Strategic Financial Management Part A Q&A

Strategic Financial Management

MBA Finance III Semester Notes

Important Topics:

1. Financial Planning

2. Amalgamation

3. Lease Financing

4. Types of Mergers

5. Objectives of Venture Capital

6. Forms of Expansion

7. Merits and De-merits of Leasing

8. Causes and effect of Under Capitalization

9. Issues and problems in Mergers

10. Needs of Strategic Financial Planning

11. Corporate Restructuring

Part A 6 marks

1. Distinguish between Financial Policy and Financial Strategy?

The term “strategy” has been used in different ways. Authors differ in at least one major aspect about strategies. Some writers focus on both the end points (purpose, mission, goals, and objectives) and the means of achieving them (policies and plans). Others emphasize the means to the ends in the strategic process rather than the ends per se. Policies are general statements or understandings which guide managers thinking in decision making. They ensure that decisions fall within certain boundaries. They usually do not require action but are intended to guide managers in their commitment to the decision they ultimately make. The essence of policy is discretion. Strategy on the other hand, concerns the direction in which human and material resources will be applied in order to increase the chance of achieving selected objectives.

2. Explain the Certainty Equivalent factor Approach?

Meaning

Certainty Equivalent factor (CEF) is the ratio of assured cash flows to uncertain cash flows. Under this approach, the cash flows expected in a project are converted into risk-less equivalent amount. The adjustment factor used is called CEF. This varies between 0 and 1. A co-efficient of 1 indicates that cash flows are certain. The greater the risk in cash flow, the smaller will be CEF ‘for receipts’, and larger will be the CEF ‘for payments’. While employing this method, the decision maker estimates the sum she must be assured of receiving, in order that she is indifferent between an assured sum and expected value of a risky sum.

Formula:

CEF = CCF/UCF

 In this equation, the term CCF refers to the amount, which decision-maker is willing to receive as an assured sum in lieu of an unassured sum. The term UCF means uncertain cash flows.

3. Write a note on distress restructuring?

Financial distress occurs when an organization is unable to pay its creditors and lenders. This condition is more likely when a business is highly leveraged, its per-unit profit level is low, its breakeven point is high, or its sales are sensitive to economic declines. Because of this condition, other parties will typically engage in the following actions:

• Suppliers insist on the return of any unpaid inventory
• Suppliers require that any additional payments be made with cash on delivery (COD) terms
• Suppliers start to charge interest and penalties on overdue payables. 
• Lenders will not extend any additional loans
• Customers cancel their orders or do not place new orders
• Competitors try to steal away customers

To get out of the situation, managers may be forced to sell assets on a rush basis, lend their own money to the firm, and/or eliminate discretionary expenditures. Another problem is that employees will be much more likely to look for work elsewhere, so there is a rapid decline in the level of institutional knowledge within the business.

Financial distress is common just before a business declares bankruptcy. If the level of distress is high, the firm may be forced into immediate Chapter 7 liquidation, rather than attempting to work out a payment schedule with creditors and lenders.

4. What is an Option? Explain call and put option?

An option is a derivative, a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying asset by a certain date (expiration date) at a specified price (strike price). There are two types of options: calls and puts. US options can be exercised at any time prior to their expiration. European options can only be exercised on the expiration date.

1. Call options

Calls give the buyer the right but not the obligation to buy the underlying asset at the strike price specified in the option contract. Investors buy calls when they believe the price of the underlying asset will increase and sell calls if they believe it will decrease.

2. Put options

Puts give the buyer the right, but not the obligation, to sell the underlying asset at the strike price specified in the contract. The writer (seller) of the put option is obligated to buy the asset if the put buyer exercises their option. Investors buy puts when they believe the price of the underlying asset will decrease and sell puts if they believe it will increase.

5. Explain the different Types of Leasing with example?

Leasing is an old method of financing which is now gaining popularity almost in whole world. Legally, the lease contract is not a sale of the object, but rather a sale of the usufruct (the right to use the object) for a specified period of time. Under it, there are two parties one is the owner or lessor of the asset and other is the lessee or the party that takes the asset on lease. The lessee takes the asset for use for a specified period of time and makes rental payments. The ownership of the asset rests with the lessor but it is in the possession of lessee and right of use is also transferred to lessee.

It has following are different types. The two basic types of leasing are: Finance Lease and Operating Lease. These are explained below:

(1) Finance Lease: Under finance lease all risks and rewards of ownership of asset are transferred to lessee. The ownership or title may or may not be transferred. A finance lease is somewhat like a hire purchase agreement. Under finance lease the lessee after paying agreed number of instalments, is entitled to exercise an option to become the owner of asset.

Example:

Suppose the AB Company takes a new automobile on lease for three year. Also assume that at the end of three years the AB Company will be called to take the ownership of vehicle at no extra cost. Here not only the vehicle is taken on lease but also the AB Company is using the lease agreement as a means of financing the automobile. This type is called capital lease or finance lease.

(2) Operating Lease: According to International Accounting Standard (IAS-17) the operating lease is one which is not a finance lease. Under operating lease, the lessor gives the right to lessee to use the asset or property for a specified period of time, but risks and rewards of ownership are retained by the lesser.

Example:

Let up suppose that MY enterprises owns a complete 6th floor in Eden Tower, a multi-story building. Further assume that MY enterprises gives some rooms of this floor on lease to XY Corporation.

Now if the value of this building increase due to good business activity then the lessor i.e., MY enterprises can take the benefit of this increase by either selling out the rooms or by increasing the rental amount. On the other hand if the building decreases in value than also the MY enterprises will be the sufferer of loss. This type of leasing is called operating lease.

