PREVIOUS YEAR SOLVED PAPERS - July 2018
48. Profitability Index of a Project is the ratio of present value of cash inflows to:
- Option : C
- Explanation : Profitability Index (PI) or Benefit-Cost Ratio (B/C Ratio): Yet another time-adjusted capital budgeting technique is profitability index (PI) or benefit-cost ratio (B/C). It is similar to the NPV approach. The profitability index approach measures the present value of returns per rupee invested, while the NPV is based on the difference between the present value of future cash inflows and the present value of cash outlays. A major shortcoming of the NPV method is that, being an absolute measure, it is not a reliable method to evaluate projects requiring different initial investments. The PI method provides a solution to this kind of problem. It is, in other words, a relative measure. It may be defined as the ratio which is obtained dividing the present value of future cash inflows by the present value of cash outlays. Symbolically,
This method is also known as the B/C ratio because the numerator measures benefits and the denominator costs. A more appropriate description would be present value index.
Accept-Reject Rule: Using the B/C ratio or the PI, a project will qualify for acceptance if its PI exceeds one. When PI equals 1, the firm is indifferent to the project. When PI is greater than, equal to or less than 1, the net present value is greater than, equal to or less than zero respectively. In other words, the NPV will be positive when the PI is greater than 1; will be negative when the PI is less than one. Thus, the NPV and PI approaches give the same results regarding the investment proposals.
The selection of projects with the PI method can also be done on the basis of ranking. The highest rank will be given to the project with the highest PI, followed by others in the same order.
49. Which one of the following statements is false?
- A
Effective dividend policy is an important tool to achieve the goal of wealth maximisation.
- B
According to Walter, the optimal payout ratio for a growth firm is 100%.
- C
MM model asserts that the value of the firm is not affected whether the firm pays dividend or not.
- D
‘Bird-in-the-hand theory’ in reference to dividend decision has been developed by Myron Gordon.
- Option : B
- Explanation : Bird-in-the-Hand Theory: Dividends are Preferred: The principal conclusion of MM’s dividend irrelevance theory is that dividend policy does not affect the required rate of return on equity, rs. This conclusion has been hotly debated in academic circles. In particular, Myron Gordon and John Lintner argued that rs decreases as the dividend payout is increased because investors are less certain of receiving the capital gains that are supposed to result from retaining earnings than they are of receiving dividend payments. Gordon and Lintner said, in effect, that investors value a dollar of expected dividends more highly than a dollar of expected capital gains because the dividend yield component is less risky than the expected capital gain.
MM disagreed. They argued that rs is independent of dividend policy, which implies that investors are indifferent between dividends and capital gains. MM called the Gordon- Lintner argument the bird-in-the-hand fallacy because, in MM’s view, most investors plan to reinvest their dividends in the stock of the same or similar firms, and, in any event, the risk of the firm’s cash flows to investors in the long run is determined by the risk of operating cash flows, not by dividend payout policy.
- A
It refers to an obligation of an individual, firm or institution to account for its activities and accept responsibility for them.
- B
It refers to the process that helps the organization and its employees to link with their external environment through specific activities/functions.
- C
It refers to the science of morals, principles and rules of conduct.
- D
It refers to multiculturism management.
- Option : B
- Explanation : Boundary-Spanning Roles: Katz and Kahn (1966, 172-173, italics original) emphasise that organisations consist of “acts or events... a set of activities” which “constitute the role to be performed”. Aldrich and Herker (1977) identified two types of boundary-spanning functions: information processing and external representation. They consider organisational boundaries as well defined with clear organisational structure, while arguing that it is the boundary-spanning activities that need attention given the amount of information the organisation receives from the external environment. This function of information processing serves the organisational decisionmaking process and therefore the role of boundary spanning is intra-organisational. Another function Aldrich and Herker (1977) investigate is representing the organisation externally in the business environment and the role of boundary spanners is interorganisational.
