Question 1

Portfolio return is generally computed as:

Accepted Answer

Expected portfolio return = Σ (weight × return).

Question 2

Discount factor (DF) for rate r and n periods is:

Accepted Answer

DF = 1/(1+r)^n.

Question 3

The overall cost of capital is commonly denoted by:

Accepted Answer

Ko represents overall cost of capital; often computed as WACC.

Question 4

NI approach suggests that as leverage increases, WACC:

Accepted Answer

Under NI approach, cheaper debt increases and Ke assumed constant, so WACC falls.

Question 5

Working capital management mainly relates to:

Accepted Answer

Working capital focuses on cash, inventory, receivables and payables.

Question 6

Which of the following is not a method of raising external capital for a company?

Accepted Answer

c) Retained earnings

Question 7

The cost of retained earnings is generally considered equal to:

Accepted Answer

Retained earnings belong to equity holders; opportunity cost approximates Ke (basic).

Question 8

Which of the following is not a primary function of financial management?

Accepted Answer

d) Cost accounting

Cost accounting primarily focuses on managing and controlling costs within an organisation.

Question 9

The process of estimating the future value of an investment or project is known as:

Accepted Answer

b) Financial forecasting

Question 10

Which factor most directly affects the ability to pay cash dividend?

Accepted Answer

Dividends require cash; liquidity is critical.

Question 11

What financial ratio measures a companys ability to meet its interest payments on outstanding debt?

Accepted Answer

c) Interest coverage ratio

Question 12

Cost of capital is best defined as:

Accepted Answer

Cost of capital is the minimum return the firm must earn to satisfy providers of funds.

Question 13

Combined leverage (DCL) is equal to:

Accepted Answer

DCL = DOL × DFL.

Question 14

What does the Debt to Equity ratio measure?

Accepted Answer

d) The level of investment in the companys equity

Question 15

Current ratio is calculated as:

Accepted Answer

Current ratio = CA/CL.

Question 16

EOQ concept is used mainly in:

Accepted Answer

EOQ focuses on inventory ordering quantity that minimises total cost.

Question 17

Agency problem arises due to separation of:

Accepted Answer

Agency conflict occurs when managers’ interests diverge from owners’ interests.

Question 18

What is the primary goal of financial management?

Accepted Answer

b) Maximising shareholder wealth

Question 19

Profitability Index (PI) is:

Accepted Answer

PI = PV inflows divided by PV outflows.

Question 20

EBIT–EPS analysis is used to:

Accepted Answer

EBIT–EPS compares EPS under alternative financing plans.

Question 21

Define Net Present Value (NPV).

Accepted Answer

NPV is the excess of **present value of cash inflows** over **present value of cash outflows** of a project.

Question 22

What does beta (β) represent in CAPM?

Accepted Answer

Beta (β) represents **systematic (market) risk**—the sensitivity of a stock’s return to market movements.

Question 23

What is cash flow statement?

Accepted Answer

Cash flow statement shows cash inflows and outflows classified into **operating, investing and financing** activities during a period.

Question 24

What is initial outlay in a project?

Accepted Answer

Initial outlay is the cash investment at **time 0** (cost of asset + installation + working capital, if any).

Question 25

What is Ko in capital structure theories?

Accepted Answer

Ko refers to the overall cost of capital, i.e., **WACC**.

Question 26

Define cost of capital.

Accepted Answer

Cost of capital is the **minimum required return** that a firm must earn to satisfy providers of funds and maintain firm value.

Question 27

What is residual dividend policy?

Accepted Answer

Residual dividend policy pays dividend from **residual earnings** left after financing acceptable investment projects.

Question 28

Write the after-tax cost of debt formula.

Accepted Answer

After-tax cost of debt: **Kd(after) = i(1 − t)**.

Question 29

What does NI approach conclude about firm value when debt increases?

Accepted Answer

NI approach concludes that firm value **increases** as debt increases because WACC decreases (basic view).

Question 30

Define time value of money (TVM).

Accepted Answer

Time value of money means a rupee today is worth more than a rupee in future due to its **earning capacity**, inflation and risk.

Question 31

Explain the concept of optimum capital structure and how it is identified (brief) with a table.

Accepted Answer

Optimum capital structure is the debt–equity mix at which **WACC is minimum** and **firm value is maximum**.

It is identified by comparing WACC/value at different leverage levels.

| Leverage | WACC | Firm value |
|---|---|---|
| Low | higher | lower |
| Moderate (optimum) | **minimum** | **maximum** |
| High | higher | lower |

Thus, optimum occurs at the turning point of the WACC curve (U-shape).

Question 32

Write CAPM formula and explain how beta affects required return (brief) with a flow.

Accepted Answer

CAPM: **Ke = Rf + β(Rm − Rf)**

Beta effect: higher **β** increases the risk premium β(Rm−Rf), so required return rises.

