Financial Management Class 12 Important Questions and Answers Business Studies Chapter 9

We have given these Business Studies Class 12 Important Questions Chapter 9 Financial Management to solve different types of questions in the exam. Go through these Planning Class 12 Important Questions and Answers & Previous Year Questions to score good marks in the board examination.

Important Questions of Financial Management Class 12 Business Studies Chapter 9

Question 1.
In the paint industry, various raw materials are mixed in different proportions with petroleum for manufacturing different kinds of paints. One specific raw material is not readily and regularly available to the paint manufacturing companies. Bonier Paints Company is also facing this problem and because of this there is a time lag between placing the order and the actual receipt of the material. But, once it receives the raw materials, it takes less time in converting it into finished goods. Identify the factor affecting the working capital requirements of this industry. (CBSE 2018)
Answer:
The factor highlighted here is ‘Availability of raw material’.

Question 2.
VXL Ltd. is a company dealing in dairy products. It procures these products from Rajasthan and sells them to various parts of Delhi. A month before ‘Marico Ltd., a Haryana based company entered Delhi market with a similar range of products. State the impact of entry of Haryana based “Marico Ltd.’ on the working capital rquirements of VXL Ltd. Also, name the factor affecting the working capital requirements of VXL Ltd. (Compartment 2018)
Answer:
With entry ‘Marico Ltd.’, VXL Ltd. needs to increase its working capital. The factor is ‘level of competition’.

Question 3.
What is meant by ‘capital structure’? (All India 2017)
Answer:
Capital structure can be defined as the mix between the owners’ funds and borrowed funds.

Question 4.
What is meant by ‘financial management’? (Delhi 2017)
Answer:
Financial management is an area of financial decision-making harmonising individual motives and enterprise’s goals.

Question 5.
Name and state the aspect of financial management that enables to foresee the fund requirements both in terms of ‘the quantum’ and ‘the timings’. (All India 2016)
Or
Name and state the aspect of financial management that provides a link between investment and financing decisions. Foreign 2016
Answer:
Financial planning

Question 6.
The size of assets, the profitability and competitiveness are affected by one of the financial decisions. Name and state the decision. (Delhi 2016)
Answer:
Capital budgeting decision It relates to as how the funds of a firm are to be invested into different assets, so that the firm is able to earn highest possible return for the investors.

Question 7.
Radhika and Vani who are young fashion designers left their job with a famous fashion designer chain to set-up a company ‘Fashionate Pvt Ltd. ‘They decided to run a boutique during the day and coaching classes for entrance examination of National Institute of Fashion Designing in the evening. For the coaching centre they hired the first floor of a nearby building. Their major expense was money spent on photocopying of notes for their students. They thought of buying a photocopier knowing fully that their scale of operations was not sufficient to make full use of the photocopier.

In the basement of the building of ‘Fashionate Pvt Ltd’. Praveen and Ramesh were carrying on a printing and stationery business in the name of ‘Neo Prints Pvt Ltd’ Radhika approached Praveen with the proposal to buy a photocopier jointly which could be used by both of them without making separate investment, Praveen agreed to this.
Identify the factor affecting fixed capital requirements of‘Fashionate Pvt. Ltd.’ (Delhi 2016)
Answer:
Level of collaboration

Question 8.
‘Best Bulbs Pvt Ltd was manufacturing good quality LED bulbs and catering to local market. The current production of the company is 800 bulbs a day. Sumit, the marketing manager of the company surveyed the market and decided to supply the bulbs to five-star-hotels also. He anticipated the higher demand in future and decided to buy a sophisticated machine to further improve the quality and quantity of the bulbs produced.
Identify the factor affecting fixed capital requirements of the company. (Foreign 2016)
Answer:
Technology upgradation

Question 9.
Rizul Bhattacharya after leaving his job wanted to start a Private Limited Company with his son. His son was keen that the company may start manufacturing of mobile phones with some unique features. Rizul Bhattacharya felt that the mobile phones are prone to quick obsolescence and a heavy fixed capital investment would be required regularly in this business. Therefore, he convinced his son to start a furniture business.
Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya to choose furniture business over mobile phones. (All India 2016)
Answer:
Technology upgradation

Question 10.
Besides the dividend decision the finance function is concerned with two other broad decisions. Name these decisions. (Compartment 2015)
Answer:
Besides dividend decision, the two broad decisions concerned with finance are:

Investment decision
Financing decision

Question 11.
How does cost of debt affect the capital structure of a company? State. (All India 2015; Delhi 2015; Foreign 2014)
Answer:
When a firm is able to borrow at a lower rate, it increases the capacity to employ higher debt and can increase the debt component in the capital structure.

Question 12.
‘Bharat Express’ specialises in courier services. Its ‘wide range of express package and parcel service’ help business firms to make sure that the goods are made available to the customers at the right place and at the right time.
State with reason, whether the working capital requirements of ‘Bharat Express’ will be high or low. (All India 2015)
Answer:
Working capital requirement for Bharat Express will be low, as it is engaged in providing services.

Question 13.
A textile company is diversifying and starting a steel manufacturing plant.
State with reason the effect of diversification on the fixed capital requirements of the company. (Compartment 2015)
Answer:
The fixed capital requirements of the company will increase with diversification of business activity.

Question 14.
‘Indian Logistics’ has its own warehousing arrangements at key locations across the country. Its warehousing services help business firms to reduce their overheads, increase efficiency and cut down distribution time.
State with reason whether the working capital requirements of ‘Indian Logistics’ will be high or low. (Delhi 2015)
Answer:
Since, ‘Indian Logistics’ provides warehousing services which forms part of service industry therefore, working capital requirement would be low.

Question 15.
A steel manufacturing company is diversifying and starting a thermal power plant. State with reason the effect of diversification on the fixed capital requirements of the company. (Compartment 2015)
Answer:
Diversification of business activity would increase the fixed capital requirement of the company.

Question 16.
Define financial management. (Foreign 2014; All India 2011)
Answer:
According to Weston and Brighan, “Financial management is an area of financial decision-making harmonising individual motives and enterprise’s goals”.

Question 17.
What is the primary objective of financial management? (All India 2014; Delhi 2013)
Answer:
The primary aim of financial management is to maximise shareholders’ wealth.

Question 18.
Define capital structure. (Delhi 2014)
Answer:
Capital structure can be defined as the mix between the owners’ funds and borrowed funds.

Question 19.
What is meant by financial risk? (All Indio 2014)
Answer:
Financial risk refers to a position when a company is not able to meet its fixed financial charges namely interest, preference dividend payment and repayment obligations.

Question 20.
How does inflation affect the working capital requirements of a company? State. (Delhi 2014; Comportment 2013)
Answer:
With rising prices, larger amounts are required even to maintain a constant volume of production and sales. The working capital requirement of a business thus, become higher with higher rate of inflation.

Question 21.
How do ‘growing opportunities’ as a factor affect dividend decision? State. (Compartment 2013)
Answer:
A firm having higher growth opportunities may decide to retain more earnings and declare less dividends.

Question 22.
State how growth prospects affect the working capital requirement of a company? (Delhi 2013)
Answer:
If the growth potential of a concern is perceived to be higher, it will require large amount of working capital, so that it will be able to meet higher production and sales target whenever required.

