Strategic Financial Management Part B Q&A

Strategic Financial Management

PART B 10 MARKS

1. What makes risk important in the selection of projects? Explain briefly the various methods of evaluating risky projects?

2. Explain the merits and demerits of convertible preference shares?

3. Discuss the frame work for evaluation of lease from the view point of a lessor?

Lessor’s Point of View:

The financial viability of leasing out an asset from the point of view of lessor can be evaluated with the help of the two time adjusted methods of capital budgeting:

(a) Present Value Method

(b) Internal Rate of Return Method.

(a) Present Value Method:

This method involves the following steps:

(i) Determine cash outflows by deducing tax advantage of owning an asset, such as investment allowance, if any.

(ii) Determine cash inflows after-tax as below:

(ii) Determine the present value of cash outflows and after tax cash inflows by discounting at weighted average cost of capital of the lessor.

(iv) Decide in favour of leasing out an asset if P.V. of cash inflows exceeds the P.V. of cash outflows, i.e., if the NPV is +ve; otherwise in case N.P.V. is -ve, the lessor would lose on leasing out the asset.

(b) Internal Rate of Return Method:

The internal rate of return can be defined as that rate of discount at which the present value of cash- inflows is equal to the present value of cash outflows.

The Internal rate of return can also be determined with the help of present value tables.

The following steps are required to practice the internal rate of return method:

(1) Determine the future net cash flows for the period of the lease. The net cash inflows are estimated future net cash flows for the period of the lease. The net cash inflows are estimated future earnings, from leasing out the asset, before depreciation but after taxes.

(2) Determine the rate of discount at which the present value of cash inflows is equal to the present value of cash outflows. This may be determined as follows:

(a) When the annual net cash flows are equal over the life of the asset:

Firstly, find out Present Value Factor by dividing initial outlay (cost of the investment) by annual cash flow, i.e., Present Value Factor = Initial Outlay/Annual Cash Flow. Then, consult present value annuity tables with the number of year equal to the life of the asset and find out the rate at which the calculated present value factor is equal to the present value given in the table.

4. Discuss the main features of Venture Capital?

Features of Venture capital

The following are the features of venture capital

1. It is basically financing of new companies which are finding it difficult to go to the capital market at their early stage of existence.

2. This finance can also be loan-based or in-convertible debentures so that they carry a fixed yield for the providers of venture capital.

3. Those who provide venture capital aim at capital gain due to the success achieved by the concern that borrows.

4. It is a long-term investment and made in companies which have high growth potential. The provision of venture capital will bring rapid growth for the business.

5. The venture capital provider will also take part in the business of borrowing concern whereby, the venture capital financier not merely confines to finance, but also provide managerial skill.

6. Not all the capitalists will experience high risk. But venture capital financing contains risks. But the risk is compensated with a higher return.

7. Not much of technology is involved in venture capital, it involves financing mainly small and medium size firms, which are in their early stages. With the assistance of venture capital, these firms will stabilize and later can go in for traditional finance.

5. What is financial restructuring? What are the key compounds of the financial restructuring scheme?

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. This is because a company’s financial manager needs to always look at the options to minimize the cost of capital and improving the efficiency of the company as a whole which will in turn call for the continuous review of the debt part and recycling it to maximize efficiency.

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.

6. Discuss the legal process relating to approval of merger?

The Legal Procedure for Bringing About Merger of Companies

Examining the Object Clauses:

While the consideration for a merger is contemplated, an examination of the memorandum of association must be conducted to search and check whether the power of a merger is vested within it, in furtherance for permitting perpetuity on business post the inception of the newly formed company. The very purpose of examining the object clauses of both companies is to render what all can be permitted, in cases where clauses of such nature ( to carry on business, trade and commerce) do not exist, then such situations would be subject to necessary approvals of the shareholders, board of directors, and company law board.

Information to stock exchanges:

In the process of consideration taken for the merging of the companies, copies of all notices, resolutions, and orders should be properly communicated in good faith as to ascertain correct information to the stock exchange.

