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FINANCIAL MANAGEMENT(MB0029)
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MBA,SMU,SEM-2,Assignment-01

5/20/2010

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Robin Smith
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1. Why wealth maximization is superior to profit maximization in today’s context? Justify your
answer.
Ans- Maximization of profits is regarded as the proper objective of the firm, but it is not as inclusive a
goal as that of maximizing stockholder wealth. For one thing, total profits are not as important as
earnings per stock. Therefore, wealth maximization is superior in a way that it is based on cash flow, not
on the accounting profit.

Wealth maximization is superior because it values the duration of expected returns. Since
distant flows are uncertain, converting them into comparable values at base period facilitated
better comparison of financial projects. This can be achieved by for example; by discounting
all future earnings to establish their net present value.

When a firm follows wealth maximization goal, it achieves maximization of market value of
share. When a firm practices wealth maximization goal, it is possible only when it produces
quality goods at low cost. On this account therefore, society gains because of the societal
welfare.
2. Your grandfather is 75 years old. He has total savings of Rs.80,000. He expects that he live for
another 10 years and will like to spend his savings by then. He places his savings into a bank
account earning 10 per cent annually. He will draw equal amount each year- the first withdrawal
occurring one year from now in such a way that his account balance becomes zero at the end of 10
years. How much will be his annual withdrawal?
Ans-
Present Value(PV) =80000/-
Amount (A) =?
Interest Rat e(I) =10%
No. of Year(N) =10

PVAn = A {1+i)n-1} /{ i(1+i)n}

80000=A{1+.10)10 }/{.10(1+.10)10}
80000=A{ 1.593742/0.259374}
A =80000/ 6.144567
A = 13019.63 Yrly
3. What factors affect financial plan?
Ans- We live in a society and interact with people and environment. What happens to us is not always
accordance to our wishes. Many things turn out in our live are uncontrollable by us. Many decisions we
take are the result of external influences. So do our financial matters. There are many factors affect our
personal financial planning. Range from economic factors to global influences. Aware of factors
affecting your money matters below will certainly benefit your planning.

Life situation and personal value

Your life situation, namely age, marital status, employment status (income), number and age of
household and life cycle will have an effect on how you handle your money. When you are young, you
might not have much money. However, you have longer time to accumulate wealth. Therefore, younger
person usually will cope better with higher risk. If you married and have children, you have to consider
other family member need beside you. You may need to set up more emergency fund, college fund and
buy more protection. Every one of us will go through different stage of life: infant, youth, and adult
then elderly. Every stage has different need. When you reach young adult, you may not make too much.
However, you have many expenses waiting in line. You might need to pay your education loan. You
probably need to buy first car or take a home mortgage. You have to prepare for wedding or expecting
children. The size of your household and their age will also significantly influence the way you handle
your finance. Your personal value, what is important to you, your principle desire and believed will
shape the way you manage your money. Your preference to certain thing will also make you choose
certain financial strategies over the others. For instance, if you like to move around, it is wiser to rent
than buy a house. That is what the first step in the process of financial planning is to understand yourself.
(Read the process of financial planning).

Economic factors

Many economic factors will significantly affect your financial plan, i.e. supply and demand, various
institutions, business, labor force, and government. Supply and demand will form price. Price level will
change your consumption pattern, so do your investment and others. Labor force will determine your
income. When unemployment rate is high, it will be more difficult to find job. When job is rare, people
are willing to work for less money, and vice versa. Financial institutions and others business are the user
of labors. Their activities will shape the economic and eventually affect your financial. Government will
influence economic by monetary and fiscal policy. The steps government take will affect you financially.
When government raise the interest rate, economic will cool down. When economic slow down,
government will lower the interest rate. When interest rate is low, invest your money in bank will not
give you decent return. It means take longer time for your investment to reach your financial goals.
Therefore, in order to get higher return people invest in stock market or business.

