Fall 2010

Course: MBA Semester 2 Master of Business Administration MBA Semester 2 MB0045 Financial Management - 4 Credits Assignment Set- 1

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Q.1 Write the short notes on 1. Financial management 2. Financial planning 3. Capital structure 4. Cost of capital 5. Trading on equity. Ans: 1. Financial Management: Financial Management of a firm is concerned with procurement and effective utilisation of funds for the benefit of its stakeholders. It embraces all those managerial activities that are required to procure funds at the least cost and their effective deployment. The three core elements of financial management are: a. Financial Planning Financial Planning is to ensure the availability of capital investments to acquire the real assets. Real assets are land and buildings, plants and equipments. Capital investments are required for establishing and running the business smoothly. b. Financial Control Financial Control involves managing the costs and expenses of a business. For example, it includes taking decisions on the routine aspects of day to day management of collecting money due from the firms customers and making payments to the suppliers of various resources. c. Financial Decisions Decision needs to be taken on the sources from which the funds required for the capital investments could be obtained. There are two sources of funds - debt and equity. In what proportion the funds are to be obtained from these sources is to be decided for formulating the financing plan. In this unit, you will learn about these core elements of financial management. 2. Financial Planning: Financial planning deals with the planning, execution and the monitoring of the procurement and utilisation of the funds. Financial planning process gives birth to financial plan. It could be thought of as a blue-print explaining the proposed strategy and its execution There are six steps involved in financial planning which are as below. Establish corporate objectives The first step in financial planning is to establish corporate objectives. Corporate objectives can be grouped into qualitative and quantitative. For example, a companys mission statement may specify create economic value added. However this qualitative statement has to be stated in quantitative terms such as a 25 % ROE or a 12 % earnings growth rates. Since business enterprises operate in a dynamic environment, there is a need to formulate both short run and long run objectives. Formulate strategies The next stage in financial planning is to formulate strategies for attaining the defined objectives. Operating plans helps achieve the purpose. Operating plans are framed with a time horizon. It can be a five year plan or a ten year plan.

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Delegate responsibilities Once the plans are formulated, responsibility for achieving sales target, operating targets, cost management bench-marks, profit targets is to be fixed on respective executives. Forecast financial variables The next step is to forecast the various financial variables such as sales, assets required, flow of funds and costs to be incurred. These variables are to be translated into financial statements. Financial statements help the finance manager to monitor the deviations of actual from the forecasts and take effective remedial measures. This ensures that the defined targets are achieved without any overrun of time and cost. Develop plans This step involves developing a detailed plan of funds required for the plan period under various heads of expenditure. From the plan, a forecast of funds that can be obtained from internal as well as external sources during the time horizon is developed. Legal constrains in obtaining funds on the basis of covenants of borrowings is given due weight-age. There is also a need to collaborate the firms business risk with risk implications of a particular source of funds. A control mechanism for allocation of funds and their effective use is also developed in this stage. Create flexible economic environment While formulating the plans, certain assumptions are made about the economic environment. The environment, however, keeps changing with the implementation of plans. To manage such situations, there is a need to incorporate an inbuilt mechanism which would scale up or scale down the operations accordingly. 3. Capital Structure: The design of an ideal capital structure requires five factors to be considered Return The capital structure of a company should be most advantageous. It should generate maximum returns to the shareholders for a considerable period of time and such returns should keep increasing. Risk Debt does increase equity holders returns and this can be done till such time that no risk is involved. Use of excessive debt funds may threaten the companys survival. Flexibility The company should be able to adapt itself to situations warranting changed circumstances with minimum cost and delay. Capacity The capital structure of the company should be within the debt capacity. Debt capacity depends on the ability for funds to be generated. Revenues earned should be sufficient enough to pay creditors interests, principal and also to shareholders to some extent. 4. Cost of Capital: Cost of capital is the rate of return the firm requires from investment in order to increase the value of the firm in the market place. In economic sense, it is the cost of raising funds required to finance the proposed project, the borrowing rate of the firm. Thus under economic terms, the cost of capital may be defined as the weighted average cost of each type of capital. There are three basic aspects about the concept of cost 1. It is not a cost as such: The cost of capital of a firm is the rate of return which it requires on the projects. That is why; it is a hurdle rate.

