An overview on Financial Management is described.

1. AN OVERVIEW ON FINANCIAL MANAGEMENT
Mrs. LUBNA SURAIYA M.Com., MBA., DIT., M.Phil., PGDE., (Ph.D)
Full Time Research Scholar
Research Department of Commerce
Holy Cross College, Tiruchirapalli - 2
Email : lubnasadiyah@gmail.com

2. MEANING OF FINANCIAL MANAGEMENT
Financial Management means planning, organizing, directing and
controlling the financial activities such as managing money, including credit unions,
credit card companies, insurance companies, accountancy companies, consumer-
finance companies, stock brokerages, investment funds, and some government
sponsored enterprises or procurement of financial resources and utilization of funds
of the enterprise.
DEFINITIONS OF FINANCIAL MANAGEMENT
In words of Solomon, “Financial management aims to effectively use the
capital funds which also happens to be a significant economic resource.”
According to Phillippatus, “Financial Management is concerned with the
managerial decisions that results in the acquisition and financing of short and long
term credits for the organizations.

3. OBJECTIVES OF FINANCIAL MANAGEMENT
OBJECTIVES
Basic Objectives
Secondary Objectives

4. OBJECTIVES OF FINANCIAL MANAGEMENT
1) Ensure regular and adequate supply of funds to the concern (Liquidity).
2) Maximization of owners’ wealth : Wealth maximization means maximizing the
market value of investment in shares of the company.
Wealth of shareholders = Number of shares held × Market price per share
3) Adequate returns to the shareholders (Profitability)
(a) funds should be invested in safe ventures
(b) depend upon the earning capacity, market price of the share.
4) Optimum funds utilization (Financial Control) : cut down unnecessary costs.
5) Sound capital structure : Fair composition mix between debt, debentures, shares
and equity capital.

5. 6) Security of funds through the creation of reserves re-investing profits, etc.
(minimization of risk). Some of the reserves created for this purpose are Sinking
Funds, General Reserves etc.
7) Profit Maximization happens when Marginal Cost = Marginal Revenue
Marginal Cost is an increase or decrease in the total cost of a production run for
making one additional unit of an item. Marginal Cost = (Change in Costs) / (Change
in Quantity).
Marginal Revenue = Marginal revenue is the increase in revenue that results from
the sale of one additional unit of output.
8) Solvency : A business can meet financial commitments in the long run (5 years).

6. DIFFERENCE BETWEEN LIQUIDITY AND PROFITABILITY
Liquidity
1. The liquidity is the ability of a firm to pay its short term obligation for the
continuous operation.
2. A firm is considered normally financially solid and low risky which has huge cash in
its balance sheet.
3. The liquidity is not only measured by the cash balance but also by all kind of assets
which can be converted to cash within one year without losing their value.
4. The liquidity of a firm is measured primarily by Current Ratio and Net Working
Capital.
5. The liquidity measures also include the quality of current assets. Expenses,
repayment of loans, purchase of assets or distribution of profits and dividends.

7. 6. Liquidity measures the ease at which a business can meet its immediate
and short-term financial obligations (usually due within the next 12
months).
7. Liquidity measurement ratio is called the Current Ratio (i.e. Current
Assets / Current Liabilities). Ideally 2:1
8. A business is said to have good liquidity when use of cash to make
payments for expenses, repayment of loans, purchase of assets (equipment,
vehicles, machinery) or distribution of profits and dividends.

8. Profitability
1. The profitability measures the economic success of the firm irrespective to cash flow
in the firm. A firm is very profitable in its books but it does not have sufficient cash
and cash equivalent to pay its daily bills and due obligations.
Profit = Revenue - Expenses
2. The profitability of a firm is measured by the ROE (return on equity) and ROA
(return on assets).
3. It illustrates that the firm can survive without profit for some years but the long term
survival is not possible without profit.
4. The Return On Equity is estimated on accrual basis of accounting irrespective to the
actual cash flow. Return On Asset is estimated by the considering the return before
fixed financing costs to total capital invested (Debt plus Equity).

9. 5. The state of yielding profit or financial gain.
6. Profitability is a financial performance measure that is reported on the
Statement of Financial Performance (Profit & Loss Statement) as the
‘bottom line’ Net Profit.
7. Profit = Revenue – Expenses
Profitability is the amount of revenue remaining after deducting all the
expenses.
8. Profitability provides the financial rewards.
9. Return on investment on capital is created by the profitability of a
business.