Global influence

Since the advance of technology causes this globe to become “smaller”, especially in the era of
globalization. Now people do business cross the country boundary, therefore what happen in other
country will have an effect on people in another country “Rain at Wall Street, drizzle around the world”.
The economic of particular country depend on foreign investment. When many foreign investors come,
they will create new businesses. New business will absorb many labors, therefore lowering
unemployment rate and increasing wages. However higher wage does not always guarantee the
prosperity of workers in certain country. When you earn high income but everything is so expensive
there. It is identical with make little, since your much money actually cannot buy many things. For
instance, average worker in Indonesia make approximately 1 million Rupiah monthly. Can you imagine
make 1 million dollars monthly here? Unfortunately, that 1 million Rupiah is only around $ 108, since
the currency exchange of Rupiah is around Rp. 9,200 to $ 1 USD. Currency exchange surely will impact
your purchasing power and your financial situation. Currency of a country is usually base on its
economic condition i.e. government’s budget, balance trade, inflation level and growth. Foreign
exchange is the biggest financial market in the world, we definitely will learn about it in later articles.

Economic condition

Consumer price, consumer spending, interest rate, money supply, unemployment, house started, gross
domestic product, trade balance and market indication are among economic condition that affect your
decision in handling your money matters.
Consumer price
Measure the value of your money through inflation rate. It influences your personal financial planning
because consumer price alter your money purchasing power. When consumer price increase beyond your
income, you will unable to buy as much thing as you used to. Consumer spending measures the demand
of good and service by individuals and household. When consumer spending is up, more jobs will be
available and wage will be higher. Increase in consumer spending will drive consumer price to increase
and inflation level as well.
Interest rate
Measure cost of money or credit and return of investment. Increase in interest rate will make credit more
expensive and discourage borrowing. With high interest, people are more likely to invest their money to
earn interest than take higher risk to do business. Excessive investment from investor with inability of
bank lending to third party will create over supply of fund. In which will drive down the interest rate
eventually.

Money supply
Measures money available for spending in an economic. More money make people have more to save.
Therefore, increases in money supply tend to decrease interest rate as more people save. Moreover,
higher saving and lower spending will reduce job opportunity.
Unemployment measures number of people, who willing and able to work, out of work. High
unemployment rate reduce consumer spending and job opportunity. It is wiser to setup higher emergency
fund and reduce debt to cope with high unemployment rate, since it is harder to get new job when
unemployment rate are high. House started measures the number of new house built. New house build
is sign of economic expansion. When new house build increase, it creates more jobs, higher wage and
higher consumer spending.
Gross domestic product measures the total value produce within a country’s border. GDP indicate
country prosperity. High GDP will increase employment opportunity and opportunity for personal
financial wealth.
Trade balance
Measures different between export and import. Deficit happen, when import exceed export. Large deficit
over long run will hurt employment and GDP. Surplus happen, when export exceed import. Large
surplus will raise the value of the currency, reducing the future opportunity of export, since commodity
become more expensive to foreigner.
Market indication (stock market index)
measures the relative value of stocks. These indexes provide indication of the price movement of
stocks. Since you will invest your money in the market to help you reach your financial goals, understand
how the market work will benefit you.
4. Suppose you buy a one-year government bond that has a maturity value of Rs.1000. The market
interest rate is 8 per cent. (a) How much will you pay for the bond? (b) If you purchase the bond
for Rs.904.98, what interest rate will you earn from this investment?

