FM - Indicative (not Exhaustive) List of Questions for Viva

An Overview of Financial Management

1. What is the basic purpose of any business organisation?

To earn profits.

2. What is the difference between Finance and Accounting?

Finance covers all aspects of the company’ day-to-day running of the business.
Accounting is the process of recording all transactions/ book-keeping.

3. What is the significance of Investment/ Financing/ Dividend decisions?

Investment decisions - help the firm to know the current and future investments and
how much profitable these may be for the firm’s survival in the market.
Financing decision - are the decisions taken by the management regarding the
various sources of finances from which the firm will raise its capital.
Dividend decisions - are the ones that help the management decide whether to pay
dividend, how much is to be paid and whether it could be ploughed back into
business instead of being paid out.

4. What is the difference between Intrinsic Value and Market Value of a share?
Intrinsic value is the face value of the shares of a company.
Market value is the value of the share in the share market which may fluctuate
according to the company’s performance during a particular period of time.

5. Provide examples of conflicts between the interests of managers and

shareholders. How can these be resolved?
The managers may decide to reinvest the entire profits into the business, but the
shareholders may want dividends.
This could be solved through a compromise (some part as dividends and the
remaining to be reinvested), as paying the shareholder’s their dividends is an ethical
way of doing business in return for using their capital. The ultimate decision rests in
the hands of the company’s management.
6. Provide examples of conflicts between the interests of bond holders and
shareholders. How can these be resolved?
Shareholders may/may not take part in the business decisions of the firm as they’re
the owners of the company.
Bondholders are however investors without the right of taking any business
decisions. This could create a conflict in case the business decisions taken by the
shareholders are not in favour of the bondholders.

7. Why do firms offer stock options in addition to cash compensation to senior

executives?
Stock options essentially pay for themselves by motivating employees to increase
the value of the business and thus generate their own financial reward. This brings a
sense of responsibility among the senior executives.

8. What are agency costs? How can these be minimised?

An agency cost is a type of internal company expense, which comes from the
actions of an agent acting on behalf of a principal. Agency costs typically arise in the
wake of core inefficiencies, dissatisfactions, and disruptions, such as conflicts of
interest between shareholders and management.

9. When Reliance sponsors a mega cricket match by spending 200 crores, how does
it affect the stock price of Reliance?
The stock prices will boom in such a case as the investors will believe that the firm is
doing well in the market and is thus able to invest such a huge sum into sponsoring a
cricket match.

10. What is the difference between Profit and Wealth?

Profit is earned in the due course of the business and is short-term in nature.
Wealth is usually gained over a long period of time.

Time Value of Money

1. Why is a cash inflow of Rs 100 today more valuable than that of Rs 100 a year
later?
Money value fluctuates over time: ₹100 today has a different value than $100 in five
years. This is because one can invest ₹100 today in an interest-bearing bank
account or any other investment, and that money will grow/shrink due to the rate of
return.

2. What is the difference between simple and compound rate of interest?

Interest at a simple rate is calculated annually (or as the case may be) every year
and the principal amount (on which the interest is calculated) remains constant every
year.
Interest at a compounded rate bears “interest on interest”, i.e., the principal amount
and the interest of the current year becomes the principal amount for the next year
and so on.

3. What is the difference between stated annual rate and effective annual rate?
The stated annual rate describes an annualized rate of interest that does not take
into account the effect of intra-year compounding. Effective annual rates do account
for intra-year compounding of interest.

4. How can cash flows occurring in different periods be compared?

Through a table or schedule showing the cash flows during the periods specified.

5. What is the formula for calculating FV in case of continuous compounding?

FV = PV (1+r)n

6. What is the difference between annuity and annuity due?

Annuity due has payments made at the beginning of the period.
Ordinary annuity payments are always made at the end of the period.

7. How do you value any financial asset that has future cash flows?
We can calculate it’s present value through the formula PV = FV/(1+r)n and
alternatively also create a schedule/table to show each period’s cash flows.

8. How do you decide the discount rate to be used for discounting future cash flows?
DCF analysis finds the present value of expected future cash flows using a discount
rate. Investors can use the concept of the present value of money to determine
whether future cash flows of an investment or project are equal to or greater than the
value of the initial investment.

9. Where would Time Value of Money concepts find application in your life?
Before investing in a Fixed deposit/mutual funds or shares. The alternative with the
highest future value (provided that I’m willing to take up the risk associated with it)
will help me in taking these decisions.

10. How do you develop an amortisation schedule for any loan?

By calculating the monthly value of repayment through the given interest rate. Once
the amounts are known, they can be put into a schedule for further analysis as per
the user’s needs.

Cost of Capital
1. What is WACC? How is it calculated?
WACC stands for weighted average cost of capital. The weighted average cost of
capital (WACC) is the rate that a company is expected to pay on average to all its
security holders to finance its assets.
It is calculated by taking the weights of all the sources of capital with respect to the
total capital of the company and multiplying each with the after-tax cost of the
respective sources.

