financial management - copy

8/2/2019 Financial Management - Copy

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FINANCIAL MANAGEMENT

Q1. Scope of financial management.

Ans. Taking a commercial business as the most common organizational

structure, the key objectives of financial management would be to:

Create wealth for the business

Generate cash, and

Provide an adequate return on investment bearing in mind the risks

that the business is taking and the resources invested

There are three key elements to the process of financial management:

(1) Financial Planning

Management need to ensure that enough funding is available at the

right time to meet the needs of the business. In the short term, funding

may be needed to invest in equipment and stocks, pay employees and

fund sales made on credit.

In the medium and long term, funding may be required for significant

additions to the productive capacity of the business or to make

acquisitions.

(2) Financial Control

Financial control is a critically important activity to help the business

ensure that the business is meeting its objectives. Financial controladdresses questions such as:

Are assets being used efficiently?

Are the businesses assets secure?


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Do management act in the best interest of shareholders and in

accordance with business rules?

(3) Financial Decision-making

The key aspects of financial decision-making relate to investment,

financing and dividends:

Investments must be financed in some way however there are

always financing alternatives that can be considered. For example it is

possible to raise finance from selling new shares, borrowing from banks

or taking credit from suppliers.

Q2. What is time value of money?

Ans. The basic idea of time value of money is that a dollar today is

worth more than a dollar tomorrow. This can be shown in many ways;

many people find it easiest to understand if they think in terms of

something they already know: food. For example having the money

today allows you to buy some food immediately. Alternatively you may

be willing to forgo current consumption and wait until later to purchase

your food. Thus you could lend your "food money" to another with the

promise of being paid back at some future time. Since you are passing

up food today you would demand a return sufficient to allow you to

buy at least as much food in the future that you are giving up now.

As we do not know the future this type of deal involves risks. For

example the borrower may decide to not pay you back. This is called

default risk. Or the borrower may pay you back but due to rising prices

you can no longer purchase the same amount of food as you hadexpected to be able to buy. As a result of these risks (you as a lender)

would require a higher interest rate to compensate for accepting the

risks. However if you ask for too high of interest rates you will not find

any takers for your loan.


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Q3.What is capital structure?

Ans. The term capital structure refers to the percentage of capital

(money) at work in a business by type. Broadly speaking, there are two

forms of capital: equity capital and debt capital. Each has its ownbenefits and drawbacks and a substantial part of wise corporate

stewardship and management is attempting to find the perfect capital

structure in terms of risk / reward payoff for shareholders. This is true

for Fortune 500 companies and for small business owners trying to

determine how much of their startup money should come from a bank

loan without endangering the business.

Equity Capital: This refers to money put up and owned by the

shareholders (owners). Typically, equity capital consists of two types:

1.) Contributed capital, which is the money that was originally

invested in the business in exchange for shares of stock or ownership

2.) Retained earnings, which represents profits from past years that

have been kept by the company and used to strengthen the balance

sheet or fund growth, acquisitions, or expansion.Many consider equity capital to be the most expensive type of capital

a company can utilize because its "cost" is the return the firm must

earn to attract investment. A speculative mining company that is

looking for silver in a remote region of Africa may require a much

higher return on equity to get investors to purchase the stock than a

firm such as Procter & Gamble, which sells everything from

toothpaste and shampoo to detergent and beauty products.
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Debt Capital: The debt capital in a company's capital structure refers

to borrowed money that is at work in the business. The safest type is

generally considered long-term bonds because the company has

years, if not decades, to come up with the principal, while paying

interest only in the meantime.

Other types of debt capital can include short-term commercial paper

utilized by giants such as Wal-Mart and General Electric that amount

to billions of dollars in 24-hour loans from the capital markets to

meet day-to-day working capital requirements such as payroll and

utility bills. The cost of debt capital in the capital structure depends

on the health of the company's balance sheet - a triple AAA rated

firm is going to be able to borrow at extremely low rates versus a

speculative company with tons of debt, which may have to pay 15%

or more in exchange for debt capital.

Q4.Explain the term-

White knight. A corporation that is the target of a hostile takeover

sometimes seeks out a white knight that comes to the rescue by

making an offer to acquire the target company in a friendly takeoverthat suits the needs and goals of the target's management and board.

The hostile acquirer is called a black knight, and if the white knight is

outbid by a third potential acquirer, who is both less friendly than the

white knight and more friendly than the black knight, the third bidder is

called a gray knight.

Poison Pill - A strategy used by corporations to discourage hostiletakeovers. With a poison pill, the target company attempts to make its

stock less attractive to the acquirer. There are two types of poison pills:

1. A "flip-in" allows existing shareholders (except the acquirer) to buy

more shares at a discount.


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2. A "flip-over" allows stockholders to buy the acquirer's shares at a

discounted price after the merger.

Economic Value Added-A measure of a company's financial

performance based on the residual wealth calculated by deducting cost

of capital from its operating profit (adjusted for taxes on a cash basis).

(Also referred to as "economic profit".)

