2nd PUC Business Studies Important Questions Chapter 9 Financial Management

Karnataka 2nd PUC Business Studies Important Questions Chapter 9 Financial Management

Question 1.
A company wants to establish a new unit in which a machinery worth Rs.10 lakhs is involved. Identify the type of decision involved in financial management.
Answer:
Investment decision

Question 2.
A decision is taken to raise money for long term capital needs of the business from certain sources. What is this decision called ?
Answer:
Financing decision

Question 3.
A decision is taken to distribute certain parts of the profit to shareholders after paying tax. What is this decision called?
Answer:
Dividend decision

Question 4.
Name the source of finance carrying two fixed obligations viz., interest and redemption.
Answer:
Debentures

Question 5.
In case of inflation, does an enterprise need more or less of the working capital?
Answer:
More working capital

Question 6.
Identify the decision taken in financial management which affects the liquidity as well as the profitability of business.
Answer:
Capital budgeting decision

Question 7.
State why the working capital needs for a service industry are different from that of a manufacturing industry.
Answer:
Nature ofbusiness determines the working capital needs. Service industries which usually do not have to maintain inventory require less working capital whereas manufacturing industries have to maintain inventory in the form of Raw materials to finished goods there require more working capital.

Question 8.
To avoid the problem of shortage and surplus of funds what is required in financial management? Name the concept and explain its any three points of importance.
Answer:
Financial Planning. Sound financial planning is essential for success of any business enterprise. It is important because

1. it facilitates collection ;of optimum funds.
2. It helps in fixing the most appropriate capital structure.
3. It helps in investing finance in right projects.

Question 9.
State the factors which affect the capital structure of a company.
Answer:

1. Cash flow ability
2. control
3. Floatation cost
4. Flexibility
5. Market condition

Question 10.
Why is Financial Planning done?
Answer:
It is done to achieve the following two objectives:

1. To ensure the availability of funds whenever these are required.
2. To see that firm does not raise resources unnecessarily.

Question 11.
The length of the Production cycle affects the working capital requirements of an organization. Explain how?
Answer:
The production cycle is the time span between the receipt of raw material and their conversion into finished goods. Duration and length of the production cycle affects the amount of fonds required of R/M and expenses. Consequently, the working capital requirement is higher in firms with longer processing cycle and lower in firms with shorter processing cycle.

Question 12.
‘Primary objective of financial management is to maximize the wealth of shareholders’. Explain.
Answer:
Maximization of shareholders wealth depends upon the market price of shares. Market price of equity share increase if the benefits from a decision exceeds the cost involved.

Question 13.
The directors of a manufacturing company are thinking of issuing Rs. 20 lacs additional debentures for expansion of their production capacity. This will lead to an increase in debt- equity ratio from 2:1 to 3:1. What are the risks involved in it?
Answer:
The increase in debt-equity ratio from 2:1 to 3:1 is subject to following risks-
(a) Interest on debt has to be paid even when the company is not making sufficient profits.
(b) The debenture holders have charge over the assets of the company so there is threat of solvency.

Question 14.
A businessman, who wants to start a manufacturing concern, approaches you to suggest him whether the following manufacturing concern would require large or small working capital: (a) Bread, (b) Coolers, (c) motorCar.
Answer:
(a) Bread: Requirement of working capital will be less because it has quick cash turnover.
(b) Coolers: Require for working capital will be more because it is a seasonal product.
(c) Motor car: Working capital requirement will be more.

Question 15.
You are the finance manager of a newly established company. The directors of the company have asked you to plan the capital structure of the company. State any four factors that you would consider while planning the capital structure.
Answer:
Following factors would be considered for the purpose-

1. Cash Flow Position
2. Interest Coverage Ratio
3. Return on Investment
4. Cost of debt
5. Tax rate

Question 16.
How Stock market conditions affect the capital structure especially when company is planning to raise additional capital?
Answer:
There are two main conditions of stock market i.e., Boom condition and Recession condition

During recession market is slow and investors also hesitate to take risk so at this time it is advisable to issue borrowed funds as they are less risky and ensure fixed repayment and regular interest. But during boom period, business flourishes and investors also take risk and prefer to invest in equity shares to earn more in the form of dividend.

