UGC NET Management Unit - V Syllabus

State the Net Income (NI) approach to capital structure (Durand).

It assumes the cost of debt and cost of equity remain constant regardless of leverage; therefore increasing debt lowers the overall cost of capital (WACC) and raises firm value. The optimal capital structure is at maximum debt (100% debt).

State the Net Operating Income (NOI) approach to capital structure.

It holds that the overall cost of capital (Ko) and firm value are independent of the capital structure; as debt increases, the cost of equity rises just enough to offset the cheaper debt, so WACC stays constant and there is no optimal capital structure.

What does the Modigliani-Miller (MM) theory state about capital structure (without taxes)?

In a perfect market without taxes, the value of a firm is independent of its capital structure (Proposition I); the cost of equity rises linearly with leverage (Proposition II). With corporate taxes, value rises with debt due to the interest tax shield.

What is the traditional approach to capital structure?

A compromise view holding that judicious use of debt initially lowers WACC and raises firm value up to a point; beyond an optimal level, rising financial risk increases both cost of debt and equity, raising WACC. Thus an optimal capital structure exists.

Explain Walter's model of dividend policy and its key conclusions.

Walter's model links dividend policy to firm value via P = [D + (r/Ke)(E - D)] / Ke. If r > Ke (growth firm), retain all earnings (zero payout); if r < Ke (declining firm), pay out all earnings (100% payout); if r = Ke (normal firm), dividend policy is irrelevant.

What does Gordon's model conclude about dividend policy?

Gordon's 'bird-in-the-hand' model argues dividends are relevant because investors prefer certain current dividends to uncertain future capital gains. For growth firms (r > Ke) value rises with retention; for declining firms (r < Ke) value rises with higher payout.

What is the MM dividend irrelevance theory?

Under perfect markets, no taxes, and given investment policy, Modigliani and Miller argue dividend policy does not affect share value; the value depends only on earning power and investment decisions. Investors can create 'homemade dividends', making payout immaterial.

What factors determine a firm's dividend policy?

Stability and level of earnings, liquidity/cash position, growth and investment opportunities, access to capital markets, legal and contractual restrictions, taxation, shareholder preferences, control considerations, and the desire to maintain a stable dividend record.

What is corporate restructuring?

The process of significantly changing a company's structure, operations, ownership, or finances to improve efficiency and increase value. It includes mergers, acquisitions, demergers, divestitures, spin-offs, leveraged buyouts, and financial (capital) restructuring.

How is value created (synergy) in mergers and acquisitions?

Synergy means the combined value exceeds the sum of the standalone values (2+2=5). Sources include operating synergy (economies of scale/scope, revenue enhancement, cost cuts) and financial synergy (lower cost of capital, tax benefits, greater debt capacity).

Distinguish between a merger, an acquisition, and an amalgamation.

A merger combines two firms into one surviving entity (absorption) or a new one (consolidation). An acquisition is one firm taking control of another, which may continue to exist. Amalgamation is the legal blending of two or more companies into one new company.

What is the role of the exchange ratio (swap ratio) in merger negotiations?

The exchange ratio is the number of acquirer's shares given for each target share. It is negotiated using relative EPS, market price, or book value, and determines how the combined entity's value and any synergy gains are shared between the two sets of shareholders.

What is a Leveraged Buyout (LBO)?

The acquisition of a company financed predominantly with borrowed funds (debt), where the assets and cash flows of the target serve as collateral and the source of debt repayment. It allows acquirers to make large purchases with relatively little equity.

What is a Management Buyout (MBO)?

A form of LBO in which the existing management team of a company acquires a controlling stake, usually using substantial debt financing, thereby converting from managers into owners of the firm.

What is a takeover, and how does a friendly takeover differ from a hostile one?

A takeover is acquisition of control over a target company. A friendly takeover is negotiated with and approved by the target's management/board, whereas a hostile takeover is pursued against the target board's wishes, typically through a direct tender offer to shareholders or a proxy fight.

Name common anti-takeover defence tactics.

Poison pill (issuing rights to dilute the raider), white knight (a friendly alternative acquirer), greenmail (buying back the raider's shares at a premium), crown jewel defence (selling key assets), golden parachutes, staggered boards, and the Pac-Man defence (counter-bid).

State the Capital Asset Pricing Model (CAPM) equation.

E(Ri) = Rf + βi x (Rm - Rf), where Rf = risk-free rate, βi = beta of the security, Rm = expected market return, and (Rm - Rf) = the market risk premium.

What does beta (β) measure in the CAPM?

Beta measures a security's systematic (non-diversifiable) risk—its sensitivity to market movements. β = 1 moves with the market; β > 1 is more volatile (aggressive); β < 1 is less volatile (defensive); β = 0 means no market risk.

What is the Security Market Line (SML)?

A graphical representation of the CAPM plotting expected return against beta (systematic risk). Its intercept is the risk-free rate and its slope is the market risk premium; correctly priced securities lie on the SML.

What is the Arbitrage Pricing Theory (APT)?

A multi-factor asset-pricing model in which a security's expected return is a linear function of several macroeconomic risk factors (e.g. inflation, GDP, interest rates), each with its own beta and risk premium. Unlike CAPM, it does not rely on a single market portfolio.