12. TECHNIQUES OF FINANCIAL MANAGEMENT
Technique # 1. Common-Size Statements:
1) Figures are converted into percentage to some common base.
2) Identification of causes for changes taken place over a period of time.
3) Each percentage shows the relation of the individual item to its respective total.
Technique # 2. Trend Ratios:
1. The trend of financial items which are used in analysis of behaviour are prepared
and projected for financial statements.
2. The Base accounting period should be selected given the index number of 100.
Technique # 3. Funds Flow Analysis:
i. Funds flow statement is a parameter for testing of the effective use of working
capital.
ii. Movement of funds which cause a change in working capital of the organization.
iii. The net increase or decrease in working capital is analyzed by preparation of
Statement of changes in working capital position

13. Technique # 4. Cash-Flow Analysis:
i. It reports a net cash inflow or outflow for each activity and for the overall
business.
ii. Net changes in cash receipts and cash payments.
iii. Resulting from operating, investing and financing activities of an enterprise
during the period.
Technique # 5. Ratio Analysis:
1. Ratios are used as an index or yardstick for evaluating the financial position and
performance of a firm.
2. Make quantitative judgment about the financial position and performance of the
firm
3. The comparison of past ratios with future ratios shows the firm’s relative strength
and weaknesses.
Technique # 6. Working Capital Management: Day to day expenses for operation
Technique # 7. Capital Structure:
1. Optimum capital structure to maximize the wealth of shareholders.
2. EPS , EBIT analysis, financial break-even point,
Technique # 8. Capital Budgeting Techniques:
1. Investment in long-term assets for increasing the revenue of firm.
2. Long-term planning for proposed capital outlays and financing.

14. OTHER DISCIPLINES AND FINANCIAL MANAGEMENT
I. Production Department
1. Production cycle
2. Skilled and unskilled labour
3. Storage of finished goods
4. Capacity utilization
5. Replacing machinery
6. Installation of safety devices
II. Material Department:
1. Maintenance and supply of materials
2. Procurement
3. Determining Economic Order Quantity
EOQ is a tool used to determine the volume and frequency of orders required to satisfy
a given level of demand while minimizing the cost per order.

15. Components of the EOQ Formula:
D : Annual Quantity Demanded
Q : Volume per Order
S : Ordering Cost (Fixed Cost)
C : Unit Cost (Variable Cost)
H : Holding Cost (Variable Cost) (I *C)
I : Carrying Cost (Interest Rate)
III. Personnel Department:
1. Recruitment
2. Training
3. Placement
4. Evaluate employees’ welfare
5. Revision of their pay scale
6. Incentive Schemes
IV. Marketing Department:
1. Marketing
2. Selling
3. Advertising
4. policies to achieve the sales target
5. increase the market share
6. create a brand name

16. V. Cost Accounting:
1. Monitor expenditures
2. Proper utilization of funds
3. Operational costs of the firm
VI. Financial Accounting:
1. Ensuring that funds are procured at optimum cost
2. Minimum financial risk
3. Take decisions
VII. Mathematics and Economics:
1. Application of Statistical Tools
2. Discount Factor
3. Time Value
4. Present Value of Money
5. Cost of Capital
6. Capital Structure Theories
7. Dividend Theories
8. Ratio Analysis
9. Working Capital Analysis

17. SOURCES OF FINANCE
INTRODUCTION
Choosing the right source and the right mix of finance is a key challenge
for every finance manager. The process of selecting the right source of finance
involves in-depth analysis of each and every source of fund. There are many
characteristics on the basis of which sources of finance are classified.
1. On the basis of Time
2. On the basis of Ownership & Control
3. On the basis of Source of Generation

19. ON THE BASIS OF TIME
LONG-TERM SOURCES OF FINANCE
 Long-term financing means capital requirements for a period of more than 5
years to 10, 15, 20 years.
 Capital expenditures in fixed assets like plant and machinery, land and building
etc of a business are funded using long-term sources of finance.
 Part of working capital which permanently stays with the business is also
financed with long-term sources of funds.
1. Equity shares represent the ownership of a company and capital raised by the
issue of such shares is known as ownership capital or owner's funds.
Equity shareholders are paid on the basis of earnings of the company and do not
get a fixed dividend.