Question 17.
How is Interest Coverage Ratio computed? What does it indicate?
Answer:
Interest Coverage Ratio = Earnings before interest and tax/interest

Higher ICR means companies can have more of borrowed fund securities whereas lower ICR means less borrowed fund securities.

Question 18.
How is Return on Investment computed?
Answer:
Return on Investment = Earnings before Interest and tax/ Total investment

I. One Mark Questions and Answers

Question 1.
Name any one basic objectives of Financial Management?
Answer:
Profit Maximisation.

Question 2.
What do you mean by financial decision?
Answer:
Decision – making in three major issues relating to the financial operations of a business organisation is called financial decision.

Question 3.
Name any one type of capital requirement of an organisation?
Answer:
Fixed Capital.

Question 4.
What is fixed Capital?
Answer:
The amount invested in acquisition and development of fixed assets is known as fixed capital.

Question 5.
What is working capital?
Answer:
Working capital refers to the funds, which an organisation must possess to finance its day – to – day operations.

Question 6.
State any one factor affecting working capital requirement of a business concern.
Answer:
Nature of the business.

Question 7.
State one factor affecting fixed capital requirement of a business concern.
Answer:
Scale of operation.

II. Two Marks Question and Answers

Question 1.
What is Financial Management?
Answer:
It involves the application of general management principles to financial activities.

Question 2.
Give the meaning of Investment Decisions.
Answer:
The investment decision relates to how the firm’s funds are invested in different assets. Investment decision can be long term investment decision or capital budgeting decisions or short – term investment decision or working capital decision.

Question 3.
Give the meaning of Dividend Decisions.
Answer:
Dividend decisions relate to the appropriation of profit. Dividend decisions relate to what part of profit should be retained in the organisation and what part of it should be declared and distributed to shareholders as dividend.

Question 4.
Give the meaning of Financing Decisions.
Answer:
Financing decisions are concered with the financing ofbusiness activities and the quantum of finance to be raised from various sources of finance. The main sources of funds for an organisation are shareholders funds (owners fund) and borrowed funds (debt fund).

Question 5.
State any two factors affecting working capital requirement of a business concern.
Answer:

1. Nature of the business
2. Business cycle.

Question 6.
State any two factors affecting fixed capital requirement of a business concern.
Answer:

1. Scale of operation
2. Growth and expansion prospects.

Question 7.
What is Financial planning?
Answer:
Financial planning is the process of determining the objectives, polices, procedures and programmes to deal with the financial activities of an organisation.

Question 8.
Write the difference betweeen working capital and fixed capital
Answer:
Working capital refers to the fends, which an organisation must possess to finance its day – to -day operations whereas the amount invested in acquisition and development of fixed assets is known as fixed capital.

III. Five Marks Questions and Answers

Question 1.
Describe the importance of Financial Management
Answer:
(a) Financial Management helps in estimating the capital requirements of an organisation.
(b) Financial Management is capital budgeting i.e, procurement ofan organisation.
(c) Financial Management also procures working capital, it is the excess of current assets over current liabilities.
(d) Financial Management helps in appraisal of financial performance and financial control
(e) Financial Management helps the organisations in making financial decisions.
(f) Financial Management helps the organisation for making dividend policy decisions.
(g) It provides solutions to financial problems.

Question 2.
What do you mean by a financial decision? Explain in brief the types of financial decisions?
Answer:
Decision-making in three major issues relating to the financial operations of a busines sorganisation is called financial decision.

The three major issues are as follows:
(a) Investment Decisions:
The investment decision relates to how the firm’s fends are invested in different assets. Investment decision can be long term investment decision or capital Budgeting decisions or short – term investment decision. Capital Budgeting decisions involve investment in fixed assets which has long – term implications. Working capital decisions involve investment in current assets and immediate return can be expected from such investment.

(b) Financial Decisions:
Financing decisions are concerned with the financing ofbusiness activities and the quantum of finance to be raised from various sources of finance. The main sources of fends for an organisation are shareholder’s funds (owners fund) and borrowed funds (debt fond). A firm has to decide the right proportion between these two important sources of finance, viz., owner’s fond and debt fend by evaluating different factors affecting financing decisions such as cost, risk, effect on management control state of capital market etc.

