MB0045 –Financial Management

Q.1 Considering the following information, what is the price of the share as per Gordon’s Model?

|Details of the Company Net sales |Rs.120 lakhs | |Net profit margin |12.5% | |Outstanding preference shares |Rs.50 lakhs@ 12% dividend | |No. of equity shares |25, 000 | |Cost of equity shares |12% | |Retention ratio |40% | |Rate of interest (ROI) |16% |

Ans. Net sales=rs 120 lakhs

Net profit=120 lakhs *12.5=15 lakhs

Dividend paid on preference shares=Rs 50 lakhs*12%= 6 lakhs

Total earnings=15-6= 9 lakhs

EPS=900000/250000

= 3.6

Apply the Gordon formula of p= E(1-b)/(ke-br)

Where p is the price of share,=?

E is earning per share= EPS = 3.6

b is Retention ration=40%=0.4

(1-b) is dividend payout ratio=1-0.4=0.6

Ke is cost of equity capital=12%=0.12

Rate of return on investment=16%=.016

Br is growth rate=0.4*0.16=0.064

P=E(1-b)/(ke-br)

=3.6(1-0.4)/(0.12-0.064)

=3.6*0.6/0.056

=2.16/0.056

=38.57

The price of the share=38.57

Q.2 Examine the components of working capital & also explain the concepts of working capital. Ans. In this section, we look at the cyclicality and persistence of working capital and its constituents in UK data, as well as how working capital has been a_ected by the recent _nancial crisis. Knowledge of these stylised facts is important to motivate the importance of our modelling contribution, and will hopefully also stimulate further work on the topic. These facts will also help us assess whether our model has the right implications for the variables in which we are most interested as well as motivate our analysis of how _nancial shocks a_ect the macroeconomy via working capital. First we look at measures of corporate liquidity: deposits, loans and the di_erence between the two (net cash holdings). Then we present our limited evidence on the behaviour of trade credit and debit, before considering stockbuilding. Finally, we consider how _rms' holdings of deposits, loans and inventories have behaved during the current crisis. 2.1 Stylised facts

We start with a description of the data on _rms' cash holdings. Chart 1a looks at Hodrick- Prescott (HP) _ltered deposits and short-term borrowing of private non-_nancial companies (PNFCs) in the United Kingdom and compares these with HP-_ltered real GDP.5 Table 2 4However, C_urdia and Woodford suggest that the optimal size of the spread adjustment is less than full (as, for example, Taylor suggested). They also warn that such a simply applied modi_cation is not optimal; the monetary response to endogenous changes in the spread need to be di_erent in the case of non-_nancial shocks. 5As the HP-_lter is subject to the end point problem, and of course the end of the series in a deep recession is potentially problematic, we have also examined a band-pass _lter, a linear trend and a HP-_lter that ends in 2007 Q4. The only qualitative di_erence from the use of these alternative _lters is that the positive contemporaneous correlation with output for _rm short-term borrowing that we _nd in Table 2 becomes countercyclical in some 5

suggests that both PNFCs' deposits and short-term borrowing are around 3.7 times more volatile than output. Both series are mildly procyclical: the contemporaneous correlation of deposits with output is 0.45 and the equivalent _gure for short-term borrowing is 0.31. And both deposits and borrowing are mildly persistent; the AR(1) coe_cients are 0.71 and 0.80, respectively. Chart 1b suggests that the ratio of net cash - measured as the di_erence between PNFCs' deposits and their short-term borrowing - to GDP leads the cycle (the correlation with...