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2. It is the minimum rate of return: A firms cost of capital represents the minimum rate of return which is required to maintain at least the market value of equity shares. 3. It consists of three components. A firms cost of capital includes three components a. Return at Zero Risk Level: It relates to the expected rate of return when a project involves no financial or business risks. b. Business Risk Premium: Business risk relates to the variability in operating profit (earnings before interest and taxes) by virtue of changes in sales. Business risk premium is determined by the capital budgeting decisions for investment proposals. c. Financial Risk Premium: Financial risk relates to the pattern of capital structure (i.e., debtequity mix) of the firm, In general, a firm which has higher debt content in its capital structure should have more risk than a firm which has comparatively low debt content. This is because the former should have a greater operating profit with a view to covering the periodic interest payment and repayment of principal at the time of maturity than the latter. 5. Trading on Equity: When a co. uses fixed interest bearing capital along with owned capital in raising finance, is said Trading on Equity. (Owned Capital = Equity Share Capital + Free Reserves ) Trading on equity represents an arrangement under which a company uses funds carrying fixed interest or dividend in such a way as to increase the rate of return on equity shares. It is possible to raise the rate of dividend on equity capital only when the rate of interest on fixed interest bearing security is less than the rate of return earned in business. Two other terms: Trading on Thick Equity :- When borrowed capital is less than owned capital Trading on Thin Equity :- When borrowed capital is more than owned capital, it is called Trading on thin Equity.

Q.2 a. Write the features of interim divined and also write the factors Influencing divined policy? b. What is reorder level ? Ans: Interim Dividend and factors Influencing it: Usually, board of directors of company declares dividend in annual general meeting after finding the real net profit position. If boards of directors give dividend for current year before closing of that year, then it is called interim dividend. This dividend is declared between two annual general meetings. Before declaring interim dividend, board of directors should estimate the net profit which will be in future. They should also estimate the amount of reserves which will deduct from net profit

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in profit and loss appropriation account. If they think that it is sufficient for operating of business after declaring such dividend. They can issue but after completing the year, if profits are less than estimates, then they have to pay the amount of declared dividend. For this, they will have to take loan. Therefore, it is the duty of directors to deliberate with financial consultant before taking this decision. Accounting treatment of interim dividend in final accounts of company :First Case: Interim dividend is shown both in profit and loss appropriation account and balance sheet , if it is outside the trial balance in given question. (a) It will go to debit side of profit and loss appropriation account (b) It will also go to current liabilities head in liabilities side. Second Case: Interim dividend is shown only in profit and loss appropriation account, if it is shown in trial balance. (a) It will go only to debit side of profit and loss appropriation account. If in final declaration is given outside of trial balance and this will be proposed dividend and interim dividend in trial balance will be deducted for writing proposed dividend in profit and loss appropriation account and balance sheet of company, because if we will not deducted interim dividend, then it will be double deducted from net profit that is wrong and error shows when we will match balance sheets assets with liabilities. Factors Influencing dividend policy: The dividend decision is difficult decision because of conflicting objectives and also because of lack of specific decision-making techniques. It is not easy to lay down an optimum dividend policy which would maximize the long-run wealth of the shareholders. The factors affecting dividend policy are grouped into two broad categories. 1. Ownership considerations 2. Firm-oriented considerations Ownership considerations: Where ownership is concentrated in few people, there are no problems in identifying ownership interests. However, if ownership is decentralized on a wide spectrum, the identification of their interests becomes difficult. Various groups of shareholders may have different desires and objectives. Investors gravitate to those companies which combine the mix of growth and desired dividends. Firm-oriented considerations: Ownership interests alone may not determine the dividend policy. A firms needs are also an important consideration, which include the following: Contractual and legal restrictions Liquidity, credit-standing and working capital Needs of funds for immediate or future expansion Availability of external capital. Risk of losing control of organization Relative cost of external funds Business cycles Post dividend policies and stockholder relationships. The following factors affect the shaping of a dividend policy: Nature of Business: Companies with unstable earnings adopt dividend policies which are different from those which have steady earnings.