The formula for calculating EVA is as follows:

= Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)

Corporate restructuring:

Restructuring is the corporate management term for the act of partially

dismantling and reorganizing a company for the purpose of making it

more efficient and therefore more profitable. It generally involves

selling off portions of the company and making severe staff reductions.

Restructuring is often done as part of a bankruptcy or of a takeover by

another firm, particularly a leveraged buyout by a private equity firm. It

may also be done by a new CEO hired specifically to make the difficult

and controversial decisions required to save or reposition the company.

Commercial paper: An unsecured, short-term debt instrument issuedby a corporation, typically for the financing of accounts

receivable, inventories and meeting short-term liabilities. Maturities on

commercial paper rarely range any longer than 270 days. The

debt is usually issued at a discount, reflecting prevailing market interest


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rates.

Operating lease: A lease contract that allows the use of an asset, but

does not convey rights similar to ownership of the asset.

Money market:

An investment fund that holds the objective to earn interest for

shareholders while maintaining a net asset value (NAV) of $1 per share.

Mutual funds, brokerage firms and banks offer these funds. Portfolios

are comprised of short-term (less than one year) securities representing

high-quality, liquid debt and monetary instruments.

Q5.Compare debentures and Equity share as a source of finance?

Ans. Definitions

Share: A unit of ownership interest in a corporation or

Financial asset. While owning shares in a business does not mean that

the shareholder has direct control over the

Businesss day-to-day operations, being a shareholder does entitle thepossessor to an equal distribution in any profits, if any are declared in

the form of dividends. The two main types of shares are common

shares and preferred shares.

Debenture: A certificate or voucher acknowledging a debt.

An unsecured bond issued by a civil or governmental Corporation or

agency and backed only by the credit standing of the issuer.

DIFFERENCES

A debenture is an unsecured loan you offer to a company. The

company does not give any collateral for the debenture, but pays a


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higher rate of interest to its creditors. In case of bankruptcy or financial

difficulties, the debenture holders are paid later than bondholders.

Debentures are different from stocks and bonds, although all three are

types of investment. Below are descriptions of the different types of

investment options for small investors and entrepreneurs.

Debentures and Shares

When you buy shares, you become one of the owners of the company.

Your fortunes rise and fall with that of the company. If the stocks of the

company soar in value, your investment pays off high dividends, but if

the shares decrease in value, the investments are low paying. The

higher the risk you take, the higher the rewards you get.

Debentures are more secure than shares, in the sense that you are

guaranteed payments with high interest rates. The company pays you

interest on the money you lend it until

the maturity period, after which, whatever you invested in the

company is paid back to you. The interest is the profit you make from

debentures. While shares are for those who

like to take risks for the sake of high returns, debentures are for peoplewho want a safe and secure income.

Q6. What are Venture Capital and Seed Capital?

Ans. Venture capital:

Money provided by investors to startup firms and small businesses

with perceived long-term growth potential. This is a very important

source of funding for startups that do not have access to capital

markets. It typically entails high risk for the investor, but it has the

potential for above-average returns.

Seed capital:


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The initial capital used to start a business. Seed capital often comes

from the company founders' personal assets or from friends and

family. The amount of money is usually relatively small because the

business is still in the idea or conceptual stage. Such a venture is

generally at a pre-revenue stage and seed capital is needed for research

& development, to cover initial operating expenses until a product or

service can start generating revenue, and to attract the attention of

venture capitalists.

Q7. Write a note on leverages.

1. The use of various financial instruments or borrowed capital, such as

margin, to increase the potential return of an investment.

2. The amount of debt used to finance a firm's assets. A firm with

significantly more debt than equity is considered to be highly

leveraged.

Leverage is most commonly used in real estate transactions through

the use of mortgages to purchase a home.

Q 1 Define financial management.

Ans. The planning, directing, monitoring, organizing, and controlling of

the monetary resources of an organization.

"Finance is the art of passing currency from hand to hand until it finally

disappears." - Robert W. Sarnoff
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Q2 What is risk return trade-off.

Ans.Definition of 'Risk-Return Tradeoff'The principle that potential return rises with an increase in risk. Low

levels of uncertainty (low risk) are associated with low potential

returns, whereas high levels of uncertainty (high risk) are associated

with high potential returns. According to the risk-return tradeoff,

invested money can render higher profits only if it is subject to the

possibility of being lost.

Risk-Return Trade-Off

The concept that every rational investor, at a given level ofrisk, will

accept only the largest expected return. That is, given two

investments at the exact same level of risk, all other things being equal,

every rational investor will invest in the one that offers the higher

return. The risk-return tradeoff is pervasive

throughout economics and finance. It is the reason that

riskier bonds pay higher coupons than other bonds. It is also the reason

that bonds pay lower returns than most stocks because they are a less

risky investment.

Q3. What do you mean by capital budgeting.

Ans. The process in which a business determines whether projects suchas building a new plant or investing in a long-term venture are worth

pursuing. Oftentimes, a prospective project's lifetime cash inflows and

outflows are assessed in order to determine whether the returns

generated meet a sufficient target benchmark.

