UGC NET Commerce Business Finance Syllabus

Define the Profitability Index (PI).

PI = Present Value of Cash Inflows / Initial Investment (or PV of outflows). It is also called the Benefit-Cost ratio.

State the Profitability Index decision rule.

Accept the project if PI > 1; reject if PI < 1; the project is indifferent at PI = 1.

Why is NPV generally preferred over IRR for mutually exclusive projects?

NPV assumes reinvestment at the cost of capital (more realistic), always gives a single value, and directly measures wealth added; IRR can give multiple or conflicting rankings and assumes reinvestment at the IRR itself.

What problem can arise with IRR for projects with non-conventional cash flows?

Multiple IRRs (more than one rate giving NPV = 0) can occur when cash flow signs change more than once, making IRR unreliable.

What is the Modified Internal Rate of Return (MIRR)?

A refinement of IRR that assumes cash inflows are reinvested at the cost of capital rather than at the IRR, eliminating the multiple-IRR problem.

What is the cost of capital in capital budgeting?

The minimum required rate of return a firm must earn on its investments to satisfy its providers of capital; it is used as the discount/hurdle rate (also called the cut-off rate).

What does the Net Income (NI) approach to capital structure state?

Proposed by David Durand, it holds that using more debt (cheaper than equity) lowers the overall cost of capital and increases firm value; thus an optimal capital structure exists at maximum debt.

What does the Net Operating Income (NOI) approach state?

Also by Durand, it argues that the overall cost of capital and firm value are independent of capital structure because increasing debt raises the cost of equity, offsetting the benefit; there is no optimal structure.

State the key conclusion of the Modigliani-Miller (MM) theorem without taxes.

In a perfect market without taxes, a firm's value is independent of its capital structure; value depends only on its operating earnings and business risk (capital structure irrelevance).

How does the MM theorem change when corporate taxes are introduced?

With corporate taxes, debt provides an interest tax shield, so firm value rises with leverage; value of levered firm = value of unlevered firm + (tax rate x debt).

What is the Traditional approach to capital structure?

A view that an optimal capital structure exists at a particular debt-equity mix where the weighted average cost of capital is minimised and firm value is maximised; beyond that point added debt raises overall cost.

What does Walter's model say about dividend policy?

Dividend policy affects firm value depending on the relationship between the firm's return on investment (r) and cost of capital (k): if r > k, retain earnings (growth firm); if r < k, distribute all (declining firm); if r = k, policy is irrelevant.

What is the central idea of Gordon's dividend model?

Investors prefer current dividends to future capital gains ('bird-in-hand'); dividend policy affects share value, and value = D1/(k − g) where g = retention ratio x return on investment.

What is the MM dividend irrelevance hypothesis?

Under perfect markets, the value of a firm depends only on its earning power and investment policy, not on how earnings are split between dividends and retained earnings; dividend policy is irrelevant to value.

What is a stable dividend policy?

A policy of paying a fixed or steadily growing dividend per share regardless of short-term earnings fluctuations, signalling stability and attracting investors who value predictable income.

What does the residual theory of dividends propose?

Dividends should be paid only out of earnings left over after financing all acceptable positive-NPV investment projects; the dividend is the 'residual' amount.

Define exchange rate risk (currency risk).

The risk that the value of a firm's cash flows, assets, or liabilities will change due to fluctuations in foreign exchange rates.

What is transaction exposure?

The risk that exchange rate changes between the date a transaction is contracted and the date it is settled will alter the home-currency value of receivables or payables denominated in foreign currency.

What is translation (accounting) exposure?

The risk that consolidating foreign subsidiaries' financial statements into the parent's reporting currency produces gains or losses purely from exchange rate movements, with no immediate cash flow effect.

What is economic (operating) exposure?

The risk that long-term changes in exchange rates affect a firm's future cash flows, competitive position, and overall market value.

List the main internal hedging techniques for currency risk.

Netting, matching, leading and lagging, invoicing in home currency, and price/asset-liability adjustments.

What is 'leading and lagging' as a hedging technique?

Leading means accelerating payment/collection of a foreign-currency obligation when favourable, and lagging means delaying it; timing is adjusted to benefit from expected exchange rate movements.

What is a forward contract used for hedging?

A customised over-the-counter agreement to buy or sell a currency at a fixed exchange rate on a specified future date, locking in the rate and eliminating uncertainty.

How does a currency futures contract differ from a forward?

Futures are standardised, exchange-traded contracts with daily marking-to-market and margin requirements, whereas forwards are customised, OTC, and settled only at maturity.

What is a currency option for hedging?

A contract giving the holder the right, but not the obligation, to buy (call) or sell (put) a currency at a fixed exchange rate before/on a date, in exchange for a premium; it caps downside while keeping upside.

What is a currency swap?

An agreement between two parties to exchange principal and/or interest payments in one currency for equivalent amounts in another currency over a period, used to hedge long-term currency exposure.

What is the Eurocurrency market?

The market for currencies deposited and lent in banks outside the country of issue (e.g., US dollars held in European banks as Eurodollars); it operates free of domestic regulations and reserve requirements.

What is a Eurodollar?

A US dollar-denominated deposit held in a bank outside the United States; it is the most widely traded Eurocurrency.

What is a Eurobond?

A bond issued and sold outside the country in whose currency it is denominated (e.g., a dollar bond issued in Europe), free from the issuing country's regulations.

What is a Global Depository Receipt (GDR)?

A negotiable instrument issued by a depository bank representing shares of a foreign company, traded on international (typically European) exchanges and denominated usually in US dollars or euros, allowing companies to raise capital globally.

What is an American Depository Receipt (ADR)?

A negotiable certificate issued by a US depository bank representing shares of a foreign company, traded on US stock exchanges in US dollars, enabling Americans to invest in foreign firms.

State two key differences between an ADR and a GDR.

ADRs are issued and traded only in the US markets in US dollars and regulated by the US SEC; GDRs are issued and traded in international (mainly European) markets in dollars or euros across multiple countries. ADRs target US investors; GDRs target global investors.