(c) Dividend Decisions: Dividend decisions relate to the appropriation of profit. Dividend decisions relate to what part of profit should be retained in the organisation and what part of it should be declared as dividedend. Retained earnings increase the fixture earning capacity of the organisations whereas, dividend results in maximising shareholder’s wealth. Hence the finance manager has to take balanced dividend decisions so that owners should get reasonable return on their investment and needs of the business should not suffer.

Question 3.
Explain briefly the importance of Financial Planning.
Answer:
(a) It is a tool that helps in facing any financial uncertainties.
(b) It ensures sufficient funds are available when there is a need.
(c) It ensures liquidity of funds throughout the year.
(d) Its policies would contribute to the elimination ofwastes.
(e) It helps in optimum capital structure at minimum cost.
(f) It helps in achieving better financial co-ordination by control measures.

Question 4.
Explain any five factors which may influence the amount of working capital requirements in a business.
Answer:
(a) The nature of the business and amount required for day to day running of the business determines the working capital requirements.
(b) The scale of operations (large or small) determines the working capital requirements.

(c) The plans for growth and expansion the production rate the sales targets determines the working capital requirements.

(d) Most of the business are subject to seasonal factors and this affects and determines the working capital requirements of a company.

(e) The credit policy of a company has a huge impact in determining the working capital requirements.

(f) The stage of business cycle, recession, depression, boom fluctuations in demand all these factors determine the working capital requirements.

(g) The changes in the price levels have a greater impact in determining the working capital requirements.

(h) The level of competition also determine the working capital requirements.

(i) The span of time of production cycle i.e., the time gap between conversion into finished goods determines the working capital requirements.

(j) Profit levels also affects working capital requirements of a company.

Question 5.
Explain any five factors which may influence the amount of fixed capital requirements in a business.
Answer:
(a) The nature of the business determines the amount of fixed capital requirement of a company to a great extent.
(b) The size of operation (large or small) determines the capital requirement.
(c) The plans for growth and expansions determines the capital requirements of a company.
(d) Choice of technique, technology and methods of productions to be used determines the capital requirements.
(e) The method which the company use to purchase determines the capital requirements.
(f) The diversification policies of a company determines the capital structure requirements.
(g) The amount which the company wishes to spend on promotion determines the capital structure.
(h) The level of collaboration with other business organisation also determines the capital requirements.
(i) The place of operations also determine the capital requirements.
(j) The nature of products of its marketing strategies also determines the capital requirements.

IV. Ten Marks Questions and Answers

Question 1.
Explain the objectives of Financial Management.
Answer:
1. Basic Objectives
(a) Profit Maximisation: It is one of the basic objectives of financial management. It means earning sufficient profit for meeting expenses.
(b) Wealth Maximisation: It is another basic objective of financial management. It means the maximisation of market share value of the shares.

2. Other Objectives
(a) One of main objectives of Financial Management is proper estimation of total financial requirements of an organisation.
(b) Obtaining fimds and mobilising it is another important objective.
(c) To ensure proper and optimum utilisation offinance.
(d) To maintain proper inflow and outflow of cash for day to day expenses of an organisation.
(e) Another major objective of Financial Management to create reserves and minimising risk
(f) In addition to raising fimds co-ordination is one of the major objectives of Financial . management.
(g) To avoid deviation in inflow and outflow of fundsby financial control.
(h) To create goodwill and to help long run survival of the organisation.

Question 2.
Explain the factors which may influence the amount of working capital requirements in a business.
Answer:
(a) The nature of the business and amount required for day to day running of the business determines the working capital requirements.
(b) The scale of operations (large or small) determines the working capital requirements.

(c) The plans for growth and expansion the production rate the sales targets determines the working capital requirements.

(d) Most of the business are subject to seasonal factors and this affects and determines the working capital requirements of a company.

(e) The credit policy of a company has a huge impact in determining the working capital requirements.

(f) The stage of business cycle, recession, depression, boom fluctuations in demand all these factors determine the working capital requirements.

(g) The changes in the price levels have a greater impact in determining the working capital requirements.

(h) The level of competition also determine the working capital requirements.

(i) The span of time of production cycle i.e., the time gap between conversion into finished goods determines the working capital requirements.