Also known as "investment appraisal".
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Ideally, businesses should pursue all projects and opportunities that

enhance shareholder value. However, because the amount of capital

available at any given time for new projects is limited, managementneeds to use capital budgeting techniques to determine which projects

will yield the most return over an applicable period of time.

Popular methods of capital budgeting include net present value (NPV),

internal rate of return (IRR), discounted cash flow (DCF) and payback

period.

Q4. Define IRR.

Ans.Definition of 'Internal Rate Of Return - IRRThe discount rate often used in capital budgeting that makes the net

present value of all cash flows from a particular project equal to zero.

Generally speaking, the higher a project's internal rate of return, the

more desirable it is to undertake the project. As such, IRR can be used

to rank several prospective projects a firm is considering. Assuming all

other factors are equal among the various projects, the project with the

highest IRR would probably be considered the best and undertaken

first.

IRR is sometimes referred to as "economic rate of return (ERR)".

Q5. What do you mean by capital rationing?

Ans.Definition of 'Capital Rationing'


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The act of placing restrictions on the amount of new investments or

projects undertaken by a company. This is accomplished by imposing a

higher cost of capital for investment consideration or by setting a

ceiling on the specific sections of the budget.

Investopedia explains 'Capital Rationing'

Companies may want to implement capital rationing in situations

where past returns of investment were lower than expected. For

example, suppose ABC Corp. has a cost of capital of 10% but that

the company has undertaken too many projects, many of which are

incomplete. This causes the company's actual return on investment to

drop well below the 10% level. As a result, management decides to

place a cap on the number of new projects by raising the cost of capital

for these new projects to 15%. Starting fewer new projects would give

the company more time and resources to complete existing projects.

Q6. Define WC.

Ans.

The term working capital is commonly used for the amount requiredfor holding current assets like stock of raw material and finished goods,bills receivable, debtors and cash and also to meet the day to day expenseslike salaries and wages, rent, taxes etc. The term working capital is used in

two senses - Gross working capital and net working capital.

The Gross Working Capital refers to the firm's total investment in

current assets. Current assets mean assets which can be converted into cashwithin an accounting year. According to J.S. Mill, "the sum of the current

assets is working capital of a business."

The Net Working Capital of a business represents the excess of current

assets over current liabilities. Current liabilities include trade creditors,bills payable, bank overdraft and outstanding expenses. These are expected

to mature for payment within as accounting year. We may put the conceptof net working capital in the following equation--


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Net Working Capital = Current assets - Current liabilities.

Q6. What do you mean by Letters of Credit?

Ans.Definition of 'Letter Of Credit'

A letter from a bank guaranteeing that a buyer's payment to a seller

will be received on time and for the correct amount. In the event that

the buyer is unable to make payment on the purchase, the bank will be

required to cover the full or remaining amount of the purchase.

Letters of credit are often used in international transactions to ensure

that payment will be received. Due to the nature of international

dealings including factors such as distance, differing laws in eachcountry and difficulty in knowing each party personally, the use of

letters of credit has become a very important aspect of international

trade. The bank also acts on behalf of the buyer (holder of letter of

credit) by ensuring that the supplier will not be paid until the bank

receives a confirmation that the goods have been shipped.

Q7 .Explain Cost of Capital.

Ans. When companies require money for investments, expansion or

any activity they raise money through many options like shares,

debentures, preferential shares, bank loans etc. Cost of employing any

of these modes to raise capital is called Cost of capital.

For eg: If Reliance wants to raise money for a new power plant. It will

look for feasible options like IPO, Preferential shares debentures or

bank loan. Each of these modes have some risk and cost involved. Forshares you lose your share in the company, for preferential shares you

have to pay some fixed dividend, and for debentures also we have to

pay some amount of interest to the debenture holders.


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Q8. What do you mean by WACC.

Ans. Definition of 'Weighted Average Cost Of Capital - WACC'

A calculation of a firm's cost of capital in which each category of capitalis proportionately weighted. All capital sources - common stock,

preferred stock, bonds and any other long-term debt - are included in a

WACC calculation. All else equal, the WACC of a firm increases as the

beta and rate of return on equity increases, as an increase in WACC

notes a decrease in valuation and a higher risk.

Broadly speaking, a companys assets are financed by either debt or

equity. WACC is the average of the costs of these sources of financing,

each of which is weighted by its respective use in the given situation. By

taking a weighted average, we can see how much interest the company

has to pay for every dollar it finances.

Q9. What are the different kinds of reserves.

Ans. Factoring is a financial transaction whereby a business sells

its accounts receivable (i.e., invoices) to a third party (called a factor) ata discount. In "advance" factoring, the factor provides financing to the

seller of the accounts in the form of a cash "advance," often 70-85% of

the purchase price of the accounts, with the balance of the purchase

price being paid, net of the factor's discount fee (commission) and

other charges, upon collection.

Q10. Explain capitalization.

