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MCOM 3^rd SEMESTER

 TUTTOR MARKED ASSIGNMEN

COURSE CODE : MCO-07

COURSE TITLE : Financial Management

ASSIGNMENT CODE : MCO-07/TMA/2026

 

1) a) Explain the role of financial management in a modern business organisation. Discuss the major objectives of financial management and analyse the key challenges faced by financial managers in the context of a dynamic and competitive business environment.

b) A company requires ₹5,00,000 after 5 years for expansion. The prevailing rate of interest is 10 per cent per annum compounded annually.

I. Calculate the present value of the required amount.

II. Calculate the future value over 5 years if the amount calculated in part 1 is invested today @ 12%. Show all working notes clearly and interpret the results from a managerial decision-making perspective.

(a) Role, Objectives and Challenges of Financial Management

1. Role of Financial Management in Modern Business

Financial management refers to planning, organizing, directing, and controlling financial resources of an organisation to achieve its objectives efficiently.

In modern business organisations, financial management plays a strategic role rather than a purely accounting role. Its major functions include:

1.     Investment Decisions (Capital Budgeting) – Deciding where to invest funds for maximum return.

2.     Financing Decisions – Determining the optimal capital structure (debt vs equity).

3.     Dividend Decisions – Deciding how much profit to distribute and how much to retain.

4.     Liquidity Management – Ensuring sufficient working capital.

5.     Risk Management – Managing financial risks like interest rate and exchange rate fluctuations.

6.     Profit Planning and Cost Control – Monitoring financial performance.

Thus, financial management ensures efficient utilisation of funds and long-term sustainability.

 

2. Major Objectives of Financial Management

(1) Profit Maximisation

Focuses on increasing earnings. However, it ignores risk and timing of returns.

(2) Wealth Maximisation (Primary Objective)

Aims at maximizing shareholders’ wealth by increasing market value of shares. It considers time value of money and risk.

(3) Liquidity and Solvency

Ensuring the firm can meet short-term and long-term obligations.

(4) Financial Stability

Maintaining balanced capital structure.

 

3. Key Challenges in a Dynamic Environment

1.     Global Competition – Pressure on margins and pricing.

2.     Technological Changes – Need for continuous investment.

3.     Economic Uncertainty – Inflation, recession, exchange rate volatility.

4.     Regulatory Changes – Compliance requirements.

5.     Capital Market Fluctuations – Impact on financing decisions.

6.     Risk Management Complexity – Managing financial derivatives and global exposure.

Thus, financial managers must make strategic and risk-adjusted decisions in a highly competitive environment.

 

Q.1 (b) Numerical Problem

Given:

Future amount required after 5 years (FV) = ₹5,00,000
Interest rate = 10% per annum (compounded annually)
Time (n) = 5 years

 

Part I: Present Value Calculation

Formula:

PV = FV(1+r)ⁿ

PV = 5,00,000 / (1.10)⁵

(1.10)5 = 1.61051

PV = 5,00,000/ 1.61051

PV ≈ ₹3,10,460  

Answer (I):

The company needs to invest approximately ₹3,10,460 today at 10% to accumulate ₹5,00,000 after 5 years.

 

Part II: Future Value if Invested @ 12%

Now invest ₹3,10,460 at 12% for 5 years.

Formula:

FV=PV(1+r)n   

FV=3,10,460 (1.12)⁵  

(1.12)⁵=1.7623   

FV ≈ ₹5,47,166  

 

Managerial Interpretation

1.     If invested at 10%, ₹3,10,460 grows to exactly ₹5,00,000 in 5 years.

2.     If invested at 12%, the amount grows to approximately ₹5,47,166.

3.     This results in an excess of about ₹47,166.

Decision Perspective:

·        If the company can earn 12% instead of 10%, it will generate surplus funds.

·        Higher return investments increase financial flexibility.

·        Financial managers should seek investment opportunities yielding more than the required rate.

Thus, time value of money plays a critical role in expansion planning.

 

2) Discuss the various investment appraisal techniques used in capital budgeting decisions. Critically examine their merits and limitations.

