BBA/B.Com Financial Management DEC 2024

Description

Financial Management

December 2024 Examination

 

 

1. In the context of financial management, discuss the concepts of wealth maximization and profit maximization. What are the key differences between the two? Which concept is more appropriate for guiding the financial decisions of a corporation? (Student can make any assumptions to further explanation of their view point) (10 Marks)

Ans 1.

Introduction

Financial management serves as the backbone of corporate strategy, focusing on maximizing a company’s financial efficiency, securing its growth, and ensuring sustainable profitability. The fundamental objectives of financial management often center around two principal concepts: profit maximization and wealth maximization. Profit maximization focuses on short-term earnings and is a goal widely pursued by organizations aiming to enhance their immediate financial results. Wealth maximization, on the other hand, considers the long-term financial growth and sustainability of the organization, prioritizing shareholder value. Both these objectives play critical roles, yet they differ significantly in scope, approach, and impact. While

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2. RK Ltd has a stock with a beta of 1.3 and an expected return of 16.7%. The current risk-free rate is 7.6%. Explain how CAPM determines the expected return of a stock based on its risk relative to the market and calculate the risk premium on the market. Show the step-by-step calculation. (10 Marks)

Ans 2.

Introduction

The Capital Asset Pricing Model (CAPM) is a fundamental tool in financial management used to calculate the expected return of an asset, given its risk relative to the overall market. Developed by William Sharpe, CAPM considers both systematic risk, which affects the entire market, and the asset’s sensitivity to that risk, measured by its beta (β). The model helps investors understand the expected return on a stock based on the risk-free rate, market risk premium, and the stock’s beta, thus linking risk with return. For RK Ltd, which has a beta of 1.3 and an expected return of 16.7%,

 

 

3. A company is considering its capital structure to minimize its overall cost of capital. The company’s current capital structure consists of 40% debt and 60% equity. The cost of debt is

6%, and the cost of equity is 12%. The company is evaluating a new capital structure with 50% debt and 50% equity, where the cost of debt will increase to 7% due to higher financial risk, while the cost of equity will rise to 14%. (Assume corporate tax rate 30%)

1. Calculate the weighted average cost of capital (WACC) for the company’s current and proposed capital structures. (5 Marks)

Introduction

A company’s capital structure is a critical determinant of its overall cost of capital, directly impacting profitability and financial sustainability. The Weighted Average Cost of Capital (WACC) represents the blended cost of a company’s debt and equity financing, adjusted for tax benefits from debt. By minimizing WACC, companies can optimize their capital structure and, in turn, maximize shareholder value. Here, we will calculate the WACC for both the company’s current and proposed capital structures, which consist of different proportions of debt and equity and

 

1. Based on the WACC calculated in part (a), determine the optimal capital structure for the company. Discuss the trade-offs involved in choosing between a lower cost of debt and a potentially higher financial risk. (5 Marks)

Ans 3b.

Introduction

Determining the optimal capital structure is a fundamental decision for financial managers aiming to balance debt and equity to minimize the Weighted Average Cost of Capital (WACC) and enhance shareholder value. The calculations in part (a) revealed that the company’s