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CUSTOMER_CODE SMUDE DIVISION_CODE SMUDE EVENT_CODE APR2016 ASSESSMENT_CODE MB0045_APR2016 QUESTION_TYPE DESCRIPTIVE_QUESTION QUESTION_ID 9542 QUESTION_TEXT Discuss the goals of financial management SCHEME OF EVALUATION Profit maximization Profit maximization is based on the cardinal rule of efficiency. Its goal is to maximize the returns with the best output and price levels. Profit maximization has been criticized on many accounts: •The concept of profit lacks clarity. What does profit mean? •In these sense, profit is neither defined precisely nor correctly. It creates unnecessary conflicts regarding the earning habits of the business concern. Differences in interpretation of the concept of profit thus expose the weakness of profit maximization •Profit maximization neither considers the time value of money nor the net present value of the cash inflow. Is does not differentiate between profits of current year with the profits to be earned in later years •The concept of profit maximization fails to consider the fluctuations in profits earned from year to year. Fluctuations may be attributed to the business risk of the firm. Risks may be internal or external which will affect the overall operation of the business concern •The concept of profit maximization apprehends to be either accounting profit or economic normal profit or economic supernormal profit Wealth maximization The term wealth means shareholder’s wealth or the wealth or the wealth of the person’s those who are involved in the business concern. •Wealth maximization is based on the concept of cash flows. Cash flows are a reality and not based on any subjective interpretation. On the other hand, profit maximization is based on accounting profit and it also contains many subjective elements. •Wealth maximization considers time value of money. Time value of money translates cash flow occurring at different periods into a comparable value at zero period. In this process, the quality of cash flow is considered critical in all decisions as it incorporates the risk associated with the cash flow stream. It finally crystallizes into the rate of return that will motivate investors to part with their hard earned savings. Maximising the wealth of the shareholders means positive net present value of the decisions implemented QUESTION_TYPE DESCRIPTIVE_QUESTION QUESTION_ID 9543 QUESTION_TEXT Describe the factors affecting the determination of working capital in an organization SCHEME OF EVALUATION Nature of business: Working capital requirements are basically influenced by the nature of business of the firm. Trading organization are forced to carry large stocks of finished goods, accounts receivables and accounts payables. Public utilities require lesser investment in working capital. Size of business operation: Size of measured in terms of the scales of operations. Normally, a firm with large scale of operation requires more working capital than a firm with a low scale of operation Manufacturing cycle: Capital intensive industries with longer manufacturing process will have higher requirements of working capital, because of the need of running their sophisticated and long production process. Products policy: Production schedule of a firm influences the investments in inventories. A firm, exposed to seasonal changes in demand that follows a steady production policy, will have to face the costs and risks associated with inventory accumulation during the offseason periods. On the other hand, a firm with a variable production policy will be facing different dimensions of management of working capital. Such a firm has to effectively handle the problem of production planning and control associated with utilization of installed plant capacity, under conditions of varying volumes of production of products of seasonal demand. Volume of sales: There is a positive direct correlation between the volume of scales and the size of working capital of a firm Term of purchase and sales: A firm that allows liberal credit to its customers will need more working capital than a firm with strict credit policy. A firm, which enjoys liberal credit facilities from its suppliers requires lower amount of working capital when compared to a firm, which does not have such a facility Operating efficiency: The firm with high efficiency in operation can bring down the total investment in working capital to lower levels. Here, effective utilization of resources helps the firm in bringing down the investment in working capital Price level changes: Inflation affects the working capital levels in a firm. To maintain the operating efficiency under an inflationary set up, a firm should examine the maintenance of working capital position under constant price level. The financial capital maintenance demands a firm to maintain higher amount of working capital, keeping pace with rising price levels. Under inflationary conditions, the