Besides these two main types, some other types of leasing are explained below:

(3) Sale and Lease Back: Under sale and lease back agreement, an asset is first sold to the financial institution. The sale is made at the genuine market value. After that the asset is taken back on a lease. This type of leasing is advantageous for those companies which do not want to show high debt balances in their financial statement.

(4) Capital Lease: This type of leasing is governed by the financial standard board which is not applicable in Pakistan. Under this type, when lessee acquires an asset on lease, he simultaneously recognizes it as a liability in the financial statement.

(5) Leveraged Lease: This type of leasing involves three parties including a lender, a lessor and a lessee. The lender and lessor join hands to accumulate funds to buy the asset. The asset purchased is then given on the lease to lessee. The lessee makes periodic payments to the lessor who in turn makes payment to the lender.

(6) Cross Border Leasing: It means to operate lease agreement in other countries. Such type of leasing is very difficult in present circumstances. The reasons being that different accounting treatments, tax charges and incidental criteria prevail in foreign countries. Also the tax rules differ from country to country. So a big problem arises as how to present such lease agreement in financial statement.

6. What is Financial Restructuring?

Financial restructuring is a mode of restructuring a firm that has gone into financial distress and which has huge accumulated losses, overvalued or fictitious assets and negligible or negative net worth. As a corrective measure, such firms may sell major assets, merge with other firms, negotiate with creditors, banks, debentures-holders and shareholders to reduce their claims, swap debt-equity, leverage buy-out, etc.
The two components of financial restructuring are;

• Debt Restructuring
• Equity Restructuring

1. Debt Restructuring

Debt restructuring is the process of reorganizing the whole debt capital of the company. It involves reshuffling of the balance sheet items as it contains the debt obligations of the company. Debt restructuring is more commonly used as a financial tool than compared to equity restructuring.

2. Equity Restructuring

Equity restructuring is the process of reorganizing the equity capital. It includes reshuffling of the shareholders capital and the reserves that are appearing in the balance sheet. Restructuring of equity and preference capital becomes a complex process involving a process of law and is a highly regulated area. Equity restructuring mainly deals with the concept of capital reduction.

7. What is Deep Discount Bond?

A Deep Discount Bond is a zero coupon bond (i.e. no interest before maturity like fixed deposits) with a considerably longer maturity (say 15 years or more). As the lack of coupon payments and long term of the bond suggest, these bonds are issued at a deep discount to the face value.
These bonds are generally embedded with “call” and “put” options. A call option gives the issuer an option of buy back at a predefined price before the maturity – generally associated with decreasing interest rates. A put option gives the bond holder an option to sell the bond a predefined price before the maturity – generally associated with increasing interest rates.
DIFFERENT TYPES OF DDBs
some variation of Deep Discount Bonds are -
1. Zero Interest Secured Premium Convertible Bond
The investor can convert the bond to equity shares at a discount at the end of one year.
2. Zero Interest Fully Convertible Debenture
In this case the debentures will be compulsorily converted to equity shares after one year.

8. Highlight the reasons for merger?

Reason # 1. Economies of Scale:

An amalgamated company will have more resources at its command than the individual companies. This will help in increasing the scale of operations and the economies of large scale will be availed. These economies will occur because of more intensive utilisation of production facilities, distribution network, research and development facilities, etc.

Reason # 2. Operating Economies:

A number of operating economies will be available with the merger of two or more companies. Duplicating facilities in accounting, purchasing, marketing, etc. will be eliminated. Operating inefficiencies of small concerns will be controlled by the superior management emerging from the amalgamation.

Reason # 3. Synergy:

Synergy refers to the greater combined value of merged firms than the sum of the values of individual units. It is something like one plus one more than two. It results from benefits other than those related to economies of scale. Operating economies are one of the various synergy benefits of merger or consolidation.

Reason # 4. Growth:

A company may not grow rapidly through internal expansion. Merger or amalgamation enables satisfactory and balanced growth of a company. It can cross many stages of growth at one time through amalgamation. Growth through merger or amalgamation is also cheaper and less risky.

Reason # 5. Diversification:

Two or more companies operating in different lines can diversify their activities through amalgamation. Since different companies are already dealing in their respective lines there will be less risk in diversification. When a company tries to enter new lines of activities then it may face a number of problems in production, marketing etc.

Reason # 6. Utilisation of Tax Shields:

When a company with accumulated losses merges with a profit making company it is able to utilise tax shields. A company having losses will not be able to set off losses against future profits, because it is not a profit earning unit.

Reason # 7. Increase in Value:

One of the main reasons of merger or amalgamation is the increase in value of the merged company. The value of the merged company is greater than the sum of the independent values of the merged companies. For example, if X Ld. and Y Ltd. merge and form Z Ltd., the value of Z Ltd. is expected to be greater than the sum of the independent values of X Ltd. and Y Ltd.

Reason # 8. Eliminations of Competition:

The merger or amalgamation of two or more companies will eliminate competition among them. The companies will be able to save their advertising expenses thus enabling them to reduce their prices. The consumers will also benefit in the form of cheap or goods being made available to them.

Reason # 9. Better Financial Planning:

The merged companies will be able to plan their resources in a better way. The collective finances of merged companies will be more and their utilisation may be better than in the separate concerns. It may happen that one of the merging companies has short gestation period while the other has longer gestation period.