Confirmation of the Draft Merger Proposal by the respective Board of directors:

The Board of directors of both the companies must present the confirmation to the draft merger proposal and pass a resolution for authorizing its key managerial personal and other executives to pursue the matter further.

Application to high courts:

On the confirmation of approval of the draft Merger proposal by the respective board of directors, both the merging companies should file an application to the Honorable High Court in the state that their companies’ headquarters are situated, in furtherance to convey the meetings of the respective shareholders and creditors for passing the Merger proposal.

Meetings notice dispatched to Shareholders and Creditors:

A notice to bring together all shareholders and creditors for a meeting with the purpose of the meeting should be dispatched between both companies with prior approval from the hon’ble High Court of the state, as to acknowledge and ascertain a twenty one days advanced intimation. Thus, such a notice of meeting should be published at two newspapers.

Shareholders and Creditors Holding of Meetings:

Shareholders and Creditors must hold meetings to be help by the proposed merger ing companies’ for streamlining the passing of the proposal of merger wherein 75% of shareholders and Creditors must vote either through proxies or by themselves in person to confirm the approval of the scheme of the finalization of Merger.

Submission of petition to High Court for the confirmation of the Merging Scheme:

Once the confirmation of approval by the shareholders and creditors has been fully finalized in the merger scheme the concerned merging companies must submit a petition to the Honorable high court of that state for the primary purpose of declaring the confirmation of the Merging scheme, along with notice that has to be published in two newspapers.

Filing of the orders with the Registrar of companies:

The Honorable High court order of the concerned certified true copies must be filed with the registrar of companies within the limit specified by the Honorable High court of that state.

All Assets & Liabilities of Both Companies Conveyed to the Merged Company:

After The Honorable High court of that state passes all final orders, henceforth all the assets and liabilities of Both Companies would be conveyed to the Merged Company.

Issue for subscriptions of shares and debentures:

Once the merged company comes into existence as a separate legal entity, the company should issue shares and debentures, thus these shares and debentures so issued will be listed on the stock exchange.

7. What is conversion feature? What is conversion ratio?

Specification of the right to transform a particular investment to another form of investment, such as switching between mutual funds or converting preferred stock or bonds to common stock.

The ability to change from one investment vehicle to another. For example, one may be able to switch between mutual funds in a fund family without incurring a penalty. Likewise, one may exchange a convertible bond to common in the issuing company. Sometimes, one even may be able to change an adjustable-rate mortgage into a fixed-rate mortgage. All of these examples describe a conversion feature on the investment vehicles.

Conversion ratio

The conversion ratio is the number of common shares received at the time of conversion for each convertible security. The higher the ratio, the higher the number of common shares exchanged per convertible security. The conversion ratio is determined at the time the convertible security is issued and has an impact on the relative price of the security.

8. What are the features of Financial Strategy?

Equity finance	Decisions on the issue of new investment units, the aim of which is to achieve growth in the size and the value of the managed assets, are made based on a comprehensive consideration covering the time of acquisition of the new real-estate-related assets, the potential for utilization of the sponsor’s warehousing function, the loan-to-value ratio, the repayment date of interest-bearing debt and maturity dates, economic conditions, and other relevant factors. Account is also taken of the potential for dilution of existing unit holders’ rights and resulting fall in the trading price of the investment units, and other relevant factors.
Debt finance	In the case of borrowing of funds or issue of investment corporation bonds (including short-term investment corporation bonds), fund procurement is carried out with attention paid to achieving a balance between flexibility of procurement and financial stability. Specifically, consideration is given to the proportions of long-term and fixed-rate debt, staggering of the repayment dates, procurement method (borrowing or investment corporation bonds), establishment of commitment lines, and other relevant factors.
Loan-to-value ratio	In principle the upper limit is set at 60%, with attention paid to the maintenance of reserve funds. Note: The loan-to-value ratio refers to total interest-bearing debt as a proportion of Hulic Reit’s total assets.
Cash management policy	The capital requirements of the portfolio are constantly monitored and accurately identified for the purpose of implementing effective and appropriate cash management.

