![Fundamentals of Financial Management Solved Question Paper 2021 PDF [Gauahti University B.Com 5th Sem]](https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_6Hj-R6zyGBfpAVxzDxU7sQz3dzRXxbMH91a317JjtR7GVhBhhrcnAmx-No2bVMEZf5h6KIz-RRb1zNGxJZUmuoTr4fEbXNc24ptL0FPUGZE8pUf0_FocT2-wDiscZfhCeyEEUritznqMGbsv1KL8pfCYrfzVQzTT6atklPuO6bIxlwyeZaCCGZQbbqQg/s1280/gu%20Fundamentals%20of%20Financial%20Management%20Solved%20Paper%202021%20Gauhati%20University,%20Bcom%20GU%20Fundamentals%20of%20Fina...cial%20Management%20solved%20paper%202021%20held%20in%202022%20,%20Gauhati%20University%20Bcom%205th%20Sem%20previous%20year%20solved%20question%20paper%202021.webp "Fundamentals of Financial Management Solved Question Paper 2021 PDF [Gauahti University B.Com 5th Sem]")
In this post we have Shared Gauhati University Fundamentals of Financial Management Question Paper Solution 2021 (Held in 2022) Pdf, B.Com 5th Sem GU, Which can be very beneficial for your upcoming exam preparation. So read this post from top to bottom and get familiar with the question paper solution .
Fundamentals of Financial Management Solved Question Paper
2021(Held in 2022)
Gauhati University B.Com 5th Sem CBCS Pattern
2021 (Held in 2022)
COMMERCE (Honours)
Paper: COM-HC-5026
(Fundamentals of Financial Management)
Full Marks: 80
Time: Three hours
The figures in the margin indicate full marks for the questions.
1. (A) Choose the correct option of the following: 1x5=5
(1) Which of the following is a part of financial decision-making?
(a) Investment decision.
(b) Financing decision.
(c) Dividend decision.
(d) All of the above.
(2) Capital budgeting is a part of
(a) Investment decision.
(b) Working capital management.
(c) Capital structure.
(d) Dividend decision.
(3) Cost of capital refers to
(a) Floatation cost.
(b) Dividend.
(c) Minimum required rate of return.
(d) None of the above.
(4) The working capital ratio is
(a) Working capital/sales.
(b) Working capital/total assets.
(c) Current assets/current liabilities.
(d) Current assets/sales.
(5) The long-term objective of financial management is to
(a) Maximize earning per share.
(b) Maximize the value of the firm’s common stock.
(c) Maximize return on investment.
(d) Maximize market share.
(B) Write whether the following statements are True or False: 1x5=5
(1) Profit maximization ignores risk and uncertainty. (True)
(2) The value of a share is equal to the present value of its expected future dividend. (True)
(3) The NPV method does not consider the time value of money. (False)
(4) Retained earnings do not involve any cost. (False)
(5) Gross working capital means total current assets. (True)
2. Answer the following questions: 2x5=10
(a) What is financial management?
Ans:- Financial management is the process of planning, organizing, controlling, and monitoring a company's financial resources to achieve its objectives. It involves making decisions about acquiring and utilizing funds, budgeting, investing, and managing financial risks.
(b) What is dividend?
Ans:- Dividend is a distribution of a portion of a company's earnings to its shareholders. It is typically paid in the form of cash or additional shares of stock, serving as a reward to investors for their ownership in the company.
(c) What is internal rate of return?
Ans:- Internal rate of return (IRR) is a financial metric used to evaluate the potential profitability of an investment or project. It represents the discount rate at which the net present value (NPV) of future cash flows equals zero, indicating the project's expected rate of return.
(d) What is marginal cost?
Ans:- Marginal cost is the additional cost incurred by producing one more unit of a product or providing one more unit of a service. It helps businesses make decisions regarding production levels, pricing strategies, and resource allocation to optimize profitability.
(e) What is leverage?
