If you are looking for MMPC-014 IGNOU Solved Assignment solution for the subject Financial Management, you have come to the right place. MMPC-014 solution on this page applies to 2023 session students studying in MBA, MBF, MBAFM, MBAHM, MBAMM, MBAOM, PGDIFM courses of IGNOU.
MMPC-014 Solved Assignment Solution by Gyaniversity
Assignment Code: MMPC-014 / TMA / JAN / 2023
Course Code: MMPC-014
Assignment Name: Financial Management
Year: 2023
Verification Status: Verified by Professor
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Note: Attempt all the questions
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Q 1. Discuss the concepts of ‘Profit maximisation’ and ‘Wealth maximisation’ and analyse which concept is superior to be an objective of a Firm.
Ans) Profit maximization and wealth maximization are two important concepts in finance and economics that are used to evaluate the performance of a business or investment.
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Profit maximization is the process of increasing profits for a company by increasing revenue or decreasing costs. The main objective of profit maximization is to generate as much profit as possible in a given period of time. Companies that focus on profit maximization often prioritize short-term gains over long-term sustainability. This can lead to cutting costs, reducing quality, and neglecting investments in research and development, among other things. Critics of profit maximization argue that this approach can be detrimental to the long-term growth and success of a company.
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Wealth maximization, on the other hand, is the process of increasing the value of a company for its shareholders. The primary objective of wealth maximization is to increase the net present value of the business over the long term. Wealth maximization takes into account the time value of money, risk, and other factors that affect the value of an investment. Unlike profit maximization, wealth maximization focuses on long-term sustainability and growth. Companies that focus on wealth maximization often invest in research and development, employee training, and other initiatives that improve the long-term value of the company.
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While profit maximization and wealth maximization may seem similar, they are fundamentally different concepts. Profit maximization is focused on short-term gains, while wealth maximization is focused on long-term growth and sustainability. Wealth maximization is considered to be a more comprehensive approach to evaluating the performance of a business because it takes into account a broader range of factors that affect the value of the company.
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In practice, many companies aim to balance profit maximization and wealth maximization. While generating profits is important for any business, it is also important to consider the long-term growth and value of the company. By focusing on both profit maximization and wealth maximization, companies can create sustainable value for their shareholders while also contributing to the growth and development of the broader economy.
Superior Concept
Determining which concept is superior to be an objective of a firm, whether profit maximization or wealth maximization, is a topic of debate among economists and business professionals.
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Profit maximization is a straightforward objective that can be easily measured and tracked over time. By focusing on generating the highest possible profits in the short term, companies can maintain financial stability and generate returns for their shareholders. This approach may be especially relevant for smaller firms that are still in the early stages of growth, as they may not have the resources to invest heavily in long-term initiatives.
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On the other hand, wealth maximization takes a more comprehensive approach to evaluating the performance of a business. By focusing on long-term growth and sustainability, companies can build lasting value for their shareholders and contribute to the development of the broader economy. This approach may be especially relevant for larger firms that have already achieved a level of financial stability, as they may have more resources to invest in research and development, employee training, and other initiatives that improve the long-term value of the company.
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Ultimately, whether profit maximization or wealth maximization is the superior objective for a firm depends on a number of factors, including the size of the company, its stage of growth, and the competitive landscape in which it operates. In some cases, it may be appropriate for a company to focus primarily on profit maximization, while in other cases, wealth maximization may be the more appropriate objective.
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Moreover, there are critics of profit maximization who argue that it can lead to short-sighted decision-making that harms the long-term sustainability and growth of a business. In contrast, wealth maximization takes into account a broader range of factors that contribute to the long-term value of a business, including employee development, research and development, and social and environmental responsibility.
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In conclusion, both profit maximization and wealth maximization have their own advantages and disadvantages, and the choice of objective depends on the specific circumstances of each business. While profit maximization may be appropriate for some firms, wealth maximization may be a more comprehensive and sustainable approach to evaluating the performance of a business over the long term.
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Q 2. Meet the Finance Manager of a company/firm of your choice and discuss with him the different sources of Working capital available to the firm. Also discuss which source is better for his firm and why? Write a note on your meeting.
Ans) Information on the sources of working capital:
 Bank loans: Bank loans are a common source of working capital for many firms. They offer a reliable source of funding that can be used for day-to-day operations, as well as larger investments. However, the downside is that interest rates can be high, and securing a loan can be difficult for firms with poor credit histories.
Trade credit: Trade credit is when a supplier allows a firm to delay payment for goods or services. This can be an effective way to manage working capital, as it allows a firm to hold onto cash for longer periods of time. However, if payment terms are not managed effectively, it can lead to cash flow problems.
