FINANCIAL MANAGEMENT

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Section A:

Part one:

Multiple choices:

1. The approach focused mainly on the financial problems of corporate enterprise

a. Ignored non-corporate enterprise

b. Ignored working capital financing

c. External approach

d. Ignored routine problems

2. These are those shares, which can be redeemed or repaid to the holders after a lapse of the stipulated period

a. Cumulative preference shares

b. Non-cumulative preference shares

c. Redeemable preference shares

d. Perpetual shares

3. This type of risk arise from changes in environmental regulations, zoning requirements, fees, licenses and most frequently taxes

a. Political risk

b. Domestic risk

c. International risk

d. Industry risk

4. It is the cost of capital that is expected to raise funds to finance a capital budget or investment proposal

a. Future cost

b. Specific cost

c. Spot cost

d. Book cost

5. This concept is helpful in formulating a sound & economical capital structure for a firm

a. Financial performance appraisal

b. Investment evaluation

c. Designing optimal corporate capital structure

d. None

6. It is the minimum required rate of return needed to justify the use of capital

a. From investors

b. Firms point

c. Capital expenditure point

d. Cost of capital

7. It arises when there is a conflict of interest among owners, debenture holders and the management

a. Seasonal variation

b. Degree of competition

c. Industry life cycle

d. Agency costs

8. Some guidelines on shares & debentures issued by the government that are very important for the constitution of the capital structure are

a. Legal requirement

b. Purpose of finance

c. Period of finance

d. Requirement of investors

9. It is that portion of an investments total risk that results from change in the financial integrity of the investment

a. Bull- bear market risk

b. Default risk

c. International risk

d. Liquidity risk

10. _____________ measure the systematic risk of a security that cannot be avoided through diversification

a. Beta

b. Gamma

c. Probability distribution

d. Alpha

Part Two:

1. What is Annuity kind of cash flow?

2. What do understand by Portfolio risk?

3. What do you understand by ‘Loan Amortization’?

4. What is the Difference between NPV and IRR?

Section B: Case lets

Case let 1

This case provides the opportunity to match financing alternatives with the needs of different companies. It allows the reader to demonstrate a familiarity with different types of securities. George Thomas was finishing some weekend reports on a Friday afternoon in the downtown office of Wishart and Associates, an investment-banking firm. Meenda, a partner in the firm, had not been in the New York office since Monday. He was on a trip through Pennsylvania, visiting five potential clients, who were considering the flotation of securities with the assistance of Wishart and Associates. Meenda had called the office on Wednesday and told George's secretary that he would cable his recommendations on Friday afternoon. George was waiting for the cable. George knew that Meenda would be recommending different types of securities for each of the five clients to meet their individual needs. He also knew Meenda wanted him to call each of the clients to consider the recommendations over the weekend. George was prepared to make these calls as soon as the cable arrived. At 4:00 p.m. a secretary handed George the following telegram. George Thomas, Wishart and Associates STOP Taking advantage of offer to go skiing in Poconos STOP Recommendations as follows: (1) common stock, (2) preferred stock, (3) debt with warrants, (4) convertible bonds, (5) callable debentures STOP. See you Wednesday STOP Meenda. As George picked up the phone to make the first call, he suddenly realized that the potential clients were not matched with the investment alternatives. In Meenda's office, George found folders on each of the five firms seeking financing. In the front of each folder were some handwritten notes that Meenda had made on Monday before he left. George read each of the notes in turn. APT, Inc needs $8 million now and $4 million in four years. Packaging firm with high growth rate in tri-state area. Common stock trades over the counter. Stock is depressed but should rise in year to 18 months. Willing to accept any type of security. Good management. Expects moderate growth. New machinery should increase profits substantially. Recently retired $7 million in debt. Has virtually no debt remaining except short-term obligations.

Sandford Enterprises

Needs $16 million. Crusty management. Stock price depressed but expected to improve. Excellent growth and profits forecast in the next two year. Low debt-equity ratio, as the firm has record of retiring debt prior to maturity. Retains bulk of earnings and pays low dividends. Management not interested in surrendering voting control to outsiders. Money to be used to finance machinery for plumbing supplies.

Sharma Brothers., Inc.

Needs $20 million to expand cabinet and woodworking business. Started as family business but now has 1200 employees, $50 million in sales, and is traded over the counter. Seeks additional shareholder but not willing to stock at discount. Cannot raise more than $12 million with straight debt. Fair management. Good growth prospects. Very good earnings. Should spark investor's interest. Banks could be willing to lend money for long-term needs.

Sacheetee Energy Systems

The firm is well respected by liberal investing community near Boston area. Sound growth company. Stock selling for $16 per share. Management would like to sell common stock at $21 or more willing to use debt to raise $ 28 million, but this is second choice. Financing gimmicks and chance to turn quick profit on investment would appeal to those likely to invest in this company.

