Question 1

What does the term ROI stand for in financial management?

Accepted Answer

a) Return on Investment

Question 2

The modern objective of financial management is:

Accepted Answer

Wealth maximisation considers cash flows, risk and time value of money.

Question 3

In NOI approach, as leverage increases, Ke:

Accepted Answer

Ke rises with leverage to offset benefits of debt, keeping Ko constant.

Question 4

Which approach is also called 'irrelevance theory' (basic view)?

Accepted Answer

MM without taxes is known for irrelevance proposition.

Question 5

Future value (FV) of a single sum is computed as:

Accepted Answer

Compounding: FV = PV(1+r)^n.

Question 6

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

Accepted Answer

c) Retained earnings

Question 7

Financial risk is mainly associated with:

Accepted Answer

Financial risk arises from fixed financial obligations like interest.

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

Debt–equity ratio indicates:

Accepted Answer

Debt-equity reflects the leverage and long-term solvency risk.

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

If WACC increases, then for NPV calculations the discount rate:

Accepted Answer

WACC is used as discount rate; higher WACC means higher discount rate.

Question 13

NI approach suggests that as leverage increases, WACC:

Accepted Answer

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

Question 14

What does the Debt to Equity ratio measure?

Accepted Answer

d) The level of investment in the companys equity

Question 15

A major limitation of ratio analysis is that it:

Accepted Answer

Ratios depend on policies, may suffer window dressing, inflation, and need comparison/context.

Question 16

Dividend relevance theory is mainly supported by:

Accepted Answer

Walter and Gordon support dividend relevance (policy affects price).

Question 17

PV of an ordinary annuity of A for n periods at rate r is:

Accepted Answer

PV of ordinary annuity = A × (1 − (1+r)^−n)/r.

Question 18

What is the primary goal of financial management?

Accepted Answer

b) Maximising shareholder wealth

Question 19

CAPM is used to compute:

Accepted Answer

CAPM estimates required return on equity using beta and risk premium.

Question 20

MM theory (without taxes) states that capital structure is:

Accepted Answer

MM (no tax) proposition: firm value is independent of leverage in perfect markets.

Question 21

What is meant by wealth maximisation?

Accepted Answer

Wealth maximisation means increasing **shareholder wealth** by maximising the present value of expected future **cash flows** (reflected in share price).

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

State one objective of financial management.

Accepted Answer

One objective is **wealth maximisation** (maximising the market value of the firm/shareholders’ wealth).

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 capital budgeting.

Accepted Answer

Capital budgeting is the process of evaluating and selecting **long-term investment projects** whose benefits extend over several years.

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 IRR and how it is found by interpolation (exam-style) with a small working format.

Accepted Answer

### Meaning
**IRR** is the discount rate that makes **NPV = 0**.

### Interpolation idea (basic)
Compute NPV at two rates:
- at lower rate r1: NPV is **positive**
- at higher rate r2: NPV is **negative**

Then approximate IRR:
IRR ≈ r1 + [NPV1 / (NPV1 − NPV2)] × (r2 − r1)

| Rate | NPV sign |
|---:|---|
| r1 | **+** |
| r2 | **−** |

### Conclusion
Accept the project if **IRR ≥ cost of capital**.

Financial Management — Question Paper

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