Question 23.
Name the major determinant of dividend decision. (All India 2011)
Answer:
Dividends are paid out of current and past earnings. Therefore, earning is the most important determinant of dividend decision.

Question 24.
Which type of companies can declare higher.dividend? (Delhi (C) 2011)
Answer:
A company having stable earnings is in a position to declare higher dividends.

Question 25.
Name the financial decision which will help a businessman in opening a new branch of its business. (Delhl 2010)
Answer:
Investment decision helps a businessman in opening a new branch of its business.

Question 26.
Cost of debt is lower than the cost of equity share capital. Give reason why even then a company cannot work only with the debt? (All India 2010; Delhi 2010)
Answer:
A company cannot work only with debt because a company cannot be formed or be in existence without equity.

Question 27.
Name any two essential ingredients of sound working capital management. (All India 2010)
Answer:

Inventory management
Receivable management

Question 28.
Define fixed capital. (All India 2010; Delhi 2010)
Answer:
The amount by capital investment in fixed assets is called fixed capital, e.g. plant and machinery, land and building, etc.

Question 29.
What is working capital? (Delhi 2010)
Answer:
Working capital is that part of total capital which is required for holding current assets. It may also be defined as an excess of current assets over current liabilities.

Question 30.
What is meant by ‘financial management’? State primary objective of financial management’. (Delhi 2019,2012; All India 2012)
Or
Wealth maximisation is the primary objective of financial management. Explain with the help of diagram. (Compartment 2014)
Or
Explain the meaning and objective of financial management. (Delhi 2010)
Or
Explain the concept and the objective of financial management. (All India 2013)
Answer:
Financial management is concerned with optimal procurement as well as the usage of finance. For optimal procurement, different available sources of finance are identified and compared in terms of their costs and associated risks.

The primary objective of financial management is to maximise shareholders’ wealth. This means maximisation of the market value of equity shares. Increase in market value of shares depends on the financial decisions taken by the firm. Market price of the shares is the index of the capital invested. If the market price of the shares increases, it can be said that capital invested by the shareholders has been appreciating. On the contrary, fall in the market price of the shares has an adverse effect on their wealth.

The other main objectives of financial management are:
(i) Ensuring availability of funds at reasonable cost
(ii) Ensuring effective utilisation of funds.
(iii) Ensuring safety of funds by creating reserves and reinvestment of profits.

Question 31.
Explain the objectives of financial planning. Delhi 2019
Or Somnath Ltd. is engaged in the business of export of garments. In the past, the performance of the company had been upto the expectations. In line with the latest technology, the company decided to upgrade its machinery. For this, the Finance Manager, Dalmia estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis. Dalmia therefore, began with the preparation of a sales forecast for the next four years. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds he is trying to find out alternative sources from outside.
Justify the financial concept discussed in the above paragraph. Also state the objectives to be achieved by the use of financial concept, so identified. (Delhi 2017)
The concept discussed in the above paragraph is ‘financial planning’.
The objectives to be achieved by the use of this concept are:
(i) To ensure availability of funds whenever these are required This includes a proper estimation of the funds required for different purpose such as for the purchase of long-term assets or to meet day-to-day expenses of business, etc. Apart from this, there is a need to estimate the time at which these funds are to be made available. Financial planning also tries to specify possible sources of these funds.

(ii) TO ensure unneccessary finance is not raised Excess funding is almost as bad as inadequate funding. Even if there is some surplus money, good financial planning would put it to the best possible use so that the financial resources are not left idle and don’t unnecessarily add to the cost.

Question 32.
State any three points of importance of Financial planning. (Delhi 2019; Comportment 2013)
Or
What is meant by financial planning? State any two points of importance of financial planning. (Compartment 2011; All India 2012; Delhi 2012)
Or
‘Financial planning tries to link the present with the future’. Explain the importance of financial planning in the light of this statement. (Delhi (c) 2010)
Or Explain the meaning of financial planning. Why is it important? Give any two reasons. (All India 2010)
Answer:
Financial planning is the preparation of financial Am. blueprint, which foresees entire fund requirement in respect to quantum as well as the timing. It is the process of estimating the fund requirements of business and specifying the sources of funds. It involves the preparation of a financial blueprint of an organisation’s future operations. The objective of financial planning is to ensure that enough funds are available at right time.

Financial planning is essential in financial management because:
(i) Helps in avoiding business shocks and surprises Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments.
Hence, it helps in avoiding business shocks and surprises.
(ii) Helps in coordination It helps in coordinating various business activities, such as sales, purchase, production, finance, etc.
(iii) Helps in avoiding wastage of finance In the absence of financial planning, wastage of financial resources may take place. This arises due to the complex nature of business operations such as, excessively over or under estimation of finance for a particular business operation. Such type of wastages can be avoided through financial planning.

Question 33.
‘G Motors’ is the manufacturer of sophisticated cranes. The Production Manager of the company, reported to the Chief Executive Officer, Ashish Jain that one of the machines used in manufacturing sophisticated cranes had to be replaced to compete in the market, as other competitors were using automatic machines for manufacturing cranes. After a detailed analysis, it was decided to purchase a new automatic machine having the latest technology. It was also decided to finance this machine through long-term sources of finance. Ashish Jain compared various machines and decided to invest in the machine which would yield the maximum returns to its investors. (All India 2019)
(a) Identify the financial decision taken by Ashish Jain.
(b) Explain any three factors affecting the decision identified in (a) above.
Answer:
(a) Financial decision taken by Ashish Jain is investment (Long-term/Capital budgeting) decision.

(b) For factors affecting financial decisions:
The concept discussed in the above paragraph is ‘financial planning’.
(i) Helps in avoiding business shocks and surprises Proper provision regarding shortage or surplus of funds is made by antidpating future receipts and payments. Hence, it helps in avoiding business shocks and surprises.
(ii) Helps In coordination it helps in coordinating various business activities, such as sales, purchase, production, finance, etc. investment (Long-term/Capital budgeting) decision.

Question 34.
The Return on Investment (Rol) of a company ranges between 10-12% for the past three years. To finance its future fixed capital needs, it has the following options for borrowing debt.
Option ‘A’: Rate of interest 9%
Option ‘B’: Rate of interest 13%
Which source of debt, ‘Option A’ or ‘Option B’, is better? Give reason in support of your answer. Also state the concept being used in taking the decision. (CBSE 2018)
Answer:
The company should use ‘Option A’ as in this case the Return on Investment (10-12%) will be more Than the Cost of Debt (9%).

The concept being used in the above case is ‘trading on equity’.

The use of debt alongwith equity increases Earnings Per Share (EPS). This use of fixed financial charge, i.e. interest, increases the profit earned by shareholders. This concept is known as trading on equity.

If the company opts for Option A, it will lead to favourable trading on equity as in this case
RoI > CoD, Where
RoI – Return on Investment (10-12%)
CoD – Cost of Debt (9%) j

Question 35.
Neelabh Sarin, the Finance Manager and Atul Chopra, the Managing Director of Ghokerns Ltd. were discussing regarding the source of finance to be raised for modernisation of their existing plant. Quoting that ‘sensex has soared by 5078 points’ in the last three years, Neelabh Sarin suggests that equity should be preferred while Atul Chopra wanted to opt for debt.

