MMPC-014
Financial Management
MMPC 014 solved Free Assignment 2023
MMPC 014 Solved Free Assignment January 2023
IGNOU MBA Assignment 2023
Q 1. Discuss the concepts of ‘Profit maximisation’ and ‘Wealth maximisation’ and analyse which oncept is superior to be an objective of a Firm.
Ans The fundamental objective of any firm is to maximize its value, which means to make the most of the profits or wealth.
Profit maximization and wealth maximization are two significant concepts that guide the goals of the firm.
Profit maximization refers to maximizing the profits of the firm, while wealth maximization is the maximization of the value of the firm’s stock.
The objective of this essay is to discuss the concepts of profit maximization and wealth maximization and analyze which concept is superior to be an objective of a firm.
Concept of Profit Maximization
Profit maximization is an essential goal of any business. It refers to the process of maximizing the profit of a firm by producing and selling goods or services at a level where marginal cost equals marginal revenue.
In other words, the firm aims to produce and sell its products or services at a level where its revenue is more than its costs.
The primary goal of profit maximization is to increase the profitability of the firm by increasing its profits, which can be achieved by increasing revenue and reducing costs. MMPC 014 Solved Free Assignment 2023
One of the main advantages of the profit maximization concept is that it is easy to measure. The profits of a firm can be calculated by deducting the total costs from total revenues.
Therefore, it provides a clear and straightforward objective for the firm to achieve. Also, profit maximization is a short-term objective that can help the firm to survive in the short run.
In addition, profit maximization can help to attract investors, as higher profits lead to higher returns on investment.
However, the profit maximization concept has some limitations.
Firstly, it does not take into account the time value of money, which means that it does not consider the profitability of the firm in the long run.
Secondly, the profit maximization concept may lead to unethical behavior by the firm, such as cutting corners, reducing the quality of the products, or exploiting its employees to increase its profits.
Finally, the profit maximization concept does not consider the interests of other stakeholders, such as customers, employees, suppliers, and the environment.
Concept of Wealth Maximization
Wealth maximization is another concept that aims to maximize the value of the firm. Unlike profit maximization, wealth maximization considers the long-term profitability of the firm. MMPC 014 Solved Free Assignment 2023
It refers to the process of maximizing the net present value (NPV) of the firm’s future cash flows, which means that it considers the time value of money.
The NPV is the difference between the present value of the expected cash inflows and the present value of the expected cash outflows.
The primary advantage of the wealth maximization concept is that it considers the long-term profitability of the firm.
It provides a more comprehensive and sustainable objective for the firm to achieve. Wealth maximization takes into account the interests of all stakeholders, such as customers, employees, suppliers, and the environment.
It helps the firm to build a good reputation and gain the trust of its stakeholders.
However, the wealth maximization concept also has some limitations. Firstly, it is difficult to measure the value of the firm accurately.
The value of the firm depends on various factors, such as the economic conditions, the industry, and the market trends.
Secondly, wealth maximization requires a long-term perspective, which may not be suitable for all firms. MMPC 014 Solved Free Assignment 2023
Some firms may need to focus on short-term objectives to survive in the short run.
Finally, wealth maximization may require a higher investment in the firm’s infrastructure, research and development, and marketing, which may not be feasible for all firms.
Analysis of Profit Maximization and Wealth Maximization
The objective of a firm depends on various factors, such as its size, industry, competitive environment, and the interests of its stakeholders.
Both profit maximization and wealth maximization have their advantages and limitations, and their suitability depends on the firm ‘s context and objectives.
However, in general, wealth maximization is a superior concept to be an objective of a firm for several reasons.
Firstly, wealth maximization provides a long-term perspective for the firm. It considers the time value of money and the long-term profitability of the firm.
This helps the firm to make strategic decisions that can benefit the firm in the long run. MMPC 014 Solved Free Assignment 2023
For example, the firm can invest in research and development to improve its products or services, which can lead to higher profits and a competitive advantage in the future.
Secondly, wealth maximization considers the interests of all stakeholders, not just the shareholders.
This helps the firm to build a good reputation and gain the trust of its stakeholders, which can lead to long-term benefits for the firm.
For example, the firm can focus on producing high-quality products or services that meet the needs and expectations of its customers, which can lead to customer loyalty and repeat business.
Thirdly, wealth maximization is a more comprehensive and sustainable objective than profit maximization.
Profit maximization may lead to short-term gains, but it may also lead to unethical behavior, such as exploiting employees or cutting corners.
In contrast, wealth maximization considers the long-term interests of the firm and its stakeholders and promotes ethical behavior that can benefit the firm in the long run.