Ans.The term 'capitalization' is used in quantitative aspect and refers to

the amount at which a company's business can he valued.

In a broader sense, the term capitalization has been used in the sense

of financial planning. It means, it includes the amount of capital to be
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raised, the securities through which it is to be raised and the relative

proportion of different classes of securities to be issued and the

administration of capital. The analysis of this interpretation shows that

it is nothing less than financial planning.

Over Capitalisation

Generally over-capitalization implies that the capital of the company

exceeds its requirements. In other words, a company is said to be

overcapitalized when its actual profits are not sufficient to pay interest

(on debentures and borrowings) and dividends (on share capital) at fair

rates.

Reasons:

The main causes of over-capitalization are (i) Promotion of company with overvalued

assets, (ii) Purchase of assets during boom period, i.e., at higher prices; (iii) High

promotional expenses; (iv) Raising excessive capital, i.e., more capital than what it can

profitably use; (v) Borrowing money at high rates of interest; (vi) Overestimation of

earnings: (vii) Under provision of depreciation; (viii) High rate taxation; (ix) Lack of

reserves; (x) Liberal dividend policy etc.

Merits/Advantages:

The main advantages or merits of overcapitalization are:

Increase in the competitive power of the company.

Easy expansion of the company's activities.

Morale of the management is raised.

Risk-taking capacity is increased.

No fear of shortage of capital.

Power to face depression period is increased.Demerits/ Disadvantages:

Form Company's Point View: (i) It reduces the earning capacity of the company; (ii)

Reputation and goodwill of the company is adversely affected, i.e., reduced; (iii)

Company takes resort to unfair practices; (iv) Manipulation of accounts etc. by the


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company; (v) Feeling of instability is developed; (vi) Fear of winding up of a company;

(vii) Borrowings on higher rate of interest.

From Investor's or Shareholder's Point of View: (i) Loss in the value of

investment (shares); (ii) Loss of easy marketability; (iii) Irregular, uncertain and lower

earnings on the investment (dividend on shares); (iv) Speculation is encouraged; (v)Reduction in the liquidity of investment; (vi) Shares cannot be mortgaged easily as their

utility as collateral security is reduced; (vii) Loss due to reorganization and liquidation

etc.

From the Point of view of the Society: (i) Increase in prices or reduction in quality

of goods; (ii) Wage cuts or retrenchment of workers; (iii) Increase in unemployment;

(iv) Encouragement to reckless speculation; (v) Mis utilization and wastage of resources;

(vi) Reduced efficiency of the management; (vii) Loss of public confidence in investment

etc.

Under capitalization.

Situation where a business does not have

sufficient stockholders' funds for its size ofoperations. An

undercapitalized firm does not have enough cash to carryout

its functions and usually does not qualify for bank or other loans due to

its unacceptably high loan-to-equity ratio. Under capitalization is one of

the major causes of business startup failures.

Generally under-capitalization denotes the inadequacy of capital;i.e., the shortage of capital.

Causes of Under-capitalization:

There may be a number of causes of under-capitalization. However, the main causes of

under-capitalization are - (i) Under-estimation of earnings; (ii) Under-estimation of

capital requirement; (iii) Promotion of company during the period of depression; (iv)

Unforeseen increase in earnings, such as, during boom period, the company will finditself under-capitalized when its earnings exceed the increase in the amount of capital

employed; (v) Conservative dividend policy of the company; (vi) Sound financial

management with high efficiency; (vii) Tight conditions in the money market.
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Merits of Under-capitalization:

The main advantages/ merits of under-capitalization are -(i) Creation of secret reserves,

(ii) Higher rate of dividend, (iii) Rapid increase in the prices of shares in the stock

exchange; (iv) Symptom of economic prosperity of the company; (v) Increase in the rateof profits of the company; and (vi) Shares can be sold easily.

Evils/ Demerits/ Disadvantages of Under-capitalization:

The evils of under capitalization are- (i) Wide fluctuation in the prices of shares etc., (ii)

Increase in competition, (iii) Increase in speculative activities, (iv) Increase in

opportunities for manipulation by management, (v) Industrial relations tend to be

strained, (vi) Dissatisfaction amongst consumers, they feel they are being exploited by

the company, (vii) Increase in the tax burden of the company, (viii) Increased

Government interference etc.

Q11. Explain the term CAPM.

Ans. Definition of 'Capital Asset Pricing Model - CAPM'

A model that describes the relationship between risk and expected

return and that is used in the pricing of risky securities.

The general idea behind CAPM is that investors need to be

compensated in two ways: time value of money and risk.

Using the CAPM model and the following assumptions, we can compute

the expected return of a stock in this CAPM example: if the risk-free

rate is 3%, the beta (risk measure) of the stock is 2 and the expected


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market return over the period is 10%, the stock is expected to return

17% ie (3%+2(10%-3%)).

Q12. What do you mean by EVA.

Ans. A measure of a company's financial performance based on the

residual wealth calculated by deducting cost of capital from its

operating profit (adjusted for taxes on a cash basis). (Also referred to as

"economic profit".)

