Part-A

6. To invest in more than one risky security is called a portfolio.

7. Time value of money means that the value of sum of money received today is more than its value
received after a year sometime.
8. Diversification is a corporate strategy to enter into a new market or industry which the
business is not currently in, whilst also creating a new product for that new market.
9. Generally, the higher the expected return, the higher the risk is. In the following graph the
relationship between risk and return is shown.

Expected Return

Risk premium
Risk free rate

0 Risk
Fig: Combination of risk and return
Part-B
1. To accomplish the financial activities properly, all kinds of business firms need to collect funds.
Simply, business finance is the collecting funds from several selected sources at the lowest cost and
invest them in the highest profitable way. In a broad sense, business finance is the combination of all
financial activities including raising of funds, using of fund, adjusting and controlling to earn profit by
any business organization.
According to Gloss and backer, “Business Finance is concerned with the sources of funds available to
enterprises of all sizes and the proper use of money or credit obtained from such sources”.
According to E. W. Walker, “Business finance can be broadly defined as the activity concerned with the
planning, raising, controlling and administering of funds in the business.”
Features of definition:
a. Business finance is the planning of the required funds.
b. Business finance is concerned with the accomplishing financial activities of a firm.
c. Business finance invests funds by adjusting the risk-return trade-off.
d. Business finance achieves short-term and long-term goal through business finance.
2.
Subject Profit Maximization Wealth Maximization
1. Definition The maximization of firm’s net Share price represents the owner’s
income is called profit maximization. wealth in the firm. So, maximizing
the share price of the shareholders of
the firm is called wealth
maximization.
2. Time It does not consider the time value of It considers the time value of money.
value of
 money money.
3. Dividend In this case dividend policy is not Here, dividend policy is logically
policy logically made. made.
4. Risk It does not consider the risk of the It considers the risk of the firm.
project.
5. Value of Through profit maximization, value Through wealth maximization, the
the firm. of the firm is not increased. value of the firm is increased.
6. Cash It does not consider the cash flows of It considers the cash flows of the
flows the project. project.
7. Exactness It is not a clear concept. It is a clear concept.
8. Monetary Profit maximization does not Wealth maximization policy
policy consider the monetary policy. considers
the monetary policy.
9. Retained In this case, an adequate amount of In this case, an adequate amount of
earnings earnings is not retained for future
expansion. earnings is retained for future
expansion.
10. Salvage In profit maximization, salvage value In wealth maximization, salvage
value is not considered. value is considered.

4.
Subject Money market Capital market
1.Definition The market in which short-term The markets in which long-term
securities are traded is called money securities are traded are called capital
market. market.
2. Example Bangladesh bank, different Dhaka Stock Exchange and Chittagong
commercial banks, etc. Stock Exchange.
3.Maturity The maturity of the money market The maturity of the capital market
securities is one day to one year. securities is more than one year.
4. Example of Treasury bills, commercial paper, Common stock, preferred stock, bonds
securities Banker’s acceptance, etc. etc.
5. Liquidity Money market securities are highly Capital market securities are
liquid comparatively lower liquid.
6. Selling Generally securities are sold at Securities are sold at par, premium, or
pattern discount. discount.

Part-C
2. A person who is actively involved in the financial affairs of any organization is called financial
manager. The three major decisions taken by the financial managers are:
1. Investment decision: In order to estimate and arrange for a cash requirement of any
enterprise, it is necessary to decide how much cash will be invested in fixed assets and how
much in current assets. Accordingly, investment in assets can be categorized in two ways:
 a. Working capital management: Here, the manager has to take decision on how much
money he should invest in current asset to perform its operation efficiently.
b. Capital budgeting: Here, the manager takes long-term investment decisions. To take
long-term decisions, manager considers financing requirements, length of the projects,
expected future income, etc.
2. Financing decision: Here, financial manager is to identify the requirements and sources of
finance to attain the desired project. The financial manager will choose that optimal debt-
equity mix where the cost of capital is the lowest.
Major decisions
of a financial
manger

Investment Financing Dividend

decision decision decision

Working capital Capital

management budgeting

3. Dividend decisions: How to allocate the net profit of the firm is another important decision of
a financial manager. The available net profits of the firm can be allocated for three purposes:
(a) paying dividends to the shareholders (b) distributing bonus to the employees for better
performance, and (c) retaining the profit for the expansion of business.

3. The objective of a firm is to maximize the economic welfare of the owners of the firm. There
are two widely discussed approaches:
1. Profit Maximization Approach
2. Wealth maximization Approach.
Profit maximization approach: When income is higher than expenditure then it is called profit.
Corporations commonly measure profits in terms of earnings per share (EPS), which is represented
by:
Earnings available for common stockholders
EPS= No . of shares outstanding
Earnings per share
Projects Year 1 Year2 Year 3 Total for years 1,2 and 3
X 1.40 1.00 0.50 2.90
Y 0.60 1.00 1.40 3.00
In terms of the profit maximization goal, X is better than Y because it has higher earnings per share.
Why profit maximization is not a reasonable goal:
1. It ignores the timing of returns and time value of money: Profit maximization concept
does not consider the time value of money. In the above example, project X is better than
Y if we consider time of the value of money.
2. It ignores the cash flow concept: Profit maximization concept considers accounting
profit which is calculated on accrual basis.
Comparative statistics of two companies
Company A Company B
Sales 20,000 Sales 20,000
 100% cash sales 10% cash sales
0% due in next year 90% due in next year
In terms of profit maximization goal, both transactions is equal. However, company A is
in a better position because of cash flow.
3. It ignores risk: Profit maximization does not consider the risk and uncertainty. For
example,
Project Year 1 Year 2 Year 3 Year 4 Year Total profit
5
A 200 -100 200 -300 650 650
B 50 100 110 150 200 610
Though project A provides higher profit, project B is better because it has less risk.
Wealth Maximization: The ultimate goal of the firm is to maximize the wealth of the owners
for whom it is being operated.
Wealth=price per share × No. of shares

Financial
Decision Return? Increase …
Financial Y
Accept manager Alternative or Risk? share price
action

Reject
According to Ross Westerfield, “The goal of financial management is to maximize the current
value per share of the existing stock.”
According to I. M. Panday, “Shareholder wealth maximization means maximizing the net
present value of a course of action to shareholders. The net present value of a course of
action is the difference between the present value of its benefits and present value of its cost”.
We can use the following formula to measure the present value of wealth of a firm.

[
Wealth=NPV= ( 1+ k )
CF 1
1
+
CF 2
( 1+k ) 2
+−−−−+
CF n
( 1+ k )n ] −CF 0

Why wealth maximization should be the ultimate goal of a firm:

1. Wealth maximization criterion considers the timing of return and time value of money:
Considering the time value of money concept, the present values of cash inflows and outflows
helps the management to achieve the overall objective of an organization.
2. It considers risk: The concept of wealth maximization considers the impact of risk factor
while calculating the Net Present Value (NPV) at a particular discount rate.
3. It considers cash flow: The wealth maximization criterion is based on the concept of cash
flows rather than accounting profit.
Cash flows and risk affect the share price. That is,
Higher cash flow Higher share price
Higher risk Lower share price
Finally we can say that the profit maximization as a goal of a firm fails to maximize the welfare
of the shareholders whereas wealth maximization eliminates all the weaknesses of profit
maximization. That is why; wealth maximization should be the ultimate goal of a firm.