20. 2. Preference shares more commonly referred to as preferred stock. Preference
shares are those shares which carry certain special or priority rights. Firstly, dividend
at a fixed rate is payable on these shares before any dividend is paid on equity shares.
Preference shares are shares in a company that are owned by people who have the right
to receive part of the company's profits before the holders of ordinary shares are paid.
They also have the right to have their capital repaid if the company fails and has to
close.
3. Debentures : A long-term security yielding a fixed rate of interest, issued by a
company and secured against assets.
4. Bonds : A fixed income investment in which an investor loans money to an entity
(typically corporate or governmental) which borrows the funds for a defined period of
time at a variable or fixed interest rate. Bonds are used by companies, municipalities,
states and sovereign governments. Owners of bonds are debt holders/creditors.

21. 5. Term Loan: A monetary loan that is repaid in regular payments over a set period
of time. Term loans usually last between one and ten years, but may last as long as 30
years in some cases. A term loan usually involves an unfixed interest rate that will
add additional balance to be repaid.
6. Venture capital (VC) : A type of private equity, a form of financing that is
provided by firms or funds to small, early-stage, emerging firms that are deemed to
have high growth potential, or which have demonstrated high growth (in terms of
number of employees, annual revenue, or both).
Securitization is the process of taking an illiquid asset, or group of assets, and
through financial engineering, transforming them into a security.
7. Asset Securitization: An asset-backed security (ABS) is a financial security
collateralized by a pool of assets such as loans, leases, credit card debt, royalties or
receivables.

22. 8. Internal Accruals : The accumulation of retained earnings and depreciation
charges. The depreciation charge is considered an internal source of funds and is a
non-cash charge. The retained earnings make a portion of the equity earnings that
are reinvested in the business.
9. International finance : The economic and monetary system that transcends
national borders. Concerned with exchange rates of currencies, monetary systems of
the world, foreign direct investment (FDI). The risk of fluctuating prices of currency
depends upon the business cycles.

23. MEDIUM TERM SOURCES OF FINANCE
 Medium term financing means financing for a period of 3 to 5 years and is used
generally for two reasons.
 Firstly, when long-term capital is not available for the time being
 Secondly when deferred revenue expenditures like advertisements are made
which are to be written off over a period of 3 to 5 years.
Deferred Revenue Expenditure ?
VIDEO 1

24. 1. Lease Financing : A way of providing finance in which a finance company is the
legal owner of the asset for the duration of the lease. The owner of the assets is
called lessor and the user of the asset is called lessee. The lessee not only has
operating control over the asset, but also has a substantial share of the economic
risks and returns from the change in the valuation of the underlying asset. Assets
such as vehicles, equipment or software are popular items attracting lease finance.
2. Hire Purchase Financing : Hire purchase (HP) or leasing is a type of asset
finance that allows firms or individuals to possess and control an asset during an
agreed term, while paying rent or installments covering depreciation of the asset,
and interest to cover capital cost. The ownership is transferred only after the
paying all installments.
3. Debentures/ Bonds
4. Preference Shares

25. 5. Other forms of Medium Term Loans
1. Financial Institution : A company engaged in the business of dealing
with financial and monetary transactions, such as deposits, loans, investments and
currency exchange.
2. Commercial Banks : A commercial bank is a type of financial institution that
accepts deposits from the general public, offers checking account services, makes
business, personal and mortgage loans, giving loans for investment with the aim of
earning profit and offers basic financial products like certificates of deposit (CDs)
and savings accounts to individuals and small businesses.
3. Public Sector Banks : Public sector bank is a bank in which the government
holds a major portion of the shares or majority stake (i.e. more than 50%). PNB is
a public sector bank, the government holds a stake of 58.87% and SBI with the
government holding in this bank is 58.60%.

26. SHORT TERM SOURCES OF FINANCE
 Short term financing means financing for a period of less than 1 year.
 The need for short-term finance arises to finance the current assets of a business
like an inventory of raw material and finished goods, debtors, minimum cash
and bank balance etc.
 Short-term financing is also named as working capital financing.
1. Trade Credit : An arrangement to buy goods or services on account, that is,
without making immediate cash payment. Trade credit is the credit extended to
you by suppliers who let you buy now and pay later.