9. Describe the pooling of interest method and purchase method of accounting for amalgamation?

BASIS FOR COMPARISON	POOLING OF INTEREST METHOD	PURCHASE METHOD
Meaning	Pooling of Interest Method of accounting is one in which the assets, liabilities and reserves are combined and shown at their historical values, as of the date of amalgamation.	Purchase Method, is an accounting method, wherein the assets and liabilities of the transferor company are shown at their market value in the books of the transferee company, as of the date of amalgamation.
Applicability	Merger	Acquisition
Assets and liabilities	Appear at book values.	Appear at fair market values.
Recording	All the assets and liabilities of the companies undergoing merger are aggregated.	Only those assets and liabilities are recorded in the books of transferee company, which are taken over by it.
Reserves	The identity of transferor company's reserves is kept intact.	The identity of the transferor company'es reserves except statutory reserves is not kept intact.
Purchase Consideration	Difference in the amount of purchase consideration and share capital is adjusted with reserves.	Surplus of deficit of purchase consideration over the net asset acquired, should be credited or debited, as capital reserves or goodwill.

Definition of Pooling of Interest Method

The pooling of interest method is based on the assumption that the deal is nothing but an exchange of equity securities. Hence the capital account of the firm acquired is removed and replaced with the new stock by the acquiring company. The balance sheet of the two firms is united, in which the assets and liabilities are shown at their book values, as on the date of acquisition. In the end, the aggregate assets of the united firm are equal to the aggregate of the assets of the individual firm. Neither goodwill is general, nor there a charge against the incomes. The transferor company’s assets, liabilities, and reserves are entered in the books of accounts of the transferee company, at their existing carrying amounts, after giving effect to relevant adjustments. Further, the reserves shown on the balance sheet of the transferor company is taken to the transferee company’s balance sheet. The dissimilarity in the capital, as a result of exchange ratio, is adjusted in the reserves.

Definition of Purchase Method

In purchase method, the assets are depicted in the books of the merged firm, at their fair market value and liabilities at agreed values, as on the date of acquisition. It is based on the premise that the final values should represent, the market values decided during the negotiation. The aggregate liabilities of the united firm is equal to the sum of the liabilities of the individual firms. The equity capital of the transferee company is increased by the amount of the purchase consideration. It is the method of accounting in which the transferee company records amalgamation, either by keeping track of assets and liabilities at their existing carrying amount or by assigning the purchase consideration, to individual assets and liabilities of the transferor company, that are recognizable, at their fair market value, on the date amalgamation becomes effective.

10. Explain the major types of Option Contracts?

Types of Option:

1. Call Options:

A call option gives the holder (buyer/one who is long call); the right to buy specified quantity of the underlying asset at the strike price on or before expiration date. The seller (one who is short call) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy.

2. Put Options:

A Put option gives the holder (buyer/one who is long Put), the right to sell specified quantity of the underlying asset at the strike price on or before expiry date. The seller of the put option (one who is short Put) however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell.

11. What is process of venture capital? Explain its method of financing?

Process:

Deal Origination:

Venture capital financing begins with origination of a deal. For venture capital business, stream of deals is necessary. There may be various sources of origination of deals. One such source is referral system in which deals are referred to venture capitalists by their parent organizations, trade partners, industry association, friends, etc.

Screening:

Venture capitalist in his endeavour to choose the best ventures first of all undertakes preliminary scrutiny of all projects on the basis of certain broad criteria, such as technology or product, market scope, size of investment, geographical location and stage of financing.

Evaluation:

After a proposal has passed the preliminary screening, a detailed evaluation of the proposal takes place. A detailed study of project profile, track record of the entrepreneur, market potential, technological feasibility future turnover, profitability, etc. is undertaken.

