Q1.) Which cryptographic system is used in Electronic Cash Transactions?
Ans. Public-key cryptography and digital signatures (both blind and non-blind signatures) make e-money possible. The basic gist is that banks and customers would have public-key encryption keys. Public-key encryption keys come in pairs. A private key known only to the owner, and a public key, made available to everyone. Whatever the private key encrypts, the public key can decrypt, and vice verse.
Banks and customers use their keys to encrypt (for security) and sign (for identification) blocks of digital data that represent money orders. A bank "signs" money orders using its private key and customers and merchants verify the signed money orders using the bank's widely published public key. Customers sign deposits and withdraws using their private key and the bank uses the customer's public key to verify the signed withdraws and deposits
To understand the digital cash let us first view the token system (traditional)

Fm

Walter’s Model
Walter JE supports the view that the dividend policy has a bearing on the market price of the share and has presented a model to explain the relevance of dividend policy for valuation of the firm based on the following assumptions:
- All investment proposals of the firm are to be financed through retained earnings only and no external finance is available to the firm.
- The business risk complexion of the firm remains same even after fresh investment decisions are taken. In other words the rate of return on investments i.e. ‘r’ and the cost of capital of the firm i.e., ke , are constant.
- The firm has an infinite life.
This model considers that the investment decisions and the dividend decision of a firm are inter related. A firm should or should not pay dividends depends upon whether it has got the suitable investment opportunities to invest the retained earnings or not.
The dividend policy of a firm depends upon the relationship between r & ke . If r>ke the firm should have zero payout and reinvest the entire profits to earn more than the investors. If, however, r is less than ke then the firm should have the 100% payout ratio. If r=ke, the dividend is irrelevant and the dividend policy is not expected to affect the market value of the share.
Formula to testify this: P= D/Ke + [(r/ke) (E-D)]/Ke
D= Dividend per share paid by the firm
P= Market price of the equity share
R+ Rate of return on investment of the firm
Ke= Cost of equity share cap[ital
E= earnings per share of the firm.

Gordon’s Model
Myron Gordon’ model suggests that the dividend policy is relevant and can affect the value of the firm as well as the share. The assumptions are same as Walter’s Model. Two new assumptions have been made:
- The growth rate of the firm ‘g’ is the product of retention ratio ‘b’ and its rate of return ‘r’, i.e., g=br
- The cost of capital besides being constant is more than the growth rate, i.e., ke >g
Gordon argues that the investors do have a preference for current dividends and there is a diect relationship between the dividend policy and the market value of the share. Investors are basically risk averse and thus they value current dividends more highly than an expected future capital gain. This is called the “bird-in-hand” argument. When the investors are certain about their returns they discount the firm’s earnings at a lower rate and thus placing a higher value for the share and that of the firm. And the vice-versa happens if the returns are not certain.
Formula to testify this: P= E(1-b)/ ke –br
B= Retention ratio (1- payout ratio)
r= rate of return on the investment of the firm.

Modigliani and Miller Approach:
The irrelevance of dividend policy for the valuation of the firm has been most comprehensively presented by MM. They have argued that the market price of the share is affected by the earnings of the firm and is not influenced by the pattern of income distribution. Thus, what is important is the company’s investment decisions which determi9ne the earnings of the firm.
The MM approach to irrelevance of dividend is based on the following assumptions:
- The capital markets ate perfect and the investors behave rationally.
- All the information is freely available to all the investors.
- There is no transaction cost and no big time lag.
- Securities are divisible and can be split into any fraction. No investor can affect the market price.
- There are no taxes and floatation cost.
- The firm has a defined investment policy and the future profits are known with certainty.
They have used the ARBITRAGE process to show that the division of profits between dividends and retained earnings is irrelevant from the point of view of shareholders. They have shown that given the investment opportunities, a firm will raise an equal amount of new share capital externally by selling new shares . the amount of dividends paid to existing share holders will be replaced by new share capital raised externally.
Formula to testify this: P0 = 1/(1+ke) * (D1 + P1)
P0 = present market value of the share
D1 = Expected dividend at the end of the year 1.
P1 = Expected market price of the share at the end of the year 1
The value of the firm can be calculated as:
nP0= 1/ (1 + Ke) * (nD1 + nP1)
n= number of equity shares outstanding
If the firm declares to finance its investment decision by issuing ‘m’ no. of equity shares at a price ‘P1’ , then it will raise funds equal to mP1
Thus, mP1 = I – ( E – n D1 )
I= total investment made
E=Total earnings
nD1= Total dividend paid
Thus, if the firm raises mP1 amount of capital, then its value can be calculated as:
nP0 = 1/(1+Ke )[ (n+m) P1 – I + E]
The process of Arbitrage can be better explained with the help of the following example:
Q. A firm has 1 lac shares outstanding and planning div. of Rs. 5 at the end of the year 1. Present market price of the share is Rs. 100, Ke is 10%. Calculate the P1 if
(i) if div is paid
(ii) if div. is not paid

Q2. Now with the same example calculate the market value of the firm if , the firm’s total earnings were Rs. 10lakhs and it is planning to invest Rs.20 lakhs in the end of year1
(i) If it pays div. of Rs.5
(ii) If it does not pay div of Rs.5

Operating Cycle:
The operating cycle of a firm consists of the time required for the completion of the chronological sequence of some or all of the following events:
i) Procurement of raw materials and services.
ii) Conversion of raw materials onto work in progress.
iii) Conversion of work in progress into finished goods
iv) Sale of finished goods(cash or credit)
v) Conversion of receivables into cash.