Ans:- Leverage involves using borrowed funds or debt to amplify potential returns on an investment or business operation. While it can enhance profitability, it also increases the risk of financial losses, making it a critical aspect of financial decision-making and risk management.
3. Answer any four from the following questions: 5x4=20
(a) Write a brief note on valuation of equity shares.
Ans:- Valuation of Equity Shares:
Valuation of equity shares refers to the process of determining the fair market value or intrinsic worth of a company's common stock. It is crucial for both investors and companies. There are several methods used for valuing equity shares, including:
1. Market Price Method: This method simply involves determining the current market price of the company's shares in the stock market. It is based on the principle of supply and demand.
2. Earnings Valuation Method (Price-Earnings Ratio): This method involves calculating the price-earnings (P/E) ratio of the company by dividing the market price per share by the earnings per share (EPS). A higher P/E ratio typically indicates higher growth prospects.
3. Dividend Discount Model (DDM): DDM calculates the present value of all expected future dividends to be received from the company's shares. It assumes that dividends will grow at a constant rate.
4. Asset-Based Valuation: This method involves valuing the company based on its net assets, which include tangible assets like property and equipment, as well as intangible assets like patents and trademarks.
5. Comparative Valuation (Relative Valuation): This method compares the company's valuation metrics (such as P/E ratio or price-to-book ratio) to those of similar companies in the same industry.
(b) Explain various types of dividend.
Ans:- Various Types of Dividend:
Dividends are payments made by a corporation to its shareholders out of its profits. There are several types of dividends:
1. Cash Dividend: This is the most common type of dividend, where shareholders receive cash payments based on the number of shares they own. It provides liquidity to investors.
2. Stock Dividend: Instead of cash, shareholders receive additional shares of stock. This does not affect the company's cash position but dilutes the ownership of existing shareholders.
3. Property Dividend: Shareholders receive assets or property of the company, such as bonds or other securities, instead of cash. This type of dividend is less common.
4. Scrip Dividend: Similar to a stock dividend, shareholders receive a certificate or script representing the right to obtain additional shares at a future date.
5. Liquidating Dividend: This occurs when a company decides to distribute assets to shareholders after winding down its operations or selling off its assets. It is usually a one-time payment.
(c) What is optimum capital structure? Explain.
Ans:- Optimum Capital Structure:
The optimum capital structure refers to the ideal mix of debt and equity financing that a company should maintain to maximize its value and minimize its cost of capital. Achieving the right balance between debt and equity is essential because it impacts a company's risk, cost of capital, and financial stability. Here are some key points:
1. Debt: Using debt can provide tax advantages due to interest deductions, but it increases financial risk and can lead to bankruptcy if not managed properly.
2. Equity: Relying more on equity financing results in lower financial risk but can be costly as shareholders expect a return on their investments.
3. Trade-Off Theory: The optimal capital structure involves finding a balance between the benefits of debt (interest tax shield) and the costs (financial distress, bankruptcy risk).
4. Pecking Order Theory: This theory suggests that companies prefer internal financing (retained earnings) first, followed by debt and then equity issuance, in that order.
5. Modigliani-Miller Theorem: In a perfect world with no taxes or financial distress costs, the capital structure is irrelevant to a firm's value.
(d) State the advantages and disadvantages of pay-back period method.
Ans:- Advantages and Disadvantages of Payback Period Method:
Advantages:
1. Simplicity: The payback period is a straightforward and easy-to-understand method for evaluating investment projects. It calculates the time it takes to recoup the initial investment.
2. Liquidity Focus: It provides a focus on the recovery of the initial investment, which is important for companies with limited liquidity or those looking for quick returns.
3. Risk Assessment: The payback period method implicitly considers the risk associated with an investment by emphasizing early cash flows. Shorter payback periods are often associated with lower risk.
4. Benchmarking: It can be used as a benchmark for comparing different investment opportunities, especially when the objective is to recover the initial investment quickly.
Disadvantages:
1. Ignores Profitability: The payback period does not take into account the profitability of an investment beyond the payback period. It neglects the time value of money, making it less useful for comparing projects with different cash flow patterns.