Deal Negotiation:

Once the venture is found viable, the venture capitalist negotiates the terms of the deal with the entrepreneur. This it does so as to protect its interest. Terms of the deal include amount, form and price of the investment.

Post Investment Activity:

Once the deal is financed and the venture begins working, the venture capitalist associates himself with the enterprise as a partner and collaborator in order to ensure that the enterprise is operating as per the plan.

Exit Plan:

The last stage of venture capital financing is the exit to realise the investment so as to make a profit/minimize losses. The venture capitalist should make exit plan, determining precise timing of exit that would depend on an a myriad of factors, such as nature of the venture, the extent and type of financial stake, the state of actual and potential competition, market conditions, etc.

Method of financing:

§ Equity Financing: A firm needs funds for a longer period to survive and grow, but as venture capital firm is a new company the firm is not able to give timely returns to its investors, for which equity financing proves beneficial. The investor’s contribution is not more than 49% of the total stake, and so the ultimate power remains with the entrepreneur.

§ Conditional Loan: Conditional loans are the one that does not carry interest and are repayable to the lender in the form of royalty after the venture capital undertaking is able to make revenue. The royalty rate may vary from 2% to 15%, on the basis of factors such as gestation period, external risk and cash flow patterns.

§ Income Note: A form of hybrid financing, that combines the characteristics of the traditional loan and conditional loan, on which the venture capital firm pays both royalty and interest, but at low rates.

§ Participating Debentures: The interest on participating debentures is payable at three various rates, as per the phase of operation:

§ Start-up phase — Nil

§ Initial operations phase — Low rate of interest

§ After a particular level of operations – High rate of interest

§ Convertible loans: The loans which are convertible into equity when interest on the loan is not paid within the stipulated period.

Venture Capital provides long term funding to unquoted companies to grow and succeed. Raising venture capital is a bit different from borrowing money from lenders because lenders have the right to interest on the loan and capital repayment. On the other hand, venture capital investment provides equity stake to the investor, and the return on investment relies on the growth and profitability.

12. Describe the internal and external devices for controlling agency costs?

Direct and Indirect Agency Costs

Agency costs are subdivided into direct and indirect agency costs.

There are two types of direct agency costs:

Corporate expenditures that benefit the management team at the expense of shareholders
An expense that arises from monitoring management actions to keep the principal-agent relationship aligned.

The first type of direct agency costs is illustrated above, where the management team unnecessarily books the most expensive hotel or orders unnecessary hotel upgrades that do not add value or benefits to shareholders.

An example of the second type of direct agency cost is paying external auditors to assess the accuracy of the company’s financial statements.

Indirect agency costs refer to lost opportunity. Say, for example, shareholders want to undertake a project that will increase stock value. However, the management team is afraid that things might turn out badly, which might result in the termination of their jobs. If management does not take on this project, shareholders lose a potentially valuable opportunity. This becomes an indirect agency cost because it arises out of the shareholder/management conflict but does not have a directly quantifiable value.

13. Define Joint venture. Explain the reasons behind its failure in India?

A Joint Venture (JV) is a cooperative enterprise entered into by two or more business entities for the purpose of a specific project or other business activity. The reason for a joint venture is usually some specific project.

Joint ventures can be informal (a handshake) or formal, and they can be short term or long term. Often the joint venture creates a separate business entity, to which the owners contribute assets, have equity, and agree on how this entity may be managed. The new entity may be a corporation, limited liability company, or partnership.

1. Lack of experience. To the usual confusion when entering a new market add the fact that often it is the first Joint Venture for both partners. The lack of previous experiences and the need of consensus between the parties normally turn things around and create difficulties to solve the conflicts and for correct decision-making, both vital for the positive progress of the business.

2. Cultural differences. Even if the business culture in India may be more similar to ours than what we may expect beforehand, Indian values, customs, management style and communication subtly differ from that of western cultures. The use of a non-mother language is also an additional barrier. Even when the parties talk in similar English, huge gaps stand between what one wants to say and what others may understand.

