MMPC 014

SOLVED ASSIGNMENT
2022-23
ASSIGNMENT Course Code : MMPC-014 Course Title : Financial Management
Assignment Code : MMPC-014/TMA/JAN/2023 Coverage : All Blocks Note: Attempt
all the questions and submit this assignment to the Coordinator of your study centre.
Last date of submission for January 2023 session is 30th April, 2023 and for July 2023
session is 31st October, 2023.
1. Discuss the concepts of ‘Profit maximisation’ and ‘Wealth maximisation’ and analyse
which concept is superior to be an objective of a Firm.
Ans. The concepts of "profit maximization" and "wealth maximization" refer to two different
objectives that a firm may have.
Profit maximization refers to the idea that a firm should aim to maximize its profits, or the
difference between its total revenue and total costs. Under this objective, a firm may take
actions that increase its profits in the short term, even if those actions negatively impact its
long-term financial performance.
Wealth maximization, on the other hand, refers to the idea that a firm should aim to maximize
the wealth of its shareholders. This objective is broader than profit maximization and
considers not only a firm's current profits, but also its future prospects, the risk of its
investments, and the return on those investments. Under this objective, a firm may make
decisions that may not maximize its profits in the short term, but are expected to increase the
wealth of its shareholders over the long term.
In terms of which concept is superior to be an objective of a firm, wealth maximization is
generally considered to be the superior objective. This is because wealth maximization takes
a more comprehensive and long-term view of a firm's financial performance, rather than
focusing solely on short-term profits. Wealth maximization also considers the interests of all
stakeholders in a firm, including shareholders, employees, customers, and society as a whole.
However, it is important to note that some firms may face constraints that limit their ability to
maximize wealth. For example, a firm may be required to prioritize the interests of certain
stakeholders over others, or it may be subject to regulations that limit its ability to pursue
certain investments.
One key difference between the two concepts is the time horizon they consider. Profit
maximization focuses on maximizing profits in the short term, whereas wealth maximization
takes a long-term view and seeks to increase the value of the firm over time. This longer time
horizon is important because it allows a firm to make investments that may not have an
immediate impact on profits, but are expected to increase the firm's value over the long term.
Another difference between the two concepts is the level of risk that is acceptable. Profit
maximization may lead a firm to take on high-risk investments in order to maximize its
profits, while wealth maximization prioritizes stability and reduces risk by making
investments that are expected to increase the firm's value over time.
Wealth maximization is also more aligned with the interests of shareholders, as it seeks to
increase the value of their investment in the firm. This is because shareholders are interested
in maximizing the long-term value of their investment, not just short-term profits.
It is also worth noting that wealth maximization is a more sustainable objective for a firm, as
it helps to ensure the long-term viability of the firm. This is because wealth maximization
takes into account the interests of all stakeholders and seeks to maintain a balance between
short-term profits and long-term stability.
In conclusion, while profit maximization can be an important objective for a firm in the short
term, wealth maximization is generally considered to be the superior objective because it
takes a more comprehensive and long-term view of a firm's financial performance and is
better aligned with the interests of all stakeholders.

2. Meet the Finance Manager of a company/firm of your choice and discuss with him
the different sources of Working capital available to the firm. Also discuss which source
is better for his firm and why? Write a note on your meeting.
Ans. Working capital refers to the funds a company has available to meet its short-term
obligations and finance its day-to-day operations. There are several sources of working
capital, including:
Short-term loans: These are loans with a maturity of less than one year, such as lines of credit
or overdraft facilities. They can provide quick access to funds, but typically come with higher
interest rates.
Trade credit: This refers to the credit extended by suppliers to a company, allowing it to
purchase goods or services on credit and pay for them later.
Accounts receivable financing: This is a type of financing that allows a company to borrow
against its outstanding invoices, using them as collateral.
Inventory financing: This is a type of financing that allows a company to borrow against its
inventory, using it as collateral.
Retained earnings: This refers to the portion of a company's profits that are kept in the
business, rather than being paid out as dividends. Retained earnings can be used to finance
working capital needs, but may also be needed for other purposes such as investing in growth
opportunities.
The best source of working capital for a particular firm will depend on a variety of factors,
including its financial position, the cost of each source of financing, and the terms and
conditions attached to each source.
For example, a company with strong financials and a good credit history may be able to
access short-term loans at a relatively low cost, making this a good option for its working
capital needs. On the other hand, a company that is struggling financially may be better off
using trade credit or accounts receivable financing, as these sources of financing may be
more accessible for firms that are less financially secure.
It's also important to consider the company's specific needs when choosing a source of
working capital. For example, if the company has a large amount of inventory that is not
selling quickly, inventory financing may be a good option as it provides access to funds based
on the value of the inventory. Similarly, if the company has a large amount of outstanding
accounts receivable, accounts receivable financing may be a good option as it provides access
to funds based on the value of the receivables.
Another factor to consider is the company's cash flow. If the company has a stable and
predictable cash flow, short-term loans may be a good option as they provide a predictable
source of funds. On the other hand, if the company has an unpredictable cash flow, trade
credit or accounts receivable financing may be a better option, as they provide more flexible
sources of funds that can be used as needed.
It's also worth noting that the availability of different sources of working capital can vary
depending on the country and region in which the company operates. In some countries,
access to trade credit or accounts receivable financing may be limited, while in others, access
to short-term loans may be more difficult to obtain. The finance manager should be familiar
with the financing options available in his region, and consider these options when choosing
the best source of working capital for his firm.
In conclusion, when choosing a source of working capital, a finance manager should consider
the company's financial position, the cost and accessibility of each source, the terms and
conditions attached to each source, and the company's specific needs and cash flow. By
carefully considering these factors, the finance manager can select the best source of working
capital for his firm and help ensure its short-term financial stability and long-term success.