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Composition of Shareholding: In the case of a closely held company, the personal objectives of the directors and of a majority of shareholders may govern the decision. To the contrary, widely held companies may take a dividend decision with a greater sense of responsibility by adopting a more formal and scientific approach. Investment Opportunities: Many companies retain earnings to facilitate planned expansion. Companies with low credit ratings may feel that they may not be able to sell their securities for raising necessary finance they would need for future expansion. So, they may adopt a policy for retaining larger portion of earnings. Similarly, is a company has lucrative opportunities for investing its funds and can earn a rate which is higher than its cost of capital, it may adopt a conservative dividend policy. Liquidity: This is an important factor. There are companies, which are profitable but cannot generate sufficient cash, since profits are to be reinvested in fixed assets and working capital to boost sales. Restrictions by Financial Institutions: Sometimes financial institutions which grant long-term loans to a company put a clause restricting dividend payment till the loan or a substantial part of it is repaid. Inflation: In period of inflation, funds generated from depreciation may not be adequate to replace worn out equipment. Under inflationary situation, the firm has to depend upon retained earnings as a source of funds to make up for the shortfall. Consequently, the dividend pay out ratio will tend to be low. Other factors: Age of the company has some effect on the dividend decision. The demand for capital expenditure, money supply, etc., undergoes great oscillations during the different stages of a business cycle. As a result, dividend policies may fluctuate from time to time. b. What is reorder level? Reorder Level This is that level of materials at which a new order for supply of materials is to be placed. In other words, at this level a purchase requisition is made out. This level is fixed somewhere between maximum and minimum levels. Order points are based on usage during time necessary to requisition order, and receive materials, plus an allowance for protection against stock out. The order point is reached when inventory on hand and quantities due in are equal to the lead time usage quantity plus the safety stock quantity. Formula of Re-order Level or Ordering Point: The following two formulas are used for the calculation of reorder level or point. Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time The above formula is used when usage and lead time are known with certainty; therefore, no safety stock is provided. When safety stock is provided then the following formula will be applicable: Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time + Safety stock

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Q.3 Sales Rs.400, 000 less returns Rs 10, 000, Cost of Goods Sold Rs 300,000, Administration and selling expenses Rs.20, 000, Interest on loans Rs.5000, Income tax Rs.10000, preference dividend Rs. 15,000, Equity Share Capital Rs.100, 000 @Rs. 10 per share. Find EPS. Ans: less returns Rs 10, 000 Cost of Goods Sold Rs 300,000 Administration and selling expenses Rs.20, 000 Interest on loans Rs.5000 Income tax Rs.10000 preference dividend Rs. 15,000 =total cost including interest & Tax =Rs. 360,000/Profit after tax & interest =Total sales - total cost = 400,000 - 360,000 = Rs 40,000/Total no. of shares = 100,000 @ Rs 10/share= 10,000 shares. EPS= Profit after tax & interest / Total no. of shares = 40,000 / 10,000 = Rs 4/- per Share.

