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Profit Maximization Is Not an Operationally Feasible Criterion

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					Subject Code: IMT-61
Subject Name : CORPORATE                                            FINANCE
Notes:
a.    Write answers in your own words as far as possible and refrain from copying from the text books/handouts.
b.    Answers of Ist Set (Part-A), IInd Set (Part-B), IIIrd Set (Part – C) and Set-IV (Case Study) must be sent
      together.
c.    Mail the answer sheets alongwith the copy of assignments for evaluation & return.
d.    Only hand written assignments shall be accepted.
A. First Set of Assignments:                         10 Questions, each question carries .5 marks.
B. Second Set of Assignments:                        5 Questions, each question carries 1 marks.
C. Third Set of Assignments:                         5 Questions, each question carries 1 marks. Confine your answers to 150
                                                     to 200 Words.
D.    Forth Set of Assignments:                      Two Case Studies : 5 Marks. Each case study carries 2.5 marks.

                                                                  ASSIGNMENTS
                                                                             PART– A

       1. ‘Profit maximization is not an operationally feasible criterion’. Do you agree? Illustrate your views.
       2. Discuss the fundamental principle behind the concept of ‘value of time’.
       3. There is a direct relationship between risk and return in every area of financial management. Explain.
       4. A firm is considering the following project:
                                                      CASH FLOWS (Rs) FOR FIVE YEARS

                                    0                  1                 2                 3                 4                   5
                                -50000            +11300            +12769            +14429            +16305              +18421


              (a) Calculate the NPV for the project if the cost of capital is 10%. What is the project’s IRR?
              (b) Recompute the project’s NPV assuming a cost of capital of 10% for years 1 and 2, 12% for years
                  3 and 4 and 13% for year 5. Can the IRR method be used for accepting or rejecting the project
                  under these conditions of changing cost of capital over time? Why or why not?
       5. Define cost of capital. Explain its significance in financial decision-making.




Corporate Finance .................................................. Page 1 of 5 ............................................................................... IMT-61
                                                                           PART– B

      1. A company requires Rs 500,000 to construct a new plant. The feasible financial plans are as follows: (i)
         The Company may issue 25,000 common shares at Rs 10 per share and 2,500 debentures of Rs 100
         denomination bearing an 8 per cent rate of interest. (ii) The Company may issue 50,000 common
         shares at Rs 10 per share. (iii) The Company may issue 25,000 common shares at Rs 10 per share
         and 2,500 preference shares at Rs 100 per share bearing an 8 per cent rate of dividend.
            If the company’s earnings before interest and taxes are Rs 10,000, Rs 20,000, Rs 40,000, Rs 60,000
            and Rs 1,00,000, what are the earnings per share under each of the three financial plans? Which
            alternative would you recommend and why?
       2. Explain the NI and NOI approaches of financing the capital structure with hypothetical examples.
       3. Discuss the Modigliani and Miller approach, and critically analyse the hypothesis.
       4. The following is the summarized balance sheet of Philips India Ltd as on 31 March 2002 and 2003.
          Prepare the cash flow statement for the year ended 2003.
                              Liabilities                         2002        2003       Assets                   2002          2003
                              Share Capital                   1350000      1350000       Fixed Assets           1200000        960000
                              General Reserve                     900000     930000      Investments              150000       180000
                              Profit & Loss a/c                   168000     204000      Stock                    720000       630000
                              Creditors                           504000     402000      Debtors                  630000      1365000
                              Provision for Taxation              225000      30000      Bank                     447000       591000
                              Mortgage Loan                   -            810000
                              Total                           3147000      3726000       Total                  3147000       3726000


            Additional Information:
              (a) Investments costing Rs 24,000 were sold during the year for Rs 25,500.
              (b) Provision for tax made during the year was Rs 27,000.
              (c) During the year, a part of the fixed assets costing Rs 30,000 were sold for Rs 36,000. The profit
                  was included in the profit and loss account.
              (d) Interim dividend paid during the year amounted to Rs 1,20,000.