3. As a natural consequence of the previous two points, a lot of communication problems and misunderstandings arise, ingredients for a stew of mistrust.

4. Referring to operations, it is frequent to establish Joint Ventures between companies that produce the same goods, leading to conflicts on strategic objectives. This may turn the success of the JV on a threat to one or even both of the partners.

5. To this add the fact that still nowadays, it is difficult for both partners to think on win-win terms and so both partners tend to look after oneself by trying to profit as much as possible their part instead of the JV.

6. Sometimes, the JV is perceived as a business on itself for one of the partners, who may focus on exploiting this relationship instead of focusing on the development of the JV.

7. All the above explained, plus the combination of the day-to-day problems inherent to the management of a company and the no less numerous difficulties of the Indian market, create a lot of tensions at all levels. Add the usual resistance to change and we get an accumulation of non-solved problems that tend to paralyze the functioning of the JV that feeds the loss of trust between the partners, ending irremissibly in rupture.

14. Explain the important steps involved in strategic financial planning of a large scale unit?

· Step 1: Determine Your Current Financial Situation

In this first step of the financial planning process, you will determine your current financial situation with regard to income, savings, living expenses, and debts. Preparing a list of current asset and debt balances and amounts spent for various items gives you a foundation for financial planning activities.

· Step 2: Develop Financial Goals

You should periodically analyse your financial values and goals. This involves identifying how you feel about money and why you feel that way. The purpose of this analysis is to differentiate your needs from your wants.
Specific financial goals are vital to financial planning. Others can suggest financial goals for you; however, you must decide which goals to pursue. Your financial goals can range from spending all of your current income to developing an extensive savings and investment program for your future financial security.

· Step 3: Identify Alternative Courses of Action

Developing alternatives is crucial for making good decisions. Although many factors will influence the available alternatives, possible courses of action usually fall into these categories:
Continue the same course of action.
Expand the current situation.
Change the current situation.
Take a new course of action.

Not all of these categories will apply to every decision situation; however, they do represent possible courses of action.
Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help you make more effective and satisfying decisions.

· Step 4: Evaluate Alternatives

You need to evaluate possible courses of action, taking into consideration your life situation, personal values, and current economic conditions.
Consequences of Choices. Every decision closes off alternatives. For example, a decision to invest in stock may mean you cannot take a vacation. A decision to go to school full time may mean you cannot work full time. Opportunity cost is what you give up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in dollars.
Decision making will be an ongoing part of your personal and financial situation. Thus, you will need to consider the lost opportunities that will result from your decisions.

· Evaluating Risk

Uncertainty is a part of every decision. Selecting a college major and choosing a career field involve risk. What if you don’t like working in this field or cannot obtain employment in it?
Other decisions involve a very low degree of risk, such as putting money in a savings account or purchasing items that cost only a few dollars. Your chances of losing something of great value are low in these situations.
In many financial decisions, identifying and evaluating risk is difficult. The best way to consider risk is to gather information based on your experience and the experiences of others and to use financial planning information sources.

· Financial Planning Information Sources

Relevant information is required at each stage of the decision-making process. Changing personal, social, and economic conditions will require that you continually supplement and update your knowledge.

· Step 5: Create and Implement a Financial Action Plan

In this step of the financial planning process, you develop an action plan. This requires choosing ways to achieve your goals. As you achieve your immediate or short-term goals, the goals next in priority will come into focus.
To implement your financial action plan, you may need assistance from others. For example, you may use the services of an insurance agent to purchase property insurance or the services of an investment broker to purchase stocks, bonds, or mutual funds.

· Step 6: Revaluate and Revise Your Plan

Financial planning is a dynamic process that does not end when you take a particular action. You need to regularly assess your financial decisions. Changing personal, social, and economic factors may require more frequent assessments.
When life events affect your financial needs, this financial planning process will provide a vehicle for adapting to those changes. Regularly reviewing this decision-making process will help you make priority adjustments that will bring your financial goals and activities in line with your current life situation.