The formula for calculating EVA is as follows:

= Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)

Q13. What do you mean by public deposits.

Ans. Meaning of "public deposits".

Besides the issue of shares- equity and preference and debentures, a

company can accept deposits from the public to finance its mediumand short-term requirements of funds. This source has become very

popular recently because, a company offers interest at a rate higher

than offered by banks. Under this method, companies are able to

obtain funds directly from public without financial intermediaries.

Q14. What do you mean by operating lease.

Ans.Lease contract that allows the use of an asset, but does not convey rightssimilar to ownership of the asset.

Capital Leases vs. Operating Leases - What's the Difference? Which One Should I

Use?


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Leasing equipment is a common alternative to purchase. Of the two kinds of

leases - capital leases and operating leases - each is used for different purposes

and results in differing treatment on the accounting books of a business.

Capital Leases Capital leases are used for long-term leases and for items that not become

technologically obsolete, such as many kinds of machinery.

Capital leases give the lessee (the person who is leasing) the benefits and

drawbacks of ownership, so they are considered as assets, and they may be

depreciated.

These leases are considered as debts of the lessee.

In order to be considered a capital lease, theFinancial Accounting Standards

Board (FASB)requires that at least one of these conditions must be met:

Title to the equipment passes automatically to the lessee by the end of thelease term

The lease contains an option to purchase the equipment at the end of the lease

for substantially less than fair market value; sometimes this is a $1 purchase

The term of the lease is greater than 75% of the useful life of the equipment

The present value of the lease payments is greater than 90% of thefair market

valueof the equipment.

Operating Leases

Operating leases, sometimes called service leases are used for shot-term

leasing and often for assets that are high-tech or in which the technologychanges often, like computer and office equipment.

The lessee uses the property but does not take on the benefits or drawbacks of

ownership, which are retained by the lessor.

The rental cost of an operating lease is considered an operating expense.

Which is Better?

As usual, it depends. If you are leasing a high-technology piece of equipment, you

will probably have an operating lease. For example, if you are leasing copiers for

your office, you probably have an operating lease. If you are leasing a piece ofmachinery which you intend to use for a long time, you probably have a capital

lease. Each type of lease is applicable to different leasing situations.
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Q15. What do you mean by financial leverage.

Ans. Definition of 'Leverage'

1. The use of various financial instruments or borrowed capital, such asmargin, to increase the potential return of an investment.

2. The amount of debt used to finance a firm's assets. A firm with

significantly more debt than equity is considered to be highly

leveraged.

Leverage is most commonly used in real estate transactions through

the use of mortgages to purchase a home.

Definition of 'Degree of Financial Leverage - DFL'

A leverage ratio summarizing the affect a particular amount of financial

leverage has on a company's earnings per share (EPS). Financial

leverage involves using fixed costs to finance the firm, and will include

higher expenses before interest and taxes (EBIT). The higher the degreeof financial leverage, the more volatile EPS will be, all other things

remaining the same. The formula is as follows:

Operating Leverage.

A measurement of the degree to which a firm or project incurs acombination of fixed and variable costs.

A business that has a higher proportion of fixed costs and a lower

proportion of variable costs is said to have used more operating


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leverage. Those businesses with lower fixed costs and higher variable

costs are said to employ less operating leverage.

Q16. What do you mean by CA and CL.

Ans. In personal finance, current assets are all assets that a person

can readily convert to cash to pay outstanding debts and cover

liabilities without having to sell fixed assets.

CL are bills that are due to creditors and suppliers within a short period

of time. Normally, companies withdraw or cash current assets in orderto pay their current liabilities.

Q17. What do you mean by retained earnings.

Ans.The percentage of net earnings not paid out as dividends, but

retained by the company to be reinvested in its core business or to pay

debt. It is recorded under shareholders' equity on the balance sheet.

In most cases, companies retain their earnings in order to invest them

into areas where the company can create growth opportunities, such as

buying new machinery or spending the money on more research and

development.

Q18. What do you mean by merger and acquisitions.

Ans. General term used to refer to the consolidation of companies. A

merger is a combination of two companies to form a new company,

while an acquisition is the purchase of one company by another in

which no new company is formed.


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Q19. What do you mean by NPV

Ans.T he difference between the present value of cash inflows and the

present value of cash outflows. NPV is used in capital budgeting to

analyze the profitability of an investment or project.

NPV analysis is sensitive to the reliability of future cash inflows that an

investment or project will yield.

Formula:

Q20. Advantages of Lease Financing.

Ans. It offers fixed rate financing; you pay at the same rate

monthly.

Leasing is inflation friendly. As the costs go up over five years,

you still pay the same rate as when you began the lease, therefore

making your dollar stretch farther. (In addition, the lease is not

connected to the success of the business. Therefore, no matter

how well the business does, the lease rate never changes.)

There is less upfront cash outlay; you do not need to make large

cash payments for the purchase of needed equipment.

Leasing better utilizes equipment; you lease and pay for

equipment only for the time you need it.

