6th semester Financial Management (3201)

1 * Define finance, business finance and financial management?(2010):

Finance: L.J Gitman says “Finance is concerned with the process, institutions, markets and instruments involved in the transfer of money among individuals, business governments ’’. So we can say than finance is the combination of different activities like rising of funds, and management of funds to accomplish the objectives of an individual or of a firm.

Business finance: Gloss & Baker says ‘Business finance says concerned with the sources of funds available enterprises of all sizes and the proper use of money or credit obtain from such sources” B.O. Wheeler says “Business finance is that business activity which is concern with the acquisition and conservation of capital funds in meeting the financial need and overall objective of business enterprise “.

Financial management (2009): Financial management or managerial finance is the branch of finance that concerns itself with the managerial significance of finance techniques. It is focused on assessment rather then technique.

2 * Differentiate between NPV & IRR? (2010, 2007):

a. NPV Or net present value is a tool used to determine whether a project is worth the investments made , IRR or Internal Rate Of return is a formula used  to calculate your investment profitability, Basically, it is the rate of return at which NPV is zero.

b. IRR assumes that the cash flows are reinvested in the projected at the some discount rate . This is a major limitation for the use of IRR. NPV makes no such assumption

c. NPV is measured in terms of currency where IRR is matured in terms of expected percentage return.

3 *NPV & IRR which is the best? Why? (2010):

 Some people prefer the NPV method as superior to the IRR, because the IRR method implies reinvestment's rates that will differ depending on the cash flow stream for each investment proposal under consideration. With the NPV method, however, the implied reinvestment rate, namely the required rate of return or hardly rate, is the some for each proposal. In essence, this reinvestment rate presents the minimum return on opportunities available to you.

4 * what is agency problem? When? (2010):

A conflict of interest arising between the creditors, shareholders & management because of differing goals. For example agency problem exists when management & stockholder conflicting ideas on how the company should be run. The agency problem also refers to simple disagreement between agents & principals. Two most common agency problems are “adverse selection” and “moral hazard”. The solution (which is closely related to the moral hazard problem) is to ensure the provision of appropriate incentives so that agents act in the way principal wish them to. Even in the limited arena of employment contracts, the difficulty of doing this in practice is reflected in a multitude of compensation mechanisms and supervisory schemes.

5 * What do you mean by weighted average cost of capital(WACC)?Why & How is it calculated?(2010):

The weighted average cost of capital (WACC) is the rate that a company is expected to pray on average to all its security holders to finance its assets. The WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other provider of capital, or they will invest elsewhere. Companies raise money from a number of sources . Common equity, preferred equity, straight debit, convertible debit, exchangeable debt, warrants, options, & so on.

The WACC is calculated taking into account the relative weight of each component of the capital structure.  A Calculation of a firms    Cost of capital in which each category of capital is proportionately weighted. All capital sources-common stock, preferred stock, bonds & any other long- term debt are included in a WACC calculation. Alleles equal the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation & higher via risk.

6 * What is capital structure?(2010,2009):

IN finance capital structure refers to the way a corporation finance its assets through some combination of equity, debt, or hybrid securities. A firm’s capital structure is then the compositions or ‘structure’ of its liabilities  

 

7 *What are the factors that influence the capital structure decisions? (2010):

1. Business Risk; excluding debt, business risk is the basic risk of the company’s operations. The greater the business risk, the lower debt ratio.

2. Company’s tax Exposure: Debt payments are tax deductible. As such, if a company’s tax rate is high, using debt as a means of financing a project is attractive because the tax deductibility of the debt payments protects some income from taxes.

3. Financial Flexibility:  This is essentially the firm’s ability to raise capital in bad times. It should come as no surprise that companies typically have no problem raising capital when sales are growing & earning are strong.

4. Management Style: Management Style range from aggressive to conservative. The more conservative a managements approach is the less inclined it is to use debt to increase profits.

5. Growth Rate: Firms that are in the growth stage of their cycle typically finance that growth through debt, borrowing money to grow faster.