15. Discuss the risk adjusted discount rate method of investment decision?

Risk-adjusted discount rate is the rate used in the calculation of the present value of a risky investment, such as the real estate or a firm. In fact, the risk-adjusted discount rate represents the required return on investment.

Risk-adjusted discount rate method refers to the adjustment of risk in valuation model that is NPV.

Risk-adjusted discount rate can be expressed as follows:

d = 1/ 1+r+µ

Where, r = risk free discount rate

µ = risk probability

The preceding formula can be used for calculating risk-adjusted present value. For example, if the expected rate of return after five years is equal to R₅, then the risk-adjusted present value can be determined with the help of the following formula.

Present Value (PV) = 1/ (1+r+µ)⁵R₅

The advantages of risk-adjusted discount rate method are as follows:

(a) Changing discount rate by changing risk factor (µ) for different time periods and amount of risk

(b) Adjust the high risk of future by increasing the time duration for risk adjusted rate. For example, the risk-adjusted discounted rate for 50^th year is equal to:

However, the disadvantage of risk-adjusted discount rate method is that it fails to provide tool for measuring risk factor. Therefore, it is required to be supplemented with the method to calculate risk factor.

16. Discuss the procedure for simulation analysis?

The Simulation Analysis is a method, wherein the infinite calculations are made to obtain the possible outcomes and probabilities for any choice of action.

Problem Definition
The initial step involves defining the goals of the study and determine what needs to be solved. The problem is further defined through objective observations of the process to be studied. Care should be taken to determine if simulation is the appropriate tool for the problem under investigation.
Project planning
The tasks for completing the project are broken down into work packages with a responsible party assigned to each package. Milestones are indicated for tracking progress. This schedule is necessary to determine if sufficient time and resources are available for completion.
System Definition
This step involves identifying the system components to be modelled and the performance measures to be analysed. Often the system is very complex, thus defining the system requires an experienced simulator who can find the appropriate level of detail and flexibility.
Model Formulation
Understanding how the actual system behaves and determining the basic requirements of the model are necessary in developing the right model. Creating a flow chart of how the system operates facilitates the understanding of what variables are involved and how these variables interact.
Input Data Collection & Analysis
after formulating the model, the type of data to collect is determined. New data is collected and/or existing data is gathered. Data is fitted to theoretical distributions. For example, the arrival rate of a specific part to the manufacturing plant may follow a normal distribution curve.
Model Translation
The model is translated into programming language. Choices range from general purpose languages such as FORTRAN or simulation programs such as Arena.
Verification & Validation
Verification is the process of ensuring that the model behaves as intended, usually by debugging or through animation. Verification is necessary but not sufficient for validation that is a model may be verified but not valid. Validation ensures that no significant difference exists between the model and the real system and that the model reflects reality. Validation can be achieved through statistical analysis. Additionally, face validity may be obtained by having the model reviewed and supported by an expert.
Experimentation & Analysis
Experimentation involves developing the alternative model(s), executing the simulation runs, and statistically comparing the alternative(s) system performance with that of the real system.
Documentation & Implementation
Documentation consists of the written report and/or presentation. The results and implications of the study are discussed. The best course of action is identified, recommended, and justified.

17. Discuss the factors that influence the value of a warrant?

1) Underlying price

This is the most obvious factor since anyone that buys a warrant expects the underlying stock to move in a particular direction. Remember every warrant has a strike price? The difference between the strike price and the underlying price is the intrinsic value of the warrant. Since strike price is fixed, the only way for changes in a warrant’s intrinsic value is through the changes in underlying price.

For a call warrant: Underlying price increases, warrant price increases
For a put warrant: Underlying price decreases, warrant price increases

2) Days to maturity

As we know warrants have expiry dates, days to maturity simply means the remaining number of days a particular warrant has to its expiry date. A warrant, besides having an intrinsic value, has time value which is related to the number of days to maturity. The longer the days to maturity, the higher the time value of the warrant.