     5. What are the important ratios used to assess the financial position of a company?




Corporate Finance .................................................. Page 2 of 5 ............................................................................... IMT-61
                                                                         PART – C

       1. What is the difference between hire purchase and lease finance?
       2. A firm has applied for working capital finance from a commercial bank. You are requested by the bank
          to prepare an estimate of the working capital requirements of the firm. You may add 10% to your
          estimated figure to account for exigencies. The following is the firm’s projected profit and loss account:

                                                    Particulars                                       Rupees
                                                    Sales                                             2247000
                                                    Cost of Goods Sold                                1637100
                                                    Gross Profit                                        609900
                                                    Administrative expenses                             149800
                                                    Selling expenses                                    139100
                                                    Profit before tax                                   321000
                                                    Tax Provision                                       107000
                                                    Profit after Tax                                    214000
            The cost of goods sold is calculated as follows:

                                               Particulars                                             Rupees
                                               Material Used                                               898800
                                               Wages & other mfg. expenses                                 668750
                                               Depreciation                                                251450
                                                                                                         1819000
                                               Less: Stock of finished goods                               181900
                                                     (10% product not yet sold)
                                               Cost of Goods Sold                                        1637100

            The figures given above relate only to the goods that have been finished, and not to work in progress;
            goods equal to 15% of the year’s production (in terms of physical units) are in progress, on an average
            requiring full material but only 40% of other expenses. The firm has a policy of keeping two months’
            consumption of materials in stock. All expenses are paid one month in arrear. Suppliers of material
            grant one and a half month’s credit; 20% sales are made in cash while the remaining is sold on two
            months’ credit. 70% of income tax has to be paid in advance in quarterly instalments.


       3. What synergies exist in a (a) horizontal merger, (b) vertical merger and (c) conglomerate merger?
       4. What are the different forms of public-sector enterprises? Explain with the help of a chart.
       5. Explain overcapitalization. What are the advantages & evils of overcapitalization?




Corporate Finance .................................................. Page 3 of 5 ............................................................................... IMT-61
                                                                   CASE STUDY-1
The following is the capital structure of Simon co.as on 31st March 2008

Equity Shares : 10000 shares ( of Rs 100 each)                                   10,00,000
12% Preference Shares ( of Rs 100 each)                                            4,00,000
10% Debentures                                                                    6,00,000
                                                                                 20,00,000

The market price of the company’s share is Rs 110 & it is expected that a dividend of Rs 10 per share would be
declared at the end of current year . The dividend growth rate is 6%.

      (i)         If the tax rate is 35% compute the WACC by book value & market value weights
      (ii)        For expansion the company intends to borrow a fund of Rs 10 lakh bearing 12% rate of interest,
                  what will be revised WACC ? The financing decision is expected to increase dividend from Rs 10 to
                  Rs 12 per share & the market price of share will reduce to Rs 105 per share



                                                                   CASE STUDY-2

 While corporate finance is concerned with treasury operations; working capital management; and project
 evaluation and investor relations, cash management refers to the collection, concentration and disbursement
 of cash. It encompasses a company‘s level of liquidity, its management of cash balance and its short-term
 investment strategies. The need for effective cash flow management is felt due to uncertainty in cash flows
 and the lack of synchronization of inflows and outflows. Although companies want to hold as little cash as
 possible, they would also keep enough reserves to face contingencies that may occur.


 At CPL Ltd, a study was conducted on the measures used for collections management.


 The Company was aware of the benefits of a cash management system. They realized that a CMS would help
 optimize working capital management, speed up the realization of receivables, allow the Company to stress on
 core competency and make use of their bankers’ sophisticated technology and expertise. CPL realized that as
 banks have centres at many locations, CMS would be an additional revenue generator and they would not
 charge high amounts from companies for their service.