Operating Cycle Period: The length of time duration of the operating cycle of any firm can be defined as the sum of its Inventory Conversion Period and the Receivable Conversion Period.
ICP- it is the time required for the conversion of raw materials into finished goods for sales. In a mfg. firm the ICP consists of Raw Material Conversion Period, Work in Progress Coversion Period, and Finished Goods Conversion Period.
RCP: it is the time required to convert the credit sales nto cash realization.
ICP + RCP = Total OCP (TOCP)
Net OC = TOCP – Deferral Period (DP)-[ the period for which the credit facilities are availed by the firm.]

Management of cash:
Baumol’s Model:
This model is same as the EOQ model of the inventory management. This model attempts to balance the income foregone on cash held by the firm against the transaction cost of converting cash into marketable securities or vice-versa.
Assumption: The firm uses the cash at an already known rate per period and that this rate of use is constant.
Holding Cost: there is always a cost of holding the cash by the firm. This cost may be the opportunity cost in terms of the interest foregone on the investment of this cash.
Transaction Cost: Whenever cash is to be converted into marketable securities, or vice-versa, there is always a cost involved in the form of brokerage, commission etc.
This model is based on the proposition that in order to reduce the holding cost, a firm keeps the least amount cash in hand. However, as the cash level depletes, the firm can acquire cash by selling some of its marketable securities. Each time the firm transacts in this way, it bears transaction cost, so , it will like to transact as occasionally as possible. This could be done by maintaining a higher cash level involving a high holding cost. Thus, the firm has to deal with holding cost as well as the transaction cost. The optimum cash balance is found by controlling the holding cost and transaction cost so as to minimize the total cost of holding cash.
It can be presented as : c √ 2FT/r
C= cash required each time to restore balance to minimum cash
F= Total cash required during the year.
T= cost of each transaction between cash and marketable securities
R= Rate of interest on marketable securities

CAPM- Capital Asset Pricing Model

A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.

The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).

The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas).

Using the CAPM model and the following assumptions, we can compute the expected return of a stock: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2 and the expected market return over the period is 10%, the stock is expected to return 17% (3%+2(10%-3%)).

Ra = Rf= + βa (Rm – Rf )
Rf= risk free rate
β a = beta of the security
Rm = expected market return

cut-off point

the cut off point refers to the point below which a project would not be accepted. For Example. if 10% is the desired rate of return, the cut-off rate is 10%. The cut-off point may also be in terms of period. For example, if the management desires that the investment in the project should be recouped in 3 years , the period of three years would be taken as the cut-off point. A project, incapable of generating necesaary cash to pay for the initial investment in the project within three years will not be accepted.

time value of money

The time value of money' is the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. In other words, the present value of a certain amount of money a is greater than the present value of the right to receive the same amount of money time t in the future. This is because a amount of money could be deposited in an interest-bearing bank account (or otherwise invested) from now to time t and yield interest. Consequently, lenders acting at arm's length demands interest payments for use of their capital.
Additional motivations for demanding interest are to compensate for the risk of borrower default and the risk of inflation (as well as some other more technical factors).

finacing decisions

Investment Decision
Management must allocate limited resources between competing opportunities ("projects") in a process known as capital budgeting. Making this capital allocation decision requires estimating the value of each opportunity or project: a function of the size, timing and predictability of future cash flows.

The financing decision
Achieving the goals of corporate finance requires that any corporate investment be financed appropriately. As above, since both hurdle rate and cash flows (and hence the riskiness of the firm) will be affected, the financing mix can impact the valuation. Management must therefore identify the "optimal mix" of financing – the capital structure that results in maximum value. (See Balance sheet, WACC, Fisher separation theorem; but, see also the Modigliani-Miller theorem.)
The sources of financing will, generically, comprise some combination of debt and equity. Financing a project through debt results in a liability that must be serviced - and hence there are cash flow implications regardless of the project's success. Equity financing is less risky in the sense of cash flow commitments, but results in a dilution of ownership and earnings. The cost of equity is also typically higher than the cost of debt (see CAPM and WACC), and so equity financing may result in an increased hurdle rate which may offset any reduction in cash flow risk.
Management must also attempt to match the financing mix to the asset being financed as closely as possible, in terms of both timing and cash flows.


