This study material provides detailed explanations of essential Business Finance concepts, including Working Capital Management, Bond & Stock Valuation, Risk Assessment, and Investment Strategies. With step-by-step solutions and real-world applications, these notes are designed to help BIM Sixth Semester students excel in their FIN 201 course and apply these financial principles effectively in business decision-making. 🚀💰

TRIBHUVAN UNIVERSITY

FACULTY OF MANAGEMENT

Office of the Dean

August 2021

BIM / Sixth Semester / FIN 201: Business Finance

Full Marks: 60

Pass Marks: 30

Time: 3 Hrs.

Candidates are required to give their answers in their own words as far as practicable.

Group "A"

Indicate whether the following statements are 'True' or 'False'. Support your answer with reason.

(10 x1 = 10]

1. Wealth maximization goal of a firm is superior goal to profit maximization goal.

2. Net cash flow of a firm usually differs from firm's net income.

3. If we deposit Rs 1,000 today at an annual interest rate of 10 percent, it is compounded to Rs 1,464 at the end of year 4.

4. The risk-free rate and expected market return are 8 percent and 14 respectively. If Mega Company's stock has a beta of 2, required rate of return should be 16 percent.

5. When required rate of return is greater than the coupon rate, the bond will sell at premium.

6. Stock beta measures total risk associated with the security.

7. Increase in the working capital is considered as cash inflow at the beginning of the long-term investment.

8.Management attempts to increase total assets turnover.

9.Effective annual rate is always higher than nominal rate when compounding period is less than a year.

10. Higher cash conversion cycle increases the profitability of the firm.

Here are the True/False answers along with their justifications:

1. True – Wealth maximization considers the time value of money, risk, and cash flow, making it a more comprehensive goal than profit maximization, which focuses only on short-term gains.

2. True – Net cash flow includes non-cash items like depreciation and changes in working capital, whereas net income is based on accounting earnings.

3. False – Using the compound interest formula:

The correct future value is Rs 1,464.10, so the statement is incorrect as it should be rounded properly.

4. False – Required rate of return is calculated using CAPM formula:

The correct answer is 20%, not 16%.

5. False – A bond sells at a discount (not premium) when the required rate of return (market rate) is greater than the coupon rate.

6. False – Beta measures systematic risk (market risk), not total risk, which includes both systematic and unsystematic risks.

7. False – Increase in working capital is a cash outflow at the beginning of an investment, as it requires additional funds.

8. True – Total asset turnover measures efficiency, and management aims to increase it to improve the firm’s performance.

9. True – The Effective Annual Rate (EAR) considers compounding effects, making it higher than the nominal rate when compounding occurs more than once a year.

10. False – A higher cash conversion cycle (CCC) means a firm takes longer to convert investments into cash, which can reduce profitability by tying up capital.

11. What do you mean by agency problem between shareholders and management? How do you resolve the agency problem between shareholders and the management?

📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Agency Problem Between Shareholders and Management

🔹 Understanding the Agency Problem

In a corporation, there is a separation between ownership (shareholders) and management (executives, managers, and directors). This separation creates a potential conflict of interest known as the agency problem.

🔸 Definition of the Agency Problem

The agency problem arises when managers (agents), who are responsible for running the company, make decisions that may not align with the best interests of the shareholders (principals).

Key reasons for the agency problem:
1️⃣ Different Goals & Interests – Shareholders aim for profit maximization and long-term growth, whereas managers may prioritize personal benefits, such as high salaries and job security.
2️⃣ Risk Appetite Difference – Shareholders often prefer higher risks for higher returns, while managers may prefer stability to protect their jobs.
3️⃣ Lack of Direct Supervision – Managers may take actions that benefit themselves rather than the company, as shareholders cannot monitor every decision.

📌 Examples of the Agency Problem

📉 Excessive Perks & Wages – Managers might increase their own salaries and bonuses at the expense of company profits.
🚀 Short-term vs. Long-term Growth – Managers may focus on short-term results (to boost their bonuses) rather than long-term sustainability.
💰 Misuse of Company Funds – Investing in projects that benefit managers personally rather than maximizing shareholder value.
🛑 Empire Building – Expanding the business unnecessarily to increase managerial power, even if it reduces profitability.

🔹 How to Resolve the Agency Problem?

To reduce the conflict between shareholders and management, companies implement several strategies:

1️⃣ Aligning Interests Through Compensation

• Performance-Based Pay – Offering stock options, bonuses, and profit-sharing tied to company performance.
• Stock Ownership for Managers – Encouraging managers to own company shares so that their wealth grows with shareholder wealth.

2️⃣ Strengthening Corporate Governance

• Independent Board of Directors – Having non-executive directors to monitor management decisions.
• Shareholder Voting Rights – Allowing shareholders to vote on major company decisions, including CEO selection.
• Transparency & Reporting – Regular audits and financial disclosures ensure that management decisions are aligned with company goals.

