QUESTIONS AND ANSWERS FINANCIAL MANAGEMENT (Theory)


QUESTIONS AND ANSWERS FINANCIAL MANAGEMENT

(Theory)


YEAR-DEC-2003:


1.      Liquidity and profitability are competing goals for the finance manager” comment.

·        Liquidity ensures the ability of the firm to honour it’s short term commitments, that means, the firm has adequate cash, to pay for it’s bills, to make unexpected large purchases and to meet contingencies, at all times.

·        It also reflects the ability of the firm to convert its assets into cash and pay off liabilities quickly.

·        Under liquidity management, the finance manager is expected to manage all its current assets including near cash assets in such a way as to ensure its effectively with the view to minimize its costs.

·        Under profitability objective, the finance manager is expected to utilize the funds of the firm in such a manner as to ensure the highest return.

·        However, the two objectives of the liquidity and profitability have inverse relationship

·        If liquidity increases profitability decreases and vise-a-versa.

2.      Depreciation is a part of cost of production and is at the same time an important source of internal finance”.

    • While calculating cost of production of an item, prime costs and factory overheads are considered.

    • Under factory overheads depreciation on plants and machinery and other assets are included.

    • Thus depreciation forms part of cost of production.

    • Depreciation indicates the decrease in the value of assets due to wear and tear, lapse of time and accident and hence some funds are desired to be kept apart for replacement of worn-out assets.
    • “ It’s a deduction out of profits of the company calculated as per accounting rules on the basis of estimated life of each asset each year over the life of the assets to an amount equal to original value of the assets”.

    • The pool of funds generated due to accumulation of depreciation provides an opportunity to a firm to use it in the funding of its working capital requirements, acquisition of new assets or replacement of worn out plant and machinery.

    • Those who consider dep. As a source of funds argue that dep. does not result into any cash outlay since it is a non-cash expense.

    • Those who oppose considering dep. As a source of funds argue that funds are generated by operating profits and not by making provision for dep.

    • Dep. is considered as a special amount set aside out of the revenue generated by the firm.

    • If it would have been really a source of funds, any firm could have improved its position at its will, just by increasing the periodical depreciation charge.

    • Hence in a strict sense, dep. should not be considered as a source of funds.

  1. “ Retained earnings (RE) have no cost” do you agree? Give reasons of your answer.

·        RE are funds accumulated over the years, of the company, by keeping part of the funds generated without distribution as distribution as dividend amongst shareholders.

·        The funds so generated become one of the major sources of funding for the company to finance its expansion and diversification programmes.

·        The funds belong to equity shareholders and it is taken into account while calculating cost of equity.

·        Many people consider RE as cost free source of funds, which may not be a correct approach.

·        The reason is that RE indicates the amount of profits not distributed among equity shareholders.

·        Virtually, the company has deprived the equity holders of this earning by retaining a portion of profit with it.
·        Therefore the cost of RE may be considered as equivalent to the earnings foregone by the shareholders.

·        In other words, the opportunity cost of retained earnings may be considered as their cost, which is equal to the income that they would otherwise earn by placing these funds in alternative investment.

·        Therefore, the statement that RE has no cost is not correct.

  1. Discuss in brief the techniques of economic appraisal for an industrial project

·        A project is accepted if it proves it feasibility from market, technical, financial and economical angles.

·        An economic analysis of industrial project is made with the help of the following economic appraisal techniques:


·        Economic rate of return: it indicates the rate of return to the company or society and not to the private promoters and other agencies involved in the promotion of project.

·        Domestic resource cost: it measures the resource cost of manufacturing a project as compared to importing/ exporting cost of it. And it is computed as the quantum of domestic resources or costs deployed in production to the net foreign exchange saved or earned.

·        Effective rate of protection: it is offered to a particular stage of manufacture of a product is an important consideration in the determination of competitive strength of the product.

·        ERP=value added at domestic prices – value added at international prices

  1. What is ‘treasury management’? Explain the various tools of treasury management. How is it different from financial management?

·        Is the science of managing treasury operations of a firm.

·        It refers to all activities involving the management of revenues, inflows and outflows of government.

·        The treasury management and fund management are used almost synonymously.
·        Conceptually, the latter is general term, applicable to the business sector, while treasury mgt. refers to the mgt. Of cash, currency and credit of sovereign power of the country.

·        Tools of treasury management:

-         Analytic and planning tools
-         Zero based budgeting
-         Financial statement analysis

·        Difference b/w financial mgt. And treasury mgt.:

-         Control aspects
-         Reporting aspects
-         Strategic aspects; and
-         Nature of assets.


6. What are the methods of ‘venture financing’? Also indicate in brief the elements that are needed for the success of venture capital.

·        Venture capital is typically available in three forms in India:
-         Equity
-         Conditional loans; and
-         Income notes.
-         Conditional loan is quite popular source of funds made available by VCF’s in India.


The following elements are needed for the success of venture capital in any nation:

-         Entrepreneurial tradition
-         Unregulated economic environment
-         Disinvestment avenues
-         Fiscal incentives
-         Broad based education
-         Venture capital managers
-         Promotion efforts
-         Institution industry linkages
-         Research and development activities






6.      “Bonus shares represents simply a division of corporate pie into a large number of pieces” discuss

·        Most of the shareholders, considered that the bonus shares are valuable. But they fail to realize that the bonus shares do not affect their wealth and therefore, in itself they have no value for them.