Invoice factoring: Invoice factoring is when a firm sells its outstanding invoices to a factoring company in exchange for immediate cash. This can be useful for firms that need quick access to cash, but it comes at a cost, as the factoring company will take a percentage of the invoice value.
Sale of assets: Selling assets, such as property or equipment, can generate working capital for a firm. However, this is not always a practical solution, as it can impact the firm's operations and long-term growth potential.
Equity financing: Equity financing is when a firm raises working capital by issuing equity to investors. This can be a good option for firms that are looking to expand, as it allows them to raise capital without taking on additional debt. However, it also means giving up a portion of the ownership of the firm, which can impact decision-making and control.
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Note on Meeting with Finance Manager of L&T Company
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Date: 20th February 2023
Location: L&T Office
Mumbai.
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I recently had the opportunity to meet with the finance manager of a L&T company to discuss the various sources of working capital available to the firm. The finance manager provided a comprehensive overview of the different sources of working capital and shared his insights on which source is better for his firm and why.
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During our meeting, the finance manager outlined the various sources of working capital available to the firm, which included:
Bank loans: L&T Company can obtain working capital loans from banks. These loans can be secured or unsecured and can be used to finance day-to-day operations.
Trade credit: L&T Company can negotiate longer payment terms with suppliers, which allows the firm to delay payment and hold onto cash for a longer period of time.
Invoice factoring: L&T Company can sell their outstanding invoices to a factoring company, which will provide immediate cash in exchange for a percentage of the invoice value.
Sale of assets: L&T Company can sell assets, such as equipment or property, to generate working capital.
Equity financing: L&T Company can raise working capital by issuing equity to investors.
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The finance manager went on to explain that the best source of working capital for L&T Company is bank loans. The reason for this is that bank loans are a reliable and consistent source of funding, and the firm has a strong credit history that enables it to secure favourable loan terms. In addition, bank loans allow the firm to maintain control over its operations and avoid the need to give up equity in the company.
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The finance manager also emphasized the importance of managing working capital effectively, as this can have a significant impact on the financial health of the firm. He explained that L&T Company employs a range of strategies to optimize working capital, such as managing inventory levels, negotiating favourable payment terms with suppliers, and using technology to streamline accounts payable and accounts receivable processes.
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Overall, my meeting with the finance manager of L&T Company provided valuable insights into the different sources of working capital available to firms and the importance of managing working capital effectively. The finance manager's perspective on the best source of working capital for his firm and the strategies used to optimize working capital will undoubtedly be useful to other firms in similar industries.
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Q 3. Explain the relevance Theories of Dividend and comment which theory is more suited to the Indian Business Environment.
Ans) The relevance theories of dividends suggest that the payment of dividends by a company is relevant to the value of the firm and to the preferences of its shareholders. The three main relevance theories are the traditional theory, Walter's model, and Gordon's model.
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Relevance of Dividend Theories in the Indian Business Environment
The relevance dividend theories support the view that the dividend policy has profound impact on the value of a firm. There are three theories under this school of thought. They are:
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Traditional Theory
The traditional theory of dividends suggests that the value of the firm is determined by the market capitalization of its shares, and the payment of dividends does not affect the value of the company. This theory may be suitable for Indian companies that are large, established, and have a stable dividend policy. Such companies may have a large number of shareholders who depend on the regular income from dividends, and the payment of dividends may not have a significant impact on the value of the firm.
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The model is expressed in the following way: P = M [D + E/ 3]
where,
P = Market price per share
D = Dividend per share
E = Earnings per share
M = Multiplier
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On simplification,
P = M [4D + R) = [4/3 D + 1/3R] x M
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The weight attached to dividends is equal to four times the weight attached to retained earnings (R). These weights provided by Graham and Dodd are based on their subjective judgement and not derived from objective analysis. According to their view the liberal pay-out policy has favourable impact on stock prices.
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Walter’s Model
Walter's model suggests that the value of the firm is directly related to the dividend policy of the company, and that the payment of dividends increases the value of the company by increasing the confidence of investors in the future earnings of the firm. This model may be suitable for Indian companies that are in the growth stage and have a large number of growth opportunities. Such companies may not have enough cash to pay dividends and may need to reinvest their earnings into the business to fund their growth opportunities.
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The following is the Walter’s formula to determine the market price (P) per share:
P = [ D + (E - D)r / k]
                  k
where,
P = Market price of an equity share (MPS)
D = Dividend per share (DPS)
E = Earnings per share (EPS)
r = Rate of return on investment
k = Cost of capital
(E - D) = Retained earnings
(E – D)r = Return on retained earnings invested.