2. Arbitrary Cutoff: The method relies on an arbitrary cutoff point (e.g., a predetermined payback period) to make investment decisions, which may not consider the long-term benefits of a project.
3. Ignores Cash Flow Timing: It doesn't consider the timing of cash flows beyond the payback period, which may lead to misleading investment decisions, especially for projects with uneven cash flows.
4. Limited for Complex Projects: It is less suitable for evaluating complex projects with multiple cash inflows and outflows, as it oversimplifies the analysis.
(e) Explain the main objective of inventory management.
Ans:- Main Objective of Inventory Management:
The main objective of inventory management is to strike a balance between ensuring an uninterrupted supply of products or materials and minimizing the costs associated with holding excess inventory. The specific objectives of inventory management include:
1. Ensuring Adequate Supply: Inventory management aims to ensure that a business has enough stock on hand to meet customer demand and production requirements without experiencing stockouts or disruptions in operations.
2. Minimizing Holding Costs: It seeks to minimize the costs associated with holding inventory, such as warehousing costs, storage costs, insurance, and the opportunity cost of tying up capital in inventory.
3. Optimizing Ordering and Reordering: Inventory management involves determining the optimal order quantities and reorder points to minimize costs while maintaining adequate stock levels. This includes managing economic order quantities (EOQ) and safety stock levels.
4. Reducing Obsolescence and Spoilage: Efficient inventory management helps in reducing the risk of inventory becoming obsolete or spoiling, which can lead to financial losses.
5. Minimizing Stockouts: Inventory management aims to minimize the occurrence of stockouts, as they can lead to lost sales, dissatisfied customers, and production delays.
6. Increasing Asset Turnover: By effectively managing inventory, a business can improve its asset turnover ratio, which measures how efficiently assets, including inventory, are used to generate sales revenue.
7. Enhancing Profitability: Ultimately, the objective of inventory management is to enhance profitability by ensuring that the right amount of inventory is available at the right time to support sales and production while minimizing associated costs.
(f) Explain the main tools of cash planning and control.
Ans:- Main Tools of Cash Planning and Control:
Cash planning and control are crucial for ensuring that a business has enough cash on hand to meet its short-term financial obligations while efficiently managing its cash resources. The main tools of cash planning and control include:
1. Cash Budget: A cash budget is a detailed projection of a company's expected cash inflows and outflows over a specific period, typically on a monthly or quarterly basis. It helps in anticipating cash surpluses and deficits, allowing the business to plan accordingly.
2. Cash Flow Statement: A cash flow statement provides an overview of a company's cash inflows and outflows during a specific accounting period. It helps in identifying the sources and uses of cash, allowing for better cash management.
3. Receivables Management: Managing accounts receivable effectively by implementing credit policies, monitoring customer payments, and pursuing collections can improve cash flow by accelerating cash receipts.
4. Payables Management: Efficiently managing accounts payable by negotiating favorable payment terms with suppliers and paying invoices strategically can help extend payment periods, preserving cash.
5. Inventory Management: As mentioned earlier, optimizing inventory levels can free up cash that would otherwise be tied up in excess inventory.
6. Short-Term Financing: Utilizing short-term financing options such as lines of credit, overdraft facilities, or factoring can help bridge temporary cash shortfalls.
7. Expense Management: Controlling operating expenses and discretionary spending can help conserve cash and improve cash flow.
8. Cash Flow Forecasting: Regularly forecasting cash flows based on current and expected financial data helps in anticipating cash needs and taking proactive measures to address them.
9. Working Capital Management: Efficiently managing working capital by optimizing the balance between current assets (e.g., cash, accounts receivable, inventory) and current liabilities (e.g., accounts payable) is essential for maintaining healthy cash flow.
10. Investment Policies: Developing investment policies for excess cash can ensure that idle cash is earning a return, rather than sitting idle and losing value due to inflation.
