Topics: Net present value, Rate of return, Time value of money Pages: 10 (2318 words) Published: May 19, 2013

Master of Business Administration- Semester 2
(4 credits)
(Book ID: B1628)



Q1. What are the goals of financial management?

Ans. Goal of financial management

Financial management means maximization of economic welfare of its shareholders. Maximization of economic welfare means maximization of wealth of its shareholder’s wealth maximizations reflected in the market value of the firm’s shares. Experts believe that, the goal of financial management is attained when it maximizes the market value of shares. There are two versions of the goal of financial management of the firm-Profit Maximization and Wealth maximization. Let us now discuss the goals of financial management in datial.

Profit maximization

Profit maximization is based on the cardinal rule of efficiency. Its goal is to maximize the returns with the best output and price levels. A firm’s performance is evaluated in terms of profitability. Profit maximization is the traditional and narrow approach, which aims at maximizing the profit of the concern. Allocation of resources and investor’s perception of the company’s performance can be traced to the goal of profit maximization. Profit maximization has been criticized on many accounts:

• The concept of profit lacks clacks clarity.
1. Is it profit after tax or before tax?
2. Is it operating profit or net profit available to shareholders?

• Profit maximization neither considers the time value of money nor the net present value of the cash inflow. It does not differentiate between profit of current year with the profits to be earned in later years.

• The concept of profit maximization apprehends to be either accounting profit or economic normal profit or economic supernormal profit.

Profit maximization as a concept, even though has the above-mentioned drawbacks, is still given importance as profit do matter for any kind of business. Ensuring continued profits ensure maximization of shareholder’s wealth.

Wealth Maximization

The term wealth means shareholder’s wealth or the wealth of the persons those who are involved in the business concern. Wealth maximization is also known as value maximization or net present worth maximization. This objective is an universally accepted concept in the field of business. Wealth maximization is possible only when the company pursues policies that would increase the market value of shares of the company. It has been accepted by the finance manager as it overcomes the limitations of profit maximization.

Q2. Calculate the PV of an annuity of Rupees 500 received annually for four years when discounting factor is 10%.

Ans. Annuity Refers to the periodic flows of equal amounts. Given the interest rate, compounding technique can be used to compare the cash flows separated by more than one time period. With this technique, the amount of present cash can be converted into amount of cash of equivalent value in future.

Depicts the calculated present value of annuity:

| End of year | Cash inflows | PV factor | PV in Rupees | |1 |Rs.500 |0.909 |454.5 | |2 |Rs.500 |0.827 |413.5 | |3 |Rs.500 |0.751 |375.5 | |4 |Rs.500 |0.683 |341.5 | | | |3.170 |1585.0 |

Computation of PV of...
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