There is typically an option to buy equipment at end of lease

term.

You can keep upgrading; as new equipment becomes available

you can upgrade to the latest models each time your lease ends.


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Typically, it is easier to obtain lease financing than loans from

commercial lenders.

It offers potential tax benefits depending on how the lease is

structured.

Q21.Acquisition vs Merger

Ans.A lthough they are often uttered in the same breath and used as though they

were synonymous, the terms merger and acquisition mean slightly different

things.

Whether a purchase is considered a merger or an acquisition really depends onwhether the purchase is friendly or hostile and how it is announced. In other

words, the real difference lies in how the purchase is communicated to and

received by the target company's board of directors, employees and

shareholders.

When one company takes over another and clearly established itself as the new

owner, the purchase is called an acquisition. From a legal point of view, the target

company ceases to exist, the buyer "swallows" the business and the buyer's stock

continues to be traded.In the pure sense of the term, a merger happens when two firms, often of about

the same size, agree to go forward as a single new company rather than remain

separately owned and operated. This kind of action is more precisely referred to

as a "merger of equals." Both companies' stocks are surrendered and new

company stock is issued in its place. For example, both Daimler-Benz and Chrysler

ceased to exist when the two firms merged, and a new company,

DaimlerChrysler, was created.

In practice, however, actual mergers of equals don't happen very often. Usually,one company will buy another and, as part of the deal's terms, simply allow the

acquired firm to proclaim that the action is a merger of equals, even if it's

technically an acquisition. Being bought out often carries negative connotations,

therefore, by describing the deal as a merger, deal makers and top managers try

to make the takeover more palatable.


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A purchase deal will also be called a merger when both CEOs agree that joining

together is in the best interest of both of their companies. But when the deal is

unfriendly - that is, when the target company does not want to be purchased - it

is always regarded as an acquisition.

Q22. Acquisition and takeovers.

Ans. There is no tangible difference between an acquisition and

a takeover; both words can be used interchangeably - the only

difference is that each word carries a slightly different connotation.

Typically, takeover is used to reference a hostile takeover where the

company being acquired is resisting. In contrast, acquisition is

frequently used to describe more friendly acquisitions, or used inconjunction with the word merger, where both companies are willing

to join together. An acquisition or takeover occurs when one company

purchases another.

Q23. Merger vs takeovers.

Ans. In a general sense, mergers and takeovers (or acquisitions) are

very similar corporate actions - they combine two previously separatefirms into a single legal entity. Significant operational advantages can

be obtained when two firms are combined and, in fact, the goal of

most mergers and acquisitions is to improve company performance and

shareholder value over the long-term.

merger involves the mutual decision of two companies to combine and

become one entity;

A typical merger, in other words, involves two relatively equalcompanies, which combine to become one legal entity with the goal of

producing a company that is worth more than the sum of its parts

A takeover, or acquisition, on the other hand, is characterized by the

purchase of a smaller company by a much larger one.
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A larger company can initiate a hostile takeover of a smaller firm, which

essentially amounts to buying the company in the face of resistance

from the smaller company's management. Unlike in a merger, in an

acquisition, the acquiring firm usually offers a cash price per share to

the target firm's shareholders or the acquiring firm's share's to the

shareholders of the target firm according to a specified conversion ratio

Q24.What do you mean by Time Value of money.

Ans. If you were offered $100 today or $100 a year from now, which

would you choose? Would you rather have $100,000 today or $1,000 a

month for the rest of your life?

Net present value (NPV) provides a simple way to answer these types of

financial questions. This calculation compares the money received in

the future to an amount of money received today, while accounting for

time and interest. It's based on the principle oftime value of

money (TVM), which explains how time affects monetary value. (For

background reading, see Understanding.)

The TVM calculation may look complicated, but with someunderstanding of NPV and how the calculation works, along with its

basic variations: present value and future value, we can start putting

this formula to use in common application.

Q25 .What do you mean by permanent and temporally working capital.

Ans. kinds of Working Capital

There are 2 kinds of working capital. These are

i. Permanent Working capital and
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ii. Temporary Working capital.

1.Permanent Working capital

Permanent working capital refers to the minimum amount of allcurrent assets that is required at all times to ensure a minimum

level of uninterrupted business operations. Some minimum

amount of raw materials, work-in-progress, bank balance, finished

goods etc., a business has to carry all the time irrespective of the

level of manufacturing or marketing operations. This level of

working capital is referred to as core working capital or core

current assets. But the level of core current assets is not a

constant sum at all the times. For a growing business thepermanent working capital will be rising, for a declining business it

will be decreasing and for a stable business it will almost remain

the same with few variations. So, permanent working capital is

perennially needed one though not fixed in volume. This part of

the working capital being a permanent investment needs to be

financed through long-term funds.

