost of capital is the minimum required rate of needed to justify b. There is no cost for internally generated funds c. CAPM approach is one of the approaches used in computation of equity capital d. _______ value weights are based on the values found on the balance sheet 4. Book a. Capital b. Market c. Weighted d. CAPM stands for? 5. Capital asset price model a. Capital asset pricing model b. Capital asset pricing maturity c. Capital assignment pricing model d. The composite cost of capital lies between the least and most _________ funds. 6. expensive a. costly b. low cost c. cheap d. ____________debentures are those having a maturity period or repayable after a certain given period of time. 7. Redeemable a. Irredeemable b. Capital c. Asset d. 47/JNU OLE Retention of earnings involves an __________ cost 8. opportunity a. fixed b. capital c. explicit d. Retained earnings are those parts of ________ earnings that are retained by the firm for investing in capital 9. budgeting proposals instead of paying them as dividends to shareholders reduced a. net b. complete c. entire d. Cost of preference share when the _______ amount is repaid in one lump sum amount. 10. interest a. total b. principal c. half d.