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Q.4 What are the techniques of evaluation of investment? Ans: Steps involved in the evaluation of any investment proposal are: Estimation of cash flows both inflows and outflows occurring at different stages of project life cycle Examination of the risk profile of the project to be taken up and arriving at the required rate of return Formulation of the decision criteria Estimation of cash flows Estimating the cash flows associated with the project under consideration is the most difficult and crucial step in the evaluation of an investment proposal. Estimation is the result of the team work of many professionals in an organisation. Capital outlays are estimated by engineering departments after examining all aspects of production process Marketing department on the basis of market survey forecasts the expected sales revenue during the period of accrual of benefits from project executions Operating costs are estimated by cost accountants and production engineers Incremental cash flows and cash out flow statement is prepared by the cost accountant on the basis of the details generated in the above steps The ability of the firm to forecast the cash flows with reasonable accuracy lies at the root of the success of the implementation of any capital expenditure decision. Estimation of incremental cash flows Investment (capital budgeting) decision requires the estimation of incremental cash flow stream over the life of the investment. Incremental cash flows are estimated on tax basis. Incremental cash flows stream of a capital expenditure decision has three components. Initial cash outlay (Initial investment) Initial cash outlay to be incurred is determined after considering any post tax cash inflows. In replacement decisions existing old machinery is disposed of and a new machinery incorporating the latest technology is installed in its place. On disposal of existing old machinery the firm has a cash inflow. This cash inflow has to be computed on post tax basis. The net cash out flow (total cash required for investment in capital assets minus post tax cash inflow on disposal of the old machinery being replaced by a new one) therefore is the incremental cash outflow. Additional net working capital required on implementation of new project is to be added to initial investment. Operating cash inflows Operating cash inflows are estimated for the entire economic life of investment (project). Operating cash inflows constitute a stream of inflows and outflows over the life of the project. Here also incremental inflows and outflows attributable to operating activities are considered. Any savings in cost on installation of a new machinery in the place of the old machinery will have to be accounted on post tax basis. In this connection incremental cash flows refer to the change in cash flows on implementation of a new proposal over the existing positions.

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Q.5 What are the problems associated with inadequate working capital? Ans: Working capital is defined as the excess of current assets over current liabilities and provisions. It is that portion of asset of a business which is used frequently in current operations and in the operating cycle of the firm. Inadequacy or mismanagement of working capital is the leading cause of many business failures. A financial manger, therefore, spends a larger part of his time in managing working capital. There are two important elements to be considered under the working capital management: Decisions on the amount of current assets to be held by a firm for efficient operations of its business Decisions on financing working capital requirement The need for proper management of working capital management is even more important in the modern era of information technology. In support of the above argument, let us consider the performance of Dell computers as reported in one of the recent Fortune articles. A perusal of the article will give you an insight into how Dell could use the technology for improving the performance of components of working capital. Use of internet as a tool for reducing costs of linking manufacturer with their suppliers and dealers Outsourcing on operations, if the firms competence does not permit the performance of the operation effectively Training the employees to accept change Introducing to internet business Releasing capital by reduction in investment in inventory for improving the profitability of operating capital Working capital management is concerned with managing the different components of current assets and current liabilities. The following are the components of current assets: Inventories Sundry debtors Bills receivables Cash and bank balances Short-term investments Advances such as advances for purchase of raw materials, components and consumable stores and pre-paid expenses The components of current liabilities are: Sundry creditors Bills payable

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Creditors for out-standing expenses Provision for tax Other provisions against the liabilities payable within a period of 12 months A firm must have adequate working capital, neither excess nor inadequate. Maintaining adequate working capital is crucial for maintaining the competitiveness of a firm. Any lapse of a firm on this account may lead a firm to the state of insolvency.

Q.6 What is leverage? Compare and Contrast between operating Leverage and financial leverage Ans: Leverage is the influence of power to achieve something. The use of an asset or source of funds for which the company has to pay a fixed cost or fixed return is termed as leverage. Leverage is the influence of an independent financial variable on a dependent variable. It studies how the dependent variable responds to a particular change in independent variable. There are three types of leverages: operating, financial and combined. Operating Leverage : Operating leverage arises due to the presence of fixed operating expenses in the firms income flows. A companys operating costs can be categorised into, three main sections fixed costs, variable costs and semi-variable costs Fixed costs Fixed costs are those which do not vary with an increase in production or sales activities for a particular period of time. These are incurred irrespective of the income and value of sales and generally cannot be reduced. For example, consider that a firm named XYZ enterprises is planning to start a new business. The main aspects that the firm should concentrate at are salaries to the employees, rents, insurance of the firm and the accountancy costs. All these aspects relate to or are referred to as fixed costs. Variable costs Variable costs are those which vary in direct proportion to output and sales. An increase or decrease in production or sales activities will have a direct effect on such types of costs incurred. For example, we have discussed about fixed costs in the above context. Now, the firm has to concentrate on some other features like cost of labour, amount of raw material and the administrative expenses. All these features relate to or are referred to as Variable costs, as these costs are not fixed and keep changing depending upon the conditions. Semi-variable costs

