CA Intermediate PAPER 6: FINANCIAL MANAGEMENT AND STRATEGIC MANAGEMENT Syllabus

Define the Internal Rate of Return (IRR) and its acceptance rule.

IRR is the discount rate at which NPV = 0 (PV of inflows = PV of outflows). Accept the project if IRR > the cost of capital / cutoff rate.

What is the Payback Period and a key limitation of it?

Payback Period = time required to recover the initial investment from cash inflows. Key limitation: it ignores the time value of money and cash flows occurring after the payback point.

What is the Profitability Index (PI) and its decision rule?

PI = PV of cash inflows / Initial investment (or PV of outflows). Accept if PI > 1; it is a relative measure useful for ranking under capital rationing.

State the formula for the Accounting (Average) Rate of Return (ARR).

ARR = (Average Annual Accounting Profit after tax / Average Investment) x 100, where Average Investment is typically (Initial outlay + Salvage)/2.

According to Walter's model, what is the relationship between r, Ke, and dividend policy?

If r > Ke (growth firm): retain all earnings, optimum payout = 0%. If r < Ke (declining firm): distribute all earnings, payout = 100%. If r = Ke (normal firm): dividend policy is irrelevant.

What is the central proposition of the Modigliani-Miller (MM) dividend irrelevance theory?

In a perfect market (no taxes, no transaction/flotation costs, perfect information), dividend policy is irrelevant to firm value; value depends only on earning power and investment decisions, not on the split between dividends and retention.

State Gordon's dividend capitalization model formula for share price.

P0 = E(1 - b) / (Ke - br) = D1 / (Ke - g), where b = retention ratio, r = return on investment, g = br = growth rate, E = earnings per share.

Define the Operating Cycle in working capital management.

The operating cycle is the time gap between acquiring raw materials and collecting cash from sale of finished goods = Raw material period + WIP period + Finished goods period + Debtors (receivables) period - Creditors (payables) period.

What is the difference between Gross Working Capital and Net Working Capital?

Gross Working Capital = total current assets. Net Working Capital = current assets - current liabilities (it indicates the liquidity margin financed by long-term sources).

What are the three approaches to financing working capital based on risk-return trade-off?

Conservative approach (low risk, low return - more long-term funds), Aggressive approach (high risk, high return - more short-term funds), and Hedging/Matching approach (match asset maturity with financing maturity).

What does the term 'Permanent' vs 'Temporary (Fluctuating)' working capital mean?

Permanent working capital is the minimum level of current assets always required to run operations. Temporary/fluctuating working capital is the extra amount needed to meet seasonal or cyclical demand spikes.

What is the Economic Order Quantity (EOQ) formula in inventory management?

EOQ = sqrt[(2 x A x O) / C], where A = annual demand, O = ordering cost per order, C = carrying cost per unit per year.

What is the Miller-Orr model used for in cash management?

It is a cash management model used when cash flows are uncertain/random; it sets an upper limit, a lower limit, and a return point, buying/selling securities only when cash hits the upper or lower bound.

Define a 'cash discount' policy and its purpose in receivables management.

A cash discount is a reduction (e.g., 2/10 net 30) offered to customers for early payment; its purpose is to speed up collection, reduce the average collection period, and lower the investment in receivables.

Define Strategic Management.

Strategic management is the set of managerial decisions and actions that determine the long-run performance of an organization - it involves formulating, implementing, and evaluating cross-functional strategies to achieve objectives.

Distinguish between Vision and Mission of an organization.

Vision describes what the organization aspires to become in the future (long-term aspiration). Mission states the organization's fundamental purpose - what business it is in, whom it serves, and how - in the present.

What are the three levels of strategy in an organization?

Corporate-level strategy (overall scope/direction of the firm), Business-level strategy (how to compete in a particular market/SBU), and Functional-level strategy (operational plans for departments like marketing, finance, HR).

What is a Strategic Business Unit (SBU) and its three characteristics?

An SBU is a distinct, autonomously managed division of a firm. Characteristics: (1) it is a single business or collection of related businesses, (2) it has its own set of competitors, and (3) it has a manager responsible for strategic planning and profit.

List the components of PESTLE analysis of the external macro-environment.

Political, Economic, Social (socio-cultural), Technological, Legal, and Environmental (ecological) factors.

Name the five forces in Michael Porter's Five Forces model of industry analysis.

1) Threat of new entrants, 2) Bargaining power of buyers, 3) Bargaining power of suppliers, 4) Threat of substitute products/services, 5) Rivalry among existing competitors.

What does SWOT analysis stand for and which factors are internal vs external?

Strengths, Weaknesses, Opportunities, Threats. Strengths and Weaknesses are internal organizational factors; Opportunities and Threats are external environmental factors.

What is the Value Chain analysis and its two activity categories?

Value chain analysis (Porter) examines activities that create value/competitive advantage. Primary activities: inbound logistics, operations, outbound logistics, marketing & sales, service. Support activities: firm infrastructure, HR management, technology development, procurement.

In the BCG Growth-Share Matrix, name the four categories and their axes.

Axes: market growth rate (vertical) and relative market share (horizontal). Categories: Stars (high growth, high share), Cash Cows (low growth, high share), Question Marks/Problem Children (high growth, low share), and Dogs (low growth, low share).

State Porter's three generic competitive strategies.

Cost Leadership (lowest cost producer), Differentiation (unique products/services commanding a premium), and Focus/Niche (targeting a narrow segment via cost focus or differentiation focus).

In the Ansoff Product-Market Growth Matrix, name the four strategies.

Market Penetration (existing product, existing market), Product Development (new product, existing market), Market Development (existing product, new market), and Diversification (new product, new market).

Distinguish between related (concentric) and unrelated (conglomerate) diversification.

Related/concentric diversification adds businesses sharing synergy with existing operations (technology, markets, products). Unrelated/conglomerate diversification adds businesses with no commonality to existing operations, mainly for financial/risk-spreading reasons.

What is the difference between expansion through Merger and through Acquisition (Takeover)?

A merger combines two companies into one (often mutual, forming a new/surviving entity). An acquisition/takeover is one company purchasing controlling interest in another, which may be friendly or hostile; the acquired company may retain its identity.

What are the key types of strategic alliances/cooperative strategies?

Joint ventures (separate jointly-owned entity), strategic alliances (cooperation without new entity), licensing/franchising, and outsourcing arrangements - all used to share resources, risk, and access markets/technology.

What is Strategy Implementation and how does it differ from formulation?

Strategy implementation is putting the chosen strategy into action - allocating resources, designing structure, leadership, and systems. Formulation is deciding what to do (an entrepreneurial, analytical, intellectual task); implementation is doing it (an administrative, operational, motivational task).

What is a Balanced Scorecard and its four perspectives used in strategy evaluation?

The Balanced Scorecard (Kaplan & Norton) translates strategy into performance measures across four perspectives: Financial, Customer, Internal Business Process, and Learning & Growth (innovation).

What are the three core activities of the strategy evaluation and control process?

1) Establishing standards/targets and reviewing the underlying bases of strategy, 2) Measuring actual performance against standards, and 3) Taking corrective action where deviations exist.