4. Explain the characteristics of financial management. Describe the goals of financial management. 4+6=10
Ans:- Financial management is a critical aspect of running a successful organization, whether it's a business, government agency, or non-profit organization. It involves planning, organizing, controlling, and monitoring an entity's financial resources to achieve its goals and objectives efficiently and effectively. Here are some key characteristics of financial management:
1. Planning: Financial management starts with setting financial goals and objectives. This involves forecasting future financial needs, creating budgets, and developing financial plans to achieve the organization's goals.
2. Organizing: This characteristic involves arranging the necessary financial resources, such as capital, funds, and assets, to meet the organization's financial requirements. It also includes creating an organizational structure for financial operations.
3. Controlling: Financial management includes monitoring and controlling financial activities to ensure they are in line with the established plans and objectives. This involves tracking expenses, revenue, and other financial metrics and taking corrective actions when necessary.
4. Decision-Making: Financial managers play a crucial role in making financial decisions that impact the organization's financial health. They analyze financial data, assess risks, and make informed choices regarding investments, financing, and other financial matters.
5. Risk Management: Financial management involves identifying and managing financial risks. This includes assessing the organization's exposure to various financial risks, such as market risk, credit risk, and operational risk, and implementing strategies to mitigate them.
6. Optimization: Financial managers aim to optimize the allocation of financial resources to achieve the organization's goals. This involves finding the right balance between risk and return and maximizing the use of available funds.
Following are the goals of financial management:
1. Profit Maximization: In the case of for-profit organizations, the primary goal is often to maximize profits. This means generating as much revenue as possible while minimizing expenses and taxes. Profitability ensures the sustainability and growth of the business.
2. Wealth Maximization: This goal is closely related to profit maximization but takes into account the time value of money. It aims to increase the long-term value of the organization by making decisions that maximize the wealth of shareholders, including the value of their investments and dividends received.
3. Risk Management: Financial management also focuses on minimizing financial risks to ensure the stability and continuity of the organization. This includes protecting the organization from potential financial losses due to factors like market fluctuations, economic downturns, and credit issues.
4. Liquidity Management: Maintaining an appropriate level of liquidity is essential to meet short-term financial obligations. Financial managers must ensure that the organization has enough cash and liquid assets to cover operational expenses, debts, and emergencies.
5. Cost Control: Effective financial management aims to control costs and expenses to enhance profitability. This involves optimizing operational efficiency, reducing wastage, and managing overhead expenses.
6. Capital Budgeting: Financial managers must make wise investment decisions, selecting projects and assets that provide the best return on investment (ROI) and align with the organization's strategic objectives.
7. Stakeholder Value: Beyond shareholders, financial management also considers the interests of other stakeholders, such as customers, employees, creditors, and the community. It seeks to create value for these groups through responsible financial practices.
Or
Discuss the various factors that affect bond value. Also explain the steps in bond valuation. 5+5=10
Ans:- Factors Affecting Bond Value:
Bond value, also known as bond price or bond market price, is influenced by several factors:
a. Interest Rate Movements: Bond prices have an inverse relationship with interest rates. When interest rates rise, the value of existing bonds decreases, and vice versa. This is because investors demand higher yields on new bonds to compensate for the higher prevailing interest rates.
b. Maturity Date: The time to maturity affects bond value. Generally, longer-term bonds are more sensitive to interest rate changes than shorter-term bonds. This is known as interest rate risk or duration risk.
c. Credit Quality: The creditworthiness of the issuer impacts bond value. Bonds from issuers with higher credit ratings are more valuable because they carry lower default risk. Conversely, bonds from riskier issuers have lower values and higher yields to compensate for the added risk.
d. Coupon Rate: The coupon rate, or the interest rate the bond pays, also affects its value. If a bond's coupon rate is lower than prevailing market interest rates, it will trade at a discount. Conversely, if the coupon rate is higher, the bond may trade at a premium.
e. Call Provisions: Bonds with call provisions give the issuer the option to redeem the bond before maturity. This can impact bond value, as investors may receive the principal earlier than expected.
f. Economic Conditions: Economic factors like inflation, economic growth, and overall market conditions can influence bond prices. Inflation erodes the purchasing power of future bond payments, making bonds less valuable during inflationary periods.