Ans-
a) MV = P(1+i)
=>1000 =P(1+0.08)
=> P =1000/ 1.08 = 926

b)P = 904.98
=>1000 =904.98(1+i)
=>(1+i) = (1000/904.98)*100
=>(1+i)=10.5%
Q.5.
Case Study: (20 Marks)
Deepak Hand tools Private Limited
DHPL is a small sized firm manufacturing hand tools. It manufacturing plan is situated in Haryana. The
company’s sales in the year ending on 31st March 2007 were Rs.1000 million (Rs.100 crore) on an asset
base of Rs.650 million. The net profit of the company was Rs.76 million. The management of the
company wants to improve profitability further. The required rate of return of the company is 14 percent.
The company is currently considering an investment proposal. One is to expand its manufacturing
capacity. The estimated cost of the new equipment is Rs.250 million. It is expected to have an economic
life of 10 years. The accountant forecasts that net cash inflows would be Rs.45 million per annum for the
first three years, Rs.68 million per annum from year four to year eight and for the remaining two years
Rs.30million per annum. The plant can be sold for Rs.55 million at the end of its economic life.
The company would need to raise debt to the extent of Rs.200 million. The company has the following
options of borrowing Rs.200 million:
a. The company can borrow funds from a nationalized bank at the interest rate of 14 percent for 10 years.
It will be required to pay equal annual installment of interest and repayment of principal.
b. A financial institution has offered to lend money to DHPL at 13.5 per annum but it needs to pay
equated quarterly installment of interest and repayment of principal.

Questions:
1. Should the company expand its capacity? Show the computation of NPV
2. What is the annual installment of bank loan?
3. Calculate the quarterly installments of the Financial Institution loan
4. Should the company borrow from the bank or from the financial institution.
1. Should the company expand its capacity? Show the computation of NPV?

Ans :- company should not go with expansion project. Because according to accountant prediction after
10 years the NET PRESENT VALUE of the company is 29.409 million. If we add economic value of
the plant after 10 years i.e. 55 million. Total value can get to the company after 10 years is 29.409+55=
84.409 million. But company is decide they should borrow 200 million money from the outside i.e. from
bank or financial institute. If they borrow money from bank then for 10 years company has to pay 183.43
million more and for financial institute 176 million more. So if we compare NPV after 10 year and total
expenses after 10 year then expenses is more. It means plant will run in loss. So company avoid to start
this new plant.
Cash inflow PV factor @14% PV of cash inflow
1 45 million 0.877
39.465 million
2 0.769
45 million 34.605 million
3 0.675
45 million 30.375 million
4 0.592
68 million 40.256 million
5 0.519
68 million 35.292 million
6 0.456
68 million 31.008 million
7 0.400
68 million 27.2 million
8 0.351
68 million 23.868 million
9 0.308
9.24 million
30 million
10 0.270
8.1 million
30 million

279.40
9 million
Total
QUE 2 :- What is the annual installment of bank loan?

Ans :- Before calculating annual installment we have to calculate annuity factor

ANNUITY FACTOR = 1i - 1i1+in

= 10.14 - 10.141+0.1410

=7.143 – 1.927

ANNUITY FACTOR= 5.216

SO, yearly installment if company borrow loan from bank is

Yearly installment = 200 million5.216

Yearly installment = 38.343 million

Que 3 :- Calculate the quarterly installments of the Financial Institution loan?

Ans :- Before calculating annual installment we have to calculate annuity factor

ANUITY FACTOR = 1i - 1i1+in

= 10.135 - 10.1351+0.13510

=7.407 – 2.087

ANUITY FACTOR= 5.32

SO, yearly installment if company borrow loan from bank is

Yearly installment = 200 million5.32

Yearly installment = 37.60 million

And, quarterly installment = 37.60 million4

quarterly installmen = 9.4 million

4. Should the company borrow from the bank or from the financial institution?

Ans :- company should barrow money from bank. Because if they borrow money from bank they have to
pay 0.5% more yearly. But company have to pay money per year basis. In case of financial institution
company have to pay quarterly basis.

In case of bank

Company has to pay 38.343 million / year

Means at the end of 10 years 383.43 million

In case of Financial institution

Company has to pay 37.60 million /year

And 9.40 million /quarterly

But, if we compare both company face loss if company go to the financial institution because the money
out flow is frequent and more in this case. Because in financial institution company has to pay quarterly.
So company should go with bank they can use money whole year. Its beneficial for company

NPV = PV of cash inflow ― PV of cash out flow

= 279.409 million ― 250 million

= 29.409 million