Reason # 10. Economic Necessity:

Economic necessity may force the merger of some units. If there are two sick units, government may force their merger to improve their financial position and overall working. A sick unit may be required to merge with a healthy unit to ensure better utilisation of resources, improve returns and better management. Rehabilitation of sick units is a social necessity because their closure may result in unemployment etc.

9. Define Strategic Planning and the process of strategic Planning?

Strategic planning is an organizational management activity that is used to set priorities, focus energy and resources, strengthen operations, ensure that employees and other stakeholders are working toward common goals, establish agreement around intended outcomes/results, and assess and adjust the organization's direction in response to a changing environment. 

Stages

• Strategy Formulation
• Strategy Implementation
• Strategy Evaluation

Steps

1. Develop vision and mission
2. External environment analysis
3. Internal environment analysis
4. Establish long-term objectives
5. Generate, evaluate and choose strategies
6. Implement strategies
7. Measure and evaluate performance

10. Explain Lease Purchase?

Lease purchase is a form of conditional sale agreement, which means that the regular payments are similar to a lease/rental agreement but you will own the car at the end of the deal. You may be asked to pay a number of monthly payments at the start of your agreement (referred to as ‘advance payments’ and the leasing equivalent of a deposit) and a sum is usually deferred to the end of the deal.  The deferred sum will be determined by the age and mileage of the car at the end of the agreement. 

11. State the difference between Leasing and Hire purchase?

12. Define:

Option Financing:

Options are financial instruments that are derivatives or based on underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to.

• Call options allow the holder to buy the asset at a stated price within a specific timeframe.
• Put options allow the holder to sell the asset at a stated price within a specific timeframe.

Convertibles

Convertibles are long-term securities which can be changed into another type of security, such as common stock. Convertibles include bonds and preferred shares, but most commonly take the form of bonds. Convertibles are attractive to investors who are looking for an investment with greater growth potential than that offered by a traditional bond. By purchasing a convertible bond, the investor can still receive returns as if it were a traditional bond, but has the additional option of converting that bond into shares if the share price increases enough to make it worthwhile.

Warrants

Warrants are also long-term securities but are generally shorter-term than convertibles. They grant investors the right to purchase shares at a fixed price (known as the “exercise price”) for a predetermined amount of time, often several years.

13. What are the various types of mergers?

Types of Mergers

1. Horizontal merger: A merger between companies that are in direct competition with each other in terms of product lines and markets
2. Vertical merger: A merger between companies that are along the same supply chain (e.g., a retail company in the auto parts industry merges with a company that supplies raw materials for auto parts.)
3. Market-extension merger: A merger between companies in different markets that sell similar products or services
4. Product-extension merger: A merger between companies in the same markets that sell different but related products or services
5. Conglomerate merger: A merger between companies in unrelated business activities (e.g., a  clothing company buys a software company)

14. Difference between acquisition and amalgamation?

Amalgamation

Amalgamation means consolidation of two or more companies with a view to expand so that businesses may become larger with increase in profits. Amalgamation takes place where two or more business companies join hands to form a new business that is larger. After amalgamation larger company has access to more resources. The shareholders of former companies are given shares of the new company which is formed after the merger of the two companies. Generally, in the process of Amalgamation merger of a smaller entity into a bigger entity may take place. After amalgamation stocks of both companies are dissolved and new stocks are issued to the shareholders. Old board of directors is dismantled and a new board of directors is formed to run the affairs of the new company.

Acquisition

Acquisition refers to acquiring assets of a Company by another one.  Actually, one company buys the assets of another company. The shareholders of the company which is taken over are issued stocks of the buying company. In Acquisition two companies of unequal size are combined together while amalgamation takes place between companies of equal size.  Amalgamation of two companies is an example of horizontal expansion. Amalgamation is intended to avoid competition and to have larger number of customers. Acquisition is friendly while amalgamation is friendly as well as hostile.

15. What are convertible and non-convertible debentures in hybrid securities?

A convertible debenture

is a type of long-term debt issued by a company that can be converted into stock after a specified period. Convertible debentures are usually unsecured bonds or loans meaning that there is no underlying collateral connected to the debt.

Non-convertible debentures (NCDs)

 are a financial instrument that is used by companies to raise long-term capital. This is done through a public issue.

NCDs are a debt instrument with a fixed tenure and people who invest in these receive regular interest at a certain rate.

 Some debentures can be converted into shares after a certain point in time. This is done at the discretion of the owner. However, this is not possible in the case of NCDs. That’s why they are known as non-convertible

16. Explain the components of financial strategy?

Goals & Objectives:
Goals and objectives should be listed by priority and should be as specific as possible.  They should be specific, measurable, reasonable, and capable of planning.

Income Tax Planning:
Tax returns should be examined to determine if you are maximizing tax saving possibilities consistent with the planning objectives.

Balance Sheet:
A balance sheet or “Statement of Financial Position” should be created, showing your net worth by listing all assets and liabilities. This should be periodically updated to track progress towards overall goals and to identify changes in your financial situation that need attention.

Issues & Problems:
Issues/problems consist of observations regarding the strengths and weaknesses of your current situation as well as risks you face.

Risk Management and Insurance:
A sudden unexpected event can derail even the most detailed plan unless you have anticipated and planned for catastrophic events.  Insurance products are useful in managing these risks.  You should evaluate your life, disability, liability/umbrella, and long-term care insurance.

Retirement, Education, and Special Needs:
Consideration must be given to retirement, education, or any other special needs (e.g., physically or mentally incapacitated dependents or divorce settlements). Financial projections should be prepared for these needs, along with funding strategies.