Q 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. I recently had the opportunity to meet with the finance manager of XYZ Company, a manufacturing firm that produces and sells consumer goods.
During our meeting, we discussed the different sources of working capital available to the firm and which source would be better for their specific needs.
Working capital is the funds used by a company to finance its day-to-day operations, such as paying suppliers, employees, and other expenses. A company can obtain working capital from various sources, including:
Bank loans: A bank loan is a common source of working capital for companies. Banks typically offer short-term loans with fixed or variable interest rates, and the amount borrowed depends on the company’s creditworthiness and collateral.
Trade credit: Trade credit refers to the credit extended to a company by its suppliers. Suppliers may allow the company to delay payment for a certain period, which can help the company manage its cash flow.
Factoring: Factoring involves selling the company’s accounts receivables to a third party at a discount. MMPC 014 Solved Free Assignment 2023
The third party then collects the payments from the company’s customers and pays the company for the accounts receivables, less the discount.
Commercial paper: Commercial paper is a short-term debt instrument issued by companies to raise funds. It typically has a maturity of less than 270 days and is sold at a discount to its face value.
Equity financing: Equity financing involves selling shares of the company to investors in exchange for funds. This is a long-term source of working capital and can dilute the ownership of existing shareholders.
After discussing these sources of working capital, the finance manager of XYZ Company informed me that they have been relying mainly on bank loans and trade credit to finance their operations.
However, they were exploring other options for working capital, especially in light of the current economic environment.
When asked which source would be better for their firm, the finance manager stated that it depends on several factors, including the company’s creditworthiness, the amount of funds needed, and the urgency of the financing.
For example, bank loans may be more suitable for long-term financing needs, while trade credit may be better for short-term needs.
The manager also noted that factoring could be a good option for the company, as it would allow them to obtain funds quickly and without adding to their debt.
During the meeting, the finance manager also emphasized the importance of managing working capital effectively.
He explained that it is critical for companies to strike a balance between managing their cash flow and meeting their operational needs.
He noted that companies that are too focused on cash flow management may miss out on growth opportunities, while companies that do not manage their cash flow effectively may face financial difficulties.
Furthermore, the finance manager stressed that it is important for companies to have a clear understanding of their working capital needs.
This requires careful planning and forecasting to ensure that the company has enough cash to cover its expenses while also allowing for growth and investment in the business. MMPC 014 Solved Free Assignment 2023
He explained that companies should regularly review their working capital position and make adjustments as needed to ensure that they are on track to meet their financial goals.
Another topic we discussed was the role of technology in working capital management.
The finance manager noted that advances in technology have made it easier for companies to manage their cash flow and working capital.
For example, companies can now use cloud-based software to automate their accounts receivable and accounts payable processes, which can help to speed up payment collections and reduce payment delays.
We also talked about the importance of communication with suppliers and customers in working capital management.
The finance manager emphasized the need for companies to maintain strong relationships with their suppliers and customers to ensure that payments are made on time and to reduce the risk of payment disputes.
He noted that effective communication can also help companies to negotiate better terms with suppliers and customers, which can lead to improved cash flow and working capital management.MMPC 014 Solved Free Assignment 2023
In addition, the finance manager discussed the importance of inventory management in working capital management.
He explained that companies need to carefully manage their inventory levels to ensure that they are not holding too much inventory, which can tie up cash, or too little inventory, which can lead to stockouts and lost sales.
He noted that companies can use software to help them optimize their inventory levels and reduce the risk of stockouts.
We also touched on the topic of risk management in working capital management. The finance manager noted that companies need to be aware of the risks associated with different sources of working capital and take steps to manage these risks effectively.
For example, companies that rely heavily on bank loans may face risks such as interest rate fluctuations or changes in the lending policies of banks.
To manage these risks, companies may need to consider diversifying their sources of working capital or using risk management tools such as interest rate swaps or credit insurance.
Finally, the finance manager discussed the role of financial metrics in working capital management. MMPC 014 Solved Free Assignment 2023
He explained that companies need to regularly monitor and analyze financial metrics such as cash flow, working capital turnover, and days sales outstanding (DSO) to gain insights into their working capital position and identify areas for improvement.
He noted that financial metrics can also be used to benchmark the company’s performance against industry standards and to track progress towards financial goals.
Q 3. Explain the relevance Theories of Dividend and comment which theory is more suited to the Indian Business Environment.
Ans. Dividend policy is a crucial aspect of corporate finance that determines how much of a company’s earnings should be paid out to shareholders as dividends and how much should be retained for reinvestment in the business.