Keeping in mind the high operating costs of the company, suggest the source of finance that should be used for moderninsation of existing plant. Also, explain the two factors highlighted above which should be kept in mind for taking this decision. (Compartment 2018)
Answer:
The company should opt for equity as the source of finance to modernise the existing plant. Following factors were taken into consideration from the decision:

Stock market condition In boom and favourable stock market conditions, equity should be preferred as the investors are ready to risk.
Cash flow positions It the costs are high and therefore cash flow position is weak, company should opt equity as there is permanent payment of interest on debt.

Question 36.
Ramnath Ltd. is dealing in import of organic food items in bulk. The company sells the items in smaller quantities in attractive packages. Performance of the company has been up to the expectations in the past. Keeping up with the latest packaging technology, the company decided to upgrade its machinery. For this, the Finance Manager of the company, Mr. Vikrant Dhull, estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis. Therefore, Mr Vikrant Dhull began with the preparation of a sales forecast for the next four years. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources. For the remaining funds he is trying to find out alternative sources.

Identify the financial concept discussed in the above paragraph. Also state any two points of importance of the financial concept, so identified. (All India 2017)
Answer:
The concept discussed in the above paragraph is ‘financial planning’.
The two points of importance of this concept are:
(i) Helps in avoiding business shocks and surprises Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments. Hence, it helps in avoiding business shocks and surprises.

(ii) Helps in coordination it helps in coordinating various business activities, such as sales, purchase, production, finance, etc.

Question 37.
Explain the factors that affect capital budgeting decision. (Compartment 2014)
Answer:
Factors affecting capital budgeting/long-term investment decisions are:
(i) Cash flow of the project Whenever a company is investing huge funds in an investment proposal, it expects some regular amount of cash to meet its day-to-day requirements. The amount of cash flow of an investment proposal will be assessed properly before investing in the proposal.

(ii) Return on investment The most important criteria to decide the investment proposal is rate of return it will bring back for company, e.g. if project A is bringing 10% return and project B is bringing 15% return then, a businessman would prefer project B.

(iii) Risk involved With every investment proposal, some degree of risk is also involved. The company must try to calculate the risk involved in every proposal and should prefer the investment proposal with moderate degree of risk only.

Question 38.
Give the meaning of ‘Investment decision’ and ‘Dividend decision’. (Comportment 2014)
Answer:
(i) Investment decision It relates to as how the funds of a firm are to be invested into different assets, so that the firm is able to earn highest possible return for the investors. Investment decision can be long-term, also known as capital budgeting where the funds are commited into long-term basis.
Short-term investment decision also known as working capital decision and it is concerned with the levels of cash, inventories and debtors.

(ii) Dividend decision It relates to decision regarding distribution of dividend. The decision taken is as to how much dividend is to be retained in business and how much should be distributed to shareholders, after taking into account various factors affecting it.

Question 39
What is meant by an investment decision? Give two examples of investment decision. (Comportment 2012)
Or
Give the meaning of investment and dividend decisions of financial management. Foreign 2014
Answer:
Investment decision relates to as how the funds of a firm are to be invested in fixed as well as current assets, in order to earn highest possible return on the investment. Investment in long-term assets is called capital budgeting decision, while in short-term assets is called working capital decision.

Two examples of investment decision are:

A company wants to establish a new unit and purchases machinery worth 120 lakh.
Sun Ltd. wants to open a new branch of their retail outlet.

Question 40.
What is meant by ‘Capital structure’? State any two factors which affect the capital, structure of a company. (Delhi 2012)
Answer:
Capital structure can be defined as the mix between the owners’ funds and borrowed funds.

Following are the factors determining the relative proportion of various types of funds, or the capital structure:
(i) Position of cash flow Size of projected cash flow must be considered before issuing debt. Cash flow must not only cover fixed cash payment obligations but there must be sufficient cash for smooth working of the business.

(ii) Return on Investment (Rol) It refers to the earning expected from the investment. If Rol of a company is high, it can opt for trading on equity to increase the earning per share. Thus, it is an important determinant of the extent of trading on equity.

Question 41.
Explain the following factors which affect the choice of capital structure of a company
(i) cash flow position
(ii) tax rate (Comportment 2012)
Answer:
(i) Cash flow position Dividend involves an outflow of cash. Availability of enough cash is necessary for payment of declaration of dividends.

(ii) Tax rate The decision is affected by tax treatment of dividends and capital gains. For a company, it is better to pay less by dividends when the tax rate on dividend is higher and pay more as dividends when tax rate is lower. This is because however dividends are taxable in the hands of shareholders, dividends distribution tax is levied on the company.

Question 42.
‘Financial planning is a financial blue print of an organisation’s future operations’. Explain the twin objectives of financial planning in the light of this statement. (All India 2010)
Answer:
Financial planning strives to achieve the following two objectives:
(i) To ensure availability of funds whenever these are required This includes a proper estimation of the funds required for different purpose such as for the purchase of long-term assets or to meet day-to-day expenses of business, etc. Apart from this, there is a need to estimate the time at which these funds are to be made available. Financial planning also tries to specify possible sources of these funds.

(ii) To ensure unnecessary finance is not raised Excess funding is almost as bad as inadequate funding. Even if there is some surplus money, good financial planning would put it to the best possible use so that the financial resources are not left idle and don’t unnecessarily add to the cost.

Question 43.
Explain how the:
(i) cost of debt and
(ii) cost of equity, affect the choice of capital structure. (Delhi (C) 2010)0
Answer:
(i) Cost of debt A firm’s ability to borrow at a lower rate of interest increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at lower rate.

(ii) Cost of equity Equity shareholders expect a return on their investment, i.e. Earning Per Share (EPS). When a company increases debt, the financial risk faced by the equity shareholders increases and then EPS starts decreasing with inclusion of debt, beyond a certain point. Thus, with the increase in risk, cost of equity may go up sharply and share prices may decrease.

Question 44.
Explain how the:
(i) risk consideration and
(ii) tax rate affect the choice of capital structure. (All India 2010)
Answer:
(i) Risk of consideration While deriding the capital structure, risk must be analysed and considered. Total risk consists of two types of risks
(a) Financial risk It refers to a position when a company is unable to meet its fixed financial charges namely, interest payment, preference dividend and payment obligations. It arises when a company borrows. Use of debt increases the financial risk of a business.

(b) Business risk It depends upon fixed operating costs. Higher fixed operating coshmeans higher business risk and vice-versa. If a firm’s operating risk is lower, its capacity to use debt is higher and vice-versa.

(ii) Tax rate Interest is a deductible expense. Cost of debt is affected by the tax rate. A higher tax rate makes debt relatively cheaper and increases its attraction in relation to equity.