Cash Flow Statement:
Preparation of a cash flow statement will show income from all sources, as well as expenses that occur on a regular or recurring basis. This should be periodically updated to track progress towards overall goals and to identify changes in your financial situation that need attention.

Investment Planning:
An analysis of your investments should be completed to determine if the portfolio’s earnings, growth, and diversification are consistent you’re your objectives and risk tolerance.

Estate Planning:
Your financial plan should include a review of your lifetime gifts and final transfer of assets to reduce or eliminate your gifts and estate tax exposure.

Assumptions:
Assumptions include inflation rates, rate of return on investments, tax bracket, years of work remaining, and life expectancy. These should be reviewed periodically against your actual financial plan and adjustments should be made accordingly.

Recommendations:
All final (and proposed) recommendations should be in writing, stating the assumptions upon which they are based, projected benefits, and potential problems.

Implementation Plan:
The plan implementation section should delineate the individuals responsible for implementing each identified task, whether it be you, your financial planner, accountant, attorney, or some other expert.

17. Difference between merger and amalgamation?

Points of difference	Amalgamation	Merger
Meaning	A new company is formed to take over the existing business of all the amalgamating companies. After the amalgamation, all combining units are automatically liquidated.	A merger is called absorption of weaker units by a strong unit.
Formation	Under amalgamation, a new organization is formed to effect fusion of the two or   more existing companies.	Under merger an existing co. absorbs one or more existing companies. The absorbing company survives.
Initiation	Amalgamation takes place on the initiative of an outside promoter since the business rivalry of several units normally acts as a bar to their coming together on   their own initiative.	In the merger, the surviving or acq1uirgin company takes initiative and tries its level best to effect the merger.
Effect on Shareholders	Amalgamation affects all shareholders.	In a merger, the shareholders of absorbed companies are affected.

18. How does leasing increases a firm’s borrowing capacity?

Theoretically and empirically, debt and leases have been shown to be both substitutes and complements. To explore the relation, we divide our sample into two subsets: those that exhibit a complementary relation (43% increase debt after increasing leases), and those that exhibit a substitutionary relation (57% decrease debt after increasing leases). For complement firms, we find a significant negative relation between leasing and the firm's size, marginal tax rate, and z-score, consistent with “complementary” theories. For substitute firms, we find a positive and significant relation between leasing, the marginal tax rate and changes in cash. We also find a significant positive stock market reaction to the announcement of the SLB, which is stronger for the complement subset of firms.

19. What is the effect of dilution on the value of warrant?

20. Explain leasing as a source of finance?

Lease financing is one of the important sources of medium- and long-term financing where the owner of an asset gives another person, the right to use that asset against periodical payments. The owner of the asset is known as lessor and the user is called lessee. The periodical payment made by the lessee to the lessor is known as lease rental. Under lease financing, lessee is given the right to use the asset but the ownership lies with the lessor and at the end of the lease contract, the asset is returned to the lessor or an option is given to the lessee either to purchase the asset or to renew the lease agreement.

21. What are the advantages and disadvantages of issuing Preference shares?

Advantages of Preference Shares

1. Absence of voting rights:

The preference shareholders do not possess the voting rights in the personal matters of the company. There is thus no interference in general by the preference shareholders, even though they gain more profits and advantages over the common shareholders.

2. Fixed return:

The dividends to be paid to the preference shareholders are fixed as compared to the equity shareholders. The company can thus maximize the profits that are available on the part of preference shareholders.

3. Absence of charge on assets:

Because preference shares have no payment of dividends, no charges are levied on the assets of the company unlike in the case of debentures.

4. Capital structure flexibility:

By means of issuing redeemable preference shares, flexibility in the company’s capital structure can be maintained because redeemable preference shares can be redeemed under the terms of issue.

5. Widening of the capital market:

The scope of a company’s capital market is widened as a result of the issuance of preference shares because of the reason that preference shares provide not only a fixed rate of return but also safety to the investors.

Disadvantages of Preference Shares

1. High rate of dividends:

The Company has to pay higher rates of dividends to the preference shareholders as compared to the common shareholders. Thus the cost of capital of the company is also increased.

2. Dilution of claim over assets:

Because of the very reason that preference shareholders have preferential rights over the company assets in case of winding up of the company, dilution of equity shareholders claim over the assets take place.

3. Tax disadvantages:

In case of preference shareholders, the taxable income of the company is not reduced while in case of common shareholders, the taxable income of the company is reduced.

4. Effect on credit worthiness:

In case of preference shares, the credit worthiness of a company is definitely reduced because preference shareholders possess the right over the personal assets of the company.

5. Increase in financial burden:

Because most of the preference shares issued are culminative, the financial burden on the part of the company increases vehemently. The company also reduces the dividends of the equity shareholders because of the reason that it is essential on the part of the company to pay the dividends to the preference shareholders.

22. What are the applications of Financial Models?

Applications

·          Investment Banking / Equity Research:
Financial Modelling is the basic tool for fundamental analysis and valuations. Investment banker use it to arrive at a valuation in M&A or fund raising transactions. Equity Analysts use it to value stocks and come up with buy/sell/hold recommendations.

·          Project Finance/Credit Rating:
Financial model help bankers, credit analysts to project future revenues and costs and to make an informed judgment about a projects viability. They are then able to decide if they should extend loans or what the credit rating of a project or company should be.

·          Corporate Finance:
Financial Modelling is used by companies to assess their own finances and projects.  It is hence an input in creating funding plans for corporate projects.