(j) Profit levels also affects working capital requirements of a company.

Question 3.
Explain the factors which may influence the amount of fixed captail requirements in a business.
Answer:
(a) The nature of the business determines the amount of fixed capital requirement of a company to a great extent.
(b) The size of operation (large or small) determines the capital requirement.
(c) The plans for growth and expansions determines the capital requirements of a company.
(d) Choice of technique, technology and methods of productions to be used determines the capital requirements.
(e) The method which the company use to purchase determines the capital requirements.
(f) The diversification policies of a company determines the capital structure requirements.
(g) The amount which the company wishes to spend on promotion determines the capital structure.
(h) The level of collaboration with other business organisation also determines the capital requirements.
(i) The place of operations also determine the capital requirements.
(j) The nature of products of its marketing strategies also determines the capital requirements.

Exercises

Short Answer Type Questions

Question 1.
What is meant by capital structure?
Answer:
Capital structure refers to the mix between owners and borrowed funds. It represents the proportion of equity and debt.
Capital Structure = (Debt/Equity)

Question 2.
Discuss the two objectives of Financial Planning.
Answer:
Financial Planning strives to achieve the following two objectives
1. To Ensure Availability of Funds whenever These are Required: This includes a proper estimation of the funds required for different purposes such as for the purchase of long term assets or to meet day-to-day expenses of business etc.

2. To See That the Firm Does Not Raise Resources Unnecessarily: Excess funding is almost as bad as Inadequate funding. Efficient financial planning ensures that funds are not raised unnecessarily in orderto avoid unnecessary addition of cost.

Question 3.
What is ‘ financial risk’? Why does it arise?
Answer:
It refers to the risk of company not being able to cover its fixed financial costs.
The higher level of risks are attached to higher degrees of financial leverage with the Increase in fixed financial costs, the company it’s also required to raise its operating profit (EBIT) to meet financial charges. If the company cannot cover these financial charges, it can be forced into liquidation.

Question 4.
Define a ‘current assets’ and give four examples.
Answer:
Current assets are those assets of the business which can be converted into cash within a period of one year. Cash in hand or at bank, bills receivables, debtors, finished goods inventory are some of the examples of current assets.

Question 5.
Financial management is based on three broad financial decisions. What are these?
Answer:
Financial management is concerned with the solution of three major issues relating to the financial operations of a firm corresponding to the three questions of Investment, financing and dividend decision. In a financial context, it means the selection ofbest financing alternative or best investment alternative.

The finance function therefore, is concerned with three broad decisions which are as follows

1. Decision: The investment decision relates to how the firm’s funds are invested in different assets.
2. Financing Decision: This decision is about the quantum of finance to be raised from various long term sources and short term sources. It Involves identification of various available sources of finance.
3. Dividend Decision: This decision relates to distribution of dividend. Dividend is that portion of profit which is distributed to shareholders the decision involved here is how much of the profit earned by company is to be distributed to the shareholders and how much of it should be retamed in the business for meeting investment requirements.

Question 6.
What is the main objective of financial management? Explain briefly.
Answer:
Primary aim of financial management is to maximise shareholder’s wealth, which is referred to as the wealth maximisation concept. The wealth of owners is reflected in the market value of shares, wealth maximisation means the maximisation of market price of shares. According to the wealth maximisation objective, financial management must select those decisions which result in value addition, that is to say the benefits from a decision exceed the cost involved. Such value addition increase the market value of the company’s share and hence result in maximisation of the shareholder’s wealth.

Question 7.
Discuss about working capital affecting both the liquidity as well as profitability of a business.
Answer:
The working capital should neither be more nor less than required. Both these situations are harmful. If the amount of working capital is more than required, it will no doubt increase liquidity but decrease profitability. For instance, if large amount of cash is kept as working capital, then this excessive cash will remain idle and cause the profitability to fall. On the contrary, if the amount ofcash and other current assets are very little, then lot of difficulties will have to be faced in meeting daily expenses and making payment to the creditors. Thus, optimum amount of both current assets and current liabilities should be determined so that profitability of the business remains intact and there is no fall in liquidity.

