Q1. What are the goals of financial management? Ans.

The changing financial environment is prompting those who manage the financial resources of ministries to clarify the primary goals of their work. One who has given this issue considerable thought is Paul Clark, executive pastor of Fairhaven Church in Centerville, Ohio. The following short list of goals, from his blog, Where church vision meets organizational reality, gives any ministry financial decision maker plenty to think about. Avoid Fraud There are many ways to destroy the trust between the congregation and the leadership of the churchbut financial mismanagement is a big one. Many churches do not give this area of ministry the appropriate attention by: Using volunteers who do not have the appropriate training Holding the misperception that the government will never pay any attention Mimicking the practices of other churches without proper verification of their correctness Fulfill Our Fiduciary Responsibility As leaders in the church, we have a fiduciary responsibility (the highest standard of care imposed at either equity or law) to handle finances appropriately. Effective Management Ensure that the congregation has confidence in church management. Effective Communication When done well, this gives the congregation a greater understanding of the financial position of the church, the link between finances and ministry, and their own role in the ministry. Shared Vision Be sure that congregants understand and can support our vision and our direction. The Guiding Principle: Being Above Reproach What is more, he was chosen by the churches to accompany us as we carry the offering, which we administer in order to honor the Lord himself and to show our eagerness to help. We want to avoid any criticism of the way we administer this liberal gift. For we are taking pains to do what is right, not only in the eyes of the Lord but also in the eyes of men. Q2. Calculate the PV of an annuity of Rs. 500 received annually for four years when discounting factor is 10%. Ans. In this section we will demonstrate how to find the present value of a single future cash amount,
such as a receipt or a payment. We'll refer to the present value of a single amount as PV.

1. Exercise #1. Let's assume we are to receive $100 at the end of two years. How do we calculate the

present value of the amount, assuming the interest rate is 8% per year compounded annually? The following timeline depicts the information we know, along with the unknown component (PV):

PV= ?? 1 year 0 1 n = 2; i = 8%

FV= $100 1 year 2

1a. Calculation Using the PV Formula The present value formula for a single amount is: PV = FV (1 + i)
-n

(or)

PV = FV x [ 1 (1 + i) ]

Using the second version of the formula, the solution is: PV = FV x [ 1 (1 + i) ] PV = $100 x [ 1 (1 + 0.08) ] PV = $100 x [ 1 (1.08) ] PV = $100 x [ 1 1.1664 ] PV = $100 x [ 0.8573388 ] PV factor PV = $85.73
2 2 n

The answer, $85.73, tells us that receiving $100 in two years is the same as receiving $85.73 today, if the time value of money is 8% per year compounded annually. ("Today" is the same concept as "time period 0.")

1b. Calculation Using a PV of 1 Table It's common for accounting and finance textbooks to provide present value tables to use in calculating present value amounts. In a PV of 1 table, each column heading displays an interest rate (i), and the rowindicates the number of periods into the future before an amount will occur (n). At the intersection of each column and row is the correlating present value of 1 (PV of 1) factor. The PV of 1 factor tells us what the present value will be, at time period 0, for a single amount of $1 at the end of time period (n). Click the following to see a present value of 1 table: PV of 1 Table.

The PV of 1 table has two limitations: (1) values are rounded (ours has the rounding to three decimal places for ease of use) and thus the table sacrifices a bit of accuracy, and (2) the table displays only a limited number of choices for rates and years. Once you determine the PV of 1 factor from the table, simply use it to substitute for the following term in the PV formula: n [ 1 (1 + i) ]

Before substitution: PV = FV x [ 1 (1 + i) ]. After substitution: PV = FV x [ PV of 1 factor from table ]

Using the data presented in Exercise #1, we can solve for the present value of receiving $100 at the end of two years, when discounted by an interest rate of 8% compounded annually: PV = FV x [ PV of 1 factor for n = 2; i = 8% ] PV = $100 x [ 0.857 ] PV factor from PV of 1 Table PV = $85.70

Because the PV of 1 table had the factors rounded to three decimal places, the answer ($85.70) differs slightly from the amount calculated using the PV formula ($85.73). In either case, what the answer tells us is that $100 at the end of two years is the equivalent of receiving approximately $85.70 today (at time period 0) if the time value of money is 8% per year compounded annually.