2.Temporary Working capital

The temporary or varying working capital varies with the volume

of operations. It fluctuates with the scale of operations. This is the

additional working capital required from time to time over and

above the permanent or fixed working capital. During seasons,

more production/sales take place resulting in larger working

capital needs. The reverse is true during off-seasons. As seasons

vary, temporary working capital requirement moves up and down.Temporary working capital can be financed through short term

funds like current liabilities. When the level of temporary working

capital moves up, the business might use short-term funds and

when the level for temporary working capital recedes, the

business may retire its short-term loans.


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Both permanent and temporary working capitals are necessary to

facilitate the sales and production process through operating cycle.

Q34.What is the short term sources of working capital.

Ans. There are two types of sources for financing the working capital requirement.

a) Permanent / long term sources

(i) Shares Capital

In shares we includesa)equityshares

b) Pref. Share capital

(ii) Debenture

(iii)Public deposits

(iv) Ploughing back of profit.

Here I am giving little explanation of ploughing back of profit . It means save some profit frombusiness and when need of working capital it uses this is called ploughing back of profit this isgood long term source of working capital.

(V) Loan from financial institution

b) Temporary / Short term sources

(i) Indigenous bankers are the short term source for financing the working capital .(ii) TradecreditsTrade credit means getting of goods on credit . This is also a short term source of workingcapital.(iii) Instalment credit( iv) Income received inadvance(v) Advances received from customers(vi)Bankloan include cash credit and overdraft

( vii) commercial papers(viii) Purchasing and discounting of bills( ix) Letter of credit
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Q35. Definition of bonus shares.

Ans. Free shares ofstock given to current shareholders, based upon

the number of shares that a shareholder owns. While this

stock action increases the number of shares owned, it doesnot increase the total value. This is due to the fact that since the total

number of shares increases, the ratio of number of shares held to

number ofshares outstanding remains constant.

Q36. Types of dividends.

Ans. Cash Dividends

A cash dividend is a dividend paid in cash. To be able to pay cash

dividends, companies need to have not only sufficient earnings but also

sufficient cash. Even if a company shows a large amount of retained

earnings on its balance sheet, it may not be enough to ensure cash

dividends. The amount of cash that a company has is independent of

retained earnings. Cash-poor companies still can be profitable.

Most American companies pay regular cash dividends quarterly; somepay dividends semiannually or annually. Johnson & Johnson, the

pharmaceutical company, pays quarterly dividends, and McDonalds

pays an annual dividend. A company might declare extra dividends in

addition to regular dividend

Stock Dividends

Some companies choose to conserve their cash by paying stockdividends, a dividend paid in stock. The companies then recapitalize

their earnings and issue new shares, which do not affect its assets and

liabilities
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Stock Split

A stock split is a proportionate increase in the number of outstanding

shares that does not affect the issuing companys assets, liabilities, or

earnings. A stock split resembles a stock dividend in that an increase

occurs in the number of shares issued on a proportionate basis,

whereas the assets, liabilities, equity, and earnings remain the same.

The only difference between a stock split and a stock dividend is

technical.

Property Dividends

A property dividend is a dividend paid in a form other than cash or thecompanys own stock. Aproperty dividend is generally taxable at its fair

market value. For example, when a corporation spins off a subsidiary,

shareholders might receive assets or shares of that subsidiary.

Distributing the stocks or assets of the subsidiary (rather than cash)

allows shareholders to benefit directly from the market value of the

dividends received.

Special Distributions

Companies sometimes make special distributions in various forms, such

as extra dividends, spin-offs, and split-offs.

Extra Dividends Companies might want to distribute an extra dividend

to their shareholders on a one-time or infrequent basis. A company

might have had a particularly good quarter financially, or other reasons

for this distribution might exist. The company might use a special

distribution rather than increase its regular dividends because the

distribution is a one-time occurrence. Companies would not want to

increase their dividend rates if they could not continue paying those

increased rates in the future.


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Spin-Offs A spin-off is the distribution of shares of a subsidiary

company to shareholders. Some companies allocate proportionately to

their shareholders some or all of their shares of a subsidiary company

as a spin-off.

Split-Offs A split-off is the exchange of a parent companys stock for a

pro-rata share of the stock of a subsidiary company. Splitoffs, which

differs from spin-offs, do not occur frequently. In a splitoff,

shareholders are offered the choice of keeping the shares they own in

the existing company or exchanging them for shares in the split-off

company.

Q36. What do you mean by share swap ratio.

Ans. The ratio in which an acquiring company will offer its own shares

in exchange for the target company's shares during a merger or

acquisition. To calculate the swap ratio, companies analyze financial

ratios such as book value, earnings per share, profits after tax and

dividends paid, as well as other factors, such as the reasons for the

merger or acquisition.

For example, if a company offers a swap ratio of 1:1.5, it will

provide one share of its own company for every 1.5 shares of the

company being acquired.

Q37. ESOPs.

Ans. An qualified, defined contribution, employee benefit (ERISA) plandesigned to invest primarily in the stock of the sponsoring employer.

ESOPs are "qualified" in the sense that the ESOP's sponsoring company,

the selling shareholder and participants receive various tax benefits.

ESOPs are often used as a corporate finance strategy and are also used


30/34

to align the interests of a company's employees with those of the

company's shareholders.