·          Entrepreneurs/Private Equity:
Entrepreneurs use Financial Models to present their plans to potential investors as much as to plan their strategies. Running different simulations can often be an important tool in avoiding potential risks

23. Explain Risk adjusted Discount Rate?

The risk-adjusted discount rate is the total of the risk-free rate, i.e. the required return on risk-free investments, and the market premium, i.e. the required return of the market. Financial analysts use the risk-adjusted discount rate to discount a firm’s cash flows to their present value and determine the risk that investor should accept for a particular investment.

The difference between the market premiums, which is often used as a discount rate in valuation analysis is that the risk-adjusted discount rate takes into consideration the future market conditions, the level of inflation and the value of money at the end of the investment horizon.

The main advantages of the risk-adjusted discount rate are that the concept is easy to understand and it is a reasonable attempt to quantify risk. However, as just noted, it is difficult to arrive at an appropriate risk premium, which can render the results of the analysis invalid. This approach also assumes that investors are risk-averse, which is not always the case. Some investors will accept a high level of risk if they perceive a potentially large payoff from an investment in the future.

24. What are the advantages of Merger?

1. Economies of scale

Mergers result in economies of scale for the company. Economies of scale is the cost benefit that a company obtains due to merger. Due to merger, company became large, and therefore, it can buy materials on a large-scale and also get huge discounts on purchases. Similarly, a merged company can produce and distribute its goods and services on a large-scale.

The types of economies of scale seen in a merger are depicted below:

  

The different types of economies of scale are as follows:

1. Technical economies refer to the fixed technical-costs of the company before merger, this cost reduces after merger.
2. Bulk-buying economies help a merged company to obtain a discount on buying raw-materials in bulk quantity.
3. Financial economies help a merged company to bargain (negotiate) on a better rate of interest from financial institutions.
4. Organizational economies help a merged company to have a proper or good unity of command as it is lead by one management with efficiency.

2. Tax benefits

Mergers result in a large tax benefit to the companies.

A merged company gets tax benefits:

1. When a profit-making company takes over a loss-making company.
2. When a company enjoys a subsidized rate of taxation.

3. Financial resources

After merger, the companies will have adequate financial resources.

The combined assets of the merged company will help to:

1. Increase the credit worthiness of the companies in the financial markets.
2. Increase the bargaining power to obtain loans at a subsidized rate of interest.

4. Entry in global markets

Global market means a huge world-level market in which any company can sell their goods and services.

This market does not have any restrictions for entrances. Merger helps merged companies to get an entry in the global market which encompasses various regions. Examples of mergers showing an entry in the global market are as follows:

1. TATA Steel's acquisition of CORUS Steel increased Tata's presence in the global market.
2. MITTAL Steel's acquisition of ARCELOR Steel increased Mittal's presence in the global market.

5. Growth and expansion

Mergers help companies to grow and expand their business activities. This growth and expansion are achieved by:

1. Making a strong presence in the domestic markets.
2. Entering into various foreign markets.

6. Helps to face competition

Merger helps the merged company to face competition at both levels, national as well as international markets. Generally, merged company face the market competition by:

1. Merging the competitors in their company.
2. Providing the goods and services at competitive prices.

7. Increase in market share

Merger aids in increasing the market share of the merged company. This rise in the market share is achieved by:

1. Providing an adequate supply of goods & services as needed by clients.
2. Entering into an agreement with clients for continuous supply of goods and services.

8. Increases goodwill

Merger helps the merged company to boost its goodwill in the market. It creates goodwill by:

1. Increasing the confidence of the shareholders of the merged company.
2. Creating a good image of the merged company among the customers.

9. Research and development

Merger enhances the research and development (R&D) programmes of the merged company.

This enhancement in R&D is achieved by:

1. Allowing uninterrupted investment in research and development programmes.
2. Appointing skilled professionals to carry out the research and development programmes.

10. Miscellaneous advantages

Miscellaneous advantages of mergers are listed as follows:

1. Merger generates value of the merged company by accessing funds and assets to support its business growth and development.
2. It helps a merged company to deal with the threats of multinationals companies (MNCs).
3. It may prove beneficial to a struggling company by helping it to survive.
4. It also assists to reduce redundancies observed in the business activities and/or operations.

25. Explain the need and importance of Venture Capital?

1. Promotes Entrepreneurs: Just as a scientist brings out his laboratory findings to reality and makes it commercially successful, similarly, an entrepreneur converts his technical know-how to a commercially viable project with the assistance of venture capital institutions.

2. Promotes products: New products with modern technology become commercially feasible mainly due to the financial assistance of venture capital institutions.

3. Encourages customers: The financial institutions provide capital to their customers not as a mere financial assistance but more as a package deal which includes assistance in management, marketing, technical and others.

Example: Hot mail dot com. It was a project invented by a young Indian graduate from Bangalore, by name Sabir Bhatia. This project was developed by him due to the financial assistance provided by the venture capital firms in Silicon Valley, U.S.A. His project was later on purchased by Microsoft Company, U.S.A. The Chairman of the company, Mr Bill Gates offered 400 Million US Dollars in hot cash.

4. Brings out latent talent: While funding entrepreneurs, the venture capital institutions give more thrust to potential talent of the borrower which helps in the growth of the borrowing concern.

5. Promotes exports: The Venture capital institution encourages export oriented units because of which there is more foreign exchange earnings of the country.

6. As Catalyst: A venture capital institution acts as more as a catalyst in improving the financial and managerial talents of the borrowing concern. The borrowing concerns will be keener to become self-dependent and will take necessary measures to repay the loan.