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The above equation gives the sum of the present value of future stream of dividends (D/K), and capital gains resulted by reinvestment of retained earnings (EPS-D) at the firm’s internal rate of return (r). The discount value is equal to the firm’s cost of capital (K).
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Gordon’s Model
Gordon's model suggests that the value of the firm is determined by the dividend yield, and that the payment of dividends increases the value of the company by increasing the dividend yield. This model may be suitable for Indian companies that have a high proportion of shareholders who are interested in dividend income. Such companies may need to pay higher dividends to attract and retain investors and may need to balance their dividend payments with their investment opportunities.
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According to the Gordon’s model, the market value of a firm’s share will be equal to the present value of future stream of dividends payable for that share.
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Accordingly, the value of share can be obtained by the following equation:
Po = E1(1-b)
        k - br
where,
Po = Market price of a share at the end of year 0
E1 = Earnings per share at the end of year 1
b = Retention ratio (% of earnings retained by the firm)
(1-b) = Dividend pay-out ratio
k = Cost of capital [rate of return expected by the shareholders]
r = return on investment
(br = g) = growth rate of earnings and dividends.
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The above equation highlights the relationship of earnings, dividends policy, internal rate of return, and the firm's cost of equity in deciding the value of the share.
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In conclusion, the most suitable relevance theory of dividends for Indian businesses would depend on various factors, and each theory may be more appropriate for different types of companies in different stages of development. Ultimately, the decision to pay dividends should be based on the preferences of the shareholders and the financial needs of the company, while considering the tax laws and regulations in the country.
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Q 4. Good garden Company has currently an ordinary share capital of Rs 25 lakh, consisting of 25,000 shares of Rs 100 each. The management is planning to raise another Rs 20 lakhs to finance a major programme of expansion through one of four possible financing plans. The options are as under:
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(a) Entirely through ordinary shares.
Ans) To determine the EPS (Earnings per share) for each financing option, we need to calculate the net profit after tax and then divide it by the total number of outstanding shares.
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Entirely through ordinary shares.
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In this case, the company will issue additional shares worth Rs. 20 lakhs.
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The number of new shares issued will be 20,000 (20,00,000/100).
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Assuming the expected EBIT of Rs. 8 lakhs, and a corporate tax rate of 50%, the net profit after tax will be Rs. 4 lakhs (8 lakhs - 4 lakhs).
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The total number of outstanding shares after the issue will be 45,000 (25,000+20,000).
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Therefore, the EPS will be Rs. 8.88 (4 lakhs/45,000).
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(b) Rs. 10 lakh through ordinary shares, and Rs. 10 lakh through long-term borrowings at 15% interest per annum.
Ans) Rs. 10 lakh through ordinary shares, and Rs. 10 lakh through long-term borrowings at 15% interest per annum:
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In this case, the company will issue new shares worth Rs. 10 lakhs (10,000 shares) and borrow Rs. 10 lakhs at 15% per annum.
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Assuming the expected EBIT of Rs. 8 lakhs, the interest expense on the loan will be Rs. 1.5 lakhs (10 lakhs x 15%).
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The net profit before tax will be Rs. 6.5 lakhs (8 lakhs - 1.5 lakhs).
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After paying the corporate tax of 50%, the net profit after tax will be Rs. 3.25 lakhs (6.5 lakhs x 50%).
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The total number of outstanding shares after the issue will be 35,000 (25,000+10,000).
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Therefore, the EPS will be Rs. 9.29 (3.25 lakhs/35,000).
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(c) Rs. 5 lakh through ordinary shares, and Rs. 15 lakh through long-term borrowings at 16% interest per annum.
Ans) Rs. 5 lakh through ordinary shares, and Rs. 15 lakh through long-term borrowings at 16% interest per annum:
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In this case, the company will issue new shares worth Rs. 5 lakhs (5,000 shares) and borrow Rs. 15 lakhs at 16% per annum.
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Assuming the expected EBIT of Rs. 8 lakhs, the interest expense on the loan will be Rs. 2.4 lakhs (15 lakhs x 16%).
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The net profit before tax will be Rs. 5.6 lakhs (8 lakhs - 2.4 lakhs).
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After paying the corporate tax of 50%, the net profit after tax will be Rs. 2.8 lakhs (5.6 lakhs x 50%).
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The total number of outstanding shares after the issue will be 30,000 (25,000+5,000).
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Therefore, the EPS will be Rs. 9.33 (2.8 lakhs/30,000).
(d) Rs. 10 lakh through ordinary shares, and Rs. 10 lakhs through preference shares with 14% dividend. The company’s expected EBIT will be Rs. 8 lakh. Assuming a corporate tax rate of 50%, determine the EPS in each alternative, and comment on the implications of financial leverage.
