Theory and Problems in Financial Management

458 Pages·1993·3.969 MB·English

by  P. K. Jain

TMH OUTLINE SERIES
THEORY AND PROBLEMS IN
FINANCIAL MANAGEMENT
Second Edition
By the Same Authors
— Financial Management: Text & Problems, 3/e
— Management Accounting
— Theory and Problems in Management and Cost Accounting
TMH OUTLINE SERIES
THEORY AND PROBLEMS IN
FINANCIAL MANAGEMENT
SECOND EDITION
M Y KHAN
Professor of Finance
Department of Financial Studies
University of Delhi
Delhi
P K JAIN
Dalmia Chair Professor and Professor of Finance
Department of Management Studies
Indian Institute of Technology
Delhi
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R***************
P
REFACE TO THE FIRST EDITION
This book has been written as a supplement to our earlier text: Financial Management, published by Tata
McGraw-Hill Publishing Company Limited. It is designed for management, commerce, finance, and char-
tered and cost accountancy students. It would be especially useful to students undergoing the management
courses offered by the All India Management Association and Indira Gandhi National Open University
(IGNOU), and the finance courses of the Institute of Chartered Financial Analyst of India (ICFAI).
The idea of writing this volume was conceived during our long experience as teachers, wherein we
realised that the basic principles and tools of financial management are best grasped by students by actually
solving problems. In view of this, the problem-solving approach has been adopted in this book with special
emphasis on the practical applications of the principles and techniques of financial management.
In the beginning of each chapter, the important formulae, equations and theories are recapitulated to help
the student to quickly review the concepts. Another distinguishing feature of the volume is the inclusion of
a variety of problems, some of which have been taken from professional/university examinations.
The book presents various aspects of both theory and applications in a succinct form. A large number of
chapter-end review problems in the form of exercises along with their answers are given to test the reader’s
understanding of each topic.
We hope that the book would succeed in meeting the growing requirements of the professional students
in this emerging area. Suggestions for improvement of the book are welcome.
M Y KHAN
P K JAIN
P
REFACE TO THE SECOND EDITION
The second edition of our book, Financial Management: Text and Problems, published by Tata McGraw-
Hill, has been revised to update its contents to reflect the advances in the knowledge about the financial
management discipline as well as to portray the developments in the taxation, financial and regulatory
environment in the country in the post-liberalisation era and their impact on corporate financial practices.
As a complementary volume, a revision of Theory and Problems of Financial Management is necessitated
due to the same reasons.
The revised edition includes 367 real-life solved problems, some of which have also been taken from
professional examinations like CA, ICWA and ICS. Ninety exercises with suggested answers have been
included too. The material has also been tested with our students in the class. Another notable feature of this
edition is the inclusion of a new chapter on Basic Financial Concepts covering time value of money,
valuation of long-term securities, and risk and return.
Like the first edition, a bird’s eye view of the basic concepts/theories/formulae are depicted in the
beginning of each chapter in the form of exhibits for understanding of the subsequent problems-solutions,
and exercises. A complete set of financial tables at the end of the book is also included.
We hope that the thoroughly revised and enlarged second edition will receive the same overwhelming
response from the readers as the first edition. Suggestions for improvement are welcome.
AUTHORS
C
ONTENTS
Preface to the Second Edition v
Preface to the First Edition vii
1. Statement of Changes in Financial Position 1.1-1.62
Basic Theory 1.1
Solved Problems 1.7
Exercises 1.57
Answers 1.62
2. Ratio Analysis 2.1-2.39
Basic Theory 2.1
Solved Problems 2.6
Exercises 2.36
Answers 2.39
3. Basic Financial Concepts 3.1-3.19
Basic Theory 3.1
Solved Problems 3.6
Exercises 3.18
Answers 3.19
4. Cost of Capital 4.1-4.23
Basic Theory 4.1
Solved Problems 4.4
Exercises 4.20
Answers 4.22
5. Capital Budgeting 5.1-5.79
Basic Theory 5.1
Solved Problems 5.5
Exercises 5.75
Answers 5.78
6. Risk Analysis 6.1-6.20
Basic Theory 6.1
Solved Problems 6.3
Exercises 6.18
Answers 6.20
x Contents
7. Leasing 7.1-7.33
Basic Theory 7.1
Solved Problems 7.3
Exercises 7.31
Answers 7.33
8. Mergers and Acquisitions 8.1-8.17
Basic Theory 8.1
Solved Problems 8.2
Exercises 8.15
Answers 8.17
9. Analysis of Leverage 9.1-9.15
Basic Theory 9.1
Solved Problems 9.2
Exercises 9.13
Answers 9.14
10. Capital Structure Theories 10.1-10.13
Basic Theory 10.1
Solved Problems 10.3
Exercises 10.12
Answers 10.13
11. Capital Structure Planning 11.1-11.26
Basic Theory 11.1
Solved Problems 11.3
Exercises 11.24
Answers 11.26
12. Dividend Policy 12.1-12.13
Basic Theory 12.1
Solved Problems 12.3
Exercises 12.12
Answers 12.13
13. Working Capital Planning 13.1-13.21
Basic Theory 13.1
Solved Problems 13.3
Exercises 13.19
Answers 13.21
14. Cash Management 14.1-14.26
Basic Theory 14.1
Solved Problems 14.3
Exercises 14.24
Answers 14.26
Contents xi
15. Receivables Management 15.1-15.14
Basic Theory 15.1
Solved Problems 15.2
Exercises 15.12
Answers 15.13
16. Inventory Management 16.1-16.10
Basic Theory 16.1
Solved Problems 16.2
Exercises 16.9
Answers 16.10
S
TATEMENT OF CHANGES
IN FINANCIAL POSITION
B T
ASIC HEORY
INTRODUCTION
The statement of changes in financial position (SCFP) is a statement of flows, that is, it measures the
changes that have taken place in the financial position of a firm between two balance sheet dates. It
summarises the sources and uses of the funds obtained. Drawing on the information contained in the basic
financial statements, namely profit and loss account/income statement and balance sheet, it shows the
sources of funds and their application to uses during the period. The changes in financial position could be
related to several different concepts of funds. Accordingly, the presentation and use of the SCFP, as a tool
of financial analysis, can be illustrated with reference to changes in (a) the net working capital (NWC),
(b) the cash position, (c) the total resources, and (d) according to the ICAI’s AS-3 (revised).
SCFP-WORKING CAPITAL BASIS (FUNDS FLOW STATEMENT)
The NWC of a firm is the amount by which its current assets (CA) exceed its current liabilities (CL). The
magnitude of NWC is a measure of the safety margin for the protection of short-term creditors.
The NWC may also be viewed as funds available for acquisition of non-CA, as well as to repay non-CL.
Any transaction that results in an increase in NWC is a source of working capital (WC); any transaction that
causes a net decrease in WC is an application of WC. Some transactions merely change the form and not the
amount of the WC. Such items constitute neither source nor use of working capital.
The major sources and uses of working capital are summarised in Exhibit 1.1.
EXHIBIT 1.1 Sources and Uses of Working Capital
Sources of Working Capital
(a) Funds from business operations
(b) Other incomes
(c) Sale of non-current assets
(d) Long-term borrowings
(e) Issue of additional equity capital or preference share capital or debentures
Uses of Working Capital
(a) Losses from business operations
(b) Purchase of non-current assets
(c) Redemption of debentures and/or preference shares
(d) Dividends to shareholders
(e) Repayment of long-term borrowings
Funds from Business Operations
The computation of funds from business operations are shown in Exhibits 1.2 and 1.3.