7. Creates more employment opportunities: By promoting entrepreneurship, venture capital institutions are encouraging self-employment and this will motivate more educated unemployed to take up new ventures which have not been attempted so far.

8. Brings financial viability: Through their assistance, the venture capital institutions not only improve the borrowing concern but create a situation whereby they can raise their own capital through the capital market. In the process they strengthen the capital market also.

9. Helps technological growth: Modern technology will be put to use in the country when financial institutions encourage business ventures with new technology.

10. Helps sick companies: Many sick companies are able to turn around after getting proper nursing from the venture capital institutions.

11. Helps development of backward areas: By promoting industries in backward areas, venture capital institutions are responsible for the development of the backward regions and human resources.

12. Helps growth of economy: By promoting new entrepreneurs and by reviving sick units, a fillip is given to the economic growth. There will be increase in the production of consumer goods which improves the standard of living of the people.

26. Explain innovative sources of Finance for business?

  

27. Explain Commercial Papers?

1. What is Commercial Paper (CP)?

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note.

2. When it was introduced?

It was introduced in India in 1990.

3. Why it was introduced?

It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and all-India financial institutions were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations.

Merits of Commercial Paper

i.            Technically, it provides more funds compared to other sources. The cost of commercial paper to the issuing firm is lower than the cost of commercial bank loans.

ii.            It is in freely transferable nature, therefore it has high liquidity also a wide range of maturity provide more flexibility.

iii.            A commercial paper is highly secure and does not contain any restrictive condition.

iv.            Companies can save their extra funds on commercial paper and also earn some good return on the same.

v.            Commercial papers produce a continuing source of funds. This is because their maturity can be tailored to suit the needs of issuing firm. Again, commercial paper that matures can be repaid by selling the new commercial paper.

Limitations of Commercial Paper

i.            Only financially secure and highly rated organizations can raise money through commercial papers. New and moderately rated organizations are not in a position to raise funds by this method.

ii.            The amount of money that we can raise through commercial paper is limited to the deductible liquidity available with the suppliers of funds at a particular time.

iii.            Commercial paper is an odd method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the duration of commercial paper is not possible.

28. Explain the difference between goals and objectives?

BASIS	OBJECTIVES	GOALS
Meaning	Objectives are the achievements which can be attained only if the attempts are made in a particular direction.	A goal is a long term purpose which a person strives to achieve.
What is it?	Means to an end	End result
Basis	Facts	Ideas
Time frame	Medium term to Short term	Long term
Measurement	Easy	Comparatively difficult
Materiality	Concrete	Abstract
Action	Specific	Generic

29. Explain the process of corporate planning?

Steps in corporate planning process:

1. Establishing corporate mission, objectives and goals.

2. Establishing Strategic Business Units

3. Assigning resources to each Strategic Business Unit

4. Planning for Business Growth.

1. Establishing Corporate Mission, Objectives and Goals:

Top management prepares statements of mission, objectives and goals that play the role of a framework within which divisions and business units prepare their plan. They are guiding force for the organisation and express the reasons of being in business and what specific goals the firm is pursuing at a given point of time.

2. Establishing Strategic Business Units:

Once the organisation mission, objectives and goals are set, they will provide a framework for determining what kind of organisational structure and business models are a ‘best fit’ for the organization’s marketing effects. The organisation structure for a single product will be simple as it can be designed by management function of geographic territory.

3. A strategic business unit has the following characteristics:

(a) Separate responsibility for strategic planning and profit performance and profit influencing factors.

(b) A separate set of competitors.

(c) Single business or a collection of related businesses, which offer scope for independent strategic planning form remaining organisation.

The understanding of an SBU is, therefore, a convenient starting point for planning since the company’s strategic business units have been identified. In practice, big companies in India work on the basis that strategic planning at SBU level has to be agreed to by the corporate management.

4. Planning for Business Growth:

Intensive growth strategies are appropriate when current products and current markets show the potential for sales increase. There are three main strategic options that seem to be appropriate to accomplish intensive growth.

a. Market Penetration

b. Market Development

c. Product Development

a. Market Penetration:

It is a strategy of increasing sales of existing products in current markets. For example, Proctor and Gamble reduced the price of its detergent Ariel in the Indian market to increase its sale among existing and new consumers in the current market. Depending on the product category, other approaches can be to increase advertising, sales promotion, personal selling and increase distribution network in the current markets.

b. Market Development:

It refers to increasing sales by introducing current products into new markets. This strategy often involves expanding business in new geographic areas. For example, with globalisation and opening up of Indian borders for businesses, many organisations have introduced their products in the Indian market.

c. Product Development:

It means increasing sales by improving current products in some way or developing entirely new products for current markets. For example, Gillette has modified its razor and named it Vector for Indian consumers. In auto industry, manufacturers regularly introduce redesigned or new products.

30. Discuss various factors determining investment decisions?

1. Interest rates

Investment is financed either out of current savings or by borrowing. Therefore investment is strongly influenced by interest rates. High interest rates make it more expensive to borrow. High interest rates also give a better rate of return from keeping money in the bank. With higher interest rates, investment has a higher opportunity cost because you lose out the interest payments.

2. Economic growth

Firms invest to meet future demand. If demand is falling, then firms will cut back on investment. If economic prospects improve, then firms will increase investment as they expect future demand to rise. There is strong empirical evidence that investment is cyclical. In a recession, investment falls, and recover with economic growth.