Various theories have been proposed to explain the determinants of dividend policy, including the dividend irrelevance theory, the bird-in-hand theory, the clientele effect theory, and the signaling theory. MMPC 014 Solved Free Assignment 2023
The dividend irrelevance theory, also known as the Modigliani-Miller hypothesis, suggests that the value of a firm is independent of its dividend policy.
According to this theory, shareholders are indifferent to whether a firm pays out dividends or retains earnings because they can create their own dividend stream by selling some of their shares.
This theory assumes that investors have access to the same information as management and can make their own investment decisions based on the firm’s expected earnings.
The bird-in-hand theory, proposed by John Lintner, argues that investors prefer current dividends to future capital gains because they are uncertain about the firm’s future earnings and growth prospects. MMPC 014 Solved Free Assignment 2023
This theory suggests that firms with a high payout ratio will have a higher stock price than those with a low payout ratio because they offer a higher current dividend yield.
This theory assumes that investors are risk-averse and prefer certainty over uncertainty.
The clientele effect theory, proposed by Merton Miller and Franco Modigliani, argues that firms should adopt a dividend policy that caters to the preferences of their investors.
This theory suggests that investors have different preferences for current dividends and capital gains, and firms should align their dividend policy to attract the investors they desire. MMPC 014 Solved Free Assignment 2023
For example, if a firm’s investors are predominantly retirees who require a steady income stream, the firm should adopt a high payout ratio to cater to their preferences.
The signaling theory, proposed by Bhattacharya and Ritter, suggests that firms use dividend policy to signal their future earnings and growth prospects to investors.
This theory argues that firms that increase their dividend payout are signaling that they have positive future prospects and are confident about their ability to maintain or increase their future earnings.
On the other hand, firms that decrease their dividend payout are signaling that they have negative future prospects and are unsure about their ability to maintain or increase their future earnings.
In the Indian business environment, the clientele effect theory is more suited to explain dividend policy. India has a large population of individual investors who prefer steady income streams from their investments.
This is because the Indian financial system is relatively underdeveloped, and investors have limited access to other investment opportunities such as mutual funds or pension plans. MMPC 014 Solved Free Assignment 2023
Therefore, Indian firms should cater to the preferences of their investors by adopting a high payout ratio and providing a steady income stream.
However, the signaling theory also has some relevance in the Indian context. India has a vibrant stock market, and many investors are sophisticated and well-informed.
Therefore, firms may use dividend policy to signal their future earnings and growth prospects to attract these investors.
This is especially true for firms in the technology and pharmaceutical sectors, which have high growth potential and may need to retain earnings for reinvestment in the business.
In contrast, the dividend irrelevance theory and the bird-in-hand theory are less relevant in the Indian business environment.
The dividend irrelevance theory assumes that investors have access to the same information as management and can make their own investment decisions based on the firm’s expected earnings. MMPC 014 Solved Free Assignment 2023
However, this may not be true in the Indian context, where information asymmetry is high, and many investors may not have access to the same information as management.
Furthermore, there are some challenges to implementing a dividend policy in India. One challenge is the lack of clear regulations and guidelines from the Securities and Exchange Board of India (SEBI) on dividend policy.
This can lead to confusion and inconsistency in how firms set their dividend policy. Another challenge is the high tax rate on dividends in India.
This can discourage firms from paying out dividends and instead opt to retain earnings for reinvestment in the business.
Additionally, there are cultural factors that can impact dividend policy in India. For example, there is a cultural expectation that firms should prioritize the well-being of all stakeholders, including employees, customers, and the community, over the interests of shareholders.MMPC 014 Solved Free Assignment 2023
This can lead to a reluctance to pay out large dividends to shareholders, as it may be seen as taking away resources that could be used for other stakeholders.
Another factor to consider is the size and nature of the firm. Small and medium-sized enterprises (SMEs) in India may face difficulties in accessing external sources of funding and may rely heavily on internal sources of funding such as retained earnings.
This can limit their ability to pay out dividends to shareholders. In contrast, large, well-established firms with access to external sources of funding may be better positioned to pay out dividends to shareholders.
In recent years, there has been a trend towards share buybacks in India as an alternative to dividends.
Share buybacks involve a company buying back its own shares from shareholders, which can increase the value of the remaining shares.
Share buybacks have become increasingly popular in India as they offer tax advantages over dividends and can signal to investors that the company believes its shares are undervalued.
MMPC 014 Assignment Question Pdf
Q 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.
