Prof M. S. Bhat – Managerial Economics and Financial Analysis

Managerial Economics and Financial Analysis

While Managerial Economics is the application of economics in decision making, financial analysis judges financial performance of a firm.
Several methods of analysis have been examined in the book, the two main tools being ratio analysis and analysis of balance sheet and profit and loss account of the firms. The book examines several steps involved in financial analysis: Establishing the objectives of the analysisStudying the various operations of the
industryCollection of information relevant for preparing financial statements and their evaluation

Salient Features

Chapter summaries, problems and their solutions at the end of each chapter.Multiple Choice Questions (MCQs) along with answers provided at the end of the Book.

Contents

1. Introduction to Managerial Economics

2. Elasticity of Demand

3. Theory of Production Function and Cost Analysis

4. Market Structures

5. Business and New Economic Environment

6. Working Capital Management

7. Introduction to Financial Accounting

8. Financial Analysis Through Ratios

About the Authors

Dr. M.S. Bhat, B.E.(IISc), M.Tech., PhD,
has been working in School of Management Studies JNTU for the past fifteen years as Professor of Management Science. For 10 years he was Head of School of Management Studies and for two and half years its Director. Presently, he is Chairman, Board of Management Studies.Dr. Bhat has more than 50 research articles to his credit and co-author of two books. He has successfully guided 6 research scholars for their PhD and another three are in advanced stage of the work. Dr. Bhat has also coordinated number of short term and Executive Development Programmes. He also held several Honorary Positions.

Mr. A.V. Rau, MBA, is presently working as Teaching Associate, Dept. of Management Studies, Andhra University Campus, Vizianagaram, A.P. He also worked as Asst. Professor, Management Science, Godavari Institute of Engineering and Technology, Rajahmundry.He has already authored one book – Management Science, published by BS Publications, Hyderabad.

Contents Detail:

Chapter 1 Introduction to Managerial Economics

1.1 Introduction ………………………………………………………………….. 1
1.2 Definition of Economics ………………………………………………………. 2
1.3 Microeconomics ………………………………………………………………. 3
1.4 Nature of Managerial Economics ………………………………………………. 4
1.5 Characteristics of Managerial Economics ………………………………….. 5
1.6 Scope of Managerial Economics ………………………………………………. 6
1.7 Managerial Economics and Other Subjects ………………………………….. 8
1.8 Demand Analysis ……………………………………………………………….. 9
1.9 Meaning of Demand …………………………………………………………. 10
1.10 Types of Demand …………………………………………………………….. 10
1.11 Determinants of Demand ……………………………………………….. 13
1 . 12 Law of Demand ………………………………………………………………… 1 5
Summary …………………………………………………………………………………. 18
Essay Questions ………………………………………………………………………… 19
Short Questions ………………………………………………………………………. 20
Contents (x)

Chapter 2 Elasticity of Demand

2.1 Elasticity of Demand ……………………………………………………. 21
2.2 Types of Elasticity ……………………………………………………….. 21
2.3 Factors Governing Elasticity of Demand ……………………………………….. 24
2.4 Demand Forecasting …………………………………………………… 25
2.5 Market Research Methods…………………………………………………… 26
2.6 Statistical Methods ……………………………………………………………. 26
2.7 Demand Estimation and Demand Forecasting ………………………………. 27
2.8 Importance of Demand Forecasting ……………………………………………… 28
2.9 Steps in Demand Forecasting ………………………………………………………. 29
2.10 Methods of Demand Forecasting …………………………………………………. 30
2.10.1 Consumers’ opinion survey ……………………………………………. 30
2.10.2 Expert opinion method or Delphi method ………………………… 30
2.10.3 Collective opinion surveyor sales force
opinion survey method ………………………………………………….. 31
2.1 0.4 Test marketing or controlled experimentation ………………….. 31
2.10.5 End-use or input-output method …………………………………….. 31
2.11 Statistical Methods ……………………………………. 31
2.11.1 Trend projection or mechanical exploration method …………. 32
2.11.2 Regression technique or method of least squares …………… 33
2.11.3 Moving Average Method ………………………………………………… 36
2.11.4 Leading indicators method …………………………………………….. 36
Summary …………………………………………. 38
Essay Questions ……………………………………………….. , 39
Short Questions ……………………………………. 40