Steps in Bond Valuation:
Bond valuation is the process of determining the intrinsic value of a bond. The key steps involved in bond valuation are as follows:
a. Gather Information: Collect all necessary information about the bond, including its coupon rate, par value, maturity date, and any other relevant features such as call provisions or sinking funds.
b. Estimate Future Cash Flows: Calculate the expected future cash flows from the bond, which include periodic coupon payments and the principal repayment at maturity. These cash flows are typically discounted to their present value using a discount rate.
c. Determine Discount Rate: The discount rate used in bond valuation is usually the current market interest rate for bonds with similar risk profiles. This rate is also known as the required rate of return or yield to maturity (YTM).
d. Calculate Present Value: Discount all the expected future cash flows back to their present value using the determined discount rate. The sum of these present values represents the intrinsic value of the bond.
e. Compare to Market Price: Compare the calculated intrinsic value to the current market price of the bond. If the intrinsic value is higher than the market price, the bond may be undervalued and potentially a good investment. If it's lower, the bond may be overvalued.
f. Make Investment Decision: Based on the comparison, decide whether to buy, sell, or hold the bond. Investors should consider their investment goals, risk tolerance, and market conditions when making this decision.
5. Define capital budgeting. Discuss the capital budgeting process. 2+8=10
Ans:- Capital Budgeting:
Capital budgeting is the process of evaluating and selecting long-term investment projects or expenditures that will significantly impact a company's financial performance. It involves determining which projects or investments are worth pursuing based on their potential to generate future cash flows and contribute to the organization's overall objectives.
The capital budgeting process typically includes the following steps:
a. Project Identification: Identify and evaluate potential investment opportunities, which can include projects such as acquiring new assets, expanding operations, launching new products, or entering new markets.
b. Project Evaluation: Assess the financial feasibility of each investment opportunity by estimating the expected cash flows over the project's life, considering factors like revenues, expenses, and capital costs. Common techniques for evaluation include net present value (NPV), internal rate of return (IRR), payback period, and profitability index.
c. Risk Analysis: Evaluate the risks associated with each project, including market risks, operational risks, and financial risks. Understanding and quantifying these risks helps in making informed investment decisions.
d. Capital Allocation: Determine the available budget for capital investments and allocate it among the selected projects based on their expected returns, risk profiles, and alignment with the company's strategic goals.
e. Implementation: Once projects are approved, proceed with their implementation, which may involve securing financing, managing resources, and overseeing project execution.
f. Monitoring and Review: Continuously monitor the progress and performance of the projects and make necessary adjustments to ensure they meet their expected financial targets and strategic objectives.
g. Post-Implementation Review: After a project is completed, conduct a post-implementation review to assess whether the expected benefits and returns were realized. This feedback informs future capital budgeting decisions.
Bond value is influenced by interest rates, maturity, credit quality, coupon rate, call provisions, and economic conditions. Bond valuation involves estimating future cash flows, determining a discount rate, and calculating the present value of those cash flows. Capital budgeting is the process of evaluating and selecting long-term investment projects, and it includes steps such as project identification, evaluation, risk analysis, capital allocation, implementation, and ongoing monitoring and review.