3️⃣ Implementing Monitoring Mechanisms

• Internal & External Audits – Ensuring financial accountability through independent audits.
• Market Discipline – Poor-performing managers risk losing their jobs due to stock price declines.

4️⃣ Threat of Takeovers & Competition

• Hostile Takeovers – If a company underperforms, external investors may buy a majority stake and replace management.
• Market Competition – Competitive pressure forces managers to focus on performance to avoid losing market share.

📋 Conclusion

The agency problem creates conflicts between shareholders and management, which can reduce company efficiency and profitability. However, by implementing performance-based incentives, strong governance, and monitoring mechanisms, companies can align managerial decisions with shareholder interests, ensuring long-term success.

🎯 Key Takeaways

✅ The agency problem occurs when managers act in their self-interest instead of maximizing shareholder wealth.
✅ Examples include excessive perks, short-term focus, misuse of funds, and unnecessary expansion.
✅ Solutions include performance-based compensation, corporate governance, audits, and shareholder rights to align management actions with company goals.

🚀 Final Thought

Understanding the agency problem is crucial for future business leaders. Whether you are an investor, manager, or executive, knowing how to balance incentives and governance ensures that a company operates efficiently and maximizes shareholder wealth.

12. Consider the following information associated with Stock A and Stock B given in the following table.

• Which one stock is more risky? Which one stock would you prefer?

• If you form a portfolio of Stock A and Stock B comprising 40 percent wealth in Stock A and the rest in Stock B, calculate the risk and return of your portfolio. 

 📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Stock Risk Analysis and Portfolio Management

🔹 Understanding Stock Risk & Return

Investors aim to maximize returns while minimizing risk when choosing between different stocks. The risk of a stock is measured using its standard deviation, and the return indicates the expected profit.

In this case, we have two stocks (Stock A & Stock B) with the following details:

📌 Step 1: Identifying the Riskier Stock

🔹 Understanding Risk Measurement

• Standard Deviation measures the volatility of stock returns. A higher standard deviation means the stock is riskier.
• Coefficient of Variation (CV) helps compare risk per unit of return: CV=Standard DeviationExpected ReturnCV = \frac{\text{Standard Deviation}}{\text{Expected Return}}

🔸 Calculating Coefficient of Variation (CV)

CVA=5%10%=0.5CV_A = \frac{5\%}{10\%} = 0.5 CVB=8%20%=0.4CV_B = \frac{8\%}{20\%} = 0.4

🔸 Which Stock is More Risky?

Since Stock A has a higher CV (0.5 vs. 0.4), it carries higher risk per unit of return.
✅ Stock A is riskier than Stock B.

🔸 Which Stock Would You Prefer?

• Stock A is less rewarding but riskier.
• Stock B provides higher return (20%) with lower relative risk (CV = 0.4).
  ✅ Stock B is the better choice for investors looking for higher returns with lower risk per unit of return.

📌 Step 2: Calculating Portfolio Return & Risk

🔹 Understanding Portfolio Diversification

• A portfolio reduces risk by combining multiple assets.
• A 40% investment in Stock A and 60% in Stock B helps spread the risk.
• The portfolio return and risk depend on the weights of each stock, their individual risks, and their correlation.

📌 Step 3: Calculating Portfolio Expected Return

The Portfolio Return (E(Rp)) is calculated as:

E(Rp)=(WA×E(RA))+(WB×E(RB))E(R_p) = (W_A \times E(R_A)) + (W_B \times E(R_B))

Where:

• WAW_A = Weight of Stock A (40% or 0.40)
• WBW_B = Weight of Stock B (60% or 0.60)
• E(RA)E(R_A) = Expected return of Stock A (10% or 0.10)
• E(RB)E(R_B) = Expected return of Stock B (20% or 0.20)

E(Rp)=(0.40×0.10)+(0.60×0.20)E(R_p) = (0.40 \times 0.10) + (0.60 \times 0.20) E(Rp)=0.04+0.12=0.16 or 16%E(R_p) = 0.04 + 0.12 = 0.16 \text{ or } 16\%

✅ Portfolio Expected Return: 16%

📌 Step 4: Calculating Portfolio Risk (Standard Deviation)

The Portfolio Variance (σp2\sigma_p^2) is calculated using:

σp2=(WA2×σA2)+(WB2×σB2)+(2×WA×WB×CovAB)\sigma_p^2 = (W_A^2 \times \sigma_A^2) + (W_B^2 \times \sigma_B^2) + (2 \times W_A \times W_B \times Cov_{AB})

Where:

• WA=0.40W_A = 0.40, WB=0.60W_B = 0.60
• σA=5%σ_A = 5\% or 0.050.05
• σB=8%σ_B = 8\% or 0.080.08
• CovAB=ρAB×σA×σBCov_{AB} = ρ_{AB} \times σ_A \times σ_B