 

1. Introduction

Capital budgeting refers to the process of evaluating and selecting long-term investment projects such as purchase of machinery, expansion of plant, or launching new products. Since such decisions involve large funds and long-term commitment, firms use various investment appraisal techniques to assess profitability and feasibility.

Investment appraisal techniques are broadly classified into:

1.     Traditional (Non-Discounting) Methods

2.     Modern (Discounting) Methods

 

2. Traditional (Non-Discounting) Techniques

(A) Payback Period Method

This method measures the time required to recover the initial investment.

Decision Rule:
Select the project with the shortest payback period.

Merits:

·        Simple and easy to understand

·        Emphasizes liquidity

·        Suitable for risky projects

Limitations:

·        Ignores time value of money

·        Ignores cash flows after payback period

·        Does not measure profitability

 

(B) Accounting Rate of Return (ARR)

ARR measures the average profit as a percentage of investment.

ARR=Average Annual Profit / Average Investment×100   

Merits:

·        Easy to calculate

·        Uses accounting data

·        Useful for performance evaluation

Limitations:

·        Ignores time value of money

·        Based on accounting profit, not cash flows

·        Does not consider project life properly

 

3. Modern (Discounting) Techniques

These methods consider the time value of money.

 

(A) Net Present Value (NPV)

NPV is the difference between present value of cash inflows and present value of cash outflows.

NPV=PV of Inflows − PV of Outflows

Decision Rule:
Accept the project if NPV is positive.

Merits:

·        Considers time value of money

·        Based on cash flows

·        Directly linked to wealth maximisation

·        Suitable for mutually exclusive projects

Limitations:

·        Requires accurate estimation of discount rate

·        Slightly complex

 

(B) Internal Rate of Return (IRR)

IRR is the discount rate at which NPV becomes zero.

Decision Rule:
Accept if IRR > required rate of return.

Merits:

·        Considers time value of money

·        Easy to interpret as percentage

·        Popular in practice

Limitations:

·        Difficult to calculate

·        May give multiple IRRs

·        Problem in ranking mutually exclusive projects

 

(C) Profitability Index (PI)

PI = PV of Inflows   ​

Accept if PI > 1.

Merits:

·        Considers time value

·        Useful when capital is rationed

Limitations:

·        May conflict with NPV in ranking projects

 

4. Comparative Evaluation

Method	Time Value Considered	Profitability Measure	Simplicity
Payback	No	No	Very Simple
ARR	No	Partial	Simple
NPV	Yes	Yes	Moderate
IRR	Yes	Yes	Complex
PI	Yes	Yes	Moderate

 

5. Critical Examination

·        Traditional methods focus on liquidity and accounting profit but ignore time value of money.

·        Modern methods provide more accurate evaluation as they consider discounted cash flows.

·        Among modern methods, NPV is considered superior because it directly measures increase in shareholder wealth.

·        IRR is popular but may produce misleading results in complex projects.

6. Conclusion

Capital budgeting decisions require careful evaluation of long-term investments. While traditional methods are simple, modern techniques like NPV and IRR are more reliable as they incorporate time value of money. For effective decision-making, firms should preferably rely on NPV while using other methods as supportive tools.

 

3) Explain the concept of cost of capital. Discuss the significance of cost of capital in financial decision-making and describe the major components of overall cost of capital.

1. Introduction

The cost of capital is one of the most important concepts in financial management. It represents the minimum rate of return that a company must earn on its investments to satisfy its investors (both equity shareholders and debt holders). In other words, it is the cost of obtaining funds for business operations.

Cost of capital acts as a benchmark or cut-off rate for evaluating investment decisions.

 

2. Concept of Cost of Capital

Cost of capital refers to the weighted average cost of various sources of finance used by a firm, such as equity, preference shares, debt, and retained earnings.

It can be defined as:

The minimum required rate of return that a firm must earn to maintain the market value of its shares.

If a firm earns less than its cost of capital, the value of the firm declines. If it earns more, shareholders’ wealth increases.

 

3. Significance of Cost of Capital in Financial Decision-Making

(1) Capital Budgeting Decisions

Cost of capital is used as the discount rate in NPV and IRR calculations. Projects are accepted only if their return exceeds the cost of capital.