Or
A company has to select one of the two alternative projects whose particulars are given below:
The company can arrange necessary fund at 8%. Compute NPV of each project and comment on results. 10
[The PV factor of Re. 1 received at the end of 1st year is 0.926, 2nd year is 0.857, 3rd year is 0.794 and 4th year is 0.735]
Ans:-
![Fundamentals of Financial Management Solved Question Paper 2021 PDF [Gauahti University B.Com 5th Sem]](https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-l5r9OoIOXA18avZPSz_YRpoL1MQctlR5Uw0yY2izQbMO0XI-GNtIRIZ_tkkvkSZlj-JFjAx9bBCsjhXTnhTMd43oryl8Wc0eESr9kE_r0yrHp-oYZC1fpQKnhNKwhD-O6-aT9BJc8a4ThH5hgknHhoWLn4WybL7_h05SK5Y4KqsHXEtxhqL1i_JbX70K/s1267/gu%20Fundamentals%20of%20Financial%20Management%20Solved%20Paper%202021%20Gauhati%20University,%20Bcom%20GU%20Fundamentals%20of%20Fina...cial%20Management%20solved%20paper%202021%20held%20in%202022%20,%20Gauhati%20University%20Bcom%205th%20Sem%20previous%20year%20solved%20question%20paper%202021%20(1).webp "Fundamentals of Financial Management Solved Question Paper 2021 PDF [Gauahti University B.Com 5th Sem]")
6. Explain the concept of cost of capital. Also explain the methods for calculating cost of capital. 2+8=10
Ans:- Cost of capital is a fundamental financial concept that represents the cost a company incurs to raise funds for its operations and investments. It is the rate of return that an investor or lender expects to receive for providing capital to a company. In essence, it is the price a company pays for using external funds to finance its projects and activities. Understanding the cost of capital is crucial for making informed financial decisions and evaluating the profitability of potential investments.
There are several methods for calculating the cost of capital, with the most commonly used ones being:
1. Cost of Debt (Kd): This represents the cost associated with raising funds through debt instruments, such as loans, bonds, or other forms of borrowing. It can be calculated using the following formula:
Kd = \frac{I \cdot (1 - T)}{P}
Where:
- Kd = Cost of debt
- I = Annual interest expense
- T = Tax rate
- PA = Principal amount of debt
The cost of debt is usually the yield to maturity (YTM) of a company's outstanding debt.
2. Cost of Equity (Ke): This represents the return expected by the company's equity shareholders, such as common stockholders. The most common method for calculating the cost of equity is the Capital Asset Pricing Model (CAPM), which is expressed as:
Ke = Rf + (Rm - Rf) \cdot \beta
Where:
- Ke = Cost of equity
- Rf = Risk-free rate (e.g., government bond yield)
- Rm = Market return rate
- \beta = Beta coefficient of the company's stock (a measure of its systematic risk)
The CAPM reflects the relationship between a company's expected return, the risk-free rate, and its systematic risk relative to the market.
3. Weighted Average Cost of Capital (WACC): WACC is the average cost of all the sources of capital a company uses, taking into account their respective weights in the company's capital structure. The formula for WACC is:
WACC = (Wd \cdot Kd) + (We \cdot Ke)
Where:
- WACC = Weighted Average Cost of Capital
- Wd = Weight of debt in the capital structure
- Kd = Cost of debt
- We = Weight of equity in the capital structure
- Ke = Cost of equity
The weights (Wd and We) represent the proportion of debt and equity in the company's capital structure.
4. Cost of Preferred Stock (Kp): If a company has preferred stock, its cost can be calculated by dividing the preferred dividend by the net preferred stock price (preferred stock price minus flotation costs).
Kp = \frac{Dp}{Pp - Fp}
Where:
- Kp = Cost of preferred stock
- Dp = Preferred dividend
- Pp = Preferred stock price
- Fp = Flotation costs
By calculating the cost of debt, cost of equity, and other components of a company's capital structure, and then combining them using the WACC formula, a company can determine the overall cost of capital. This cost serves as a benchmark for evaluating potential investments and projects, as any project or investment should ideally generate returns that exceed the company's cost of capital to create value for its shareholders.