The dividend decision
In general, management must decide whether to invest in additional projects, reinvest in existing operations, or return free cash as dividends to shareholders. The dividend is calculated mainly on the basis of the company's unappropriated profit and its business prospects for the coming year. If there are no NPV positive opportunities, i.e. where returns exceed the hurdle rate, then management must return excess cash to investors - these free cash flows comprise cash remaining after all business expenses have been met. (This is the general case, however there are exceptions. For example, investors in a "Growth stock", expect that the company will, almost by definition, retain earnings so as to fund growth internally. In other cases, even though an opportunity is currently NPV negative, management may consider “investment flexibility” / potential payoffs and decide to retain cash flows; see above and Real options.)
Management must also decide on the form of the distribution, generally as cash dividends or via a share buyback. There are various considerations: where shareholders pay tax on dividends, companies may elect to retain earnings, or to perform a stock buyback, in both cases increasing the value of shares outstanding; some companies will pay "dividends" from stock rather than in cash. (See Corporate action.) Today it is generally accepted that dividend policy is value neutral

discounted cash flow

In finance, the discounted cash flow (or DCF) approach describes a method to value a project or an entire company using the concepts of the time value of money. The DCF methods determine the present value of future cash flows by discounting them using the appropriate cost of capital. This is necessary because cash flows in different time periods cannot be directly compared since most people prefer money sooner rather than later (put simply: a dollar in your hand today is worth more than a dollar you may receive at some point in the future). The same logic applies to the difference between certain cash flows and uncertain ones, or "a bird in the hand is worth two in the bush". This is due to opportunity cost and risk over time.
DCF procedure involves three problems
the forecast of future cash flows,
the incorporation of taxes (firm income taxes as well as personal income taxes),
the determination of the appropriate cost of capital.
Discounted cash flow analysis is widely used in investment finance, real estate development, and corporate financial management.
Depending on the financing schedule of the company four different DCF methods are distinguished today. Since the underlying financing assumptions are different they do not need to arrive at the same value of the project or company:

fm

The internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments.
The IRR is the return rate which can be earned on the invested capital, i.e. the yield on the investment.
A project is a good investment proposition if its IRR is greater than the rate of interest that could be earned by alternative investments (investing in other projects, buying bonds, even putting the money in a bank account). The IRR should include an appropriate risk premium.
Mathematically the IRR is defined as any discount rate that results in a net present value of zero of a series of cashflows.
In general, if the IRR is greater than the project's cost of capital, or hurdle rate, the project will add value for the company.



Net present value (NPV) is a standard method for financial evaluation of long-term projects. Used for capital budgeting, and widely throughout economics, it measures the excess or shortfall of cash flows, in present value (PV) terms, once financing charges are met. By definition,
NPV = Present value of cash inflows - Present value of cash outflows. For its expression, see the formula section below.
Formula
Each cash inflow/outflow is discounted back to its PV. Then they are summed. Therefore

Where
t - the time of the cash flow
n - the total time of the project
r - the discount rate
Ct - the net cash flow (the amount of cash) at that point in time.
C0 - the capitial outlay at the begining of the investment time ( t = 0 )
If... It means... Then...
NPV > 0 the investment would add value to the firm the project should be accepted
NPV < 0 the investment would subtract value from the firm the project should be rejected
NPV = 0 the investment would neither gain nor lose value for the firm the project could be accepted as shareholders obtain required rate of return


Payback Period

Payback period in business and economics refers to the period of time required for the return on an investment to "repay" the sum of the original investment. For example, a $1000 investment which returned $500 per year would have a two year payback period. It is intuitively the measure that describes how long something takes to "pay for itself"; shorter payback periods are obviously preferable to longer payback periods (all else being equal). Payback period is widely used due to its ease of use despite recognized limitations, described below.
The expression is also widely used in other types of investment areas, often with respect to energy efficiency technologies, maintenance, upgrades, or other changes. For example, a compact fluorescent light bulb may be described of having a payback period of a certain number of years or operating hours (assuming certain costs); here, the return to the investment consists of reduced operating costs. Although primarily a financial term, the concept of a payback period is occasionally extended to other uses, such as energy payback period (the period of time over which the energy savings of a project equal the amount of energy expended since project inception); these other terms may not be standardized or widely used.
Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavour. When used carefully or to compare similar investments, it can be quite useful. As a stand-alone tool to compare an investment with "doing nothing", payback period has no explicit criteria for decision-making (except, perhaps, that the payback period should be less than infinity).
The payback period is considered a method of analysis with serious limitations and qualifications for its use, because it does not properly account for the time value of money, inflation, risk, financing or other important considerations. Alternative measures of "return" preferred by economists are internal rate of return and net present value. An implicit assumption in the use of payback period is that returns to the investment continue after the payback period. Payback period does not specify any required comparison to other investments or even to not making an investment.