Flow: β ↑ → risk premium ↑ → **Ke ↑**

Question 33

Write the CAPM equation for cost of equity and explain each term briefly.

Accepted Answer

CAPM:

**Ke = Rf + β(Rm − Rf)**

Where:
- **Rf** = risk-free rate
- **Rm − Rf** = market risk premium
- **β** = systematic risk measure

Thus, higher β increases required return on equity.

Question 34

Explain the relationship between DOL, DFL and DCL with a small table.

Accepted Answer

Relationship:

- **DCL = DOL × DFL**
- DOL captures operating (business) risk; DFL captures financing risk.

| Measure | Sensitivity of | Basic formula |
|---|---|---|
| **DOL** | EBIT to sales | Contribution/EBIT |
| **DFL** | EPS to EBIT | EBIT/(EBIT−Interest) |
| **DCL** | EPS to sales | **DOL×DFL** |

Thus, total risk combines operating and financial effects.

Question 35

State the main conclusion of the traditional approach (brief) with a small table/shape.

Accepted Answer

Traditional approach concludes that an **optimum capital structure** exists.

- Initially, debt increases → WACC **falls** → value **rises**.
- After an optimum point, risk increases → WACC **rises** → value falls.

| Leverage level | WACC trend |
|---|---|
| Low to moderate | **falls** |
| Beyond optimum | **rises** |

(Shape: U-shaped WACC curve).

Question 36

Explain NI approach and NOI approach (exam-style) with assumptions and conclusions (use a table).

Accepted Answer

### NI approach
Assumes **Kd** is cheaper and constant; **Ke** is constant (basic). As debt increases, WACC **decreases** and firm value **increases**.

### NOI approach
Assumes WACC (**Ko**) is constant. As leverage increases, **Ke rises** to offset benefit of cheap debt, so firm value remains **constant**.

| Point | **NI** | **NOI** |
|---|---|---|
| Ko (WACC) | decreases | **constant** |
| Value | increases | **constant** |
| Ke | constant (basic) | increases |

### Conclusion
NI supports more debt; NOI suggests capital structure is irrelevant under its assumptions.

Question 37

Explain inventory management and EOQ concept (exam-style) with a flow/table.

Accepted Answer

### Meaning
Inventory management ensures that inventory is available for smooth production/sales at minimum total cost.

### EOQ concept
EOQ is the order quantity that minimises total inventory cost, balancing:
- **ordering cost** (cost of placing orders)
- **carrying cost** (storage, insurance, obsolescence)

Flow: Ordering cost ↓ with larger orders, Carrying cost ↑ with larger orders → **EOQ at minimum total cost**

| Cost type | Behavior with order size |
|---|---|
| **Ordering cost** | decreases |
| **Carrying cost** | increases |

### Conclusion
By ordering near EOQ, a firm reduces total inventory cost and lowers funds blocked in inventory.

Question 38

Explain MM dividend irrelevance theory: assumptions and conclusion (exam-style) with a table/flow.

Accepted Answer

### MM irrelevance proposition
MM argues dividend policy does not affect firm value under **perfect market** assumptions.

### Assumptions (basic)
- no taxes and no transaction costs
- perfect information
- fixed investment policy
- investors can create homemade dividends (sell/buy shares)

Flow: Investment policy तय → Earnings/cash flows तय → **Firm value** तय (dividend split doesn’t change value)

| Item | MM view |
|---|---|
| Dividend policy | **irrelevant** |
| Driver of value | **investment policy + earnings** |

### Conclusion
Thus, in ideal conditions dividend is just a distribution decision; value comes from investment returns.

Question 39

Differentiate between NPV and IRR (exam-style) and state which is preferred when they conflict (use a table).

Accepted Answer

### Difference

| Basis | **NPV** | **IRR** |
|---|---|---|
| Output | ₹ value added | % return |
| Reinvestment assumption (basic) | at cost of capital | at IRR |
| Use | accept/reject; ranking | accept/reject; ranking |

### Preference in conflict
For **mutually exclusive** projects with conflicting rankings, **NPV is generally preferred** because it measures absolute value addition and aligns with **wealth maximisation**.

### Conclusion
Use NPV as primary criterion; IRR can be used as a supporting indicator.

Question 40

Explain how to avoid unit mismatch errors in TVM problems (exam-style) with a short flow.

Accepted Answer

### Core rule
Always match the **rate per period** with the **number of periods**.

### Steps (flow)
Given data → identify compounding/discounting frequency → convert rate to **periodic rate** (r/m) → convert time to **number of periods** (n×m) → apply correct formula → write answer with units

| Given | Convert to |
|---|---|
| 12% p.a. monthly compounding | 1% per month |
| 3 years monthly | 36 months |

### Conclusion
Following this flow prevents the most common TVM mistakes and ensures correct PV/FV results.

Financial Management — Question Paper

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