CovAB=(−0.8)×(0.05)×(0.08)=−0.0032Cov_{AB} = (-0.8) \times (0.05) \times (0.08) = -0.0032

🔸 Calculating Portfolio Variance

σp2=(0.402×0.052)+(0.602×0.082)+(2×0.40×0.60×−0.0032)\sigma_p^2 = (0.40^2 \times 0.05^2) + (0.60^2 \times 0.08^2) + (2 \times 0.40 \times 0.60 \times -0.0032) σp2=(0.16×0.0025)+(0.36×0.0064)+(2×0.40×0.60×−0.0032)\sigma_p^2 = (0.16 \times 0.0025) + (0.36 \times 0.0064) + (2 \times 0.40 \times 0.60 \times -0.0032) σp2=0.0004+0.002304−0.001536\sigma_p^2 = 0.0004 + 0.002304 - 0.001536 σp2=0.001168\sigma_p^2 = 0.001168

🔸 Calculating Portfolio Standard Deviation

σp=0.001168=0.0342 or 3.42%\sigma_p = \sqrt{0.001168} = 0.0342 \text{ or } 3.42\%

✅ Portfolio Risk (Standard Deviation): 3.42%

📋 Final Summary

✅ Stock A is riskier due to its higher Coefficient of Variation (CV = 0.5).
✅ Stock B is preferred as it offers higher returns with relatively lower risk (CV = 0.4).
✅ A portfolio with 40% Stock A & 60% Stock B reduces risk to only 3.42% while achieving a return of 16%.

🎯 Key Takeaways

✅ Stock B is a better individual investment choice as it offers higher return (20%) with lower risk per unit of return.
✅ Investing in a portfolio diversifies risk and reduces standard deviation to 3.42% compared to individual stock risks (5% & 8%).
✅ The negative correlation (-0.8) between Stock A and Stock B helps in risk reduction through diversification.

🚀 Final Thought

Investors should always consider both return and risk before investing. While Stock B alone is preferable, forming a portfolio with Stock A and Stock B provides a balanced investment strategy, reducing overall risk through diversification.

 

I have calculated the Accounts Receivable, Current Liabilities, Current Assets, Total Assets, and Return on Assets (ROA) for Hi-Tech Company. You can review the values in the table provided. Now, I will structure this information into detailed and well-organized bachelor-level notes with step-by-step explanations. Stay tuned! 🚀📊

13.Following data apply to Hi-Tech Company (Rs in Thousands)

Calculation is based on a 360 days.

Hi-Tech has not issued any preferred stocks.

Find Hi-Tech's

• Account receivable,

• Current liabilities,

• Current assets,

• Total assets, and

Return on assets. 📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Financial Analysis of Hi-Tech Company

🔹 Understanding Financial Ratios & Statements

Financial analysis helps businesses evaluate their performance using different financial metrics. In this case, we analyze Hi-Tech Company’s financial health based on given data and key ratios.

📌 Given Financial Data (Rs in Thousands)

Now, let's calculate Accounts Receivable, Current Liabilities, Current Assets, Total Assets, and Return on Assets (ROA).

📌 Step 1: Calculating Accounts Receivable

🔹 Understanding Days Sales Outstanding (DSO)

DSO measures how long it takes for a company to collect payments from customers.

Formula:

Accounts Receivable=(DSO360)×Sales\text{Accounts Receivable} = \left(\frac{\text{DSO}}{360} \right) \times \text{Sales}

🔸 Calculation

Accounts Receivable=(40360)×1,000\text{Accounts Receivable} = \left(\frac{40}{360} \right) \times 1,000 =111.11 (Rs ’000)= 111.11 \text{ (Rs '000)}

✅ Final Answer: Accounts Receivable = Rs 111.11K

📌 Step 2: Calculating Current Liabilities

🔹 Understanding Quick Ratio

Quick Ratio measures liquidity, showing how well a company can pay short-term liabilities without selling inventory.

Formula:

\text{Quick Ratio} = \frac{\text{Cash & Marketable Securities} + \text{Accounts Receivable}}{\text{Current Liabilities}}

🔸 Rearranging for Current Liabilities

\text{Current Liabilities} = \frac{\text{Cash & Marketable Securities} + \text{Accounts Receivable}}{\text{Quick Ratio}}

🔸 Calculation

Current Liabilities=100+111.112\text{Current Liabilities} = \frac{100 + 111.11}{2} =105.56 (Rs ’000)= 105.56 \text{ (Rs '000)}

✅ Final Answer: Current Liabilities = Rs 105.56K

📌 Step 3: Calculating Current Assets

🔹 Understanding Current Ratio

Current Ratio measures whether a company has enough short-term assets to cover short-term liabilities.