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Semi-variable costs are those which are partly fixed and partly variable in nature. These costs are typically of fixed nature up to a certain level beyond which they vary with the firms activities. For example, after considering both the fixed costs and the variable costs, the firm should concentrate on some-other features like production cost and the wages paid to the workers which act at some point of time as fixed costs and can also shift to variable costs. These features relate to or are referred to as Semi-variable costs. The applications of operating leverage are as follows: Business risk measurement Production planning Financial Leverage : Financial leverage as opposed to operating leverage relates to the financing activities of a firm and measures the effect of earnings before interest and tax (EBIT) on earnings per share (EPS) of the company. A companys sources of funds fall under two categories Those which carry a fixed financial charges like debentures, bonds and preference shares and Those which do not carry any fixed charges like equity shares Debentures and bonds carry a fixed rate of interest and have to be paid off irrespective of the firms revenues. Though dividends are not contractual obligations, dividend on preference shares is a fixed charge and should be paid off before equity shareholders are paid any. The equity holders are entitled to only the residual income of the firm after all prior obligations are met. Financial leverage refers to the mix of debt and equity in the capital structure of the firm. This results from the presence of fixed financial charges in the companys income stream. Such expenses have nothing to do with the firms performance and earnings and should be paid off regardless of the amount of earnings before income and tax (EBIT). Use of Financial Leverage Studying the degree of financial leverage (DFL) at various levels makes financial decisionmaking, on the use of fixed sources of funds, for funding activities easy. One can assess the impact of change in earnings before interest and tax (EBIT) on earnings per share (EPS). Like operating leverage, the risks are high at high degrees of financial leverage (DFL). High financial costs are associated with high DFL. An increase in financial costs implies higher level of EBIT to meet the necessary financial commitments. A firm which is not capable of honouring its financial commitments may be forced to go into liquidation by the lenders of funds. The existence of the firm is shaky under these circumstances. On one side the trading on equity improves considerably by the use of borrowed funds and on the other hand, the firm has to constantly work towards higher EBIT to stay alive in the business. All these factors should be considered while formulating the firms mix of sources of funds. One main goal of financial planning is to devise a capital structure in order to provide a high return to equity holders. But at the same time, this should not be done with heavy debt financing which drives the company on to the brink of winding up.

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Course: MBA Semester 2 Master of Business Administration MBA Semester 2 MB0045 Financial Management - 4 Credits Assignment Set- 2

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Q. 1 Discuss the three broad areas of Financial Decision Making Ans: Finance functions deal with the functions performed by the finance manager. They are closely related to financial decisions. In the course of performing these functions, finance manager takes several decisions (see figure1.2): Finance decisions Investment decisions Liquidity decisions Dividend decisions Organisation of a finance function Finance decisions Financing decisions relate to the acquisition of funds at the least cost. Cost has two dimensions: Explicit Cost Implicit cost Explicit cost refers to the cost in the form of coupon rate, cost of floating and issuing the security. Implicit cost is not a visible cost but it may seriously affect the companys operations especially when it is exposed to business and financial risk In India, if a company is unable to pay its debts, creditors of the company may use legal means to sue the company for winding up. This risk is normally known as risk of insolvency. A company which employs debt as a means of financing normally faces this risk especially when its operations are exposed to high degree of business risk. In all financing decisions, a firm has to determine the proportion of equity and debt. The composition of debt and equity is called the capital structure of the firm. Debt is cheap because interest payable on loan is allowed as deductions in computing taxable income on which the company is liable to pay income tax to the Government of India. An investor in a companys shares has two objectives for investing: Income from capital appreciation (capital gains on sale of shares at market price) Income from dividends It is the ability of the company to give both these incomes to its shareholders that determines the market price of the companys shares. The most important goal of financial management is maximisation of net wealth of the shareholders. Therefore, management of every company should strive hard to ensure that its shareholders enjoy both dividend income and capital gains as per the expectation of the market. Investment decisions To survive and grow, all organisations have to be innovative. Innovation demands managerial proactive actions. Proactive organisations continuously search for innovative ways of performing the activities of the organisation. Innovation is wider in nature. It could be: expansion through entering into new markets adding new products to its product mix performing value added activities to enhance customer satisfaction