(2) Capital Structure Decisions

It helps determine the optimal mix of debt and equity that minimizes overall cost of capital.

(3) Performance Evaluation

Actual return on investment is compared with cost of capital to assess efficiency.

(4) Dividend Policy Decisions

Retained earnings should generate returns greater than cost of capital; otherwise dividends should be distributed.

(5) Valuation of Firm

Cost of capital is used in valuation models to determine market value of shares and firm.

Thus, cost of capital plays a central role in maximizing shareholder wealth.

 

4. Major Components of Overall Cost of Capital

The overall cost of capital is generally referred to as Weighted Average Cost of Capital (WACC). It consists of the following components:

 

(A) Cost of Debt (Kd)

Cost of debt is the effective rate a company pays on borrowed funds.

Since interest is tax-deductible:

Kd = Interest Rate (1−Tax Rate)

It is usually lower than equity cost because debt holders have prior claim on assets.

 

(B) Cost of Preference Share Capital (Kp)

It is the dividend rate payable on preference shares.

Kp = Preference Dividend Net Proceeds

Preference shareholders have fixed dividend rights.

(C) Cost of Equity Share Capital (Ke)

It is the return required by equity shareholders. It is generally higher due to higher risk.

Methods of calculation:

1. Dividend Discount Model
2. Capital Asset Pricing Model (CAPM)

(D) Cost of Retained Earnings (Kr)

Retained earnings also have a cost because shareholders expect returns on reinvested profits. It is usually equal to cost of equity.

 

5. Weighted Average Cost of Capital (WACC)

WACC is calculated by assigning weights to each source of capital.

WACC = (Ke×We) + (Kd×Wd) + N (Kp×Wp)    

Where W represents proportion of each source.

WACC represents the overall cost of financing the firm.

 

6. Conclusion

Cost of capital is the minimum required rate of return that a firm must earn to maintain its value. It is essential for capital budgeting, capital structure planning, and performance evaluation. The major components include cost of debt, preference capital, equity capital, and retained earnings. Proper management of cost of capital helps firms minimize financing costs and maximize shareholder wealth.

 

4) a) Explain the various dividend valuation models used for the valuation of equity share. Compare the assumptions and applicability of Walter’s Model and Gordon’s Growth Model, and discuss their relevance in real-world valuation decisions.

b) A company has just paid a dividend of ₹5 per share. The dividends are expected to grow at a constant rate of 6 per cent per annum. The required rate of return of investors is 14 per cent. Using Gordon’s Growth Model, calculate the intrinsic value of the share. Interpret the result for an investor considering purchasing the share at a market price of ₹70.

1. Introduction

Dividend valuation models are used to determine the intrinsic value of equity shares based on expected future dividends. These models assume that the value of a share is equal to the present value of expected future dividends.

Dividend-based valuation is particularly useful for firms with stable dividend policies.

2. Various Dividend Valuation Models

(1) Dividend Discount Model (DDM)

This model states:

Where:

·        P0 = Current price

·        D = Dividend

·        k = Required rate of return

It discounts future dividends to present value.

 

(2) Walter’s Model

Walter’s Model assumes that dividend policy affects the value of the firm.

Formula:

Where:

·        P = Market price per share

·        D = Dividend per share

·        E = Earnings per share

·        r = Internal rate of return

·        k = Cost of equity

If r > k → Firm should retain earnings
If r < k → Firm should distribute dividends

 

(3) Gordon’s Growth Model

Also called Constant Growth Model:

Where:

·        D1D_1D1​= Dividend next year

·        k = Required rate of return

·        g = Growth rate of dividends

It assumes dividends grow at constant rate.

3. Comparison Between Walter’s Model and Gordon’s Model

Basis	Walter’s Model	Gordon’s Growth Model
Focus	Dividend policy relevance	Constant growth valuation
Key Variables	r and k relationship	Growth rate (g)
Assumption	No external financing	Constant retention ratio
Dividend Policy	Influences share value	Influences share value
Applicability	Limited practical use	Widely used in practice

 

4. Assumptions

Walter’s Model Assumptions:

·        Firm finances only through retained earnings

·        r and k remain constant

·        Firm has perpetual life

Gordon’s Model Assumptions:

·        Constant growth rate

·        Retention ratio constant

·        Required rate > growth rate

·        No external financing

5. Relevance in Real World

·        Both models highlight importance of dividend policy.