Formula:

Current Ratio=Current AssetsCurrent Liabilities\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}

🔸 Rearranging for Current Assets

Current Assets=Current Ratio×Current Liabilities\text{Current Assets} = \text{Current Ratio} \times \text{Current Liabilities}

🔸 Calculation

Current Assets=3.0×105.56\text{Current Assets} = 3.0 \times 105.56 =316.67 (Rs ’000)= 316.67 \text{ (Rs '000)}

✅ Final Answer: Current Assets = Rs 316.67K

📌 Step 4: Calculating Total Assets

Total Assets include Fixed Assets + Current Assets.

Formula:

Total Assets=Fixed Assets+Current Assets\text{Total Assets} = \text{Fixed Assets} + \text{Current Assets}

🔸 Calculation

Total Assets=283.50+316.67\text{Total Assets} = 283.50 + 316.67 =600.17 (Rs ’000)= 600.17 \text{ (Rs '000)}

✅ Final Answer: Total Assets = Rs 600.17K

📌 Step 5: Calculating Return on Assets (ROA)

🔹 Understanding ROA

ROA measures how efficiently a company uses its assets to generate profit.

Formula:

Return on Assets (ROA)=Net IncomeTotal Assets\text{Return on Assets (ROA)} = \frac{\text{Net Income}}{\text{Total Assets}}

🔸 Calculation

ROA=50600.17\text{ROA} = \frac{50}{600.17} =0.0833 or 8.33%= 0.0833 \text{ or } 8.33\%

✅ Final Answer: Return on Assets (ROA) = 8.33%

📋 Final Summary of Calculations

✅ Hi-Tech Company has strong liquidity with a Quick Ratio of 2.0× and a Current Ratio of 3.0×.
✅ The company effectively collects payments in 40 days (DSO), meaning it has efficient receivables management.
✅ The company earns an 8.33% return on its total assets (ROA), showing good asset utilization.

🎯 Key Takeaways

✅ Financial Ratios Help Analyze a Company's Liquidity & Profitability
✅ Quick & Current Ratios Show the Company is Financially Stable
✅ Total Assets & ROA Indicate How Efficiently the Company Uses Its Resources
✅ Efficient Receivables Management Leads to Faster Cash Flow & Stronger Operations

🚀 Final Thought

Understanding financial statements and ratios helps managers, investors, and analysts evaluate a company’s financial health. Hi-Tech Company’s strong liquidity, asset management, and profitability ratios indicate good financial performance.

14. National Development Bond issued by Nepal Government carries an annual coupon rate of 6 percent, has 10 years until maturity, and sells at a yield to maturity of 8 percent. Assume par value of Bond is Rs 1,000.

• At what price does the bond sell? What is the current yield?

• What will happen to the bond price if the yield to maturity falls to 5 percent?

•  Himalayan Tea Company has just paid a cash dividend of Rs 20 per share. Dividend is expected to grow at a steady rate 5 percent per year forever. If investors require 15 percent return from investment, what should be the value of stock at present? What will be the stock worth at the end of the fifth year, PS?

I have calculated the Bond Price, Current Yield, and Stock Valuation under different scenarios. Now, I will structure this information into detailed and well-organized bachelor-level notes with step-by-step explanations. Stay tuned! 🚀📊

📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Bond and Stock Valuation

📌 Part 1: Bond Valuation – National Development Bond

A bond is a fixed-income security where investors lend money to an entity (such as a government or company) in exchange for periodic interest payments (coupon payments) and the repayment of the bond’s face value at maturity.

In this case, we analyze a National Development Bond issued by the Nepal Government with the following details:

Now, let's compute:
1️⃣ Bond Price at 8% YTM
2️⃣ Current Yield
3️⃣ Bond Price if YTM Falls to 5%

📌 Step 1: Calculating Bond Price at 8% Yield to Maturity

🔹 Understanding Bond Price Calculation

The price of a bond is the present value (PV) of future cash flows, which include:

1. Annual Coupon Payments
2. Face Value at Maturity

Formula:

P=∑C(1+r)t+F(1+r)nP = \sum \frac{C}{(1 + r)^t} + \frac{F}{(1 + r)^n}

Where:

• PP = Bond Price
• CC = Annual Coupon Payment = 6% of Rs 1,000 = Rs 60
• FF = Face Value of Bond = Rs 1,000
• rr = Yield to Maturity = 8% or 0.08
• nn = Years to Maturity = 10 years

🔸 Calculation

P=∑60(1.08)t+1000(1.08)10P = \sum \frac{60}{(1.08)^t} + \frac{1000}{(1.08)^{10}} P=865.80P = 865.80

✅ Bond Price at 8% YTM: Rs 865.80

📌 Step 2: Calculating Current Yield

🔹 Understanding Current Yield

The current yield measures the return on the bond relative to its market price.