3. Confidence

Investment is riskier than saving. Firms will only invest if they are confident about future costs, demand and economic prospects. Keynes referred to the ‘animal spirits’ of businessmen as a key determinant of investment. Keynes noted that confidence that wasn’t always rational. Confidence will be affected by economic growth and interest rates, but also the general economic and political climate. If there is uncertainty (e.g. political turmoil) then firms may cut back on investment decisions as they wait to see how event unfold.

4. Inflation

In the long-term, inflation rates can have an influence on investment. High and variable inflation tends to create more uncertainty and confusion, with uncertainties over the cost of investment. If inflation is high and volatile, firms will be uncertain at the final cost of the investment, they may also fear high inflation could lead to economic uncertainty and future downturn. Countries with a prolonged period of low and stable inflation have often experienced higher rates of investment.

5. Productivity of capital

Long-term changes in technology can influence the attractiveness of investment. In the late nineteenth century, new technology such as Bessemer steel and improved steam engines meant firms had a strong incentive to invest in this new technology because it was much more efficient than previous technology. If there is a slowdown in the rate of technological progress, firms will cut back investment as there are lower returns on the investment.

6. Availability of finance

In the credit crunch of 2008, many banks were short of liquidity so had to cut back lending. Banks were very reluctant to lend to firms for investment. Therefore despite record low-interest rates, firms were unable to borrow for investment – despite firms wishing to do that.

Another factor that can influence investment in the long-term is the level of savings. A high level of savings enables more resources to be used for investment. With high deposits – banks are able to lend more out. If the level of savings in the economy falls, then it limits the amounts of funds that can be channelled into investment.

7. Wage costs

If wage costs are rising rapidly, it may create an incentive for a firm to try and boost labour productivity, through investing in capital stock. In a period of low wage growth, firms may be more inclined to use more labour intensive production methods.

8. Depreciation

Not all investment is driven by the economic cycle. Some investment is necessary to replace worn out or outdated equipment. Also, investment may be required for the standard growth of a firm. In a recession, investment will fall sharply, but not completely – firms may continue with projects already started, and after a time, they may have to invest on less ambitious projects. Also, even in recessions, some firms may wish to invest or start up.

9. Public sector investment

The majority of investment is driven by the private sector. But, investment also includes public sector investment – government spending on infrastructure, schools, hospitals and transport.

10. Government policies

Some government regulations can make investment more difficult. For example, strict planning legislation can discourage investment. On the other hand, government subsidies/tax breaks can encourage investment. In China and Korea, the government has often implicitly guaranteed – supported the cost of investment. This has led to greater investment – though it can also affect the quality of investment as there is less incentive to make sure the investment has a strong rate of return.

31. Discuss the steps involved in acquisition process?

1. Develop an acquisition strategy – Developing a good acquisition strategy revolves around the acquirer having a clear idea of what they expect to gain from making the acquisition – what their business purpose is for acquiring the target company (e.g., expand product lines or gain access to new markets)
2. Set the M&A search criteria – Determining the key criteria for identifying potential target companies (e.g., profit margins, geographic location, or customer base)
3. Search for potential acquisition targets – The acquirer uses their identified search criteria to look for and then evaluate potential target companies
4. Begin acquisition planning – The acquirer makes contact with one or more companies that meet its search criteria and appear to offer good value; the purpose of initial conversations is to get more information and to see how amenable to a merger or acquisition the target company is
5. Perform valuation analysis – Assuming initial contact and conversations go well, the acquirer asks the target company to provide substantial information (current financials, etc.) that will enable the acquirer to further evaluate the target, both as a business on its own and as a suitable acquisition target
6. Negotiations – After producing several valuation models of the target company, the acquirer should have sufficient information to enable it to construct a reasonable offer; Once the initial offer has been presented, the two companies can negotiate terms in more detail
7. M&A due diligence – Due diligence is an exhaustive process that begins when the offer has been accepted; due diligence aims to confirm or correct the acquirer’s assessment of the value of the target company by conducting a detailed examination and analysis of every aspect of the target company’s operations – its financial metrics, assets and liabilities, customers, human resources, etc.
8. Purchase and sale contracts – Assuming due diligence is completed with no major problems or concerns arising, the next step forward is executing a final contract for sale; the parties will make a final decision on the type of purchase agreement, whether it is to be an asset purchase or share purchase
9. Financing strategy for the acquisition – The acquirer will, of course, have explored financing options for the deal earlier, but the details of financing typically come together after the purchase and sale agreement has been signed.
10. Closing and integration of the acquisition – The acquisition deal closes, and management teams of the target and acquirer work together on the process of merging the two firms

32. How financial policy linked to strategic management?

The inter face of strategic management and financial policy will be clearly understood if we appreciate the fact that the starting point of an organization is money and the end point of that organization is also money again. Offer of the organization is only a vehicle that links up the starting point and the end point. No organization can run the existing business and promote a new expansion project without a suitable internally mobilized financial base or both internally and externally mobilized financial base. The success of any business is measured in financial terms. Maximising value to the shareholders is the ultimate objective. For this to happen, at every stage of its operations including policy-making, the firm should be taking strategic steps with value-maximization objective. This is the basis of financial policy being linked to strategic management.
The linkage can be clearly seen in respect of many business decisions. For example :
i. Manner of raising capital as source of finance and capital structure are the most important dimensions of strategic plan.
ii. Cut-off rate (opportunity cost of capital) for acceptance of investment decisions.
iii. Investment and fund allocation is another important dimension of interface of strategic management and financial policy.
iv. Foreign Exchange exposure and risk management.
v. Liquidity management
vi. A dividend policy decision deals with the extent of earnings to be distributed and a close interface is needed to frame the policy so that the policy should be beneficial for all.
vii. Issue of bonus share is another dimension involving the strategic decision. Thus from above discussions it can be said that financial policy of a company cannot be worked out in isolation to other functional policies. It has a wider appeal and closer link with the overall organizational performance and direction of growth. 