Question 45.
‘Smart Stationery Ltd.’ wants to raise funds of ₹ 40,00,000 for its new project. The management is considering the following mix of debt and equity to raise this amount:

Capital Structure	Alternative
Capital Structure	I (₹)	II (₹)	III (₹)
Equlity	40,00,000	30,00,000	10,00,000
Debt	0	10,00,000	30,00,000

Other details are as follows:

Interest Rate on Debt	9%
Face Value of Equity Shares	₹ 100 each
Tax Rate	30%
Earning Before Interest and Tax (EBIT)	₹ 8,00,000

(a) Under which of the three alternatives will the company be able to take advantage of Trading on Equity?
(b) Does Earning Per Share always rise with increase in debt? (All India 2019)
Answer:
(a) The company will be available to take advantage of Trading on Equity in Alternative (III).
This is because of higher earning per share in Alternative III.

Calculation of Earning Per Share (EPS):
Alternative

(b) No, earning per shares only rises with increase in debt when the rate of interest on debt is lower then the return on investment.

Question 46.
State any four factors which affects the requirements of working capital of a company. (Compartment 2015)
Or
Explain any four factors which affect the working capital requirements of a company. (Compartment 2013; All India 2013)
Or
What is meant by ‘working capital’? State any four factors which affect the working capital requirement of a company. (Compartment 2013)
Answer:
Working capital is that part of total capital which is required for holding current assets. It may also be defined as an excess of current assets over current liabilities. The four main factors affecting working capital requirements are as follows:
(i) Production cycle It is the time span between the receipt of raw materials and their conversion into finished goods. Length of production cycle affects the working capital requirement. If the duration of production cycle is longer, the working capital requirements to meet day-to-day expenses would be higher and vice-versa.

(ii) Business cycle At times of boom period in the market, e.g. Diwali, Guru Parv, etc, the production as well as sales are likely to be higher. Whereas, the working capital requirement would be lower in times of depression in the market.

(iii) Nature of business A trading business needs less amount of working capital because there is no processing of goods. On the other hand, the working capital requirement would be more in case of manufacturing business where raw materials are converted into finished goods.

(iv) Scale of operations A large scale organisation requires large amount of working capital as compared to a small scale organisation because the quantum of inventory, debtors and cash required is generally high.

Question 47.
Give the meaning of investment and financing decisions of financial management. (All India 2014)
Or
Investment decision can be long-term and short-term. Explain long-term investment decision and state any two factors affecting this decision. (All India 2012)
Or
What is meant by long-term investment? State any three factors which affect the long-term investment decision. (Delhi 2013; All India 2013)
Answer:
Investment decisions:
It involves careful selection of assets in which funds are to be invested. Decisions, relating to investment in fixed assets are known as capital budgeting, whereas those concerning investment in current assets are called working capital decisions. A business needs to invest funds for setting up new business, for expansion and modernisation. Investment decision is taken after careful scrutiny of available alternatives in terms of costs involved and expected return.

For factors affecting this decision
(i) Helps in avoiding business shocks and surprises Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments. Hence, ft helps in avoiding business shocks and surprises.

(ii) Helps in coordination it helps in coordinating various business activities, such as sales, purchase, production,, finance, etc.

Financing decisions:
It is concerned with the decisions of how much funds are to be raised from which long-term source, i.e. by means of shareholders’ funds or borrowed funds. Shareholders’ funds include share capital, reserves and surplus and retained earnings, whereas borrowed funds include debentures, long-term loans and public deposits.

Question 48.
Explain any four points that highlight the importance of financial planning. (Delhi 2014)
Or
What is meant by financial planning? State any three points of its importance. (All India 2013)
Or
‘Sound financial planning is essential for the success of any business enterprise’. Explain this statement by giving any six reasons. (Delhi 2019,2011; All India 2011)
Or
What is meant by ‘Financial planning’? Explain any five points which highlight its importance. (Delhi 2013)
Or
Explain the term ‘Financial planning’ and any four points of its importance in financial management. (Delhi (C) 2011)
Answer:
Financial planning helps in determining the objectives, policies, procedures, programmes and budgets to deal with the financial activities of an enterprise. Various importance of financial of planning (any three):
(i) Helps to face the eventualities It forecasts the future business situations which helps in preparing alternative financial plans to face the eventual situations.

(ii) Helps in avoiding business shocks and surprises Proper provision regarding shortage or surplus of funds is made by anticipating future receipts and payments. Hence, it helps in avoiding business shocks and surprises.

(iii) Helps in coordination It helps in coordinating various business activities, such as sales, purchase, production, finance, etc.

(iv) Helps in avoiding wastage of finance In the absence of financial planning, wastage of financial resources may take place. This arises due to the complex nature of business operations such as, excessively over or under estimation of finance for a particular business operation. Such type of wastages can be avoided through financial planning.

(v) Helps to link the present with the future It makes efforts to link the present with the future. By doing so, it helps to minimise the risks of future uncertainties.

(vi) Helps in creating link between investment and financing decisions It helps in deciding where to invest and from where the required funds will be made available. Under it, the mix of share capital and debt capital is made in such a manner that cost of capital is reduced to minimum

Question 49.
Define ‘capital structure’. Explain briefly any four factors which affect the capital structure of a company. (Compartment 2013)
Or
Determining the overall cost of capital and the financial risk of the enterprise depends upon various factors. Explain any five factors. (All India 2011)
Or
Determining the relative proportion of various types of funds depends upon various factors. Explain any five such factors. (Delhi 2011)
Or
Determining the relative proportion of various types of funds depends upon various factors. Explain any six factors.(Delhi 2019)
Or
Explain briefly any four factors that affect the choice of capital structure of a company. (All India 2017; Delhi 2017)
Or
Explain any four factors which determine the choice of the capital structure of a company. (Compartment 2014; All India 2012, 2011; Delhi 2011, 2008)
Or
Explain the following as factors affecting the choice of capital structure.
(i) Return on Investment (RoI)
(ii) Flexibility
(iii) Risk consideration
(iv) Control (Foreign 2014)
Or
Explain the following factors affecting the choice of capital structure.
(i) Cash flow position
(ii) Cost of equity
(iii) Floatation tests
(iv) Stock market condition (Foreign 2014)
Answer:
Capital structure:
Capital structure refers to the mix between owners’ fund (equity) and borrowed funds (debt I.
Capital structure of a business affects both the profitability and financial risk of business. Since, use of equity and debt In the capital structure has both its merits and demerits, a judicious mix of both are used in the capital structure.

Optimal Capital Structure:
A capital structure is said to be optimal when the proportion of debt and equity Is suds that It results in the increase of shareholders’ wealth.

Factors Affecting Capital Structure:

Cash flow position
Interest coverage ratio
Debt service coverage ratio
Return un investment (RoI)
Cost of debt
Tax rate
Cost of equity
Floatation costs
Risk considerations
Flexibility
Control
Regulatory framework
Stock market conditions
Capital structure of other companies

NOTE: Factors affecting capital structure Not In syllabus Answer given from prelous years will be shown to this effect.

Following are the factors determining the relative proportion of various types of funds, or the capital structure:
(i) Position of cash flow Size of projected cash flow must be considered before issuing debt. Cash flow must not only cover fixed cash payment obligations but there must be sufficient cash for smooth working of the business.

(ii) Return on Investment (RoI) It refers to the earning expected from the investment. If Rol of a company is high, it can opt for trading on equity to increase the earning per share. Thus, it is an important determinant of the extent of trading on equity.