Long Answer Type Questions

Question 1.
What is meant by working capital? How is it calculated? Discuss five important determinants of working capital requirements.
Answer:
Working capital is that part of total capital which is required to meet day-to-day expenses, to buy raw materials, to pay wages and other expenses of routine nature in the production process or we can say it refers to excess of current assets over current liabilities.
Working Capital = Current Assets – Current Liabilities

Factors affecting working capital requirement are
1. Nature of Business: The basic nature of a business influences the amount of working capital required. A trading organisation usually needs a lower amount of working capital compared to a manufacturing organisation. This is because in trading.

There is no processing required. In a manufacturing business, however, raw materials need to be converted into finished goods, which increases the expenditure on raw material, labour and other expenses.

2. Scale of Operation: The firms which are operating on a higher scale of operations, the quantum of inventory, debtors required is generally high. Such organisations, therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.

3. Production Cycle: Production cycle is the time span between the receipts of raw materials and their conversion into finished goods. Some businesses have a longer production cycle while some have a shorter one. Working capital requirement is higher in ferms with longer processing cycle and lower in firms with shorter processing cycle.

4. Credit Allowed: Different firms allow different credit terms to their customers. A liberal credit policy results in higher amount of debtors, increasing the requirements of working capital.

5. Credit Availed: Just as a firm allows credit to its customers it also may get credit from its suppliers. The more credit a firm avails on its purchases, the working capital requirement is reduced.

Question 2.
Capital structure decision is essentially optimisation of risk-return relationship. Comment.
Answer:
Capital structure refers to the mix between owners and borrowed Hinds. It can be calculated as(Debt/Equity).

Debt and equity differ significantly in their cost and riskiness for the firm. Cost of debt is lower than cost of equity for a firm because lender’s risk is lower than equity shareholder’s risk, since lenders earn on assured return and repayment of capital and therefore they should require a lower rate of return. Debt is cheaper but is more risky for a business because payment of interest and the return of principal is obligatory for the business. Any default in meeting these commitments may force the business to go into liquidation. There is no such compulsion in case of equity, which is therefore, considered riskless for the business. Higher use of debt increases the fixed financial charges of a business. As a result increased, use of debt increases the financial risk of a business.

Capital structure of a business thus, affects both the profitability and the financial risk. A capital structure will be said to be optimal when the proportion of debt and equity is such that it results in an increase in the value of the equity share.

Question 3.
A capital budgeting decision is capable of changing the financial fortune of a business. Do you agree? Why or why not?
Answer:
Investment decision can be long term or short term. Along term Investment decision is also called a capital budgeting decision. It involves committing the finance on a long term basis, e.g., making investment inanew machine to replace an existing one or acquiring a new fixed assets or opening a new branch etc. These decisions are very crucial for any business. They affect its earning capacity over the long-run, assets of a firm, profitability and competitiveness, are all affected by the capital budgeting decisions. Moreover, these decisions normally involve huge amounts of investment and are irreversible except at a huge cost. Therefore, once made, it Is almost impossible for a business to wriggle out of such decisions. Therefore, they need to be taken with utmost care. These decisions must be taken by those who understand them comprehensively.

A bad capital budgeting decision normally has the capacity to severely damage the financial fortune of a business.

Question 4.
Explain factors affecting the dividend decision.
Answer:
Dividend decision relates to distribution of profit to the shareholders and its retention in the business for meeting the future investment requirements. How much of the profits earned by a company will be distributed as profit and how much will be retained in the business is affected by many factors.

Some of the important factors are discussed as follows
1. Earnings: Dividends are paid out of current and past year earnings. Therefore, earnings is a major determinant of the decision about dividend.

2. Stability of Earnings: Other things remaining the same, a company having stable earning is in a position to declare higher dividends As against this, a company having unstable earnings is likely to pay smaller dividend.

3. Growth Opportunities: Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. The dividend in growth companies, is therefore, smaller than that in non-growth companies.

4. Cash Flow Position: Dividends Involve an outflow of cash. A company may be profitable but short on cash. Availability of enough cash in the company is necessary for declaration of dividend by it.

5. Shareholder: Preference If the shareholder in general, desire that at least a certain amount should be paid as dividend, the companies are likely to declare the same.