27. 2. Fixed Deposit : A fixed deposit (FD) is a financial instrument provided by banks
which provides investors a higher rate of interest than a regular savings account, until
the given maturity date.
3. Factoring Services : Factoring is a financial transaction and a type of debtor
finance in which a business sells its accounts receivable (i.e., invoices) to a third party
(called a factor) at a discount. A business will sometimes factor its receivable assets to
meet its present and immediate cash needs.
4. Payables :

28. ON THE BASIS OF OWNERSHIP & CONTROL : OWNED
1. Equity Capital : The capital that a company gets from selling shares rather than
borrowing money.
2. Preference Capital :The Preference Capital is that portion of capital which is raised
through the issue of the preference shares. This is the hybrid form of financing that has
certain characteristics of equity and certain attributes of debentures.
3. Retained Earnings: Retained earnings are the net earnings after dividends that are
available reinvestment in the company's core business or to pay down its debt.
4. Convertible Debentures : A convertible debenture is a type of loan issued by a company
that can be converted into stock. Convertible debentures are different from convertible
bonds because debentures are unsecured; in the event of bankruptcy, the debentures are
paid after other fixed-income holders.

29. 5. Venture Funds: Venture capital is financing that investors provide to startup
companies and small businesses that are believed to have long-term growth
potential. Venture capital generally comes from well-off investors, investment banks
and any other financial institutions.
BORROWED
1. Commercial Loans : A commercial loan is a debt-based funding arrangement
between a business and a financial institution such as a bank, typically used to fund
major capital expenditures and/or cover operational costs that the company may
otherwise be unable to afford, as opposed to a loan made to an individual.
2. Debenture : A debenture is a type of debt instrument that is not secured by
physical assets or collateral. Debentures are backed only by the general
creditworthiness and reputation of the issuer. Both corporations and governments
frequently issue this type of bond to secure capital.
3. Financial Institutions

30. ON THE BASIS OF SOURCE OF GENERATIONS : INTERNAL
Internal is same as Owned
i. Equity Capital
ii. Preference Capital
iii. Retained Earnings
iv. Convertible Debentures
v. Venture Capital
External
1. Retained Profits : Profits generated by a company that are not distributed to
stockholders (shareholders) as dividends but are either reinvested in the business or
kept as a reserve for specific objectives (such as to pay off a debt or purchase a capital
asset). Retained earnings are reduced by losses, and are also called accumulated
earnings, profit, income, surplus, earned surplus, undistributed earnings, or undivided
profits.

31. 2. Reduction of Working Capital : The working capital cycle (WCC) is the
amount of time it takes to turn the net current assets and current liabilities into
cash. ... Therefore, companies strive to reduce their working capital cycle by
collecting receivables quicker or sometimes stretching accounts payable.
3. Sale of assets : An asset sale is completed only when the assets of a company
are acquired by a buyer. This means the seller that sold the assets retains
ownership of the company, and must pay all of the existing liabilities and debts
before taking the net cash proceeds.

32. WORKING CAPITAL MANAGEMENT
MEANING
Working capital management refers to a company's managerial accounting
strategy designed to monitor and utilize the two components of working capital,
current assets and current liabilities, to ensure the most financially efficient operation
of the company.
NEED OF WORKING CAPITAL
 Production and increase Profitability
 Strengthen the Solvency
 Enhance Goodwill
 Easy Obtaining Loan : Creditworthiness
 Regular Payment of Dividend
 Regular Supply of Raw-materials
 Ability To Face Crisis like Depression or Recessions etc.
 Efficient Use of Fixed Assets (Depreciation)
 Long-term sources of fund used in financing current assets of a business enterprise.

33. TYPES OF WORKING CAPITAL
ON THE BASIS OF PERIODICITY:
1. The requirements of working capital are continuous.
2. On the basis of periodicity working capital can be divided under two categories as
under:
A) Permanent working capital:
1. This type of working capital is known as Fixed Working Capital.
2. The part of working capital which is permanently locked up in the current assets to
carry out the business smoothly.
3. The minimum amount of current assets which is required to conduct the business
smoothly during the year is called permanent working capital.
Fixed working capital can further be divided into two categories as under:
(I) Regular Working capital: Minimum amount of working capital required to keep the
primary circulation. Some amount of cash is necessary for the payment of wages,

34. (
(II) Reserve Margin Working capital: Additional working capital may also be required
for contingencies that may arise any time. The reserve working capital is the excess of
capital over the needs of the regular working capital is kept aside as reserve for
contingencies, such as strike, business depression etc.
(B) Variable or Temporary Working Capital: The term variable working capital refers
that the level of working capital is temporary and fluctuating. Variable working capital
may change from one assets to another and changes with the increase or decrease in the
volume of business.
1. Seasonal Variable Working capital: Seasonal working capital is the additional
amount which is required during the active business seasons of the year.
2. Special variable working capital: Additional working capital may also be needed to
provide additional current assets to meet the unexpected events or special operations
such as extensive marketing campaigns or carrying of special job etc.