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adopting new technology that would drastically reduce the cost of production rendering services or mass production at low cost or restructuring the organisation to improve productivity These innovations change the profile of an organisation. These decisions are strategic because they are risky. However, if executed successfully with a clear plan of action, investment decisions generate super normal growth to the organisation. Dividend decisions Dividends are pay-outs to shareholders. Dividends are paid to keep the shareholders happy. Dividend decision is a major decision made by a finance manager. It is based on formulation of dividend policy. Since the goal of financial management is maximisation of wealth of shareholders, dividend policy formulation demands the managerial attention on the impact of its policy on dividend and on the market value of its shares. Optimum dividend policy requires decision on dividend payment rates so as to maximise the market value of shares. The payout ratio means what portion of earnings per share is given to the shareholders in the form of cash dividend. In the formulation of dividend policy, the management of a company will have to consider the relevance of its policy on bonus shares. Dividend policy influences the dividend yield on shares. Dividend yield is an important determinant of an investors attitude towards the security (stock) in his portfolio management decisions. The following issues need adequate consideration in deciding on dividend policy: Preferences of share holders Do they want cash dividend or capital gains? Current financial requirements of the company Legal constraints on paying dividends Striking an optimum balance between desires of share holders and the companys funds requirements Liquidity decision Liquidity decisions deals with Working Capital Management. It is concerned with the day-to-day financial operations that involve current assets and current liabilities. The important elements of liquidity decisions are: Formulation of inventory policy Policies on receivable management Formulation of cash management strategies Policies on utilisation of spontaneous finance effectively Organisation of finance function Financial decisions are strategic in character and therefore, an efficient organisational structure is required to administer the same. Finance is like blood that flows throughout the organisation. In all organisations, CFOs play an important role in ensuring proper reporting based on substance of the stake holders of the company. Finance functions are organised directly under the control of board of directors, because of the crucial role these functions play. For the survival of the firm, there is a need to ensure both long term and short term financial solvency.

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Q.2 What is the future value of an annuity and state the formulae for future value of an annuity ? Ans: Future value of an annuity Annuity refers to the periodic flows of equal amounts. These flows can be either termed as receipts or payments. The future value of a regular annuity for a period of n years at i rate of interest can be summed up as under: FVAn= A{(1+I)n -1} / i Where, FVAn = Accumulation at the end of n years i = Rate of interest n = Time horizon or no. of years A = Amount invested at the end of every year for n years The expression is called the Future Value Interest Factor for Annuity (FVIFA). This represents the accumulation of Re.1 invested at the end of every year for n number of years at i rate of interest. From the tables 3.4 and 3.5, different combinations of i and n can be calculated. We just have to multiply the relevant value with A and get the accumulation in the formula given above. We notice that we can get the accumulations at the end of n period using the tables. Calculations for a long time horizon are easily done with the help of reference tables. Annuity tables are widely used in the field of investment banking as ready beckoners.

