NAME – RUDRA MAHESHWARI

ROLL NO – 2314508689
PROGRAM – BBA
SEMESTER – 3
CODE – DBB 2104
COURSE NAME – FINANCIAL MANAGEMENT
ASSIGNMENT SET 1 –
Q1 . a) A company expects to receive Rs 120,000 annually for the next 10 years. If the discount
rate is 15%, what is the present value of this annuity?
b) Describe different sources of long-term financing available to a company

A1. (a) Present Value of Annuity Calculation

The present value of an annuity is calculated using the Present Value of Annuity (PVA)
formula:

PVA=A×(1−1(1+r)n)÷rPVA = A \times \left( 1 - \frac{1}{(1 + r)^n} \right) \div

rPVA=A×(1−(1+r)n1)÷r

Where:

• A=120,000A = 120,000A=120,000 (Annual Cash Inflow)

• r=15%=0.15r = 15\% = 0.15r=15%=0.15 (Discount Rate)
• n=10n = 10n=10 years

Let's calculate:

PVA=120,000×(1−1(1.15)10)÷0.15PVA = 120,000 \times \left( 1 - \frac{1}{(1.15)^{10}}

\right) \div 0.15PVA=120,000×(1−(1.15)101)÷0.15

We will now compute the exact value.

The present value of the annuity is approximately Rs 602,252.24.

(b) Sources of Long-Term Financing Available to a Company

Long-term financing helps businesses fund major investments, expansion, and capital
expenditures. The main sources include:

1. Equity Financing

Companies raise funds by issuing shares to investors.

• Common Shares: Shareholders get ownership rights and dividends.

• Preferred Shares: Fixed dividends but no voting rights.
• Example: A startup issues shares through an Initial Public Offering (IPO) to raise
capital.

2. Debt Financing

Borrowing money that must be repaid with interest.

 • Term Loans: Loans from banks or financial institutions, repaid over time.
• Bonds/Debentures: Companies issue bonds to investors, promising periodic interest
payments.
• Example: A company issues corporate bonds to finance a new factory.

3. Retained Earnings

Profits reinvested in the business instead of being distributed as dividends.

• Example: A company uses past profits to open new branches instead of taking loans.

4. Venture Capital & Private Equity

Funds from investors who provide capital in exchange for equity.

• Example: A tech startup receives investment from a venture capital firm to expand its
business.

5. Government Grants & Subsidies

Governments provide financial support to promote industries and innovation.

• Example: A renewable energy firm receives a government grant to develop solar

power plants.

6. Lease Financing

Companies lease equipment or property instead of purchasing it.

• Example: An airline leases aircraft instead of buying them outright.

Conclusion

A company chooses a financing method based on cost, risk, and financial needs. Equity is
risk-free but dilutes ownership, while debt provides funds without ownership loss but adds
financial liability.

Q2. a) ABC Corporation forecasts an annual EBIT of $300,000. With $800,000 in 8% bonds
and a 10% cost of equity capital, along with a corporate tax rate of 25%, determine the firm's
value.

b) Discuss the advantage of the wealth maximization objective of financial management over
profit maximization.

A2 . (a) Determining the Firm’s Value Using the Net Operating Income (NOI) Approach
According to the Net Operating Income (NOI) approach, the value of a firm is calculated as:
V=EBIT×(1−Tax Rate)Overall Cost of Capital (WACC)V = \frac{EBIT \times (1 - \text{Tax
Rate})}{\text{Overall Cost of Capital
(WACC)}}V=Overall Cost of Capital (WACC)EBIT×(1−Tax Rate)
Step 1: Calculate Net Income After Tax

Given:
• EBIT = $300,000
• Corporate Tax Rate = 25%
Net Operating Income (NOI)=EBIT×(1−Tax Rate)\text{Net Operating Income (NOI)} = EBIT
\times (1 - \text{Tax Rate})Net Operating Income (NOI)=EBIT×(1−Tax Rate)
=300,000×(1−0.25)=300,000×0.75=225,000= 300,000 \times (1 - 0.25) = 300,000 \times 0.75
= 225,000=300,000×(1−0.25)=300,000×0.75=225,000
Step 2: Calculate Weighted Average Cost of Capital (WACC)
WACC=(DV×rd×(1−T))+(EV×re)WACC = \left( \frac{D}{V} \times r_d \times (1 - T) \right)
+ \left( \frac{E}{V} \times r_e \right)WACC=(VD×rd×(1−T))+(VE×re)
Where:
• Debt (D) = $800,000
• Equity (E) = Firm’s Value (V) - Debt (D)
• Cost of Debt (r_d) = 8%
• Cost of Equity (r_e) = 10%
• Corporate Tax Rate (T) = 25%
• Firm Value (V) = To be determined
The corrected firm value is $2,812,500.

(b) Wealth Maximization vs. Profit Maximization

Wealth maximization and profit maximization are two key objectives of financial management.
However, wealth maximization is considered a superior approach.
1. Profit Maximization
Profit maximization focuses on increasing short-term earnings without considering risks or
long-term growth.
• Example: A company may cut costs (e.g., reducing employee salaries) to increase
profits, but this can harm long-term sustainability.
2. Wealth Maximization
Wealth maximization focuses on increasing the overall value of the company and
shareholders’ wealth over the long term.
• Example: A company may invest in research and development, leading to innovation
and future growth.

Advantages of Wealth Maximization Over Profit Maximization

Factors Profit Maximization Wealth Maximization

Time Horizon Short-term focus Long-term sustainability

Risk
Ignores risks Considers risks and returns
Consideration

Value Creation Focuses only on profits Enhances shareholder value

Stakeholder Benefits all stakeholders (employees,

Benefits only owners
Impact customers, investors)

May lead to unethical

Sustainability Encourages ethical business practices
decisions

Conclusion
Wealth maximization ensures sustainable growth, benefiting shareholders, employees, and
society, whereas profit maximization can lead to short-term gains but long-term losses.
Hence, modern businesses prioritize wealth maximization for better financial health.