3. Explain the relevance Theories of Dividend and comment which theory is more suited
to the Indian Business Environment.
Ans. Theories of dividends refer to various explanations and models that attempt to explain
the way firms decide on how much to pay out to shareholders in the form of dividends. There
are several theories of dividends, including:
The Residual Dividend Model: This theory suggests that dividends are paid out of residual
earnings after all investment needs have been met. In other words, the company pays
dividends only if there are excess profits after reinvestment needs have been fulfilled.
The Bird in Hand Theory: This theory states that investors prefer current dividends to future
capital gains. This is because dividends provide a tangible return and reduce uncertainty,
while capital gains are more speculative.
The Tax Preference Theory: This theory suggests that investors prefer dividends because they
are taxed at a lower rate than capital gains.
The Information Content Theory: This theory states that dividends convey information about
a company's future prospects, which can affect its stock price.
It is difficult to say which theory is more suited to the Indian business environment, as each
company's dividend policy will depend on a variety of factors, including its financial
performance, growth prospects, and investor preferences. However, the residual dividend
model and the bird in hand theory are generally considered to be the most relevant to the
Indian business environment. These theories suggest that firms in India will tend to pay out
dividends if they have excess profits after reinvesting for growth and that investors in India
prefer a stable and predictable income from dividends.
In the Indian business environment, firms often have a strong focus on reinvesting profits for
growth, which is why the residual dividend model is considered relevant. Companies in India
often have opportunities for expansion, both domestically and internationally, and they may
choose to retain earnings in order to fund these opportunities.
The bird in hand theory is also relevant to the Indian business environment because investors
in India tend to value the stability and predictability of a steady income stream. This is due to
several factors, including a general preference for low-risk investments and a lack of trust in
the stock market. As a result, companies in India that are able to pay regular dividends are
often seen as being more stable and reliable, which can lead to increased demand for their
stock.
In conclusion, both the residual dividend model and the bird in hand theory are relevant to the
Indian business environment, but each company's dividend policy will depend on a variety of
factors, including its financial performance, growth prospects, and investor preferences. The
most important factor for companies in India is likely to be the need to reinvest earnings in
order to finance growth opportunities and maintain competitiveness.

4. Good Garden Company has currently an ordinary share capital of Rs 25 lakh,

consisting of 25,000 shares of Rs 100 each. The management is planning to raise another
Rs 20 lakhs to finance a major programme of expansion through one of four possible
financing plans. The options are as under :
(a) Entirely through ordinary shares.
Ans. Entirely through ordinary shares.
Raise Rs 20 lakhs through the sale of 20,000 new ordinary shares at Rs 100 each. Total
number of ordinary shares = 25,000 + 20,000 = 45,000.
EBIT = Rs 8 lakh.
Corporate tax = Rs 8 lakh * 50% = Rs 4 lakh.
Net income = EBIT - Corporate tax = Rs 8 lakh - Rs 4 lakh = Rs 4 lakh.
EPS = Net income / Total number of ordinary shares = Rs 4 lakh / 45,000 shares = Rs 0.089
per share.

(b) Rs. 10 lakhs through ordinary shares, and Rs. 10 lakhs through long-term
borrowings at 15% interest per annum.
Ans. Rs. 10 lakhs through ordinary shares, and Rs. 10 lakh through long-term borrowings at
15% interest per annum.
Raise Rs 10 lakh through the sale of 10,000 new ordinary shares at Rs 100 each. Total
number of ordinary shares = 25,000 + 10,000 = 35,000.
Borrow Rs 10 lakh at 15% interest per annum.
EBIT = Rs 8 lakh.
Corporate tax = Rs 8 lakh * 50% = Rs 4 lakh.
Interest = Rs 10 lakh * 15% = Rs 1.5 lakh.
Net income = EBIT - Corporate tax - Interest = Rs 8 lakh - Rs 4 lakh - Rs 1.5 lakh = Rs 2.5
lakh.
EPS = Net income / Total number of ordinary shares = Rs 2.5 lakh / 35,000 shares = Rs 0.071
per share.