(iii) Cost of capital It may be defined as the payment made by company to obtain capital. Thus, interest is the cost of debentures or loan and dividend paid by the company is the cost of equity and preference share capital. The rate of dividend on preference shares is fixed which is generally lower than that of equity shares. The cost of debentures is generally lower and tax deductible.

(iv) Risk of consideration While deciding the capital structure, risk must be analysed and considered. Total risk consists of two types of risks:
(a) Financial risk: It refers to a position when a company is unable to meet its fixed financial charges namely, interest payment, preference dividend and ‘ payment obligations. It arises when a company borrows. Use of debt increases the financial risk of a business.

(b) Business risk: It depends upon fixed operating costs. Higher fixed operating cost means higher business risk and vice-versa. If a firm’s operating risk is lower, its capacity to use debt is higher and vice-versa.

(v) Flexibility To maintain flexibility, a firm should not use its debt potential in full, so that it can borrow in unforeseen circumstances.

Question 50.
What is meant by ‘dividend decision’? State any four factors which affect the dividend decision of a company. (All India 2013; Compartment 2013)
Or
Name the decision which financial manager will take, keeping in view the overall objective of maximising shareholders’ wealth. Explain any two factors which affect this decision. (All India 2011)
Or
Explain any four factors which affect the ‘dividend decision’ of a company. (Comportment 2014; All India 2013)
Or
What is meant by ‘dividend decision’? Explain any four factors which affect the dividend decision of a company. (Delhi 2013)
Or
What is meant by ‘dividend decision’? State any four factors affecting the dividend decision. (Delhi 2010)
Answer:
Dividend decision A financial manager takes decision in three broad areas, viz investment, financing and dividend, for maximising shareholders’ wealth. Wealth maximisation is possible with increase in price of shares. A good dividend policy will enhance the market value of shares thus, meeting the objective of wealth maximisation. It also influences the financing decision of the firm, since the firm will not require funds to the extent of re-invested retained earnings.
So, it should be taken keeping in view the overall objective of maximising shareholders’ wealth.

The four factors which affect dividend decisions cure:
(i) Earnings Dividends are paid to the shareholders either from the past earnings or from the current earnings or from both. Therefore, ‘earnings’ is a major factor which affects dividend decision.

(ii) Stability of earnings It also affects the dividend decision. A company having stable earnings can declare higher dividend whereas, a company having unstable earnings is likely to pay smaller dividend.

(iii) Stability of dividend Companies generally have a policy of stabilising dividends, i.e. increase in dividend is only done when the earning potential of the company has gone up and not just the current year’s earnings. Thus, dividend per share is not altered when the change is small or temporary in nature.

Shareholders’ preference While dedaring Or dividends, management must keep in mind the preferences of the shareholders in this regard. If the shareholders in general desire that at least a certain amount is paid as dividend, the companies are likely to declare the same. There are always some shareholders who depend upon a regular income from their investments.

Question 51.
Explain any four factors which affect the ‘Fixed capital’ requirements of a company. (All India 2013)
Or
What is meant by ‘fixed capital’? Explain any four factors which affect the fixed capital requirements of a company. (Compartment 2013)
Or
Explain briefly any four factors that affect the fixed capital requirements of a company. (Delhi 2018, 2017; All India 2017)
Or
Explain the following as factors affecting the requirements of fixed capital. (All India 2014; Delhi 2014)
(i) Scale of operations
(ii) Choice of technique
(iii) Technology upgradation
(iv) Financing alternatives
Or
Explain any four factors affecting fixed capital requirement of a company. (Compartment 2014)
Or
Explain in brief any six factors which affect the fixed capital requirements of a company. (Compartment 2013)
Answer:
The amount of capital investment in fixed assets is called fixed capital, e.g. plant and machinery, land and building, .etc.
The four factors which affect the fixed capital requirement of a company are:
(i) Nature of business While deciding the fixed capital requirement of a business enterprise, its nature should be considered, e.g. trading concern needs lower investment in fixed assets as compared with a manufacturing organisation; since it does not 11. require to purchase plant and machinery, etc.

(ii) Scale of operations A large organisation operating at a higher scale needs higher investment in fixed assets as compared to a small organisation.

(iii) Choice of technique A capital intensive organisation requires higher investment in Ans. plant and machinery. So, requirement of fixed capital would be higher. On the other hand, labour intensive organisation requires less investment in fixed assets.

(iv) Technology upgradation These days upgradation with the latest technologies is essential and there is a need to replace old technology with new. Thus, in this case, higher investment is required and vice-versa.

Question 52.
Pranav is engaged in transport business.
Identify the working capital requirements of Pranav stating the reason in support of your answer. Pranav wants to expand and diversify his transport business. Explain any tw6 factors that will affect his fixed capital requirements. (Compartment 2013; All Indio 2012)
Or
Neelabh is engaged in transport business and transports fruits and vegetables to different states. Stating the reason in support of your answer, identify the working capital requirements of Neelabh. Neelabh also wants to expand and diversify his transport business, explain any two factors that will affect his fixed capital requirements. (Delhi 2012)
Answer:
In the transportation business, lesser amount of working capital is required as Neelabh and Pranav are engaged in service industry. A firm engaged in service industry needs less working capital.
(i) Lower investment is required to carry out the day-to-day operations.
(ii) Lower investment require to maintain inventory, if any.

Factors affecting the fixed capital requirement are:
(i) Growth prospects: Businessman wants to expand his business, in such a situation, company requires higher investment to meet the anticipated demand in future. Thus the requirement of fixed capital will be higher.
(ii) Diversification: If the businessman diversify his business, this mean larger amount of fixed capital is required.

Question 53.
Explain the following as factors affecting financing decision:
(i) Cost
(ii) Cash flow position of business
(iii) Control considerations
(iv) Floatation cost (Delhi 2012)
Answer:
(i) Cost The cost of raising funds through different sources are different. A prudent financial manager would normally opt for a source which is the cheapest. Debt is considered the cheapest of all sources, tax deductibility makes it still cheaper.

(ii) Cash flow position of business A stronger cash flow position may make debt financing more viable than funding through equity. Therefore, in order to take advantage of cheap finance, companies prefer debt to equity.

(iii) Control considerations The ultimate control of the company is that of the equity shareholders. Greater the number of equity shareholders, the greater will be the control in the hands of more people. This is not a good situation. Therefore, from this point of view the equity share capital should be avoided.

(iv) Floatation cost From the point of view of floatation costs, higher the floatation cost, less attractive the source becomes.

Question 54.
How are the shareholders likely to gain with loan components in capital employed? Explain with suitable example. (All India 2011)
Answer:
With a debt component in the total capital, shareholders are likely to have the benefit of a higher rate of return on the share capital. This is because debt/loan carry a fixed charge and the amount of interest paid is deductible from the earnings before tax payment. The benefit to the shareholders will be realised only if the average rate of return on total capital invested is more than the rate of interest payable on loan/debt.

For example, Let us consider two public companies X Ltd and Y Ltd.
The following calculation will show how trading on equity increases the return on equity shares:
(i)

(ii)

Thus, it can be concluded that Y Ltd using fixed cost sources, i.e. debentures,- earn a relatively high rate of return on equity capital.