Formula:

Current Yield=Annual Coupon PaymentMarket Price of Bond×100\text{Current Yield} = \frac{\text{Annual Coupon Payment}}{\text{Market Price of Bond}} \times 100

🔸 Calculation

Current Yield=60865.80×100=6.93%\text{Current Yield} = \frac{60}{865.80} \times 100 = 6.93\%

✅ Current Yield = 6.93%

📌 Step 3: Bond Price if YTM Falls to 5%

🔹 What Happens When YTM Decreases?

• When the yield to maturity (YTM) falls, bond prices increase.
• The bond price is recalculated using a new YTM = 5%.

🔸 Calculation

P=∑60(1.05)t+1000(1.05)10P = \sum \frac{60}{(1.05)^t} + \frac{1000}{(1.05)^{10}} P=1077.22P = 1077.22

✅ New Bond Price at 5% YTM: Rs 1,077.22

📢 Key Takeaway: When interest rates decrease, bond prices increase.

📌 Part 2: Stock Valuation – Himalayan Tea Company

A stock represents ownership in a company, and its price is determined by expected future dividends and the investor’s required rate of return.

Now, let's compute:
1️⃣ Present Value of Stock (P₀)
2️⃣ Stock Price at End of Year 5 (P₅)

📌 Step 4: Calculating Present Stock Price

🔹 Gordon Growth Model (Constant Growth Dividend Model)

The Present Value of Stock (P₀) is calculated using the Gordon Growth Model:

P0=D1r−gP_0 = \frac{D_1}{r - g}

Where:

• P0P_0 = Present Value of Stock
• D1D_1 = Dividend Next Year = D0×(1+g)D_0 \times (1 + g)
• rr = Required Return = 15% or 0.15
• gg = Growth Rate = 5% or 0.05

🔸 Calculation

D1=20×(1.05)=21D_1 = 20 \times (1.05) = 21 P0=210.15−0.05P_0 = \frac{21}{0.15 - 0.05} P0=210.10=210P_0 = \frac{21}{0.10} = 210

✅ Present Stock Price = Rs 210

📌 Step 5: Calculating Stock Price at End of Year 5

🔹 Understanding Future Stock Price Calculation

The stock price grows at a steady rate (g = 5%) over time.

Formula:

P5=P0×(1+g)5P_5 = P_0 \times (1 + g)^5

🔸 Calculation

P5=210×(1.05)5P_5 = 210 \times (1.05)^5 P5=268.02P_5 = 268.02

✅ Stock Price at End of Year 5 = Rs 268.02

📋 Final Summary of Calculations

✅ Bond prices decrease when YTM increases and increase when YTM decreases.
✅ The current yield (6.93%) is different from YTM because it does not account for time value of money.
✅ Stock prices increase over time if dividends grow at a constant rate.

🎯 Key Takeaways

✅ Bonds & stocks are valued using present value techniques to estimate future cash flows.
✅ When interest rates fall, bond prices rise; when interest rates rise, bond prices fall.
✅ Stock prices are based on expected future dividends and growth rates.

📢 Final Thought:

• Investors looking for stable returns should focus on bonds.
• Investors seeking long-term growth should invest in stocks with steady dividend growth.

15. Himalayan Tea Company has just paid a cash dividend of Rs 20 per share. Dividend is expected to grow at a steady rate 5 percent per year forever. If investors require 15 percent return from investment, what should be the value of stock at present? What will be the stock worth at the end of the fifth year, PS?

📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Stock Valuation – Himalayan Tea Company

🔹 Understanding Stock Valuation

Stock valuation helps investors determine the fair price of a stock based on its expected future dividends and required return. In this case, we analyze the Himalayan Tea Company’s stock using the Gordon Growth Model (Dividend Discount Model, DDM).

📌 Given Financial Data

Now, let's compute:
1️⃣ Stock Value at Present (P₀)
2️⃣ Stock Value at End of Year 5 (P₅)

📌 Step 1: Calculating Present Stock Price (P₀)

🔹 Understanding the Gordon Growth Model (Constant Growth Dividend Model)

The Present Stock Price (P₀) is calculated using the Gordon Growth Model:

P0=D1r−gP_0 = \frac{D_1}{r - g}

Where:

• P0P_0 = Present Value of Stock
• D1D_1 = Dividend Next Year = D0×(1+g)D_0 \times (1 + g)
• rr = Required Return = 15% or 0.15
• gg = Growth Rate = 5% or 0.05

🔸 Calculation

D1=20×(1.05)=21D_1 = 20 \times (1.05) = 21 P0=210.15−0.05P_0 = \frac{21}{0.15 - 0.05} P0=210.10=210P_0 = \frac{21}{0.10} = 210

✅ Present Stock Price = Rs 210

📌 Step 2: Calculating Stock Price at End of Year 5 (P₅)

🔹 Understanding Future Stock Price Calculation

Since the stock grows at a steady rate (g = 5%), the stock price at the end of year 5 is:

P5=P0×(1+g)5P_5 = P_0 \times (1 + g)^5

🔸 Calculation

P5=210×(1.05)5P_5 = 210 \times (1.05)^5 P5=268.02P_5 = 268.02

✅ Stock Price at End of Year 5 = Rs 268.02

📋 Final Summary of Calculations

✅ The present stock price is Rs 210 based on expected dividend growth.
✅ After 5 years, the stock will be worth Rs 268.02 if the dividend continues to grow at 5% per year.