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Q.3 The equity stock of ABC Ltd is currently selling for Rs 30 per share. The dividend expected next year is Rs 2.00. the investors required rate of return on this stock is 15 per cent. If the constant growth model applies to ABC Ltd, What is the expected growth rate? Ans: In this case, P0 = Price of One share = Rs. 30 Ke=Required rate of return on the equity share = 15% = 0.15 D1=Expected dividend after one year = Rs. 2 g = growth rate = ? P0=D1/Ke-g Ke-g = D1/P0 0.15-g = 2/30 0.15-g = 0.0666 g=0.15-0.0666 g = 0.0834 Hence Growth Rate of ABC Ltd = 8.34%

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Q.4 State the assumptions underlying the CAPM model and MM model Ans: Capital Asset Pricing Model Approach This model establishes a relationship between the required rate of return of a security and its systematic risks expressed as . According to this model, Ke = Rf + (Rm Rf) Where Ke is the rate of return on share, Rf is the risk free rate of return, is the beta of security, Rm is return on market portfolio The CAPM model is based on some assumptions, some of which are: Investors are risk-averse. Investors make their investment decisions on a single-period horizon. Transaction costs are low and therefore can be ignored. This translates to assets being bought and sold in any quantity desired. The only considerations that matter are the price and amount of money at the investors disposal. All investors agree on the nature of return and risk associated with each investment. Miller and Modigliani Approach Miller and Modigliani criticise that the cost of equity remains unaffected by leverage up to a reasonable limit and K0 remains constant at all degrees of leverage. They state that the relationship between leverage and cost of capital is elucidated as in net operating income(NOI) approach. The assumptions regarding Miller and Modigliani (MM) approach are Perfect capital markets, Rational behaviour, Homogeneity, Taxes and Dividend Pay-out. Perfect capital markets: Securities can be freely traded, that is, investors are free to buy and sell securities (both shares and debt instruments), there are no hindrances on the borrowings, no presence of transaction costs, securities are infinitely divisible, availability of all required information at all times. Investors behave rationally: They choose the combination of risk and return which is most advantageous to them. Homogeneity of investors risk perception: All investors have the same perception of business risk and returns. Taxes: There is no corporate or personal income tax. Dividend pay-out is 100%: The firms do not retain earnings for future activities.

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Q.5 Write the cash flow analysis? Ans: Cash flow analysis is the study of the cycle of our business' cash inflows and outflows, with the purpose of maintaining an adequate cash flow for your business, and to provide the basis for cash flow management. (1) Estimate your annual gross income as the first step in preparing a cash flow analysis. Allow for subtractions if your business is not operating at full potential. For instance, if you own an apartment complex, you add the amount of rent for each month, but subtract an estimated amount for unforeseen vacancies. The longer you are in business, the easier it will be to predict operating losses. (2) Add any other income you receive and you will arrive at your "effective gross income." This is a reliable business accounting figure that represents your entire annual projected gross income. Write this number down for future figuring. (3) Compile a list of the expenses you incur in order to operate your business. Separate this by category. Think about the purchases of big equipment you make. If you have a painting business, you would write down the expenses you pay annually for paint sprayers, rollers, brushes and drop cloths. (4) Write down all your office expenses, utility charges, advertising expenses and other fees you pay for equipment repairs and maintenance. Everything you need to purchase in the operation of your business counts. (5) Remember to include professional fees and taxes in your cash flow analysis. If you have an accountant, his fee goes here--so does insurance policy expense, worker's compensation payments, unemployment insurance fees and taxes charged on your equipment or building. (6) Add your business accounting expense together and double check your chart of accounts to make sure you got them all. This number represents the total amount of expenses necessary to operate your business. Write it down beneath the effective income figure. (7) Figure out your debt service. Calculate the amount of payments you will make to the bank for loans, mortgages or other financing. Add these together and write the number down beneath the total expenses figure. (8) Subtract the total expenses and the total debt service figures from the effective annual income number. This is your cash flow analysis for the year.

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Q.6 The following two projects A and B requires an investment of Rs 2, 00,000 each. The income returns after tax for these projects are as follows: Year 1 2 3 4 5 6 Project A Rs. 80,000 Rs. 80,000 Rs. 40,000 Rs. 20,000 Project B Rs. 20,000 Rs. 40,000 Rs. 40,000 Rs. 40,000 Rs. 60,000 Rs. 60,000

Using the following criteria determine which of the projects is preferable.

Ans:

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