Or
a) A company plans to issue 1,000 new shares of Rs. 100 each at par. The floatation costs are expected to be 5% of the share price. The company pays a dividend of Rs. 10 per share initially and the growth in dividends is expected to be 5%. Compute the cost of new issue of equity shares. 5
Ans:- To compute the cost of the new issue of equity shares, we need to take into account the cost of issuing the shares, which includes the floatation costs, and the cost of dividends to the shareholders. The cost of issuing new equity shares can be calculated using the following formula:
Cost of New Issue of Equity Shares = [(D1 / (P0 - F)) + g]
Where:
- D1 = Expected Dividend per Share after one year
- P0 = Net Proceeds per Share (Issue Price - Floatation Costs)
- F = Floatation Costs
- g = Expected Growth Rate of Dividends
Given the information:
- D1 (Expected Dividend per Share after one year) = Rs. 10 (initial dividend) * (1 + 5%) = Rs. 10 * 1.05 = Rs. 10.50
- P0 (Net Proceeds per Share) = Rs. 100 (Par Value) - 5% of Rs. 100 (Floatation Costs) = Rs. 100 - Rs. 5 = Rs. 95
- F (Floatation Costs) = 5% of Rs. 100 = Rs. 5
- g (Expected Growth Rate of Dividends) = 5%
Now, plug these values into the formula:
Cost of New Issue of Equity Shares = [(10.50 / (95 - 5)) + 0.05]
Cost of New Issue of Equity Shares = [(10.50 / 90) + 0.05]
Cost of New Issue of Equity Shares ≈ (0.1167 + 0.05)
Cost of New Issue of Equity Shares ≈ 0.1667 or 16.67%
So, the cost of the new issue of equity shares is approximately 16.67%.
b) Distinguish between operating leverage and financial leverage. 5
Ans:-
7. State the meaning of dividend policy. Explain the Modigliani and Miller hypothesis of dividend decision. 2+8=10
Ans:- Meaning of Dividend Policy: A policy which determines the amount of earnings to be distributed to the shareholders and the amount to be retained in the company as retained earnings, is called dividend policy. In short, dividend policy determines the division of earnings between payment to shareholders and retained earnings.
Modigliani and Miller approach (M & M Hypothesis)
The residuals theory of dividends tends to imply that the dividends are irrelevant and the value of the firm is independent of its dividend policy. The irrelevance of dividend policy for a valuation of the firm has been most comprehensively presented by Modigliani and Miller. They have argued that the market price of a share is affected by the earnings of the firm and not influenced by the pattern of income distribution. What matters, on the other hand, are the investment decisions which determine the earnings of the firm and thus affect the value of the firm. They argue that subject to a number of assumptions, the way a firm splits its earnings between dividends and retained earnings has no effect on the value of the firm.
Like several financial theories, M&M hypothesis is based on the argument of efficient capital markets. In addition, there are two options:
(a) It retains earnings and finances its new investment plans with such retained earnings;
(b) It distributes dividends, and finances its new investment plans by issuing new shares.
The intuitive background of the M&M approach is extremely simple, and in fact, almost self-explanatory. It is based on the following assumptions:
a) The capital markets are perfect and the investors behave rationally.
b) All information is freely available to all the investors.
c) There is no transaction cost.
d) Securities are divisible and can be split into any fraction. No investor can affect the market price.
e) There are no taxes and no flotation cost.
f) The firm has a defined investment policy and the future profits are known with certainty. The implication is that the investment decisions are unaffected by the dividend decision and the operating cash flows are same no matter which dividend policy is adopted.
Their conclusion is that, the shareholders get the same benefit from dividend as from capital gain through retained earnings. So, the division of earnings into dividend and retained earnings does not influence shareholders' perceptions. So whether dividend is declared or not, and whether high or low payout ratio is follows, it makes no difference on the value of the share. In order to satisfy their model, MM has started with the following valuation model.
P0= 1* (D1+P1)/ (1+ke)
Where,
P0 = Present market price of the share
Ke = Cost of equity share capital
D1 = Expected dividend at the end of year 1
P1 = Expected market price of the share at the end of year 1
With the help of this valuation model we will create an arbitrage process, i.e., replacement of amount paid as dividend by the issue of fresh capital. The arbitrage process involves two simultaneous actions. With reference to dividend policy the two actions are:
a) Payment of dividend by the firm
b) Rising of fresh capital.