2. How is cost of equity estimated?

It is commonly computed using the capital asset pricing model formula: Cost of
equity = Risk free rate of return + Premium expected for risk. Cost of equity = Risk
free rate of return + Beta × (market rate of return – risk free rate of return).

3. What is DDM/ DCF method for estimating cost of equity?

DDM - Dividend discount model. P = D1/(r - g), where r= cost of equity, g = growth
rate.
DCF - Discounted cash flow. DCF analysis attempts to figure out the value of an
investment today, based on projections of how much money it will generate in the
future.
4. What is CAPM?
The Capital Asset Pricing Model (CAPM) describes the relationship between
systematic risk and expected return for assets, particularly stocks. CAPM is widely
used throughout finance for pricing risky securities and generating expected returns
for assets given the risk of those assets and cost of capital.

5. What is the significance of beta?

Beta signifies the sensitivity of the market in the CAPM model.

6. How is cost of preferred stock estimated?

Cost of preferred stock is the rate of return required by holders of a company's
preferred stock. It is calculated by dividing the annual preferred dividend payment by
the preferred stock's current market price.

7. What is the difference between Yield to Maturity and Coupon Rate?

A bond's coupon rate is the actual amount of interest income earned on the bond
each year based on its face value.
A bond's yield to maturity (YTM) is the estimated rate of return based on the
assumption it is held until maturity date and not called.

8. Equity shareholders are taxed twice. Comment.

The shareholders pay taxes first as owners of a company that brings in earnings and
then again as individuals, who must pay income taxes on their own personal
dividend earnings.
The second taxation occurs when the shareholders receive the dividends, which
come from the company's after-tax earnings.

9. Should one use book values or market values while calculating WACC?
The market value weights are appropriate compared to book value weights. Hence,
historical market value weights should be used for calculation of WACC.

10. Is there any cost of equity involved in case of proprietorship if the proprietor
contributes all the capital himself/ herself?
Yes, an opportunity cost is involved wherein the proprietor could have invested the
money elsewhere and earned an income instead of doing business with it.
 Capital Budgeting

1. Which is the best criteria for evaluating Capital Budgeting projects?

The IRR method is preferred for evaluating capital budgeting projects.

2. How does one decide when there is a conflict between NPV and IRR?
In such a case IRR must be considered since it gives the internally calculated value
of the capital.

3. What is the difference between IRR and MIRR? Which one should be preferred?
IRR is the discount amount for investment that corresponds between initial capital
outlay and the present value of predicted cash flows. MIRR is the price in the
investment plan that equalizes the latest value of cash inflow to the first cash outflow.
MIRR delineates better profit as compared to the IRR, because of two major
reasons, i.e. firstly, reinvestment of the cash flows at the cost of capital is practically
possible, and secondly, multiple rates of return don't exist in the case of MIRR.

4. What is the difference between Payback Period and Discounted Payback Period?
The payback period is the number of years necessary to recover funds invested in a
project. When calculating the payback period, we don't take time value of money into
account.
The discounted payback period is the number of years after which the cumulative
discounted cash inflows cover the initial investment.

5. How does cost of capital impact the attractiveness of a project?

The lesser the cost of capital is, the more viable it will be for a firm’s business as it
will have to repay less for borrowing it in the first place.

6. Under what circumstances would firms like to give importance to the criteria of
Payback Period?
The payback period is the number of years necessary to recover funds invested in a
project. Thus, when the firm wants to know how long a particular source will be
locked in for investment, it may consider using PBP.
7. Project P is very risky and has an NPV of $5 million. Project R is very safe and
has an NPV of $4.5 million. Which project should be chosen? Why?
Project P as it has a higher NPV. The risk involved is a part of borrowing any form of
capital. In such a case, the decision rests in the hands of the user who may/may not
be willing to take the risk.

8. Under what conditions would a project have multiple IRRs?

When cash flows of a project change sign more than once, there will be multiple
IRRs; in these cases, NPV is the preferred measure.

9. What is the difference between independent and mutually exclusive projects?

Projects are independent if the cash flows of one are not affected by the acceptance
of the other.
Conversely, two projects are mutually exclusive if acceptance of one impact
adversely the cash flows of the other; that is, at most one of two or more such
projects may be accepted.

10. How does one decide the discount rate to be used in calculation of NPV? Is it
same as WACC?
It's the rate of return that the investors expect or the cost of borrowing money. If
shareholders expect a 12% return, that is the discount rate the company will use to
calculate NPV. If the firm pays 4% interest on its debt, then it may use that figure as
the discount rate.
The discount rate is the interest rate used to calculate the present value of future
cash flows from a project or investment.
Many companies calculate their WACC and use it as their discount rate when
budgeting for a new project.