Longer the days to maturity, higher the price of warrant (for both call and put warrants)

3) Implied volatility

This is a market expectation of the volatility of the underlying stock in the near future – it is an expected value that is why the name “implied” is used. A volatile stock is means its price is not stable which always fluctuate with much price movement. Hence, a volatile underlying stock has more chance to reach the strike price.

The higher the implied volatility for an underlying stock, the higher the price of the warrant.

4) Interest rate

This factor is not as influential as the first three factors as mentioned in the opening. The reason is that interest rate remains fairly constant in the near term and since warrants are short term securities, they are unlikely to encounter significant changes. The changes in warrant prices in relations to interest rate fluctuations is to compensate the opportunity cost incurred by the warrant holder.

For a call warrant: interest rate rises, warrant price increases
For a put warrant: interest rate rises, warrant price decreases

5) Dividend

Usually the expected dividend pay-out is factored into the warrant price. The changes will only come about when there is a difference in the expected payout and the actual payout. However, it is noteworthy that underlying price may be driven higher when a high dividend payout is announced. Thus, for a call warrant, the compensation of dividend payout on the warrant can be cancelled out by the increase in underlying price.

18. Explain the significance in hybrid securities?

Higher Returns: Generally offers higher returns than traditional bond offerings. Also, provide an opportunity to participate in a firm’s growth if there is an uptick in the company’s common stock.
Diversification: Gives an opportunity to diversify a portfolio through a single instrument, reducing the overall risk element. For e.g. adding a hybrid to a traditional stock-bond portfolio reduces the overall risk and adds diversification.
Volatility: Though volatility is a risk element with hybrids, it generally has less volatility in terms of market price as compared to traditional stocks. Since these securities provide a steady income stream, they are usually less volatile.
Cost of capital: By combining the benefits of debt and equity, hybrids usually lowers the overall cost of capital for the issuer. Additionally, the issuer benefits through hybrid bonds as they have minimal impact on their overall credit rating.

19. Explain the uses of Financial Modelling?

Uses of Financial Modelling:

In the finance industry, the value of financial modelling is increasing rapidly.
Financial modelling acts as an important tool which enables business ideas and risks to be estimated in a cost-effective way.
Financial modelling is an action of creating attractive representation of a financial situation of company.
Financial Models are mathematical terms aimed at representing the economic performance of a business entity.

20. Discuss the techniques of investment decisions?

Payback period method
this method of investment appraisal calculates how long it takes a project to repay its original investment. The method therefore concentrates on cash flow, highlighting projects that recover quickly their initial investment. Here is an example of how it works.

Accounting rate of return (ARR) method
this method of investment appraisal calculates the expected profits from the investment, expressing them as a percentage of the capital invested. The higher the rate of return, the ‘better’ (i.e. the more profitable) is the project. The ARR is therefore based on anticipated profits rather than on cash flow.

ARR = (expected average profits / original investment) x 100

Discounted cash flow (DCF) method
the principle of DCF is based on using discounted arithmetic to get a present value for future cash inflows and outflows. This method is sometimes divided into two elements, which complement each other:

· the net present value (NPV) method, which takes account of all relevant cash flows from the project throughout its life, discounting them to their ‘present value’

· the internal rate of return (IRR) method, which compares the rate of return expected from the project with that identified by the company as being the cost of its capital – projects having an IRR that exceeds the cost of capital are worth considering.

21. Explain the process and methods of financing?

Project Finance

Corporate finance

Lease Financing

Debt Financing

Venture capital

Equity financing

Corporate bonds

22. Explain the tools and techniques of Financial Modelling?

· Historical data: This is instrumental in determining future trends. Since the data collected from past references is going to be the foundation of your future predictions, it is essential that the data collected is credible and accurate.

· Assumptions: Assumptions involve analysing a company’s historical data and coming up with a strategy for building a financial model. While the term suggests that it is merely guesswork, assumptions in financial modelling must be vivid and well-defined. This is because they are used as the ‘drivers’ or ‘inputs’ for financial models of a business while also representing a company’s expectations and realities.