·        Gordon’s model is more practical for stable companies.

·        Walter’s model is theoretical but helps understand dividend relevance.

·        In reality, firms use external financing, so assumptions are restrictive.

Thus, these models are useful as conceptual frameworks but have limitations in dynamic markets.

 

Q.4 (b) Numerical Solution Using Gordon’s Growth Model

Given:

Dividend just paid (D₀) = ₹5
Growth rate (g) = 6% = 0.06
Required return (k) = 14% = 0.14

Step 1: Calculate D₁

D1 =5 (1.06) = 5.30

Step 2: Apply Gordon’s Model

P0 = 5.30 / 0.14−0.06      

P0=5.30/ 0.08   

P0=₹66.25

 

Intrinsic Value = ₹66.25

 

Interpretation for Investor

Market Price = ₹70
Intrinsic Value = ₹66.25

Since market price (₹70) is higher than intrinsic value (₹66.25):

·        The share appears overvalued.

·        It may not be advisable to purchase at ₹70.

·        Investor may wait for price correction.

Thus, from valuation perspective, the stock is slightly overpriced.

 

5) Discuss the objectives and importance of credit policy in working capital management. Explain the key elements of receivables management with suitable business examples.

1. Introduction

Working capital management focuses on managing short-term assets and liabilities efficiently to ensure smooth business operations. One of the most important components of working capital is accounts receivable, which arises when firms sell goods on credit.

A credit policy refers to the guidelines that determine how credit is granted to customers and how receivables are collected. A well-designed credit policy helps balance sales growth and liquidity.

 

2. Objectives of Credit Policy

(1) Increase Sales

Offering credit attracts customers and increases sales volume.

Example:
Manufacturers selling to retailers usually offer 30–60 days credit to boost sales.

(2) Improve Profitability

Credit sales increase revenue, but must generate returns greater than cost of funds.

(3) Maintain Liquidity

Ensure timely collection of receivables to avoid cash shortages.

(4) Minimise Bad Debts

Reduce risk of non-payment through proper credit evaluation.

(5) Maintain Customer Relationships

Flexible credit terms improve customer loyalty.

 

3. Importance of Credit Policy in Working Capital Management

1. Controls investment in receivables.
2. Influences cash flow and liquidity position.
3. Affects profitability and risk level.
4. Helps balance risk and return.
5. Prevents excessive blocking of funds.

If credit policy is too liberal, bad debts may increase. If too strict, sales may decline. Hence, proper balance is necessary.

 

4. Key Elements of Receivables Management

Receivables management involves controlling and monitoring credit sales.

(1) Credit Standards

Refers to criteria used to determine which customers are eligible for credit.

Example:
A wholesaler may check customer credit history before approving credit.

(2) Credit Terms

Includes duration of credit and discount policies.

Example:
“2/10, Net 30” means 2% discount if paid within 10 days, otherwise full payment in 30 days.

(3) Credit Period

Length of time allowed for payment.

Longer credit period increases sales but also increases risk.

(4) Collection Policy

Procedures to recover outstanding payments.

• Reminder letters
• Telephone follow-ups
• Legal action

Efficient collection reduces bad debts.

(5) Monitoring and Control

Use of ageing schedules and receivables turnover ratio to track outstanding accounts.

Example:
A company regularly reviews overdue accounts to ensure timely recovery.

 

5. Business Example

A consumer electronics company offering 60-day credit to distributors may increase sales significantly. However, if distributors delay payment beyond 90 days, working capital gets blocked. Therefore, the company must monitor receivables and adjust credit policy accordingly.

6. Conclusion

Credit policy plays a vital role in working capital management by influencing sales, liquidity, and risk. Effective receivables management through proper credit standards, credit terms, and collection policies ensures a balance between profitability and financial stability. A well-designed credit policy helps firms maintain smooth operations and long-term sustainability.