With the help of arbitrage process, MM have shown that the dividend payment will not have any effect on the value of the firm. Even if the firm pays dividends, resulting in an increase in market value of the share, the effect on the value of the firm will be neutralized by the decrease in terminal value of the share.
Criticisms on MM Dividend theory: MM theory is criticized on the invalidity of most of its assumptions. Some of the criticisms are presented below:
a) First, perfect capital market is not a reality.
b) Second, transaction and floatation costs do exist.
c) Third, Dividend has a signaling effect. Dividend decision signals financial standing of the business, earnings position of the business, and so on. All these are taken as uncertainty reducers and that these influence share value. So, the stand of MM is not tenable.
d) Fourth, MM assumed that additional shares are issued at the prevailing market price. It is not so. Fresh issues - whether rights or otherwise, are made at prices below the ruling market price.
e) Fifth, taxation of dividend income is not the same as that of capital gain. Dividend income upto Rs. 10000 is fully exempt, whereas capital gain attracts a flat 20% tax in the case of individual assesses. So, investor preferences between dividend and capital gain differ.
f) Sixth, investment decisions are not always rational. Some, sub-marginal projects may be taken up by firms if internally generated funds are available in plenty. This would deflate ROI sooner than later reducing share price.
g) Seventh, investment decisions are tied up with financing decisions. Availability of funds and external constrains might affect investment decisions and rationing of capital, then becomes a relevant issue as it affects the availability of funds.
Or
Explain the concept and determinants of working capital. 2+8=10
Ans:- Working Capital :
Working capital represents the capital a company uses in its day-to-day trading operations, specifically in managing its current assets and liabilities. It is a measure of a company's operational liquidity and its ability to meet its short-term financial obligations. Working capital is calculated as follows:
\[Working\ Capital = Current\ Assets - Current\ Liabilities\]
Concept of Working Capital :
- Positive Working Capital : When a company's current assets exceed its current liabilities, it has positive working capital. This indicates that the company has enough short-term assets to cover its short-term debts and operational expenses.
- Negative Working Capital: If a company's current liabilities are greater than its current assets, it has negative working capital. This situation can indicate financial trouble, as the company may struggle to meet its immediate obligations.
Determinants of Working Capital :
Several factors influence a company's working capital requirements:
a. Nature of the Business : Different industries and businesses have varying working capital needs. For example, a retail business might require higher working capital due to the need to stock inventory, while a service-oriented business may have lower working capital requirements.
b. Seasonality : Businesses with seasonal fluctuations in sales may need to adjust their working capital to accommodate increased demand during peak seasons.
c. Credit Policies: The company's credit policies, including the terms it offers to customers and the terms it receives from suppliers, can impact its working capital.
d. Growth Plans : Expanding businesses may require more working capital to support increased production and sales.
e. Efficiency in Operations : Efficient management of inventory, accounts receivable, and accounts payable can optimize working capital.
f. Economic Conditions : Economic factors, such as inflation and interest rates, can affect a company's working capital requirements.
g. Capital Expenditure: Large capital investments can tie up working capital, reducing liquidity.
-0000-
![Fundamentals of Financial Management Solved Question Paper 2021 PDF [Gauahti University B.Com 5th Sem]](https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgV1qgXm8WLRtEUDLlGZ2PD25f6nA1G7_Pq23iTiF0NIuVuiRRhByhxh4npAH9hmVlMawatoar676bN_ZTzzMV9ZZ0frfF8Ou5jb1jlxTstOU6Iwee8Sdy-P0cIOdPAt0-zUgKCmAwUUrEYSYk81gHx2TNd0N2WsPXPAApaeYiJvvvyd7s2x7P-7qDpgOIv/s800/IMG-20231013-WA0009.jpg "Fundamentals of Financial Management Solved Question Paper 2021 PDF [Gauahti University B.Com 5th Sem]")
Also
Also Visit : Gauhati University BCom 5th Sem Question Papers, Solved Papers, PDF & Notes