· Colour coding or linkages: Formatting through colour codes is an essential part of financial modelling. Different cells contain values corresponding to different parameters. Colour coding these cells and your financial model can help your colleagues to understand the model more easily.

· a Circular reference

A circular reference is a series of references where the last object references the first, resulting in a closed-loop.

23. Explain Venture Capital Concept and recent Developments in India?

Refer 25, 4 and 11.

Recent Developments in India:

Indian economy is on ever-increasing growth curve despite problems related to downturn in global economy. As stated in the previous chapter, the developed countries are investing in the emerging Asia-Pacific countries and India is one of them attracting large amount of foreign venture capital investment. India tends to be a leading destination for VC/PE with positive indicators such as consistent GDP growth, a buoyant capital market, strong industrial growth, sound financials of Indian corporates and favourable demographic forces. The chapter reviews the evolution and growth of venture capital industry in India. The VC investments in India continuously increased till the year 2001. Following the internet crash world over, the investment activity drastically reduced up to year 2003. However, due to high growth prospects of Indian economy, investors again made a comeback in year 2004. Thereafter, apart from few fluctuations, VC investment activity has maintained its momentum in the country. These investments are majory concentrated in to IT and ITES sector. Nonetheless, these investors are diversifying into other areas such as biotechnology, retailing, life science and service sectors due to better prospects in these sectors. Moreover, VC investments in India are substantially concentrated in cities such as Mumbai and Bangalore due to financial and technological clustering respectively in these cities.

24. Explain the importance of leasing?

(i) The most important merit of leasing is flexibility. The leasing company modifies the arrangements to suit the leases requirements.

(ii) In the leasing deal less documentation is involved, when compared to term loans from financial institutions.

(iii) It is an alternative source to obtain loan and other facilities from financial institutions. That is the reason why banking companies and financial institutions are now entering into leasing business as this method of finance is more acceptable to manufacturing units.

(iv) The full amount (100%) financing for the cost of equipment may be made available by a leasing company. Whereas banks and other financial institutions may not provide for the same.

(v) The ‘Sale and Lease Bank’ arrangement enables the lessees to borrow in case of any financial crisis.

(vi) The lessee can avail tax benefits depending upon his tax status.

25. Explain the importance of corporate planning?

Long Term Goals

Corporate planning sets out long term goals. When a company has long term goals, it can focus its resources and efforts on a specific target. Employees become focused on fulfilling that goal in an efficient and effective way. In fact, having a long term goal can serve to unite employees and supervisors, because everyone is working towards a common purpose.

Focus

Creating a strategic business plan provides focus. One of the first steps of corporate planning involves writing a mission statement. The mission statement clearly tells the rest of the world what the company does. Once a company has a mission statement, it can focus on fulfilling its task. For example, if a company’s mission statement declares its purpose is to produce the best refrigerators in the country, it will not be distracted by lesser, or unrelated tasks.

Better Decisions

By developing a plan, a company can make better business decisions. The business plan needs to spell out what choices will further the company's interest, such as what personnel it needs, and what equipment it requires. When the business knows what it needs to accomplish to be successful, its leaders can steer it towards hiring the best possible people for open positions, purchase equipment appropriate to its needs, and invest in the best opportunities.

A Measure of Success

Corporate planning also acts as a yardstick for a company. A company should frequently examine its progress in regards to its corporate plan. If the business has not met a particular goal on its strategic map, its executives must ask themselves what must be done in order to get things back on track. The yardstick function of business planning works best when companies build a mechanism into the strategy which allows for change -- in case the company needs to alter its direction.

Saving Money

Corporate planning has the additional benefit of saving companies money. Part of creating a business strategy involves developing a budget. Budgeting allows businesses to allocate their financial resources to the projects which need those most, while cutting out unnecessary expenses. Budgets also eliminate confusion. With a budget, everyone knows what the company earns, what it spends, what it can afford, and what it cannot.

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Strategic Financial Management Part B Q&A