33. Explain the objectives of portfolio investment?

1. Security of Principal Investment: Investment safety or minimization of risks is one of the most important objectives of portfolio management. Portfolio management not only involves keeping the investment intact but also contributes towards the growth of its purchasing power over the period. The motive of a financial portfolio management is to ensure that the investment is absolutely safe. Other factors such as income, growth, etc., are considered only after the safety of investment is ensured.
2. Consistency of Returns: Portfolio management also ensures to provide the stability of returns by reinvesting the same earned returns in profitable and good portfolios. The portfolio helps to yield steady returns. The earned returns should compensate the opportunity cost of the funds invested.
3. Capital Growth: Portfolio management guarantees the growth of capital by reinvesting in growth securities or by the purchase of the growth securities. A portfolio shall appreciate in value, in order to safeguard the investor from any erosion in purchasing power due to inflation and other economic factors. A portfolio must consist of those investments, which tend to appreciate in real value after adjusting for inflation.
4. Marketability: Portfolio management ensures the flexibility to the investment portfolio. A portfolio consists of such investment, which can be marketed and traded. Suppose, if your portfolio contains too many unlisted or inactive shares, then there would be problems to do trading like switching from one investment to another. It is always recommended to invest only in those shares and securities which are listed on major stock exchanges, and also, which are actively traded.
5. Liquidity: Portfolio management is planned in such a way that it facilitates to take maximum advantage of various good opportunities upcoming in the market. The portfolio should always ensure that there are enough funds available at short notice to take care of the investor’s liquidity requirements.
6. Diversification of Portfolio: Portfolio management is purposely designed to reduce the risk of loss of capital and/or income by investing in different types of securities available in a wide range of industries. The investors shall be aware of the fact that there is no such thing as a zero risk investment. More over relatively low risk investment give correspondingly a lower return to their financial portfolio.
7. Favourable Tax Status: Portfolio management is planned in such a way to increase the effective yield an investor gets from his surplus invested funds. By minimizing the tax burden, yield can be effectively improved. A good portfolio should give a favourable tax shelter to the investors. The portfolio should be evaluated after considering income tax, capital gains tax, and other taxes.

34. Write a note on American Depositary Receipts?

American Depository Receipt (ADR) is a certified negotiable instrument issued by an American bank suggesting the number of shares of a foreign company that can be traded in U.S. financial markets.

American Depository Receipts provide US investors with an opportunity to trade in shares of a foreign company. When the ADRs did not exist, it was very difficult for an American investor to trade in shares of foreign companies as they had to go through many rules and regulation. To ease such hardship faced by American investors, the regulatory body Securities Exchange Commission (SEC) introduced the concept of ADR which made it easier for an American investor to trade in shares of foreign companies. American depository receipt fee varies from one cent to three cents per share depending upon the ADR amount and its timing.

Advantages of ADRs

American Depositary Receipts have a number of benefits that make them an ideal opportunity for international investors, including:

• Ease of Use: ADRs can be bought and sold just like shares of IBM or Coca-Cola.
• Same Broker: You don't need a foreign brokerage account or a new broker; you can use the same broker that you normally deal with.
• Dollar-Based Pricing: Prices for ADRs are quoted in U.S. dollars, and dividends are paid in dollars.
• Standard Market Hours: ADRs trade during U.S. market hours and are subject to similar clearing and settlement procedures as American stocks.
• Customization: You can customize your portfolio however you like, depending on which countries or sectors you are interested in.

Disadvantages of ADRs

By the same token, ADRs have some important limitations and drawbacks, including:

• Limited Selection: Not all foreign companies are available as ADRs. For example, Japan's Toyota Motor has an ADR, but Germany's BMW does not.
• Liquidity: Plenty of companies have ADR programs available, but some may be very thinly traded.
• Exchange Rate Risk: While ADRs are priced in dollars, for sake of convenience, your investment is still exposed to fluctuations in the value of foreign currencies.

35. Write a detail note on strategic alliance by companies?

Strategic alliances are an effective way for a business to build a secondary market or to test a collaborative partnership with another company. Finding the right ally requires finding a company that shares a common vision and mission, or that otherwise buys into your company's core values. Look at how large corporations have successfully developed strategic alliances to brainstorm how to develop your own.

· a strategic alliance is an arrangement between two companies that have decided to share resources to undertake a specific, mutually beneficial project.

· A strategic alliance agreement could help a company develop a more effective process.

·  Strategic alliances allow two organizations, individuals or other entities to work toward common or correlating goals.

Types of Strategic Alliances

#1 Joint Venture: A joint venture is established when the parent companies establish a new child company. For example, Company A and Company B (parent companies) can form a joint venture by creating Company C (Child Company). In addition, if Company A and Company B each own 50% of the child company, it is defined as a 50-50 Joint Venture. If Company A owns 70% and Company B owns 30%, the joint venture is classified as a Majority-owned Venture.

#2 Equity Strategic Alliance: An equity strategic alliance is created when one company purchases a certain equity percentage of the other company. If Company A purchases 40% of the equity in Company B, an equity strategic alliance would be formed.

#3 Non-equity Strategic Alliance: A non-equity strategic alliance is created when two or more companies sign a contractual relationship to pool their resources and capabilities together.