(b) Rs. 10 lakh through ordinary shares, and Rs. 10 lakh through long-term borrowings at 15% interest per annum.
(c) Rs. 5 lakh through ordinary shares, and Rs. 15 lakh through long-term borrowings at 16% interest per annum.MMPC 014 Solved Free Assignment 2023
(d) Rs. 10 lakh through ordinary shares, and Rs. 10 lakhs through preference shares with 14% dividend.
The company’s expected EBIT will be Rs. 8 lakh. Assuming a corporate tax rate of 50%,determine the EPS in each alternative, and comment on the implications of financial leverage
Ans. To determine the EPS in each alternative, we need to calculate the earnings available to ordinary shareholders in each case.
Option (a): Entirely through ordinary shares
The company will issue 20,000 new shares to raise Rs 20 lakhs. There will be no interest expense or preference share dividend to pay.
Assuming the company’s EBIT remains unchanged at Rs 8 lakhs, and after deducting corporate tax of 50%, the earnings available to ordinary shareholders will be:
Earnings available to ordinary shareholders = EBIT * (1 – tax rate) = Rs 8 lakhs * 0.5 = Rs 4 lakhsMMPC 014 Solved Free Assignment 2023
EPS = Earnings available to ordinary shareholders / Total number of ordinary shares = Rs 4 lakhs / 45,000 shares = Rs 8.89 per share
Option (b): Rs. 10 lakh through ordinary shares, and Rs. 10 lakh through long-term borrowings at 15% interest per annum
The company will issue 10,000 new shares to raise Rs 10 lakhs, and borrow Rs 10 lakhs at 15% interest per annum.
The interest expense will be Rs 1.5 lakhs (Rs 10 lakhs * 0.15). Assuming the company’s EBIT remains unchanged at Rs 8 lakhs, and after deducting corporate tax of 50%, the earnings available to ordinary shareholders will be:
Earnings available to ordinary shareholders = EBIT – Interest expense – Tax = Rs 8 lakhs – Rs 1.5 lakhs – Rs 3.25 lakhs = Rs 3.25 lakhs
EPS = Earnings available to ordinary shareholders / Total number of ordinary shares = Rs 3.25 lakhs / 35,000 shares = Rs 9.29 per share
Option (c): Rs. 5 lakh through ordinary shares, and Rs. 15 lakh through long-term borrowings at 16% interest per annum
The company will issue 5,000 new shares to raise Rs 5 lakhs, and borrow Rs 15 lakhs at 16% interest per annum. The interest expense will be Rs 2.4 lakhs (Rs 15 lakhs * 0.16). Assuming the company’s EBIT remains unchanged at Rs 8 lakhs, and after deducting corporate tax of 50%, the earnings available to ordinary shareholders will be: MMPC 014 Solved Free Assignment 2023
Earnings available to ordinary shareholders = EBIT – Interest expense – Tax = Rs 8 lakhs – Rs 2.4 lakhs – Rs 2.8 lakhs = Rs 2.8 lakhs
EPS = Earnings available to ordinary shareholders / Total number of ordinary shares = Rs 2.8 lakhs / 30,000 shares = Rs 9.33 per share
Option (d): Rs. 10 lakh through ordinary shares, and Rs. 10 lakhs through preference shares with 14% dividend
The company will issue 10,000 new shares to raise Rs 10 lakhs, and issue Rs 10 lakhs worth of preference shares with 14% dividend. The preference share dividend will be Rs 1.4 lakhs (Rs 10 lakhs * 0.14).
Assuming the company’s EBIT remains unchanged at Rs 8 lakhs, and after deducting corporate tax of 50%, the earnings available to ordinary shareholders will be:
Earnings available to ordinary shareholders = EBIT – Preference share dividend – Tax = Rs 8 lakhs – Rs 1.4 lakhs – Rs 3.3 lakhs = Rs 3.3 lakhs
EPS = Earnings available to ordinary shareholders / Total number of ordinary shares = Rs 3.3 lakh/ 35,000 shares = Rs 9.43 per share
Now, let’s analyze the implications of financial leverage on the EPS in each alternative. Financial leverage refers to the use of debt financing to increase the return on equity. MMPC 014 Solved Free Assignment 2023
The use of debt financing can amplify the returns for shareholders during good times but can also amplify losses during bad times.
Comparing option (a) to option (b), we can see that the EPS is slightly higher in option (b), even though the company has to pay interest on the borrowings. This is because the interest expense is tax-deductible, which reduces the amount of corporate tax paid, leaving more earnings available to ordinary shareholders. This illustrates the concept of financial leverage.