Q3 . PQR Ltd is evaluating a $250,000 investment project that is anticipated to produce

$60,000 annually for the next four years. With a discount rate of 18%, compute the NPV and
provide a recommendation on the project’s financial viability
A3 . Net Present Value (NPV) Calculation
NPV is calculated using the formula:
NPV=∑Ct(1+r)t−C0NPV = \sum \frac{C_t}{(1 + r)^t} - C_0NPV=∑(1+r)tCt−C0
Where:
• CtC_tCt = Cash inflow in each year ($60,000)
• rrr = Discount rate (18% or 0.18)
• ttt = Year (1 to 4)
• C0C_0C0 = Initial investment ($250,000)
Let’s calculate the NPV.
The computed NPV is -$88,596.29, which is negative.
Recommendation
Since the NPV is negative, the project would result in a financial loss. PQR Ltd should not
proceed with this investment, as it would not generate sufficient returns to cover the initial cost
and required rate of return

ASSIGNMENT SET 2 -
Q4 . Calculate the cost of equity for X Ltd, which issued Rs 100 equity shares at a 10%
premium. The expected dividend at year-end is 15%, growing annually at 8%. Also, find the
cost of equity if dividends do not grow.

A4 . The cost of equity (kek_eke) is calculated using the Dividend Discount Model (DDM):

ke=D1P0+gk_e = \frac{D_1}{P_0} + gke=P0D1+g

Where:
• D1D_1D1 = Expected dividend at year-end (15% of Rs 100)
• P0P_0P0 = Current market price of the share (Rs 100 + 10% premium = Rs 110)
• ggg = Growth rate of dividends (8% or 0.08)
Let’s calculate the cost of equity for both scenarios:
1. With dividend growth (g=8%g = 8\%g=8%)
2. Without dividend growth (g=0%g = 0\%g=0%)
Results
1. Cost of Equity with Growth (g=8%g = 8\%g=8%) = 21.64%
2. Cost of Equity without Growth (g=0%g = 0\%g=0%) = 13.64%
Conclusion
• If dividends grow at 8% annually, the cost of equity is 21.64%.
• If dividends remain constant, the cost of equity is 13.64%.
• Higher growth leads to a higher required return for investors

Q5. For X Company, which earns Rs 5 per share, capitalized at 10%, and has an 18% return on
investment:
a) Calculate the share price at a 25% dividend payout ratio using Walter’s model.
b) Determine if this is the optimal payout ratio per Walter’s theory.
A5. Walter’s Dividend Model Formula
Walter’s Model is given by:
P=D+rke(E−D)keP = \frac{D + \frac{r}{k_e} (E - D)}{k_e}P=keD+ker(E−D)
Where:
• PPP = Market price per share
• DDD = Dividend per share (25% of earnings per share)
• EEE = Earnings per share (Rs 5)
• rrr = Return on investment (18% or 0.18)
• kek_eke = Cost of equity (10% or 0.10)
Let’s first calculate the share price.
(a) Share Price Calculation

Using Walter’s Model, the calculated share price is Rs 80.

(b) Is 25% the Optimal Payout Ratio?

Walter’s theory suggests:
• If r>ker > k_er>ke (18% > 10%), the firm should retain earnings as reinvestment
provides a higher return than shareholders' required rate of return. Optimal payout
ratio = 0% (zero dividends).
• If r<ker < k_er<ke, the firm should distribute all earnings as dividends.
Since r>ker > k_er>ke, the company should ideally retain all earnings (0% payout) for
maximum share value, meaning 25% is not the optimal payout ratio.

Q6. Differentiate between:

(a) Gross Working Capital and Net Working Capital.
(b) Permanent Working Capital and Temporary Working Capital.
A6 . (a) Difference Between Gross Working Capital and Net Working Capital

Gross Working Capital

Aspect Net Working Capital (NWC)
(GWC)

Definitio Total current assets of a Difference between current assets and current
n company. liabilities.
 Gross Working Capital
Aspect Net Working Capital (NWC)
(GWC)

GWC=Total Current AssetsGW NWC=Current Assets−Current LiabilitiesNWC

C = \text{Total Current = \text{Current Assets} - \text{Current
Formula
Assets}GWC=Total Current Ass Liabilities}NWC=Current Assets−Current Liabil
ets ities

Measures total funds invested in

Focus Measures the liquidity position of a company.
short-term assets.

The availability of short-term The company’s ability to meet short-term

Indicates
resources. obligations.

Cash, inventory, accounts If current assets = Rs 5 lakh and current liabilities

Example
receivable. = Rs 3 lakh, then NWC = Rs 2 lakh.

(b) Difference Between Permanent Working Capital and Temporary Working Capital

Aspect Permanent Working Capital Temporary Working Capital

Minimum level of working capital Extra working capital needed for

Definition
required for continuous operations. seasonal demands or fluctuations.

Fixed and remains in the business for the Variable and changes as per business
Nature
long term. cycles.

Covers additional demand during peak

Purpose Ensures smooth day-to-day operations.
seasons.

Funded through long-term sources like Funded through short-term sources like
Financing
equity or long-term loans. bank overdrafts.

Minimum stock level maintained Extra inventory needed for a festive

Example
throughout the year. sales rush.

Conclusion
• Gross vs. Net Working Capital: Gross working capital refers to total current assets,
while net working capital reflects financial health.
• Permanent vs. Temporary Working Capital: Permanent WC is essential for
operations, while temporary WC is needed for seasonal or fluctuating demand.
4o