35. II ON THE BASIS OF CONCEPT
(A)Gross Working Capital: Gross working capital refers to total investment in current
assets. The current assets employed in business give the idea about the utilization of
working capital and idea about the economic position of the company.
(B) Net Working Capital: Net working capital means current assets minus current
liabilities. The difference between current assets and current liabilities is called the net
working capital. If the net working capital is positive business is able to meet its current
liabilities. Net working capital concept provides the measurement for determining the
creditworthiness of company.

36. FACTORS DETERMINING WORKING CAPITAL
 Nature of Companies: The composition of an asset is a function of the size of a
business and the companies to which it belongs. Small companies have smaller
proportions of cash, receivables and inventory than large corporation. This
difference becomes more marked in large corporations.
 Demand of Creditors: Creditors are interested in the security of loans. They
want their obligations to be sufficiently covered. They want the amount of
security in assets which are greater than the liability.
 Time : The amount of working capital depends upon inventory turnover and the
unit cost of the goods that are sold. The greater this cost, the bigger is the
amount of working capital.

37. • Volume of Sales : A firm maintains current assets because they are needed to
support the operational activities which result in sales. They volume of sales and the
size of the working capital are directly related to each other. As the volume of sales
increase in the investment of working capital-in the cost of operations, in inventories
and receivables.
• Terms of Purchases and Sales: If the credit terms of purchases are more favorable
and those of sales liberal, less cash will be invested in inventory. With more
favorable credit terms, working capital requirements can be reduced.
• Inventory Turnover: If the inventory turnover is high, the working capital
requirements will be low. With better inventory control, a firm is able to reduce its
working capital requirements.
• Receivable Turnover: A prompt collection of receivables and good facilities for
setting payable results into low working capital requirements.

38. • Business Cycles : More working capital required during periods of prosperity and
less during the periods of depression.
• Variations in Sales: A seasonal business requires the maximum amount of working
capital for a relatively short period of time.
• Value of Current Assets: Decreases in the real value of current assets as compared to
their book value reduced the size of the working capital. If the real value of current
assets increases, there is an increase in working capital.
• Production Cycle: The time taken to convert raw materials into finished products is
referred to as the production cycle or operating cycle. The longer the production
cycle, the greater is the requirements of the working capital

39. • Credit Control: Credit control includes such factors as the volume of credit sales, the
terms of credit sales, the collection policy, etc. with a sound credit control policy, it is
possible for a firm to improve in cash inflow.
• Repayment Ability: A firm’s repayment ability determines level of its working capital.
The usual practices of a firm are to prepare cash flow projections according to its
plans of repayment and to fix working capital levels accordingly.
• Cash Reserves: It would be necessary for a firm to maintain some cash reserve to
enable it to meet contingent disbursements. This would provide a buffer against
abrupt shortages in cash flows.
• Change in Technology: Technological developments related to the production process
have a sharp impact on the need for working capital.
• Firm’s Policies: Change in credit and production policy affects working capital.

40. HOW TO DETERMINE WORKING CAPITAL
1) Financial institutions use two ratios – the current ratio and the quick ratio – to
measure the financial health or liquidity of a business.
2) The current ratio is obtained by dividing the value of current assets by the value
of current liabilities.
3) A ratio above one means the current assets are more than liabilities, which is
viewed positively.
4) The quick ratio measures the proportion of short term liquidity (current assets
minus inventory) to the current liabilities of a business. It gives a good idea of the
company’s ability to meet short-term expenses quickly.

41. FINANCIAL PLANNING
Financial planning is the task of determining how a business will afford to achieve its
strategic goals and objectives.
The Financial Planning activity involves the following tasks:
1. Assess the business environment
2. Confirm the business vision and objectives
3. Identify the types of resources needed to achieve these objectives
4. Quantify the amount of resource (labor, equipment, materials)
5. Calculate the total cost of each type of resource
6. Summarize the costs to create a budget
7. Identify any risks and issues with the budget set.