Ranbaxy Industry

Needs $25 million. Manufactures boat canvas covers and needs funds to expand operations. Needs longterm money. Closely held ownership reluctant surrender control. Cannot issue debt without permission of bondholders and First National Bank of Philadelphia. Relatively low debt-equity ratio. Relatively high profits. Good prospects for growth Strong management with minor weaknesses in sales and promotion areas. As George was looking over the folders, Meenda's secretary entered the office. George said, "Did Meenda leave any other material here on Monday except for these notes?” She responded, "No, that's it, but I think those notes should be useful. Meenda called early this morning and said that he verified the facts in the folders. He also said that he learned nothing new on the trip and he sort of indicated that, he had wasted his week, except of course, that he was invited to go skiing at the company lodge up there". George pondered over the situation. He could always wait until next week, when he could be sure that he had the right recommendations and some of the considerations that outlined each client's needs and situation. If he could determine which firm matched each recommendation, he could still call the firms by 6:00 P.M. and meet the original deadline. George decided to return to his office and match each firm with the appropriate financing.

Question:

1. Which type of financing is appropriate to each firm?

2. What types of securities must be issued by a firm which is on the growing stage in order to meet the financial requirements?

Case let 2

This case has been framed in order to test the skills in evaluating a credit request and reaching a correct decision. Perluence International is large manufacturer of petroleum and rubber-based products used in a variety of commercial applications in the fields of transportation, electronics, and heavy manufacturing. In the northwestern United States, many of the Perluence products are marketed by a wholly-owned subsidiary, Bajaj Electronics Company. Operating from a headquarters and warehouse facility in San Antonio, Strand Electronics has 950 employees and handles a volume of $85 million in sales annually.

About $6 million of the sales represents items manufactured by Perluence. Gupta is the credit manager at Bajaj electronics. He supervises five employees who handle credit application and collections on 4,600 accounts. The accounts range in size from $120 to $85,000. The firm sells on varied terms, with 2/10, net 30 mostly. Sales fluctuate seasonally and the average collection period tends to run 40 days. Bad-debt losses are less than 0.6 per cent of sales. Gupta is evaluating a credit application from Booth Plastics, Inc., a wholesale supply dealer serving the oil industry. The company was founded in 1977 by Neck A. Booth and has grown steadily since that time. Bajaj Electronics is not selling any products to Booth Plastics and had no previous contact with Neck Booth. Bajaj Electronics purchased goods from Perluence

International under the same terms and conditions as Perluence used when it sold to independent customers. Although Bajaj Electronics generally followed Perluence in setting its prices, the subsidiary operated independently and could adjust price levels to meet its own marketing strategies. The Perluence's cost-accounting department estimated a 24 per cent markup as the average for items sold to Pucca Electronics. Bajaj Electronics, in turn, resold the items to yield a 17 per cent markup. It appeared that these percentages would hold on any sales to Booth Plastics. Bajaj Electronics incurred out-of pocket expenses that were not considered in calculating the 17 per cent markup on its items. For example, the contact with Booth Plastics had been made by James, the salesman who handled the Glaveston area. James would receive a 3 per cent commission on all sales made Booth Plastics, a commission that would be paid whether or not the receivable was collected. James would, of course, be willing to assist in collecting any accounts that he had sold. In addition to the sales commission, the company would incur variable costs as a result of handling the merchandise for the new account. As a general guideline, warehousing and other administrative variable costs would run 3 per cent sales. Gupta Holmstead approached all credit decisions in basically the same manner. First of all, he considered the potential profit from the account. James had estimated first-year sales to Booth Plastics of $65,000. Assuming that Neck Booth took the, 3 per cent discount. Bajaj Electronics would realize a 17 per cent markup on these sales since the average markup was calculated on the basis of the customer taking the discount. If Neck Booth did not take the discount, the markup would be slightly higher, as would the cost of financing the receivable for the additional period of time. In addition to the potential profit from the account, Gupta was concerned about his company's exposure. He knew that weak customers could become bad debts at any time and therefore, required a vigorous collection effort whenever their accounts were overdue. His department probably spent three times as much money and effort managing a marginal account as compared to a strong account. He also figured that overdue and uncollected funds had to be financed by Bajaj Electronics at a rate of 18 per cent. All in all, slow -paying or marginal accounts were very costly to Bajaj Electronics. With these considerations in mind, Gupta began to review the credit application for Booth Plastics.

Question:

1. How would you judge the potential profit of Bajaj Electronics on the first year of sales to Booth Plastics and give your views to increase the profit.

2. Suggestion regarding Credit limit. Should it be approved or not, what should be the amount of credit limit that electronics give to Booth Plastics.

Section C: Applied Theory

1. Honey Well Company is contemplating to liberalize its collection effort. Its present sales are Rs. 10 lakh, its average collection period is 30 days, its expected variable cost to sales ratio is 85 per cent and its bad debt ratio is 5 per cent. The Company’s cost of capital is 10 per cent and tax are is 40 per cent. He proposed liberalization in collection effort increase sales to Rs. 12 lakh increases average collection period by 15 days, and increases the bad debt ratio to 7 percent. Determine the change in net profit.

2. Explain the concept of working capital. What are the factors which influence the working capital?