6. Taxation Policy: If tax on dividend is higher It would be better to pay less by way of dividends. As compared to this, higher dividends maybe declared if tax rates are relatively lower.

7. Stock Market Reaction: For investors, an increase in dividend is a good news and stock prices react positively to It. Similarly a decrease in dividend may have a negative impact on the share prices in the stock market.

8. Access to Capital Market: Large and reputed companies generally have easy access to the capital market and therefore, depend less on retained earnings to finance their growth These companies tend to pay higher dividends than the smaller companies which have relatively low access to the market.

9. Legal constraints: Certain provisions of the Company’s Act place restriction on payouts as dividend. Such provisions have to be adhered, while declaring dividends.

10. Contractual Constraints: While granting loans to a company, sometimes the lender may impose certain restrictions on the payment of dividends in future The companies are required to ensure that the dividends does not violate the terms and conditions of the loan agreement in this regard

Multiple Choice Questions

Question 1.
The cheapest source of finance is
(a) debenture
(b) equity share capital
(c) preference share
(d) retained earnings
Answer:
(d) Retained earnings is the cheapest source of finance.

Question 2.
A decision to acquire a new and modem plant to upgrade an old one is a
(a) financing decision
(b) working capital decision
(c) investment decision
(d) dividend decision
Answer:
(c) Investment decision is related to careful selection of assets in which funds will be Invested by firms. Thus, the above case comes under the investment decision.

Question 3.
Other things remaining the same, an increase in the tax rate on corporate profits will
(a) make debt relatively cheaper
(b) make debt relatively less cheap home
(c) no impact on the cost of debt
(d) we can’t say
Answer:
(a) If the tax rate on corporate, profit will increase it makes debt relatively cheaper.

Question 4.
Companies with higher growth paternal are likely to
(a) pay lower dividends
(b) pay higher dividends
(c) dividends are not affected by growth considerations
(d) None of the above
Answer:
(a) Companies who are having a higher growth pattern are likely to pay lower dividends.

Question 5.
Financial leverage is called favourable if
(a) return on investment is lower than cost of debt
(b) return on investment is higher than cost of debt
(c) debt is nearly available
(d) if the degree of existing financial leverage is low
Answer:
(b) If ROI is higher than cost of debt financial leverage in this case called favourable.

Question 6.
Higher debt equity ratio (Debt/Equity) results in Equity
(a) lower financial risk
(b) higher degree of operating risk
(c) higher degree of financial risk
(d) higher EPS
Answer:
(c) Higher debt equity ratio results in higher degree of financial risk.

Question 7.
Higher working capital usually results in
(a) higher current ratio, higher risk and higher profits
(b) lower current ratio, higher risk and profits
(b) higher equitably, lower risk and lower profits
(d) lower equitably, lower risk and higher profits
Answer:
(a) If the working capital is higher it results in higher current ratio, higher risk and higher profits.

Question 8.
Current assets are those assets which get converted into cash
(a) within six month
(b) within one year
(c) between one and three year
(d) between three and five year
Answer:
(b) Current assets are those assets which are converted in cash in one year.

Question 9.
Financial planning arrives at
(a) minimising the external borrowing by resorting to equity issues
(b) entering that the firm always have significantly more fun than required so that there is no paucity of funds
(c) ensuring that the firm paces neither a shortage nor a glut of unusable funds
(d) doing only what is possible with the funds that the firm has at its disposal
Answer:
(c) Financial planning means deciding how much to spend and on what to spend it ensuring that the firm paces neither a shortage nor a glut of unusable funds.

Question 10.
Higher dividends per share is associated with
(a) high earnings, high cash flows, unusable earnings and higher growth opportunities
(b) high earnings, high cash flows, stable earnings and high growth opportunities
(c) high earnings, high cash flows, stable earnings and lower growth opportunities
(d) high earnings, low cash flows, stable earnings and lower growth opportunities
Answer:
(c) Higher dividend per share includes higher earnings, high cash flows, stable earning and lower growth opportunities.

Question 11.
A fixed asset should be financed through
(a) a long term liability
(b) a short term liability
(c) a mix of long and short term liabilities
(d) None of the above
Answer:
(a) Fixed assets financed through long term liability.

