mb0045 finacial management assignment 2

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Master of Business Administration- MBA Semester 2

MB0045 Financial Management - 4 Credits(Book ID:B1134)

Assignment Set- 2 (60 Marks)

Q1. The following data is available in respect of a company :

Equity Rs.10lakhs,cost of capital 18%

Debt Rs.5lakhs,cost of debt 13%

Calculate the weighted average cost of funds taking market

values as weights assuming tax rate as 40%

Hint: Use the equationWACC = We Ke + Wp Kp +Wr Kr + Wd Kd + Wt Kt

Answer:-

WACC = debt/TF(cost of debt) (1-tax) + equity/TF(cost of equity)

Market value of Equity = 10,00,000

Market value of Debt = 5,00,000

Cost of Equity = 18%

Cost of Debt = 13 %

Tax rate = 40 %

TF means Total Financing

WACC = debt/TF(cost of debt) (1-tax) + equity/TF(cost of equity)

WACC = 5,00,000/15,00,000(13) (1-40) + 10,00,000/15,00,000(18)= 033 X 13 X 0.60 + 0.66 X 18

= 2.57 + 11.88

WACC= 14.45

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Q2. ABC Ltd. provides the information as shown in table 6.21

regarding the cost, sales, interests and selling prices. Calculate the

DFL.

Details of ABC Ltd.

Output

20,000

units

Fixed costs Rs.3,500

Variable cost

Rs.0.05 per

unitInterest on borrowed

funds NilSelling price per unit 0.2

Hint calculate DFL =

EBITEBIT - I - {Dp /(1 -

T)}}

Answer:-

Quantity sold 200,00 units

Variable cost per unit

V

0.05

Var cost = cost * Qty 1000

Selling price S 0.2

Seles Revenue =

selling price * Qty

4000

Fixed cost F 3,500

EBIT = Q(S-V)-F 20000*(4000-1000)-3500 =

59996500

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DFL =

EBITEBIT - I - {Dp /(1 -

T)}}

EBIT = Earnings before interest & tax,

I is Interest,

Dp is dividend on preference shares,

T is tax rate.

DFL =59996500

59996500 - I - {Dp /(1 -

T)}}

DFL =59996500

59996500

DFL = 0

Interest, dividend on preference shares and tax rate is not given

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Q3. Two companies are identical in all respects except in the debt

equity profile. Company X has 14% debentures worth Rs. 25,00,000

whereas company Y does not have any debt. Both companies earn

20% before interest and taxes on their total assets of Rs. 50,00,000.

Assuming a tax rate of 40%, and cost of equity capital to be 22%,

find out the value of the companies X and Y using NOI approach?

Hint: use the formula K0 = [B/(B+S)]Kd + [S/(B+S)]Ke

Answer:-

X YNet operating income( 20 %on 5000000

1000000

1000000

Less: Interest on debentures14% 350000 0

Less: Tac 40% 260000 400000

Earning availabe to ESH (NI)39000

0 600000

Cost of equity (Ke) 22% 22%S =Value of equity shares(NI/Ke)

1772727

2727272

Value of debt (B)250000

0 0

Total value of firm (S+B=V)42727

27272727

2Overall cost of capital(EBIT/V) 23.40 36.67

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Q4. Explain the Importance of Capital Budgeting?

Answer:

Importance of capital budgeting:

Capital budgeting decisions are the most important decisions in corporate

financial management. These decisions make or a business organization.

These decisions commit a firm to invest its current funds in the operating

assets with the hope of employing those most efficiently to generate a series

of cash flows in future.

These decisions could be grouped into:

1. Replacement decisions: These decisions may be decision to replace the

equipments for maintained of current level of business or decision aiming of

cost reductions.

2. Decisions on expenditure for increasing the present operating level or

expansion through improved network of distribution.

3. Decisions for products of new goods or rendering of new services.

4. Decisions on penetrating into new geographical area.

5. Decisions to comply with the regulatory structure effecting the operations

of the company. Investment in assets to comply with the conditions imposed

by environmental protection act comes under this category.

6. Decisions an investment to build township for providing residential

accommodation to employees working in a manufacturing plant.

7. Capital budgeting decisions involve evaluation of specific investment

proposals. Here the word capital refers to the operating assets used in

production of goods are rendering of services.

8. Capital budget is a blue print of planned investments in operating assets

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9. It helps in evaluating the profitability of the projects under consideration

and deciding on the proposal to be included in the capital budget for

implementation.

Q5.Briefly explain the process of Capital Rationing?

Answer: Capital rationing is the process by which management allocatesavailable investment funds among competing capital investment proposals.Normally, management uses various combinations of the valuation methodsin developing an effective approach to capital rationing.

In capital rationing, an initial screening of alternative proposals isusually performed by establishing minimum standards for the cash paybackand the average rate of return methods. The proposals that survive this

initial screening are further analyzed using the net present value andinternal rate of return methods. Throughout the capital rationing process,qualitative factors related to each proposal should also be considered. Forexample the acquisition of new, more efficient equipment that eliminatesseveral jobs could lower employee morale to a level that could decrease overall plant productivity. alternatively, new equipment might improve thequality of the product and thus increase consumer satisfaction and sales.

The final step in the capital rationing process is to rank the proposalsaccording to management's criteria, compare the proposals with the fundsavailable, and select the proposals to be funded. The unfunded proposals

may be considered if funds later become available. The following flowchartportrays the capital rationing decision process:

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Q6. Explain the Concept of Working Capital?

Answer:Working capital is classified as(i) Gross Working Capital.(ii) Net Working Capital.(iii) Permanent Working Capital

(i) Gross Working Capital: Gross Working Capital refers to the amountsinvested in the variousComponents of current assets. This concept has the following practicalrelevance.a. Management of current assets is the crucial aspect of Working Capital

Management.b. It is an important component of operating capital. Therefore, for improvingthe profitability on tis investment a finance manager of a company must givetop priority to efficient management of current assets.c. The need to plan and monitor the utilization of funds of a firm demandsworking capitalManagement as applied to current assets.d. It helps in the fixation of various areas of financial responsibility.

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(ii) Net Working CapitalNet Working Capital is the excess of current assets over current liabilitiesand provisions. Net

Working Capital is positive. When current assets exceed current liabilitiesand negative whenCurrent liabilities exceed current assets. This concept has the followingpractical relevance.1. It indicates the ability of the firm to effectively use the spontaneousfinance in managing the Firms Working Capital requirements.2. A firms short term solvency is measured through the net Working Capitalposition itCommands.

(iii) Permanent Working Capital

Permanent Working Capital is the minimum amount of investment requiredto be made in current Assets at all times to carry on the day to day operationof firms business. This minimum level of current asset has been given thename of core current assets by the Tandon Committee. It is also known asfixed Working Capital.

Temporary Working CapitalIt is also known as Variable Working Capital or fluctuating Working Capital.The firms workingCapital requirements vary depending upon the seasonal and cyclical changesin demands for a

Firms products. The extra Working Capital required as per the changingproduction and sales levels of a firm is known as Temporary Working Capital.

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mb0045 finacial management assignment 2

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