Comparing option (b) to option (c), we can see that the EPS is slightly higher in option (c). This is because the company is borrowing more at a higher interest rate, which results in a higher interest expense, reducing the earnings available to ordinary shareholders in option (b). This illustrates the downside of too much financial leverage.
Comparing option (b) to option (d), we can see that the EPS is slightly higher in option (d). This is because the preference share dividend is not tax-deductible, unlike interest expense.
Therefore, option (b) has a higher tax shield, resulting in a higher EPS. However, preference shares are senior to ordinary shares, meaning that the preference shareholders must receive their dividend before any dividend is paid to the ordinary shareholders. MMPC 014 Solved Free Assignment 2023
This reduces the potential return for ordinary shareholders, illustrating the downside of using preference shares.
In summary, financial leverage can increase the return on equity, but it also increases the risk to ordinary shareholders. The optimal level of financial leverage depends on the company’s financial position and risk tolerance.
Q 5.
Ans. To calculate the Payback Period, we need to determine the time it takes for the initial investment to be recovered. For Project A, the payback period is as follows:
Year 1: Rs 1,50,000 (Initial Investment – Cash Inflow) remaining
Year 2: Rs 1,00,000 remaining
Year 3: Rs 40,000 remaining
Year 4: Rs 0 remaining
So, the payback period for Project A is 3 years and 9 months.
For Project B, the payback period is as follows:
Year 1: Rs 1,20,000 remaining
Year 2: Rs 20,000 remaining
Year 3: Rs 0 remaining
So, the payback period for Project B is 3 years.
To calculate the Profitability Index, we need to determine the ratio of the present value of future cash flows to the initial investment. For Project A, the profitability index is: MMPC 014 Solved Free Assignment 2023
PV of future cash flows = 30,000/(1+0.08)^1 + 50,000/(1+0.08)^2 + 60,000/(1+0.08)^3 + 65,000/(1+0.08)^4 + 40,000/(1+0.08)^5 + 30,000/(1+0.08)^6 + 16,000/(1+0.08)^7 = Rs 2,77,000
Profitability Index = PV of Future Cash Flows / Initial Investment = 2,77,000 / 1,80,000 = 1.54
For Project B, the profitability index is:
PV of future cash flows = 60,000/(1+0.08)^1 + 1,00,000/(1+0.08)^2 + 65,000/(1+0.08)^3 + 45,000/(1+0.08)^4 + 40,000/(1+0.08)^5 + 30,000/(1+0.08)^6 + 16,000/(1+0.08)^7 = Rs 4,27,000
Profitability Index = PV of Future Cash Flows / Initial Investment = 4,27,000 / 1,80,000 = 2.37
To calculate the Net Present Value, we need to determine the present value of all future cash flows and subtract the initial investment. For Project A, the NPV is:
PV of future cash flows – Initial Investment = 2,77,000 – 1,80,000 = Rs 97,000
For Project B, the NPV is: MMPC 014 Solved Free Assignment 2023
PV of future cash flows – Initial Investment = 4,27,000 – 1,80,000 = Rs 2,47,000
Therefore, based on the Payback Period, Profitability Index and Net Present Value calculations, Project B is more profitable than Project A.
For Project B:
Year 1: PV of Cash Inflow = 60,000 / (1 + 0.08)^1 = 55,555.56
Year 2: PV of Cash Inflow = 1,00,000 / (1 + 0.08)^2 = 84,938.27
Year 3: PV of Cash Inflow = 65,000 / (1 + 0.08)^3 = 50,977.31
Year 4: PV of Cash Inflow = 45,000 / (1 + 0.08)^4 = 31,867.35
Year 5: PV of Cash Inflow = 40,000 / (1 + 0.08)^5 = 26,402.97
Year 6: PV of Cash Inflow = 30,000 / (1 + 0.08)^6 = 20,215.34
Year 7: PV of Cash Inflow = 16,000 / (1 + 0.08)^7 = 10,422.35
Total PV of Cash Inflows = 2,79,979.15
NPV = Total PV of Cash Inflows – Initial Investment = 2,79,979.15 – 1,80,000 = 99,979.15
Profitability Index = Total PV of Cash Inflows / Initial Investment = 2,79,979.15 / 1,80,000 = 1.56
So, the Payback Period for Project B is 3 years, NPV is Rs 99,979.15 and the Profitability Index is 1.56.
Comparing the results, we can see that Project B has a shorter Payback Period, a higher NPV, and a higher Profitability Index compared to Project A. Therefore, based on these calculations, Arun Engineering Co. should select Project B
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