🎯 Key Takeaways

✅ Stock valuation helps investors determine the fair price of a stock before investing.
✅ The Gordon Growth Model is useful for valuing stocks with stable dividend growth.
✅ Stock prices increase over time if dividends grow at a constant rate.

📢 Final Thought:
Investors seeking stable returns should look for companies with consistent dividend growth, as seen in Himalayan Tea Company. 🚀📈

16. What do you mean by Working Capital? Describe the objectives of working capital management.

📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Working Capital & Its Management

🔹 What is Working Capital?

Working Capital (WC) refers to the funds available for a company to manage its day-to-day operations. It is the difference between current assets and current liabilities.

🔸 Formula for Working Capital

Working Capital=Current Assets−Current Liabilities\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}

🔸 Components of Working Capital

1️⃣ Current Assets – Cash, Accounts Receivable, Inventory, Marketable Securities.
2️⃣ Current Liabilities – Accounts Payable, Short-term Debt, Wages Payable.

✅ Positive Working Capital: Indicates the company can cover short-term obligations easily.
❌ Negative Working Capital: Suggests potential liquidity problems.

📌 Objectives of Working Capital Management

🔹 Why is Working Capital Management Important?

Working capital management ensures that a company has enough liquidity to meet short-term expenses, such as paying suppliers, salaries, and handling daily operations.

The main objectives of working capital management include:

1️⃣ Ensuring Liquidity & Solvency

• A company must have enough cash flow to cover day-to-day expenses.
• Poor management can lead to a liquidity crisis, making it difficult to pay bills, employees, and suppliers.

2️⃣ Maximizing Profitability

• Efficient working capital management helps avoid excessive investment in inventory or idle cash.
• Example: If too much cash is kept unused, it could have been invested for better returns.

3️⃣ Maintaining Balance Between Risk & Return

• Too much working capital → Indicates inefficiency, meaning cash is not being invested properly.
• Too little working capital → Can lead to financial distress and difficulty in meeting obligations.
• The goal is to maintain an optimal balance.

4️⃣ Reducing the Cost of Capital

• Companies use short-term financing (like bank loans, trade credit) to fund working capital.
• Proper management helps reduce borrowing costs and improves financial health.

5️⃣ Improving Cash Flow & Operational Efficiency

• Managing receivables (getting payments on time) and payables (paying suppliers strategically) helps improve cash flow.
• Example: Offering discounts to customers for early payments can increase cash availability.

6️⃣ Ensuring Smooth Business Operations

• Proper inventory management ensures that a business has enough stock to meet demand but not excess inventory that leads to higher storage costs.
• Managing cash reserves ensures smooth production and supply chain operations.

7️⃣ Enhancing Creditworthiness

• Strong working capital management ensures the company can pay debts on time.
• This improves credit ratings, making it easier to secure loans at lower interest rates.

📋 Final Summary

✅ Efficient working capital management ensures financial stability, profitability, and long-term success.

🎯 Key Takeaways

✅ Working Capital is essential for a company's short-term financial health.
✅ A balance between liquidity & profitability is crucial to prevent cash shortages.
✅ Poor working capital management can lead to financial distress, while proper management enhances business efficiency.

📢 Final Thought:
Companies must regularly monitor and optimize their working capital to ensure smooth operations, profitability, and financial growth. 🚀💰

Group "C"

Comprehensive answer questions:

Read the following information and answer the questions given below:

12 × 10 = 20]

17. Assume that you have applied for a part time job with an investment company. The investment company's evaluation process requires you to take an examination that covers several financial analysis techniques. The first section of the test addresses discounted cash flow analysis. You are asked to answer the following questions.

                 a. Draw time lines for (1) a Rs 10,000 lump sum cash flow at the end of Year 2, and

                     (2) an ordinary annuity of Rs 10,000 per year for 3 years.

B. What's the future value of an initial Rs 10,000 after 3 years if it is invested in an account paying 10 percent annual interest?

C. If you want an investment to double in 5 years, what interest rate must it earn?

D. What's the future value and present value of a'3-year ordinary annuity of Rs 10,000
if the appropriate interest rate is 10 percent?

E. What is the present value of the following uneven cash flow stream? The appropriate interest rate is 10 percent, compounded annually.

📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Discounted Cash Flow (DCF) Analysis

📌 Introduction to Discounted Cash Flow (DCF) Analysis

Discounted Cash Flow (DCF) analysis is a key technique used in financial decision-making to determine the present and future values of cash flows, taking into account the time value of money. It is widely used in investment evaluation, capital budgeting, and risk assessment.

In this scenario, we will explore several DCF-related calculations, including: ✅ Future Value (FV)
✅ Present Value (PV)
✅ Annuity Calculations
✅ Uneven Cash Flows

📌 Part A: Drawing Time Lines

A time line is a graphical representation of cash flows over different periods.

🔹 (1) Time Line for Rs 10,000 Lump Sum at the End of Year 2

This represents a single payment of Rs 10,000 received at the end of Year 2.

🔹 (2) Time Line for an Ordinary Annuity of Rs 10,000 for 3 Years

An ordinary annuity consists of equal payments made at the end of each period.

📌 Part B: Future Value of Rs 10,000 After 3 Years at 10% Interest

🔹 Understanding Future Value (FV)

Future value determines how much an investment today will grow over time at a given interest rate.

Formula for FV:

FV=P×(1+r)tFV = P \times (1 + r)^t

Where:

• PP = Initial investment = Rs 10,000
• rr = Interest rate = 10% or 0.10
• tt = Number of years = 3

🔸 Calculation

FV=10,000×(1.10)3FV = 10,000 \times (1.10)^3 FV=10,000×1.331=13,310FV = 10,000 \times 1.331 = 13,310

✅ Future Value after 3 Years = Rs 13,310

📌 Part C: Finding Interest Rate for Investment to Double in 5 Years

🔹 Understanding Required Interest Rate

To determine the interest rate required to double an investment, we use the formula:

r=(FVPV)1t−1r = \left( \frac{FV}{PV} \right)^{\frac{1}{t}} - 1

Where:

• FVFV = 2 × Initial Investment
• PVPV = Initial Investment
• tt = 5 years
• rr = Required Interest Rate

🔸 Calculation

r=(2)15−1r = (2)^{\frac{1}{5}} - 1 r=1.1487−1=0.1487=14.87%r = 1.1487 - 1 = 0.1487 = 14.87\%

✅ Required Interest Rate = 14.87%

📌 Part D: Future & Present Value of a 3-Year Ordinary Annuity (Rs 10,000) at 10%

🔹 Understanding Annuities

• Future Value (FV): The value of a series of payments at the end of the annuity period.
• Present Value (PV): The current worth of future annuity payments, discounted at the required interest rate.

🔹 Formulas

1️⃣ Future Value of an Ordinary Annuity (FVA)

FVA=P×[(1+r)t−1r]FV_A = P \times \left[ \frac{(1 + r)^t - 1}{r} \right]

Where:

• PP = Rs 10,000
• rr = 10% or 0.10
• tt = 3 years

🔸 Calculation

FVA=10,000×[(1.10)3−10.10]FV_A = 10,000 \times \left[ \frac{(1.10)^3 - 1}{0.10} \right] FVA=10,000×[1.331−10.10]FV_A = 10,000 \times \left[ \frac{1.331 - 1}{0.10} \right] FVA=10,000×3.31=33,100FV_A = 10,000 \times 3.31 = 33,100

✅ Future Value of Annuity = Rs 33,100

2️⃣ Present Value of an Ordinary Annuity (PVA)

PVA=P×[1−(1/(1+r)t)r]PV_A = P \times \left[ \frac{1 - (1 / (1 + r)^t)}{r} \right]

🔸 Calculation

PVA=10,000×[1−(1/(1.10)3)0.10]PV_A = 10,000 \times \left[ \frac{1 - (1 / (1.10)^3)}{0.10} \right] PVA=10,000×[1−0.75130.10]PV_A = 10,000 \times \left[ \frac{1 - 0.7513}{0.10} \right] PVA=10,000×2.4869=24,869.52PV_A = 10,000 \times 2.4869 = 24,869.52

✅ Present Value of Annuity = Rs 24,869.52

📌 Part E: Present Value of an Uneven Cash Flow Stream

🔹 Understanding Uneven Cash Flows

In real-world scenarios, cash flows are often irregular. The Present Value (PV) of uneven cash flows is calculated as:

PV=∑Ct(1+r)tPV = \sum \frac{C_t}{(1 + r)^t}

Where:

• CtC_t = Cash Flow at year tt
• rr = Discount rate (10%)
• tt = Year

🔹 Given Cash Flows

🔸 Present Value Calculation

PV=10,000(1.10)1+30,000(1.10)2+30,000(1.10)3+−50,000(1.10)4PV = \frac{10,000}{(1.10)^1} + \frac{30,000}{(1.10)^2} + \frac{30,000}{(1.10)^3} + \frac{-50,000}{(1.10)^4} PV=10,0001.10+30,0001.21+30,0001.331+−50,0001.4641PV = \frac{10,000}{1.10} + \frac{30,000}{1.21} + \frac{30,000}{1.331} + \frac{-50,000}{1.4641} PV=9,090.91+24,793.39+22,539.98−34,151.21PV = 9,090.91 + 24,793.39 + 22,539.98 - 34,151.21 PV=22,273.07PV = 22,273.07

✅ Present Value of Uneven Cash Flows = Rs 22,273.07

📋 Final Summary of Calculations

🎯 Key Takeaways

✅ Discounted Cash Flow (DCF) helps assess investment value over time.
✅ Future Value (FV) grows with compounding, while Present Value (PV) discounts future cash flows.
✅ Annuities and uneven cash flows require careful calculations using financial formulas.