Chapter 3 Theory of Production Function and Cost Analysis

3.1 Production Function ………………………. 41
3.2 Cobb-Douglas Producton Function ………………………. 42
3.2.1 Properties of Cobb-Douglas Production function …………….. 43
3.2.2 Managerial uses of production function ………………………….. 43
(xi) Contents
3.3 Law of Deminishing Returns or Law of Variable Proportions …………… 44
3.4 Production Function with Two Variable Inputs ………………………………… 45
3.5 Isoquants ……………………………. 45
3.6 Iso-cost or Least-cost Combination of Inputs …………………………………. 47
3.7 Economies and Diseconomies ……………………………… 47
3.8 Cost Analysis ………………………………………………… 48
3.9 Cost Function ………………………… 49
3.10 Determinanats of Cost ” ………………………………………. 49
3.11 Classification of Cost……………………………… 49
3.11.1 Classification on the Basis of Time …………………………………. 50
3.11.2 By Nature of Elements …………………………………………………… 50
3.11.3 By degree of Traceability to the Products ……………………….. 51
3.11.4 Association with the Product ………………………………………….. 51
3.11.5 By changes in Activity or Volume ……………………………………. 52
3.11.6 Functional Classification of Costs …………………………………… 53
3.11.7 Relationships with Accounting Period ……………………………… 53
3.11.8 Controllability …………………………….. 53
3.11.9 Cost of Analytical and Decision~Making Purposes ……………. 54
3.11.10 Other Costs …………………………….. 55
3.12 Cost-Output Relationship ……………………….. 56
3.13 Cost in short-run ………………………. 57
3.14 Cost in Long-run ……………………………………. 60
3.15 Optimum Size of the Firm ……………………………………….. 61
3.16 Break-Even Analysis – In the Narrao Sense ………………………………….. 62
3.17 Break-Even Chart…………………………………….. 66
3.18 CVP Anlysis ………………………………
3.19 Graphical Presentation of Break-Even Analysis
(Break Even Chart) ……………………….. 68
3.20 Simple Break-Even Chart …………………….. 69
3.20.1 Break-even Analysis through Tabular Form …………………….. 69
3.20.2 Second Method ………………….. 70
Contents (xii)
3.21 Contribution Break-Even Chart ………………………………. 71
3.22 Profit Break-Even Chart ………………………………………….. 71
Summary ………………………………………. 80
Essay Questions ……………………………… 83
Short Questions ……………………………. 84

Chapter 4 Market Structures

4.1 Market ………………………………….. 85
4.2 Classification of Markets ………………………… 86
4.3 Market Structure
4.4 Features of Perfect Competition …………………………………… 90
4.5 Role of Time Factor in determination of Price ………………………………… 91
4.6 Equilibrium Point …………………………. 91
4.7 Imperfect Competition …………………. 91
4.8 Feature of Monopoly ……………………………… 92
4.9 Types of Monopoly………………………………… 92
4.10 Is Monopoly Socially Desirable? …………………………………………………… 93
4.11 Arguments in Favour of Monopoly ……………………………………………….. 94
4.12 Characteristics of Monopolistic Competition ………………………………….. 94
4.13 Oligopoly ………………………………………. 95
4.14 objectives and Policies of Pricing Methods …………………………………… 96
4.15 Strategy-Based Pricing ……………………………. 100
4.15.1 Market skimming ………………. 100
4.15.2 Market penetration ………………… 100
4.15.3 Two-part pricing ………………….. 100
4.15.4 Block pricing ………………….. 101
4.15.5 Commodity bundling ………………………. 101
4.15.6 Peak load pricing …………………………………… 101
4.15.7 Cross-subsidisation ………………….. 102
4.15.8 Transfer pricing ……………………………… 102
Contents
4.16 Pricing Strategies in Times of Stiff Price Competition …………………… 103
4.16.1 Price Matching ……………………… 103
4.16.2 Promoting Brand Loyalty ……………………… 103
4.16.3 Time-to-time Pricing …………………………….. 103
4.16.4 Promotional Pricing ………………………… 104
4.17 Intiating Changes in Price ……………………….. 104
4.17.1 Circumstances …………………………. 104
4.17.2 Tactics ………………………………….. 104
4.17.3 Estimating Competitor Reaction …………………………. 104
Summary …………………………….. 104
Essay Questions …………………………………………………. 106
Short Questions ……………………………………………….. 107