How does APT differ from CAPM?

CAPM uses a single factor (market portfolio) and rests on restrictive assumptions about investor preferences; APT is a multi-factor model based on the no-arbitrage principle, requiring fewer assumptions but not specifying which factors matter.

Distinguish between a call option and a put option.

A call option gives the holder the right (not obligation) to buy the underlying asset at a fixed strike price on/before expiry. A put option gives the holder the right to sell the underlying at the strike price. Buyers pay a premium for these rights.

What is the payoff at expiry to a call option buyer?

Payoff = max(ST - X, 0), where ST = spot price at expiry and X = strike price. Net profit = max(ST - X, 0) - premium paid. The call buyer profits when ST > X; loss is limited to the premium.

What is the payoff at expiry to a put option buyer?

Payoff = max(X - ST, 0), where X = strike price and ST = spot price at expiry. Net profit = max(X - ST, 0) - premium paid. The put buyer profits when ST < X; loss is limited to the premium.

Name the key determinants of an option's price (premium).

Current price of the underlying, strike price, time to expiration, volatility of the underlying, the risk-free interest rate, and expected dividends. Higher volatility and longer time to expiry raise both call and put premiums.

What are intrinsic value and time value of an option?

Intrinsic value is the in-the-money amount (call: max(S - X, 0); put: max(X - S, 0)). Time value is the excess of the option premium over intrinsic value, reflecting the chance of becoming more profitable before expiry; it decays to zero at expiration.

What is the Black-Scholes model used for?

It is a mathematical model for pricing European call and put options. It values an option using the current stock price, strike price, time to expiry, risk-free rate, and volatility, assuming lognormal price distribution and continuous trading.

Differentiate between a forward contract and a futures contract.

A forward is a customised, private (OTC) agreement to buy/sell an asset at a set price on a future date, with counterparty risk and settlement at maturity. A futures contract is standardised, exchange-traded, marked-to-market daily, and guaranteed by a clearinghouse, minimising default risk.

What are the three motives for holding cash (Keynes), and what is the goal of cash management?

Transaction motive (routine payments), precautionary motive (unforeseen contingencies), and speculative motive (exploiting bargains/opportunities). The objective of cash management is to maintain adequate liquidity to meet obligations while minimising idle cash to maximise returns.

What is the Baumol model of cash management?

It applies the EOQ logic to cash, determining the optimal cash conversion (transfer) size that minimises the sum of transaction (conversion) costs and the opportunity cost of holding cash. Optimal cash C* = √(2 x T x F / i), where T = annual cash need, F = transaction cost, i = interest rate.

What is the objective of inventory management and the EOQ formula?

To balance carrying (holding) costs against ordering costs while ensuring availability. The Economic Order Quantity EOQ = √(2 x A x O / C), where A = annual demand, O = ordering cost per order, and C = carrying cost per unit per year.

What is ABC analysis in inventory control?

A selective control technique classifying inventory by value: 'A' items are high value/low quantity (tight control), 'B' items are moderate value/quantity (moderate control), and 'C' items are low value/high quantity (loose control). It focuses managerial effort where it matters most.

What are the objectives and main components of receivables management?

To optimise the level of trade credit so as to maximise sales while controlling the cost of credit and bad debts. Components: setting credit standards, credit terms (period and discount), credit analysis/evaluation of customers, and collection policy/procedures.

What does the credit term '2/10, net 30' mean?

The buyer may take a 2% cash discount if payment is made within 10 days; otherwise the full invoice amount is due within 30 days. It is an incentive to encourage early payment and reduce the collection period.

What is payables management (accounts payable / trade credit)?

Managing the firm's short-term obligations to suppliers to maximise the use of interest-free trade credit (a spontaneous financing source) by delaying payment to the latest acceptable date—without forgoing worthwhile cash discounts or damaging supplier relations.

What is factoring?

A financial arrangement in which a firm sells its trade receivables (debtors) to a factor at a discount in exchange for immediate cash. The factor takes over collection and bookkeeping, and in non-recourse factoring also assumes the credit (bad-debt) risk.

Differentiate recourse factoring from non-recourse factoring.

In recourse factoring, the client bears the risk of bad debts—the factor can recover unpaid amounts from the client. In non-recourse factoring, the factor assumes the credit risk of customer default, charging a higher fee for this protection.

What is the foreign exchange market and its main participants?

A global, decentralised over-the-counter market for buying and selling currencies, determining exchange rates. Participants include commercial and central banks, forex dealers/brokers, multinational corporations, importers/exporters, investors, and speculators.

Distinguish between the spot rate and the forward rate in the forex market.

The spot rate is the current exchange rate for immediate delivery (typically settled in two business days). The forward rate is a rate agreed today for currency delivery at a specified future date, used to hedge against future exchange-rate fluctuations.

What is the difference between direct and indirect foreign-exchange quotations?

A direct quote expresses the price of one unit of foreign currency in terms of the home currency (e.g. Rs 83 = US$1 for an Indian). An indirect quote expresses one unit of home currency in foreign currency terms (e.g. US$0.012 = Re 1).