Question 54.
Name the decision taken by a financial manager which determines the overall cost of capital and the financial risk of the enterprise. Explain any two factors which affect this decision. (All India 2011)
Answer:
Financing decision determines the overall cost of capital and the financial risk of the enterprise.
For two main factors which affect financing decisions Refer to Ans 14 on page 158.

Question 55.
Explain briefly any four factors that affect the working capital requirements of a company. (All India 2017; Delhi 2017)
Ans.
The four factors that affect the working capital requirements are:
(i) Nature of business A trading business needs less amount of working capital because there is no processing of goods. On the other hand, the working capital requirement would be more in case of manufacturing business where raw materials are converted into finished goods.

(ii) Scale of operation A large scale organisation requires large amount of working capital as compared to small scale organisation because the quantum of inventory, debtors and cash required is generally high.

(iii) Seasonal factors Business operations are affected by the seasonal changes. As during peak season, higher is the demand for the product and higher is the requirements of working capital. On the other hand, during lean season requirements of working capital will be lower.

(iv) Production cycle It is the time span between the receipt of raw materials and their conversion into finished goods. Length of production cycle affects the working capital requirement. If the duration of production cycle is longer, the working capital requirements to meet day-to-day expenses would be higher and vice-versa.

Question 56.
‘Viyo Ltd. is a company manufacturing textiles. It has a share capital of ₹ 60 lakh.
The earning per share in the previous year was ₹ 0.50. For diversification, the company requires additional capital of ₹ 40 lakh. The company raised funds by issuing 10% debentures for the same. During the current year the company earned a profit of ₹ 8 lakh on capital employed. It paid tax 40%.
(i) State whether the shareholders gained or lost, in respect of earning per share on diversification, show your calculations clearly.
(ii) Also, state any three factors that favour the issue of debentures by the company as part of its capital structure. (Delhi 2016)
Or
Sakshi Ltd is a company manufacturing electronic goods. It has a share capital of ₹ 120 lakh. The earning per share in the previous year was ₹ 0.5. For diversification, the company requires additional capital of ₹ 80 lakh. The company raised funds by issuing 10% debentures for the same.
During the current year the company earned profit of ₹ 16 lakh on capital employed. It paid tax @ 40%.
(i) State whether the shareholders gained or lost in respect of earning per share on diversification, show your calculations clearly.
(ii) Also state any three factors that favour the issue of debentures by the company as part of its capital structure. (Foreign 2016)
Or
Kay Ltd., is a company manufacturing textiles. It has a share capital of ₹ 60 lakh. In the previous year, its earning per share was ₹ 0.50. For diversification, the company requires, additional capital of ₹ 40 lakh. The company raised funds by issuing 10% debentures for the same. During the year the company earned profit of ₹ 8 lakh on capital employed. It paid tax @ 40%.
(a) State whether the shareholders gained or lost, in respect of earning per share on diversification. Show your calculations clearly.
(b) Also, state any three factors that favour the issue of debentures by the company as sort of its capital structure. (All India 2016)
Answer:
(i)

Since, Earning Per Share has fallen from 0.50 to 0.40, therefore the shareholders stand to lose on diversification.
NOTE: In the absence of any information, shares are assumed to be of ₹ 10 each.

(ii) Three factors that favour issue of debentures by the company as part of its capital structure are:
(a) Debenture interest payable is a charge to the profits. Hence a company stands to gain in terms of tax-benefits.
(b) Issue of debentures help the shareholders of the company to gain through ‘Trading on Equity’.
(c) Debenture is a cheaper source of finance as compared to equity.

Question 57.
‘Sarah Ltd.’ is a company manufacturing cotton yarn. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in furure. It is a well managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments.
It has taken loan of 40 lakh from IDBI and is bound by certain restrictions on the payment of dividend according to the terms of loan agreement.
The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company.
Quoting the lines from the above discussion identify and explain any four such factors. (Delhi 2015)
Answer:
The factors identified in the above lines are given below:
(i) The line ‘It has been consistently earning goods profits for many years’ indicated ‘Stability of earnings’. Stability of earnings of a business unit also affects the dividend decision. A company having stable earnings can declare higher dividend whereas a company having unstable earnings is likely to pay smaller dividend.

(ii) The line ‘This year too, it has been able to generate enough profits indicates ‘Earnings’ as a factor affecting dividend decision. Companies generally have a policy of stabilising dividends, i.e. increase in dividend is only done when the earning potential of the company has gone up and not just the current year’s earnings. Thus, dividend per share is not altered when the change is small or temporary in nature.

(iii) The line ‘There is availability of enough cash in the company and good prospects for growth in future’ indicates ‘Growth opportunities’.
Companies which are intended to grow, generally pay less dividend and retain more money out of profits to invest in profitable projects. On the contrary, companies which are not intended to grow and have enough earnings and cash, can pay higher dividends.

(iv) The line ‘It has many shareholders who prefer to receive a regular income from their, investments’ indicates ‘Shareholders’ Preference’.
While declaring dividends, management must keep in mind the preferences of the shareholders in this regard. If the shareholders in general desire that at least a certain amount is paid as dividend, the companies are likely to declare the same. There are always some shareholders who depend upon a regular income from their investments.

Question 58.
‘Abhishek Ltd.’ is manufacturing cotton clothes. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income form their investments.

It has taken a loan of ₹50 lakh from ICICI Bank and is bound by certain restrictions on the payment of dividend according to the terms of the loan agreement. The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company. Quoting the lines from the above discussion, identify and explain any four such factors. (All India 2015)
Answer:
The factors identified in the above lines are given below:
(i) The line ‘It has been consistently earning goods profits for many years’ indicated ‘Stability of earnings’. Stability of earnings of a business unit also affects the dividend decision. A company having stable earnings can declare higher dividend whereas a company having unstable earnings is likely to pay smaller dividend.

(iii) The line ‘There is availability of enough cash in the company and good prospects for growth in future’ indicates ‘Growth opportunities’. Companies which are intended to grow, generally pay less dividend and retain more money out of profits to invest in profitable projects. On the contrary, companies which are not intended to grow and have enough earnings and cash, can pay higher dividends.

Question 59.
Explain the following as factors affecting dividend decision. All Indio 2014; Delhi 2014
(i) Stability of earnings
(ii) Growth opportunities
(iii) Cash flow position
(iv) Taxation policy
Answer:
Dividend decision relates to how much of the company’s net profit is to be distributed to the shareholders and how much of it is to be retained in the business.

Factors affecting dividend decision are:
(i) Stability of earnings: Stability of earnings of a business unit also affects the dividend decision. A company having stable earnings can declare higher dividend whereas a company having unstable earnings is likely to pay smaller dividend.

(ii) Growth opportunity: Companies which are intended to grow, generally pay less dividend and retain more money out of profits to invest in profitable projects. On the contrary, companies which are not intended to grow and have enough earnings and cash, can pay higher dividends.

(iii) Cash flow position: Dividend involves an outflow of cash. Availability of enough cash is necessary for payment of declaration of dividends.

(iv) Taxation policy: The decision is affected by tax treatment of dividends and capital gains. For a company, it is better to pay less by dividends when the tax rate on dividend is higher and pay more as dividends when tax rate is lower. This is because however dividends are taxable in the hands of shareholders, dividends distribution tax is levied on the company.