Chapter 5 Business and New Economic Environment

5.1 Introduction…………………………………………. 108
5.2 Sale Proprietorship ………………………………………. 109
5.2.1 Merits of sale proprietorship ………………………………………… 110
5.2.2 Importance of the sale proprietorship form of
organization ………………………………….. 111
5.3 Partnership Firm. . ………………………………. 112
5.3.1 Types of Partners and Partnership Firms ……………………… 112
5.3.2 Kinds of partnership firms ……………………………………………. 113
5.3.3 Merits of Partnership Form …………………………………………… 114
5.3.4 Demerits of the Partnership …………………………………………. 114
5.4 Joint Hindu Family Firm ……………………………………………………………… 115
5.4.1 Features of Joint Hindu Family Firm ……………………………… 116
5.4.2 Advantages of a Joint Hindu Family Firm ………………………. 116
5.4.3 Disadvantages ……………………………………………………………. 116
5.5 Joint Stock Company …………………………………………………………………. 117
5.5.1 Features of a Joint Stock Company ………………………………. 117
5.5.2 Merits of a Company form of Organisation …………………….. 118
5.5.3 Demerits of a Company form of Organisation ………………… 119
Contents (xiv)
5.6 Co-operative Form of Organisation …………………………………………….. 121
5.6.1 Features of a Co-operative Organisation ……………………… 122
5.6.2 Merits of a Co-operative Society …………………………………… 122
5.6.3 Demerits of co-operative society ………………………………….. 123
5.7 Public Enterprises and Their Types ……………………………………………. 124
5.7.1 Conversion of a private company into a
public company …………………………………………………………… 126
5.8 Public Enterprises and their Types ……………………………………………… 126
5.8.1 Forms of Public Enterprises …………………………………………. 127
5.8.2 Problems faced by Public Enterprises …………………………… 128
5.9 Disinvestment in Post-Liberalisation, Privatisation and ……………………… .
Globalisation Period ………………………………………………………………….. 129
5.10 Changing Business Environment in Post-Liberalisation Scenario ….. 129
5.10.1 The impact of economic reforms on Liberalisation,
Privatisation and Globalisation …………………………………….. 130
Summary ……………………………………………………………………………………………….. 132
Eassy Questions ……………………………………………………………………………………. 135
SlIort Questions …………………………………………………………………………………….. 136

Chapter 6 Capital and Capital Budgeting

6.1 Introduction ………………………………………………………………………………. 137
6.2 Concepts of Working Capital ……………………………………………………… 137
6.3 Need of Working Capital ……………………………………………………………. 139
6.4 Importance of Working Capital …………………………………………………… 141
6.5 Excess or Inadequate Working Capital ……………………………………….. 142
6.5.1 Disadvantages of Inadequate Working Capita!. ……………… 142
6.5.2 Disadvantages of Excessive Working Capital ………………… 143
6.5.3 Working 9apital Cycle …………………………………………………. 143
6.6 Determinants of Working Capital ………………………………………………… 145
(xv) Contents
6.7 Financing of Working Capital …………………………………………………….. 148
6.7.1 Sources of Working Capital ………………………………………….. 148
6.7.2 Finance Mix of Working Capital ……………………………………. 149
6.7.3 Determing the Working Capital Financing Mix ……………….. 153
6.8 Management of Different Components of Working Capital ……………. 154
6.8.1 Motives for Holding Cash ……………………………………………… 155
6.8.2 objectives of Cash Management.. ………………………………… 155
6.8.3 Minimising funds locked up as cash balances ……………….. 156
6.9 Capital Budgeting ……………………………………………………………………… 156
6.10 Importance of Capital Budgeting ………………………………………………… 156
6.11 Capital Budgeting Process …………………………………………………………. 157
6.12 Capital Budgeting Appraisal Techniques ……………………………………… 159
6.12.1 Traditional Methods …………………………………………………….. 159
6.12.2 Pay – Back Period Method …………………………………………… 159
6.12.3 Acceptance rule ………………………………………………………….. 160
6.12.4 Merits …………………………………………………………………………. 160
6.12.5 Demerits …………………………………………………………………….. 160
6.12.6 Improvements in Traditional Approach to
Pay Back Period Method ……………………………………………… 161
6.13 Accounting Rate of Return (ARR) Method …………………………………… 162
6.13.1 Acceptance Value ……………………………………………………….. 162
6.13.2 Merits …………………………………………………………………………. 163
6.13.3 Demerits …………………………………………………………………….. 163
6.14 Discounted Cash Flow Techniques or Modern Techniques …………… 164
6.14.1 Acceptance rule ………………………………………………………….. 164
6.15 Net Present Value Method …………………………………………………………. 164
6.15.1 Acceptance Rule …………………………………………………………. 164
6.15.2 Merits …………………………………………………………………………. 164
6.15.3 Demerits …………………………………………………………………&hell

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