42. STEPS IN FINANCIAL PLANNING

44. COST OF CAPITAL
Meaning
1. Cost of capital is includes the cost of debt and the cost of equity. Another way to
describe cost of capital is the cost of funds used for financing a business.
2. Cost of capital depends on the mode of financing used — it refers to the cost of
equity if the business is financed solely through equity, or to the cost of debt if it is
financed solely through debt.
3. Many companies use a combination of debt and equity to finance their
businesses and, for such companies, the overall cost of capital is derived from a
weighted average of all capital sources, widely known as the weighted average cost
of capital (WACC).
4. Since the cost of capital represents a hurdle rate that a company must overcome
before it can generate value, it is extensively used in the capital budgeting process

46. WHAT IS CAPITAL STRUCTURE
The capital structure is how a firm finances its overall operations and
growth by using different sources of funds. Debt comes in the form of bond issues or
long-term notes payable, while equity is classified as common stock, preferred
stock or retained earnings. Short-term debt such as working capital requirements is
also considered to be part of the capital structure.

48. THORIES OF CAPITAL STRUCTURE
Capital Structure Theory # 1. Net Income (NI) Approach:
According to NI approach a firm may increase the total value of the firm by
lowering its cost of capital. When cost of capital is lowest and the value of the firm is
greatest, we call it the optimum capital structure for the firm and, at this point, the
market price per share is maximized.
(i) Cost of Debt (Kd) is less than Cost of Equity (Ke);
(ii) There are no taxes; and
(iii) The use of debt does not change the risk perception of the investors since the
degree of leverage is increased to that extent.
Since the amount of debt in the capital structure increases, weighted average cost of
capital decreases which leads to increase the total value of the firm. So, the increased
amount of debt with constant amount of cost of equity and cost of debt will highlight
the earnings of the shareholders.

49. Capital Structure Theory # 2. Net Operating Income (NOI) Approach:
Net Operating Income (NOI) Approach which was advocated by David Durand based
on certain assumptions.
(i) The overall capitalization rate of the firm Kw is constant for all degree of leverages;
(ii) Net operating income is capitalized at an overall capitalization rate in order to
have the total market value of the firm.
Thus, the value of the firm, V, is ascertained at overall cost of capital (Kw):
V = EBIT/Kw (since both are constant and independent of leverage)
(iii) The market value of the debt is then subtracted from the total market value in
order to get the market value of equity.
S – V – T
(iv) As the Cost of Debt is constant, the cost of equity will be
Ke = EBIT – I/S

50. Capital Structure Theory # 3. Traditional Theory Approach:
This approach encompasses all the ground between the Net Income Approach and the
Net Operating Income Approach, i.e., it may be called Intermediate Approach. The
traditional approach explains that up to a certain point, debt-equity mix will cause the
market value of the firm to rise and the cost of capital to decline. But after attaining the
optimum level, any additional debt will cause to decrease the market value and to
increase the cost of capital.
Thus, the basic proposition of this approach are:
(a) The cost of debt capital, Kd, remains constant more or less up to a certain level and
thereafter rises.
(b) The cost of equity capital Ke, remains constant more or less or rises gradually up to
a certain level and thereafter increases rapidly.
(c) The average cost of capital, Kw, decreases up to a certain level remains unchanged
more or less and thereafter rises after attaining a certain level.

51. Capital Structure Theory # 4. Modigliani-Miller (M-M) Approach:
Assumptions:
The MM proposition is based on the following assumptions:
(a) Existence of Perfect Capital Market It includes:
(i) There is no transaction cost;
(ii) Flotation costs are neglected;
(iii) No investor can affect the market price of shares;
(iv) Information is available to all without cost;
(v) Investors are free to purchase and sale securities.
(b) Homogeneous Risk Class/Equivalent Risk Class:
It means that the expected yield/return have the identical risk factor i.e., business risk
is equal among all firms having equivalent operational condition.

52. (c) Homogeneous Expectation:
All the investors should have identical estimate about the future rate of earnings of
each firm.
(d) The Dividend pay-out Ratio is 100%:
It means that the firm must distribute all its earnings in the form of dividend among
the shareholders/investors.
(e) Taxes do not exist:
That is, there will be no corporate tax effect (although this was removed at a
subsequent date).

53. Interpretation of MM Hypothesis:
The MM Hypothesis reveals that if more debt is included in the capital
structure of a firm, the same will not increase its value as the benefits of cheaper
debt capital are exactly set-off by the corresponding increase in the cost of equity,
although debt capital is less expensive than the equity capital. So, according to
MM, the total value of a firm is absolutely unaffected by the capital structure
(debt-equity mix) when corporate tax is ignored.