Question 60.
Explain any six factors affecting the decision that determines the amount of profit earned to he distributed and to be retained in the business. (Delhi 2019)
Or
Explain the following as factors affecting ‘dividend decision’.
(i) Stability of dividend
(ii) Shareholders’ preference
(iii) Legal constraints
(iv) Access to capital market (Delhi 2014)
Or
Explain any six factors affecting the decision that determines the amount of profit earned to he distributed and to be retained in the business. (Delhi 2019)
Answer:
Dividend decisions relate to how much of the company’s after tax profit is to be distributed to the share holders and how much of it should be retained in the business for future requirements. Factors affecting dividend decisions are:
(i) Stability of dividend Companies generally have a policy of stabilising dividends, i.e. increase in dividend is only done when the earning potential of the company has gone up and not just the current year’s earnings. Thus, dividend per share is not altered when the change is small or temporary in nature.

(ii) Shareholders preference While declaring dividends, management must keep in mind the preferences of the shareholders in this regard. If the shareholders in general desire that at least a certain amount is paid as dividend, the companies are likely to declare the same. There are always some shareholders who depend upon a regular income from their investments.

(iii) Legal constraints Certain provisions of The Companies Act place restrictions on payouts as dividend. Such provisions must be adhered while declaring the dividend.

(iv) Access to capital market Large and reputed companies generally have easy access to the capital market and, therefore, may depend less on retained earning to finance their growth. These companies tend to pay higher dividends than the smaller companies.

Question 61.
Explain the following as factors affecting the requirements of working capital (Delhi 2014)
(i) Business cycle
(ii) Operating efficiency
(iii) Availability of raw material
(iv) Level of competition
Answer:
Working capital is the capital invested in current assets which facilitates day-to-day operations of the business. The amount of working capital required depends on various factors. Factors affecting working capital requirement are:
(i) Business cycle:
Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom, the sales as well as production are likely to be larger and, therefore, larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of depression as the sales as well as production will be small.

(ii) Operating efficiency:
Firms manage their operations with varied degrees of efficiency. For example, a firm managing its raw materials efficiently may be able to manage with a smaller balance. This is reflected in a higher inventory turnover ratio. Similarly, a better debtors turnover ratio may be achieved reducing the amount tied up in receivables. Better sales effort may reduce the average time for which finished goods inventory is held. Such efficiencies may reduce the level of raw materials, finished goods and debtors resulting in lower requirement of working capital.

(iii) Availability of raw material:
If raw material required in freely available, lower stock levels may be sufficient and vice-versa. Lead time, i.e. time lag between placing the order and actual receipt of material is also a major determinant. A larger lead time will require larger amount of raw material to be stored, thus larger amount of working capital is required.

(iv) Level of competition:
Higher level of competitiveness may necessitate larger stocks of finished goods to meet urgent orders from customers. This increases the working capital requirement.

Question 62.
Explain how the following factors affect the working capital requirements of business. (Compartment 2014)
(i) Inflation
(ii) Business cycle
(iii) Level of competition
(iv) Nature of business
Answer:
Factors affecting working capital requirement are:
(i) Inflation Inflation leads to increase in prices of raw materials, thus more working capital is required.
(ii) Business cycle:
Business cycle At times of boom period in the market, e.g. Diwali, Guru Pam’, etc, the production as well as sales are likely to be higher. Whereas, the working capital requirement would be lower in times of depression in the market.

(iii) Level of competition:
Level of competition Higher level of competitiveness may necessitate larger stocks of finished goods to meet urgent orders from customers. This increases the working capital requirement.

(iv) Nature of business:
Nature of business A trading business needs less amount of working capital because there is no processing of goods. On the other hand, the working capital requirement would be more in case of manufacturing business where raw materials are converted into finished goods.

Question 64.
Explain the following as factors affecting the requirements of working capital. (All India 2014; Foreign 2014)
(i) Nature of business
(ii) Scale of operations
(iii) Seasonal factors
(iv) Production cycle
Answer:
Factors affecting working capital requirements are:
(i) Nature of business A trading business needs less amount of working capital because there is no processing of goods. On the other hand, the working capital requirement would be more in case of manufacturing business where raw materials are converted into finished goods.

(ii) Scale of operations A large scale organisation requires large amount of working capital as compared to small scale organisation because the quantum of inventory, debtors and cash required is generally high.

(iii) Seasonal factors Business operations are affected by the seasonal changes. As dining peak season higher are the level of activities and higher the requirements of working capital, on the other hand, during lean season requirements of working capital will be lower.

Question 65.
Explain the following as factors affecting the requirements of fixed capital.
(i) Nature of business
(ii) Growth prospects
(iii) Diversification
(iv) Level of collaboration (Delhi 2014)
Or
You are a finance manager of a newly established company. The directors have asked you to determine the amount of fixed capital requirement for the company. Explain any four factors that you will consider while determining the fixed capital requirement of the company. (All India 2011, 2010; Delhi(C) 2011)
Answer:
(i) Nature of business The type of business has a bearing upon the fixed capital requirements, e.g. a trading concern needs lower investment in fixed assets compared with a manufacturing organisation, since it does not require to purchase plant and machinery, etc.

(ii) Growth prospects Higher growth of an organisation generally requires higher investment in fixed assets. Even when such growth is expected, a company may choose to create higher capacity in order to meet the anticipated higher demand quicker. This entails larger investment in fixed assets and consequently larger fixed capital.

(iii) Diversification If a firm diversify its operations, its fixed capital requirements increases.

(iv) Level of collaboration Usually organisations use each other’s facilities as it is feasible and reduces the level of investment in fixed assets, e.g. PNB bank may use ATM of Andhra Bank.

Question 66.
Amar is doing his transport-business in Delhi. His buses are generally used for the tourists going to Jaipur and Agra. Identify the working capital requirements of Amar giving reason in support of your answer. Further Amar wants to expand and diversify his transport-business. Explain any two factors that will affect his fixed capital requirements. (Compartment 2012)
Or
Harish is engaged in warehousing business and his warehouses are generally used by the businessmen to store fruits. Identify the working capital requirements of Harish giving reason in support of your answer. Further Harish wants to expand and diversify his warehousing business. Explain any two factors that will affect his fixed capital requirements. (Comportment 2012)
Answer:
Working capital requirements of Amar would be less as transport compary is a service industry. Working capital requirements of Amar would include payment of salaries to staff, fuel charges, maintenance and upkeep of buses etc.

Two factors which will affect his fixed capital requirements
(i) Scale of operations The larger the size of a business, the greater is the amount of fixed capital required in terms of purchase of new and better luxury buses.
(ii) Diversification A diversified firm needs more fixed capital to meet its requirement of fixed assets of various divisions, which could be in terms of more offices and also servicing centres for buses etc.

Question 67.
You are the financial manager of a newly established company. The directors have asked you to determine the amount of working capital requirement for the company. Explain any four factors that you will consider while determining the working capital requirement of the company. (Delhi 2011)
Or
Explain any four factors which determine the working capital requirement of an organisation. (Delhi 2011)
Answer:
Working capital is the capital invested in current assets which facilitates day-to-day operations of the business. The amount of working capital required depends on various factors. Factors affecting working capital requirement are:
(i) Business cycle Different phases of business cydes affect the requirement of working capital by a firm. In case of a boom, the sales as well as production are likely to be larger and, therefore, larger amount of working capital is required. As against this, the requirement for working capital will be lower during the period of depression as the sales as wefl as production will be small.