Q3. Suraj Metals are expected to declare a dividend of Rs. 5 per share and the growth rate in dividends is expected to grow @ 10% p.a. The price of one share is currently at Rs. 110 in the market. What is the cost of equity capital to the company? Q4. What are the assumptions of MM approach? Ans. The MM approach to irrelevance of dividend is based on the following assumptions:

The capital markets are perfect and the investors behave rationally. All information is freely available to all the investors. There is no transaction cost. Securities are divisible and can be split into any fraction. No investor can affect the market price. There are no taxes and no flotation cost. The firm has a defined investment policy and the future profits are known with certainty. The implication is that the investment decisions are unaffected by the dividend decision and the operating cash flows are same no matter which dividend policy is adopted. The model

Under the assumptions stated above, MM argue that neither the firm paying dividends nor the shareholders receiving the dividends will be adversely affected by firms paying either too little or too much dividends. They have used the arbitrage process to show that the division of profits between dividends and retained earnings is irrelevant from the point of view of the shareholders. They have shown that given the investment opportunities, a firm will finance these either by ploughing back profits of if pays dividends, then will raise an equal amount of new share capital externally by selling new shares. The amount of dividends paid to existing shareholders will be replaced by new share capital raised externally. In order to satisfy their model, MM has started with the following valuation model. P0= 1* (D1+P1)/ (1+ke)

Where, P0 = Present market price of the share Ke = Cost of equity share capital D1 = Expected dividend at the end of year 1 P1 = Expected market price of the share at the end of year 1 With the help of this valuation model we will create a arbitrage process, i.e., replacement of amount paid as dividend by the issue of fresh capital. The arbitrage process involves two simultaneous actions. With reference to dividend policy the two actions are:

Payment of dividend by the firm Rising of fresh capital. With the help of arbitrage process, MM have shown that the dividend payment will not have any effect on the value of the firm. Even if the firm pays dividends, resulting in a increase in market value of the share, the effect on the value of the firm will be neutralised by the decrease in terminal value of the share.

Q5. An investment will have an initial outlay of Rs 100,000. It is expected to generate cash inflows. Table 1.2 highlights the cash inflow for four years. (Spring 2013)
Table 1.2: Cash inflow

Cash inflow 40000 50000 15000 30000

Year
1 2

3 4

If the risk free rate and the risk premium is 10%,

a) Compute the NPV using the risk free rate b) Compute NPV using risk-adjusted discount rate (10 Marks) (350-400 words) Q6. What are the features of optimum credit policy? Ans. The firms operating profit is maximized when total cost is minimised for a given level of revenue. Credit policy
at point an in represents the maximum operating profit (since total cost is minimum). But it is not necessarily the optimum credit policy. Optimum credit policy is one which maximizes the firms value. The value of t he firm is maximized when the incremental or marginal rate of return of an investment is equal to the incremental or marginal cost of funds used to finance the investment. The incremental rate of return can be calculated as incremental operating profit divided by the incremental investment in receivable. The incremental cost of funds is the rate of return required by the suppliers of funds, given the risk of investment in accounts receivable. Note that the required rate of return in not equal to the borrowing rate. Higher the risk of investment, higher the required rate of return. As the firm loosens its credit policy, its investment in accounts receivable becomes more risky because of increase in slowpaying and defaulting accounts. Thus the required rate of return is an upward sloping curve. In sum, we may state that the goal of the firms credit policy is to maximize the value of the firm. To achieve this goal, the evaluation of investment in accounts receivable should involve the following four steps: Estimation of incremental operating profit Estimation of incremental investment in account receivable Estimation to the incremental rate of return of investment Comparison of the incremental rate of return with the required rate of return. Standards variable production administrative and selling costs are per cent of sales (bad-debt losses and collection costs excluded). Thus contribution is 8.3 per cent of sales: 100 - 91.7 = 8.3 per cent. By tightening its credit policy, standard can expect to lose sales of $6 million (10 per cent of total sales of $60 million). Thus, the lost contribution will be $0.498 million: Change in contribution = change in sales x contribution ratios cont = sales x c = - 60 x 0.083 = $ - 0.498 million Since bad-debt losses and collection costs were entirely attributable to the marginal accounts, with the discontinuance of sales to those customers, these costs will be avoided. We should subtract these avoidable costs from contribution to find lost operating profit, which is equal to $ 0.456 million: Change in = change in additional Operating profit = contribution cost op - cont sales (b + d) = - 0.498 [- 60 (0.0005 + 0.0002)] = - 0.498+ 0.04 = - $ 0.502 million