Ans) Rs. 10 lakh through ordinary shares, and Rs. 10 lakhs through preference shares with 14% dividend:
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In this case, the company will issue new shares worth Rs. 10 lakhs (10,000 shares) and preference shares worth Rs. 10 lakhs with a dividend of 14%.
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Assuming the expected EBIT of Rs. 8 lakhs, the dividend payment on the preference shares will be Rs. 1.4 lakhs (10 lakhs * 14%).
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The net profit before tax will be Rs. 6.6 lakhs (8 lakhs - 1.4 lakhs).
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After paying the corporate tax of 50%, the net profit after tax will be Rs. 3.3 lakhs (6.6 lakhs * 50%).
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The total earnings available for equity shareholders after tax will be:
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Rs. 8,00,000 – (Rs. 2,00,000 + Rs. 1,40,000) = Rs. 4,60,000
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The EPS for equity shareholders can be calculated as follows:
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Option (d): EPS = Earnings available for equity shareholders / Number of equity shares outstanding
= Rs. 4,60,000 / 25,000
= Rs. 18.4
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Implications of Financial Leverage
Financial leverage refers to the use of debt financing to fund a company's operations and expansion. When a company takes on debt, it incurs interest expenses, which are tax-deductible. This creates a tax shield that reduces the company's overall tax liability, leading to an increase in the company's earnings per share (EPS) and return on equity (ROE) for its shareholders.
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In the case of Good Garden Company, we can see that the EPS increases as the company takes on more debt. This is because the interest expense reduces the taxable income, leading to a lower tax liability, and ultimately, a higher EPS. However, this increased financial leverage also increases the risk to the equity shareholders. If the company is not able to generate enough cash flows to service its debt obligations, it may default on its loans, which could lead to bankruptcy.
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Therefore, the choice of financing option should be made after considering the company's risk appetite, cost of capital, and the expected return on investment. A company with a higher risk appetite may opt for higher leverage, while a company with a lower risk appetite may choose to finance its operations through equity capital.
Q 5. Arun Engineering Co. is considering two investments. Each requires an initial investment of Rs 1,80,000. The cost of capital is 8%. The total cash inflow after tax and depreciation for each project is as follows:
Year                                       Project A (Rs.)                               Project B (Rs.)
1 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 30,000 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 60,000
2 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 50,000Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 1,00,000
3 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 60,000 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 65,000
4 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 65,000 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 45,000
5 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 40,000 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â --
6 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 30,000Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â --
7Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 16,000 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â --
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Calculate the Payback Period, Profitability Index and Net Present Value of both the projects.
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Ans) To calculate the Payback Period, we need to calculate the cumulative cash inflows for each year until the initial investment is recovered:
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For Project A:
Year 1: 30,000
Year 2: 80,000 (30,000 + 50,000)
Year 3: 1,40,000 (80,000 + 60,000)
Year 4: 2,05,000 (1,40,000 + 65,000)
Year 5: 2,45,000 (2,05,000 + 40,000)
Year 6: 2,75,000 (2,45,000 + 30,000)
Year 7: 2,91,000 (2,75,000 + 16,000)
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Therefore, the Payback Period for Project A is 4 years and 7 months.
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For Project B:
Year 1: 60,000
Year 2: 1,60,000 (60,000 + 1,00,000)
Year 3: 2,25,000 (1,60,000 + 65,000)
Year 4: 2,70,000 (2,25,000 + 45,000)
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Therefore, the Payback Period for Project B is 4 years.
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To calculate the Profitability Index, we need to calculate the present value of the cash inflows using the cost of capital:
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For Project A:
Year 1: 27,778
Year 2: 42,491
Year 3: 46,807
Year 4: 43,184
Year 5: 32,358
Year 6: 25,609
Year 7: 15,135
Total: 2,33,362
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Profitability Index = PV of cash inflows / Initial investment
Profitability Index for Project A = 2,33,362 / 1,80,000 = 1.30
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For Project B:
Year 1: 55,556
Year 2: 84,983
Year 3: 84,301
Year 4: 60,939
Total: 2,86,779
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Profitability Index for Project B = 2,86,779 / 1,80,000 = 1.59
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To calculate the Net Present Value, we need to subtract the initial investment from the present value of the cash inflows:
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For Project A:
NPV = 2,33,362 - 1,80,000 = 53,362
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For Project B:
NPV = 2,86,779 - 1,80,000 = 1,06,779
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Therefore, both projects have a positive NPV and are viable investments. Project B has a shorter Payback Period and a higher Profitability Index, indicating that it may be a better investment option for Arun Engineering Co. However, the final decision will depend on other factors such as the company's strategic objectives, risk appetite, and available resources.
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