same levels of inventory will require increased investment. The ability of a firm to revise its products’ price with rising price levels will decide the additional investment to be made to maintain the working capital intact. Business cycle: During boom, sales rise as business expands. Depression is marked by a decline in sale. During boom, expansion of business can be achieved only by augmenting investment in various assets that constitute working capital of a firm. When there is a decline in business on account of depression in economy, the inventory glut forced a firm to maintain the working capital at a level far in excess of the requirements under normal conditions. Processing technology: Longer the manufacturing cycle, larger is the investment in working capital. When raw material passes through several stages in the production, process inventory will increase correspondingly. Fluctuations in the supply of raw materials: Companies which use raw materials available only from one or two sources are forced to maintain buffer stock of raw materials to meet the requirements of uncertainty in lead time. Such firms normally carry more inventory than it would have done, had the materials been available in normal market conditions QUESTION_TYPE DESCRIPTIVE_QUESTION QUESTION_ID 9545 QUESTION_TEXT Examine the different types of costs associated with inventory management SCHEME OF EVALUATION Material cost: Material cost is the cost of purchasing goods and related costs such as transportation and handling costs that are associated with it. Ordering cost: The expenses incurred to place orders with suppliers and replenish the inventory of raw materials are called ordering cost. They include the costs of the following: •Requisitioning •Purchase ordering or set–up •Transportation •Receiving, inspecting and receiving at the ware house. These costs increase in proportion to the number of orders placed. Firms maintaining large inventory levels, place a few orders and incur less ordering costs. Carrying cost: Costs incurred for maintaining the inventory in warehouses are called carrying costs. They include interest locked up in inventory, storage, insurance, taxes, obsolescence, deterioration spoilage, salaries of warehouse staff and expenses on maintenance of warehouse building. The greater the inventory held, the higher the carrying costs. Shortage costs or stock-out costs: These are the costs associated with either a delay in meeting the demand or inability to meet the demand due to shortage of stock. These costs include: •Loss of profit on account of sales and loss caused by the stock out •Loss of future sales as customers migrate to other dealers •Loss of customer goodwill •Extra costs associated with urgent replenishment purchases QUESTION_TYPE DESCRIPTIVE_QUESTION QUESTION_ID 9546 QUESTION_TEXT Discuss the different forms of dividend SCHEME OF EVALUATION Cash Dividend: Most companies pay dividends in cash. The investors also, especially the old and retired investors, depend on this form of payment for want of current income. Scrip dividend: In this form of dividend, equity shareholders are issued transferable promissory notes with shorter maturity periods, which may or may not bear interest. This form is adopted if the firm has earned profits and it will take some time to convert its assets into cash. Payment of dividend in this form is done only if the firm is suffering from weak liquidity position. Bond dividend: Scrip and bond dividend are the same, except that they differ in terms of maturity. Bond dividends carry longer maturity periods and bear interest, whereas scrip dividends carry shorter maturity periods and they may or may not carry interest. Stock dividend( bonus shares): Stock dividend, as known as USA or bonus shares, as known in India, is the distribution of additional shares to the shareholders at no additional cost. This has the effect of increasing the number of outstanding shares of the firm. The reserves and surplus are capitalized to give effect to bonus issue. This decision has the effect of recapitalization, that is, transfer from reserves to share capital and not changing the total net worth. The investors are allotted shares in proportion to their present shareholding. Declaration of bonus shares has a favourable psychological effect on investors. They associated it with prosperity. QUESTION_TYPE DESCRIPTIVE_QUESTION QUESTION_ID 125903 QUESTION_TEXT Explain the factors related to internal constraints in capital rationing. (Each point carries 2 marks each) SCHEME OF EVALUATION a. b. c. d. Private owned company Divisional constraints Human resource limitations Dilution e. Debt constraints QUESTION_TYPE DESCRIPTIVE_QUESTION QUESTION_ID 125909 QUESTION_TEXT Write a short note on Net Income approach and net Operating Income approach. Net Income approach explanation and formula SCHEME OF EVALUATION Net Operating Income approach explanation and formula (5 marks) (5 marks)