Financial Management

Topics: Net present value, Time value of money, Cash flow Pages: 13 (3959 words) Published: April 5, 2014

Course: Executive Master Program in Business Administration. Duration: 1 Year

Semester I – Financial Management

Section A

Part One

Multiple choices:

Q1.a. Ignored non-corporate enterprise

Q2.c. Redeemable preference shares

Q3.b. Domestic risk

Q4.a. Future cost

Q5.c. Designing optimal corporate structure

Q6.d. Cost of capital

Q7.d. Agency cost

Q8.a. Legal requirement

Q9.b. Default risk

Q10.a. Beta

Part Two

Q1.Annuity is fixed sum of money paid every year in at any other fixed interval shorter than a year. This annuity may be way of return of some principal plus interest payment of against money invested or by way of payment of other dues such as pensions after retirement. In any case it represents out flow of cash from one account to in flow of cash to another account. In this way all annuities involve movements of cash or funds. Therefore all annuities are cash flows that can be suitable represented in cash flow statements. An annuity will be represented as inflow of cash in the cash flow statement for the recipient of annuity and out flow of cash in the cash flow statement of the person or firm paying out the annuity.

Q2.Portfolio risk refers to the combined risk attached to all of the securities within the investment portfolio of an individual. This risk is generally unavoidable because there is a modicum of risk involved in any type of investment, even if it is extremely small. Investors often try to minimize portfolio risk through diversification, which involves purchasing many securities with different characteristics in terms of potential risk and reward. There are some risks which cannot be solved through diversification, and these risks, known as market risks, can only be lessened by hedging with contrasting investments.

Many people who haven’t actually begun to invest their capital only foresee the positives and potential gains that come with putting one’s money onto a specific security. In reality though, investment of any kind carries the risk that the capital at stake will either be lessened or lost completely. When all of the investments in portfolio are added together, their combined risk is known as the portfolio risk.

Q3.Loan is an amount raised from outsiders at an interest and repayable at a specified period (lump sum) or in installments. The repayment of loan is known as amortisation. A financial manager may take a loan and he may be interested to know the amount of equal instalment to be paid every year to repay the complete loan amount including interest. Installment can be calculated with the following formula:

LI= PA{[I(1+I)n]/[(1+I)n-1]} or LI= PA ÷ PVIFAn.I
Where,
LI = Loan Installment
PA= Principal Amount
I = Interest rate
n = Loan repayment period
PVIFAn.I= PV interest factors at loan repayment period at a specified interest rate.

Q4.Net Present Value Method ( NPV)
The net present value method is one of the discounted cash flow methods. It is also known as discounted benefit cost ratio method. NPV can be defined as preset value of benefits minus preset value of costs. It is the process of calculating present values of cash inflows using cost of capital as an appropriate rate of discount and subtracts present value of cash outflows from the present value of cash inflows and finds the net present value, which may be positive or negative. Positive net present value occurs when the present value of cash inflow is higher than the present value of cash outflows and vice versa. Advantages of NPV Method

The merits of NPV are:
1. It takes into account the time value of money.
2. It uses all cash inflows occurring over the entire life period of the project including scrap value of the old project. 3. It is particularly useful for the selection of mutually exclusive projects. 4. It takes into consideration the changing discount rate.

5. It is consistent with the objective of maximization of shareholders’ wealth....
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