(c) Rs. 5 lakhs through ordinary shares, and Rs. 15 lakhs through long-term borrowings
at 16% interest per annum.
Ans. Rs. 5 lakhs through ordinary shares, and Rs. 15 lakh through long-term borrowings at
16% interest per annum.
Raise Rs 5 lakh through the sale of 5,000 new ordinary shares at Rs 100 each. Total number
of ordinary shares = 25,000 + 5,000 = 30,000.
Borrow Rs 15 lakh at 16% interest per annum.
EBIT = Rs 8 lakh.
Corporate tax = Rs 8 lakh * 50% = Rs 4 lakh.
Interest = Rs 15 lakh * 16% = Rs 2.4 lakh.
Net income = EBIT - Corporate tax - Interest = Rs 8 lakh - Rs 4 lakh - Rs 2.4 lakh = Rs 1.6
lakh.
EPS = Net income / Total number of ordinary shares = Rs 1.6 lakh / 30,000 shares = Rs 0.053
per share.

(d) Rs. 10 lakhs through ordinary shares, and Rs. 10 lakhs through preference shares
with 14% dividend. The company’s expected EBIT will be Rs. 8 lakhs. Assuming a
corporate tax rate of 50%, determine the EPS in each alternative, and comment on the
implications of financial leverage
Ans. Rs. 10 lakh through ordinary shares, and Rs. 10 lakhs through preference shares with
14% dividend.
Raise Rs 10 lakh through the sale of 10,000 new ordinary shares at Rs 100 each. Total
number of ordinary shares = 25,000 + 10,000 = 35,000.
Raise Rs 10 lakh through the sale of 10,000 new preference shares at Rs 100 each with a 14%
dividend.
EBIT = Rs 8 lakh.
Corporate tax = Rs 8 lakh * 50% = Rs 4 lakh.
Dividend on preference shares = Rs 10 lakh * 14% = Rs 1.4 lakh.
Net income = EBIT - Corporate tax - Dividend on preference shares = Rs 8 lakh - Rs 4 lakh -
Rs 1.4 lakh = Rs 2.6 lakh.
EPS = Net income / Total number of ordinary shares = Rs 2.6 lakh / 35,000 shares = Rs 0.

5. Arun Engineering Co. is considering two investments. Each requires an initial

investment of
Rs 1,80,000. The cost of capital is 8%. The total cash inflow after tax and depreciation
for
each project is as follows:
Year Project A (Rs.) Project B (Rs.)
1 30,000 60,000
2 50,000 1,00,000
3 60,000 65,000
4 65,000 45,000
5 40,000 --
6 30,000 --
7 16,000 --
Calculate the Payback Period, Profitability Index and Net Present Value of both the
projects.
Ans. The payback period is the amount of time it takes for an investment to recover its initial
cost. The profitability index (PI) is a measure of an investment's expected return relative to its
cost. The net present value (NPV) is the present value of all expected future cash flows minus
the initial investment cost.
For Project A:
Payback period: Project A recovers its initial cost of Rs 1,80,000 in year 2 as the cumulative
cash inflow in year 2 is Rs 50,000 + Rs 30,000 = Rs 80,000 which is more than the initial
investment cost.
Profitability Index: The PI of Project A can be calculated by dividing the present value of
expected future cash flows by the initial investment cost. (30,000 + 50,000/ (1+8%) + 60,000/
(1+8%)^2 + 65,000/ (1+8%)^3 + 40,000/ (1+8%)^4 + 30,000/ (1+8%)^5 + 16,000/
(1+8%)^6) / 1,80,000 = 1.13 As the PI is greater than 1, Project A is a profitable investment.
Net Present Value: The NPV of Project A can be calculated by subtracting the initial
investment cost from the present value of expected future cash flows. (30,000 + 50,000/
(1+8%) + 60,000/ (1+8%)^2 + 65,000/ (1+8%)^3 + 40,000/ (1+8%)^4 + 30,000/ (1+8%)^5 +
16,000/ (1+8%)^6) - 1,80,000 = 27,000 As the NPV is positive, Project A is expected to
generate a return greater than the cost of capital of 8%.
For Project B:
Payback period: Project B recovers its initial cost of Rs 1,80,000 in year 1 as the cumulative
cash inflow in year 1 is Rs 60,000 which is more than the initial investment cost.
Profitability Index: The PI of Project B can be calculated by dividing the present value of
expected future cash flows by the initial investment cost. (60,000 + 1,00,000/ (1+8%) +
65,000/ (1+8%)^2 + 45,000/ (1+8%)^3) / 1,80,000 = 1.52 As the PI is greater than 1, Project
B is a profitable investment.
Net Present Value: The NPV of Project B can be calculated by subtracting the initial
investment cost from the present value of expected future cash flows. (60,000 + 1,00,000/
(1+8%) + 65,000/ (1+8%)^2 + 45,000/ (1+8%)^3) - 1,80,000 = 78,000 As the NPV is
positive, Project B is expected to generate a return greater than the cost of capital of 8%.
Based on the calculations, both projects are profitable and expected to generate a return
greater than the cost of capital. However, Project B has a shorter payback period, a higher
profitability index, and a higher net present value compared to Project A, making it a more
attractive investment opportunity.