 The Company had very recently started working on Real Time Gross Settlement (RTGS) for collections and
 1.5 per cent of their business, i.e., about Rs 2 crore, was being handled through RTGS. There were two ways
 of implementing RTGS, one was through taking mandate from dealers and triggering a file for billing and
 debiting their account. This was in tandem with the dealer’s stock management system which was maintained
 by the Company. There was always a chance of legal issues as the dealer could later accuse the Company of
 making numerous debit entries. Therefore, this option was avoided and the Company opted for the method
 wherein the money was first transferred by the stockist as and when required by crediting the Company’s
 account; subsequently a mail was sent by the company’s bankers along with a PDF file attachment which was
 password protected. After processing this file, the order was sent to the warehouse and shipments were
 effected.
 On an average, there were forty to fifty RTGS transactions per month. None of the dealers were forced to shift
 to RTGS. It was totally voluntary.


 The Company had been using both cheques and demand drafts as collection instruments; the discretion being
 made based on the credit history of the stocklist. The Company accepted only DDs from new stockists for a
 period of three to six months and only after that, depending on their payment record, could they use either of
 the two instruments. They used RTGS only for stockists paying through the DD mode and not through
 cheques.

Corporate Finance .................................................. Page 4 of 5 ............................................................................... IMT-61
 The turnaround time for RTGS was two to three hours but in order to avail the facility, the transaction had to
 be made before a fixed time every day, that is, 10 a.m., the Mumbai account would be credited between 10
 a.m. and 12 noon. However, in remote areas, the transfer would take place between 1 and 3 p.m. In case of
 clogging of transactions, the RBI would use the priority assigned by sending the banks to their transactions as
 per their value.


 CPL planned to run both the cheque-based system and RTGS parallely because it did not want to compel the
 dealers to travel from remote areas just for remitting through RTGS.


 It would be advantageous for stockists to shift to RTGS because a commitment was made to them that their
 orders would be shipped the same day in case of payments through RTGS, which otherwise was not made.
 The Company wished to encourage their bankers to provide RTGS free of cost to itself as well as its dealers
 or offer it at a very low price.


 The legal issues related to RTGS were solved by taking cheques from dealers. If the dealers failed to pay post
 dispatch, the Company had the right to deposit the cheques. If the cheques were dishonoured, the Company
 could sue that dealer.


 The percentage of collection under RTGS was 1.5 per cent, but which was estimated to increase to at least 10
 per cent in the short run and 40 per cent in the long run as soon as viewing rights were given.
 The mapping of dealer information was in bad shape and at times CP Ltd had to just respond on the basis of
 guesswork.


 CPL soon began to benefit from the use of RTGS. Not only did costs come down by Rs 1.25 (to Rs 2) per
 1000 but DD making charges were also eliminated. The administration charges for RTGS were prohibitive.
 The Company felt that RTGS was the way ahead but for that they would first have to map RTGS entries
 manually which was not a bright proposition. So automatic mapping of data was required. In addition, it was
 discovered that since charges for T+1 transactions were very high, they had arrangements with two banks,
 one handling T+1 and the other handling T+6. They were receiving customized MIS from their two bankers.
 The time lag of two to three days for making DDs was done away with. The Company was facing the following
 problems:
       (i) Often, important information related to the sender’s identification was missing.
      (ii) In the absence of an automatic update system, they had to manually update the system into ERP.
      (iii) No mapping was being done during reconciliation.
     (iv) Dealers were unwilling to share the expenditure on RTGS. So they were unaffected by the charges by
          the bank for the RTGS.
      (v) There were many sender banks and they all followed different formats. Therefore, to match them
          manually was difficult.
     (vi) The file sent by the bankers did not contain sufficient information and could not be directly linked to
          ERP which necessitated manual intervention which was laborious and expensive.


 It was found that although the transition of the Company to RTGS seemed a little troublesome due to the
 collection network, on the whole, it was better to be a part of the system at the formation stage so that it could
 be customized according to the needs instead of allowing others to get the system organized or designed.
 Questions:
       1. What is the role of a CMS in corporate finance?
       2. What drawbacks in the existing collection system did the RTGS system seek to improve on?
       3. In your opinion, was the RTGS system able to improve the Company’s collection management?
          Analyse.



Corporate Finance .................................................. Page 5 of 5 ............................................................................... IMT-61

				
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