(ii) Operating efficiency Firms manage their operations with varied degrees of efficiency. For example. a firm managing its raw materials efficiently may be able to manage with a smaller balance. This is reflected in a higher inventory turnover ratio. Similarly, a better debtors turnover ratio may be achieved reducing the amount tied up in reccivabics. Better sales effort may reduce the average time for which fmished goods inventory is held. Such efficiencies may reduce the level of raw materials, finished goods and debtors resulting in lower requirement of working capital.

(iii) Availability of raw material If raw material required in freely available, lower stock levels may be sufficient and vice-versa. Lead time, i.e. time lag between placing the order and actual receipt of material is also a major determinant. A larger lead time will require larger amount of raw material to be stored, thus larger amount of working capital is required.

(iv) Level of competition Higher level of competitiveness may necessitate larger stocks of finished goods to meet urgent orders from customers. This increases the working capital requirement.

Factors affecting working capital requirement are:
(i) Inflation Inflation leads to increase in prices of raw materials, thus more working capital is required.
(ii) Business cycle: Business cycle At times of boom penod in the market, e.g. Diwali, Guru Pam’, etc, the production as well as sales are likely to be higher. Whereas, the working capital requirement would be lower in ümes of depression in the market.

Question 68.
What is meant by financing decision? State any four factors affecting the financing decision. (All India 2010; Delhi 2010)
Answer:
Financial decision deals with quantum of finance to be raised from long-term sources, viz debt equity. In other words, it refers to the determination as how the total funds required by the business will be obtained from various long-term sources. There should be a proper balance between debt and share capital as it influences the market price of the shares and cost of capital.

Factors affecting financing decisions:
(i) Cost The cost of raising funds through different sources are different. A prudent financial manager would normally opt for a source which is the cheapest. Debt is cons idcrcd the cheapest of ail sources, tax deductibility makes il still cheaper.

(iii) Control considerations The ultimate control of the company is that of the equity shareholders, Greater the number of equity shareholders, the greater will be the control in the hands of more people. This is not a good situation. Therefore, from this point of view the equity share capital should be avoided.

(iv) Floatatlon cost From the point of view of floatation costs, higher the floatation cost, less attractive the source becomes.

Multiple Choice Questions

Question 1.
Which of the following is the factor affecting the requirement of fixed capital?
(a) Nature of business
(b) Choice of technique
(c) Scale of operations
(d) All of the above
Answer:
(d) All of the above

Question 2.
Capital budgeting decisions are important because of
(a) long-term growth
(b) large amount of funds involved
(c) risk involved
(d) All of the above
Answer:
(d) All of the above

Hint:
Capital budgeting decisions have bearing on the long-term growth because the funds invested in long-term assets are likely to yield return in the future. Investment decisions involving fixed capital influence the overall business risk complexion of the firm as fixed capital involves investment of huge amounts.

Question 3.
An asset is considered more liquid if
(a) it can be converted into cash quicker
(b) it is converted into cash without reduction in value
(c) Both (a) and (b)
(d) it cannot be converted into cash
Answer:
(c) Both (a) and (b)

Question 4.
Which of the following factor affects the requirement of working capital?
(a) Business cycle
(b) Seasonal factors
(c) Availability of raw materials
(d) All of the above
Answer:
(d) All of the above

Question 5.
The fund raising exercise also costs something. This cost is called
(a) fixed cost
(b) floatation cost
(c) bearing cost
(d) variable cost
Answer:
(b) floatation cost

Hint:
When a company raises the funds it included some costs like brokerage, commission, etc which is known as floatation costs.

Question 6.
Identify the concept which increases the return on equity shares with a change in the capital structure of a company.
(a) Trading on equity
(b) Capital structure
(c) Debt financing
(d) Equity financing
Answer:
(a) Trading on equity

Question 7.
What happens when financial leverage increases?
(a) Cost of funds decreases
(b) Risk increases
(c) Both (a) and (b)
(d) Cost of funds increases
Answer:
(c) Both (a) and (b)

Hint:
The amount of total debt in the overall capital is called financial leverage. It is debt/equity or debt/ debt + equity. When financial leverage (i.e. debt) increases, the cost of funds decline but risk increases.

Question 8.
The impact of financial leverage on the profitability of a business can be seen through which analysis?
(a) EBIT – EBT
(b) EBIT – EPS
(c) EBT – EPS
(d) EAT – EPS
Answer:
(b) EBIT – EPS

Question 9.
Which of the following statement is not correct?
(a) Debt is considered as cheaper to equity
(b) Interest on debt is deductible for tax purpose
(c) Issue of more equity may dilute shareholders’ control over the business
(d) If RoI is more than the cost of debt, the company should prefer equity to debt
Answer:
(d) If RoI is more than the cost of debt, the company should prefer equity to debt

Question 10.
Choose the correct option regarding the arrangement of current assets in order of liquidity from highest to lowest.
(a) Cash, marketable securities, bills receivables, debtors
(b) Marketable securities, cash, debtors, bills receivable
(c) Prepaid expenses, cash, marketable securities, bills receivables
(d) Bills receivables, cash, marketable securities, debtors
Answer:
(a) Cash, marketable securities, bills receivables, debtors

Question 11.
A company has earnings before interest and tax is ₹ 3,00,000 and its total investments are ₹ 10,00,000. Find out return on investments.
(a) 20%
(b) 30%
(c) 10%
(d) 40%
Answer:
(b) 30%

Hint:
Return on Investment = (Earnings before Interest and Tax/Total Investments) × 100 In this question,
RoI = (3,00,000/10,00,000) × 100 = 30%

Question 12.
Which of the following statement is not true?
(a) Maintaining adequate liquidity is a secondary objective of financial planning
(b) Stock market reactions is an important factor while making dividend decisons
(c) Compaines with lower ICR can borrow more funds
(d) None of the above
Answer:
(c) Compaines with lower ICR can borrow more funds

Hint:
ICR refers to interest coverage ratio, i.e. the number of times EBIT covers interest obligations. Therefore, compaines with lower ICR should not borrow more funds.

Question 13.
A company has Net Working Capital = ₹ 20,000. If current assets are; Stock = ₹ 10,000, Debtors = ₹ 12,000, Cash = ₹ 6,000, Bills Receivable = ₹ 22,000. Calculate Current Liabilities.
(a) ₹ 50,000
(b) ₹ 1,20,000
(c) ₹ 20,000
(d) ₹ 30,000
Answer:
(d) ₹ 30,000

Hint: Net Working Capital = Current Assets – Current liabilities
In this question, total of current assets = 10,000 + 12,000 + 6,000 + 22,000 = ₹ 50,000.
Therefore, Current Liabilities = Current Assets – Net Working Capital = ₹ 30,000

Question 14.
Favourable financial leverage is a condition when
(a) Rate of return > Cost of debt
(b) Rate of return < Cost of debt
(c) Rate of return = Cost of debt
(d) None of the above
Answer:
(a) Rate of return > Cost of debt