·        It merely divides the ownership of the company into a large number of pieces.

·        Infact, the bonus issue does not give any extra or special benefit to a shareholder.

·        His proportionate ownership in the company does not change.

·        Further, from the company’s point of view the issue of bonus shares is more costly to administer than cash dividend.

·        The company has to print certificates and send them to lakhs of shareholders.

7.      According to Dow Jones Theory, “ identification of ‘turn’ is made on the basis of daily movement of prices”. State, with reasons, whether this statement is correct.

·        The theory states that the movement of prices of securities on the stock exchange can be studied under the three broad categories


-         Primary movements: it represent the long term movements of the prices of securities on the stock exchange, ranging from one year to three year

-         Secondary movements: this shows the short term fluctuations in stock exchange prices lasting from 3 weeks to 3 months

-         Daily movements: this shows daily irregular fluctuations in the stock exchange prices. These do not show any definite trend.

-         Virtually, such fluctuations arose because of speculative transactions and so important for speculators only.

-         Hence, no decision can be based on these movements. Therefore, the statement is not correct.
JUNE -2004




1.      “A high EPS may not always maximize the stock price.” Do you agree? Discuss.

·        The statement is true due to following reasons:

·        EPS may be high due to profit maximization, which itself is not a sure shot for a high stock price.

·        High EPS may be due to financial leverage effect, which increases a firm’s risk prospects of growth rate.

·        If the business prospectus of a company is not good the stock price may not go up in spite of high EPS.

·        The nature of business and the industry in which the company operates also affects the stock price and not the EPS alone.


2.      List out the benefits of issuing bonus shares.

·        Bonus issue is a signal of bright future of a company. It increases the firm’s value.

·        Company utilizes permanently a part of the profit of the company for its businesses without affecting the liquidity.

·        After the bonus issue share price comes down and the share becomes affordable (within the reach) of the investor

·        Bonus shares, are a capital receipt, it is not taxable. It is taxable on sale only.

·        It increases the goodwill of the company.

·        It improves market sentiments.




3.      Stability in payment of dividends has a marked bearing on the market price of the shares of a corporate firm.” Explain the statement.

·        The dividend policy determines the division of earnings between the dividend distribution and reinvestment in the firm.

·        The distribution of earnings between the two depends upon the need of funds internally for reinvestment purposes and expectations of the shareholders.

·        An increase in the dividend leads to a stock price increase while a decreased in dividend results into a stock price decline.

·        An increase in dividend payout is considered by the investors as permanent or long term increase in firm’s expected earnings and considered as good news resulting in an increase in stock price.

·        Fluctuating dividend policy will not create the desired impact over the stock price.

·        Hence, it is said that stability in payment of dividends has a marked bearing on the market price of the shares of a corporate firm.


4.      Describe the responsibility of treasury manager.

·        He is expected to establish the operational systems of the firm to ensure compliance of all statutory and regulatory guidelines. Compliance of tax provisions and payment of all government dues must also be ensured.

·        He should be fair in dealings while playing the supportive role. No undue favour or bias should reflect in his working.

·        In case of system breakdown, during periods of cash crunch and under crisis situation, a treasury manager is expected to exhibit traits of public relationship and networking.

·        He is expected to be honest and straightforward in his dealings.

·        In order to prove true professionalism, the treasury manager is required to update his knowledge as and when developments in his field take place.





5.      If the use of financial leverage magnifies the earnings per share under the   favorable economic conditions, why do companies not employ very large amount of debt in their capital structure?

·        Under favourable economic conditions a company may use financial leverage to magnify the shareholders return.

·        The financial leverage magnifies shareholders return on the assumption that the debt funding can be had a cost lower than the firms rate of return on net assets.

·        The difference of earnings generated on fixed cost funding and cost of such funding when distributed among equity shareholders magnifies their return and thus EPS or ROE increases.

·        There is negative impact of financial leverage if a leverage if a firm fails to earn adequate returns on investment to finance the cost of debt funds.

·        The difference of earnings and cost will have to be compensated by the equity shareholders by reducing their return.

·        That is why, companies do not employ very large amount of debt in their capital structure despite the advantage of financial leverage.

  1. Discuss in brief the factors to be considered while evaluating the technical feasibility of a project.

·        To protect firm from possibility of obsolescence of technology adopted, proper evaluation of available technology, use of plant and machinery to be used, must be made carefully.

·        Scale of operation plays an important role in the operations of a firm economically

·        While evaluating the technical viability of a project minimum level of scale of operations must be ensured to gain economy in operation.

·        Location should be properly evaluated

·        Credibility and experience of supplier has to evaluated carefully

·        Evaluation of the layout of the plant at the location site.

·        Power source

·        Transport facilities

·        Know how and training of workers

·        Realistic assessment of the construction schedule.

7.      Discuss in brief the attributes of debt securitisation.

·        Debt securitisation is a method of recycling of funds

·        It is especially beneficial to financial intermediaries to support the lending volumes.

·        Functions of securitisation process:
-         The origination function
-         The pooling function
-         The securitization function
Benefits of securitisation:

-         Off balance sheet funding

-         Conversion of liquid assets into liquid portfolio

-         Better balance sheet management

-         Enhancement in originators credit rating

-         Opening of new investment avenues for investors

-         As against factoring or bill discounting securitisation helps in converting the stream of cash receivables into a source of long-term finance.