📢 Final Thought:
Mastering DCF techniques is essential for investment decisions, capital budgeting, and financial analysis. 🚀💰

18. You are a financial analyst for the Nepal Press. The director of capital budgeting has asked you to analyze two proposed capital investments: Project X and Project Y. Each project has a cost of Rs 1,500,000, and the cost of capital for each project is 12 percent.

The expected net cash flows are as follows:

• Calculate each project's payback period, net present value and internal rate of
  return.

• Which project or projects should be accepted if they are independent?

• Which project should be accepted if they are mutually exclusive?

📘 Business Finance Notes for Bachelor Students (BHM) 📘

Topic: Capital Budgeting Analysis – Project X vs. Project Y

📌 Introduction to Capital Budgeting

Capital budgeting is a decision-making process used by businesses to evaluate long-term investments and determine whether a project should be accepted or rejected. The three primary methods used in capital budgeting are:
✅ Payback Period – Measures how long it takes to recover the initial investment.
✅ Net Present Value (NPV) – Measures profitability by discounting future cash flows.
✅ Internal Rate of Return (IRR) – Determines the return rate that makes NPV zero.

📌 Given Data for Project X & Project Y

• Initial Investment = Rs 1,500,000 (Rs 1,500 in thousands)
• Cost of Capital (Discount Rate) = 12%

Now, let's analyze the Payback Period, NPV, and IRR for both projects.

📌 Step 1: Payback Period Calculation

🔹 Understanding Payback Period

• The payback period is the time taken to recover the initial investment from cash inflows.
• A shorter payback period is preferred, as it indicates faster recovery of investment.

🔸 Calculation for Project X

✅ Payback Period for Project X = 3 Years

🔸 Calculation for Project Y

✅ Payback Period for Project Y = 2.75 Years

📢 Interpretation: Project Y recovers the investment faster than Project X.

📌 Step 2: Net Present Value (NPV) Calculation

🔹 Understanding NPV

• NPV measures the total value added by a project after discounting future cash flows at the cost of capital (12%).
• Formula:

NPV=∑Ct(1+r)t−Initial InvestmentNPV = \sum \frac{C_t}{(1 + r)^t} - \text{Initial Investment}

Where:

• CtC_t = Cash flow in year tt
• rr = 12% discount rate
• tt = Year

🔸 Calculated NPVs

✅ NPV for Project X = Rs 18.67K
✅ NPV for Project Y = Rs 333.58K

📢 Interpretation: Since both NPVs are positive, both projects increase shareholder value. However, Project Y has a much higher NPV, making it a better choice.

📌 Step 3: Internal Rate of Return (IRR) Calculation

🔹 Understanding IRR

• IRR is the discount rate at which the NPV becomes zero.
• A project is accepted if IRR > Cost of Capital (12%).

🔸 Calculated IRRs

✅ IRR for Project X = 12.59%
✅ IRR for Project Y = 20.90%

📢 Interpretation: Since both projects have IRR greater than 12%, both can be accepted. However, Project Y has a significantly higher IRR, making it more attractive.

📋 Final Summary of Results

✅ Both projects are financially viable (Positive NPV & IRR > 12%)
✅ Project Y is the better choice as it has a shorter payback period, higher NPV, and higher IRR.

📌 Decision Making

1️⃣ If Projects are Independent:

• Since both have positive NPV & IRR > 12%, BOTH projects can be accepted.

2️⃣ If Projects are Mutually Exclusive:

• Only one project can be selected.
• Since Project Y has a higher NPV, IRR, and shorter payback period, Project Y should be accepted.

🎯 Key Takeaways

✅ NPV is the best measure for capital budgeting as it directly represents the increase in value.
✅ A higher IRR means a project is more attractive, but it should always be compared to the cost of capital.
✅ Payback period helps understand risk – A shorter payback means lower risk.
✅ If projects are independent, take both; if mutually exclusive, choose Project Y.

📢 Final Thought:
Capital budgeting decisions are crucial for long-term growth. A good decision can increase profitability, while a bad one can waste resources. Learning NPV, IRR, and Payback Period is essential for making smart investment choices. 🚀💰