Q38. Tender offer?

Ans. An offer to purchase some or all of shareholders' shares in a

corporation. The price offered is usually at a premium to the market

price.

Tender offers may be friendly or unfriendly. Securities and Exchange

Commission laws require any corporation or individual acquiring 5% of

a company to disclose information to the SEC, the target company and

the exchange.

Q39. Risk free rate of return.

Ans. The risk-free rate represents the interest an investor would expect

from an absolutely risk-free investment over a specified period of time.

In theory, the risk-free rate is the minimum return an investor expects

for any investment because he or she will not accept additional riskunless the potential rate of return is greater than the risk-free rate.

In practice, however, the risk-free rate does not exist because even the

safest investments carry a very small amount of risk. Thus, the interest

rate on a three-month U.S. Treasury bill is often used as the risk-free

rate.

Q40. Shark repellent.

Ans. In many cases, a company will make special amendments to its

charter or bylaws that become active only when a takeover attempt is

announced or presented to shareholders with the goal of making the


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takeover less attractive or profitable to the acquisitive firm.

Most companies want to decide their own fates in the marketplace,

so when the sharks attack, shark repellent can send the predator off to

look for a less feisty target.

While the concept is a noble one, many shark repellent measures are not in

the best interests of shareholders, as the actions may damage the company's

financial position and interfere with management's ability to focus on critical

business objectives. Some examples of shark repellents are poison pills,

scorched earth policies, golden parachutes and safe harbor strategies.

Q34. Safe harbor.

Ans. . A legal provision to reduce or eliminate liability as long as good faith is demonstrated.

2. A form of shark repellent implemented by a target company acquiring a business that is

so poorly regulated that the target itself is less attractive. In effect, this gives the target

company a "safe harbor."

3. An accounting method that avoids legal or tax regulations and allows for a

simpler method (usually) of determining a tax consequence than those methods

described by the precise language of the tax code.


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Q37. Pac Man Defense.

Ans. A defensive tactic used by a targeted firm in a hostile takeover situation.

In a Pac-Man defense, the target firm turns around and tries to acquire the othe

company that has made the hostile takeover attempt.

This term comes from the Pac-Man video game. In the game, once Pac-Man eat

a power pellet he is able to turn around and eat the ghosts that are chasing

after him in the maze.

Q38.Golden Parachute.

Ans. Lucrative benefits given to top executives in the event that a company

is taken over by another firm, resulting in the loss of their job. Benefits

include items such as stock options, bonuses, severance pay, etc.

Q38. Types of merger.

Ans. 1. Horizontal merger:

It is a merger of two or more companies that compete in the same industry.

It is a merger with a direct competitor and hence expands as the firms operations in the same industry.

Horizontal mergers are designed to produce substantial economies of scale and result in decrease

in the number of competitors in the industry. The merger of Tata Oil Mills Ltd. with the

Hindustan lever Ltd. was a horizontal merger.

In case of horizontal merger, the top management of the company being meted is generally,

replaced, by the management of the transferee company.

One potential repercussion of the horizontal merger is that it may result in monopolies

and restrict the trade.


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2. Vertical merger:

It is a merger which takes place upon the combination of two companies which are operating in the

same industry but at different stages of production or distribution system. If a company takes

over its supplier/producers of raw material, then it may result in backward integration of its activities.

On the other hand,

Forward integration may result if a company decides to take over the retailer or Customer Company.

Vertical merger may result in many operating and financial economies. The transferee firm will

get a stronger position in the market as its production/distribution chain will be more integrated than

that of the competitors. Vertical merger provides a way for total integration to

those firms which are striving for owning of all phases of the production schedule

together with the marketing network (i.e., from the acquisition of raw material to the

relating of final products).

3. Co generic Merger:

In these, mergers the acquirer and target companies are related through basic technologies,

production processes or markets. The acquired company represents an extension of product line,

market participants or technologies of the acquiring companies. These mergers represent an

outward movement by the acquiring company from its current set of business to adjoining business.

The acquiring company derives benefits by exploitation of strategic resources and from entry into

a related market having higher return than it enjoyed earlier. The potential benefit from these

mergers is high because these transactions offer opportunities to diversify around a common

case of strategic resources.

4. . Conglomerate merger:

These mergers involve firms engaged in unrelated type of business activities i.e. the business of two

companies are not related to each other horizontally ( in the sense of producing the

same or competing products), nor vertically( in the sense of standing towards each other n

the relationship of buyer and supplier or potential buyer and supplier). In a pure conglomerate,

there are no important common factors between the companies in production, marketing, research

and development and technology. In practice, however, there is some degree of overlap in one or

more of this common factors.

Q40. Bear hug.Ans. An offer made by one company to buy the shares of another for a much higherper-share price than what that company is worth. A bear hug offer is usually


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made when there is doubt that the target company's management will be willing to sell.

Q48. Trade on equity.

Ans. Borrowing funds to increase capital investment with

the hope that the business will be able to generate returns inexcess of the interest charges.
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