Question 12.
Current assets of a business firm should be financed through
(a) current liability only
(b) long term liability only
(c) partly from both types i.e., long and short term liabilities
(d) None of the above
Answer:
(c) Current assets are financed through long and short term liabilities.

Case Problem:

‘S’ Limited is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is about 7% – 8% and the demand for steel is growing. It is planning to set up a new steel plant to cash on the increased demand it is flic ing. It is estimated that it will require about Rs. 5,000 crores to set up and about Rs. 500 crores of working capital to start the new plant.

Question 1.
What is the role and objectives of financial management for this company?
Answer:
Role of Financial Management Financial management is concerned with the proper management of funds it involves:

1. Managerial decisions relating to procurement of long term and short term fend
2. Keeping the risk associated with respect to procured funds under control.
3. Utilisation offends in the most productive and effective manner
4. Fixed debt equity ration capital. Objective of Financial Management

The objective of financial management is the maximisation of shareholder’s wealth The investment decision, financial decision and dividend decision help an organisation to achieve this objective In the given situation S limited envisages growth prospects of steel

Industry due to the growing demand. To expand the production capacity, the company needs to invest However, investment decision will depend on the availability of funds, the financing decision and the dividend decision. However, the company win take those financial decisions which result In value addition I e the benefits are more than the cost This leads to an increase in the market value of the shares of the company.

Question 2.
Explain the importance of having a financial plan for this company. Give an imaginary plan to support your answer.
Answer:
Importance of financial plan for the company

1. Financial Planning ensures provision of adequate funds to meet working capital requirements.
2. It brings about a balance between in flow and out flow of funds and ensures liquidity throughout the year.
3. It solves the problems of shortage and surplus of funds and ensures proper and optimum utilisation of available resources
4. It ensures increased profitability through cost-benefit analyses and by avoiding wasteful operations
5. It seeks to eliminate waste of funds and provides better financial control.
6. It seeks to avail of the benefits of trading on equity.

Financial Plan of S Ltd:
Total finance required; Fixed capital = Rs. 1,000 crores
Working capital = Rs. 100 crores
Source of finance: 2:1 Ratio i.e..
50% of finance collected by issue of shares and 50% by borrowed funds.

Question 3.
What are the factors which will affect the capital structure of this company?
Answer:
Capital structure refers to the proportion In which debt and equity funds are used for financing the operations of a business. A capital structure is said to be optimum when the proportion of debt and equity is such that it results in an increase in the value of shares.

The factors that will affect the capital structure of this company are
1. Equity Funds: The composition of equity funds in the capital structure will be governed by the following factors
(a) The requirement of funds of ’ S Limited is for long term. Hence, equity funds will be more appropriate
(b) There are no financial risks attached to this form of funding
(c) If the stock market is bullish, the company can easily raise funds through issue of equity shares.
(d) If the company already has raised . reasonable amount of debt funds, each
subsequent borrowing will come at a higher interest rate and will Increase the fixed charges.

2. Debt Funds: The usage and the ratio of debt funds in the capital structure will be governed by factors like
(a) The availability of cash flow with the company to meet its fixed financial charges. The purpose is to reduce the financial risk associated with such payments which can further be checked by using ‘debt’ service coverage ratio
(b) It will provide the benefit of trading on equity and hence will Increase the earning per share of equity shareholders However, the return on Investment’ ratio will be the guiding principle behind it. The company should opt for trading on equity only when the return on investment is more than the fixed charges.
(c) Interest on debt funds is a deductible expense and therefore, will reduce the tax liability
(d) It does not result in dilution of management control.

Question 4.
Keeping in mind that it is a highly capital intensive sector what factors will affect the fixed and working capital. Give reasons with regard to both in support of your answer.
Answer:
The working and fixed capital requirement of ‘S’ Limited Will be high due to the following reasons.

1. The business is capital intensive and the scale of operation is large.
2. Heavy Investments are required for building up the production base and for technological upgradation.
3. In case of steel industry. The major Input is iron are and coal. The ratio of cost of raw material to total cost is very high. Hence, higher will be the need for working capital
4. The longer the operating cycle, the larger is the amount of working capital required as the funds get locked up in the production process for a long period of lime
5. Terms of credit for buying and selling goods, discount allowed suppliers and to the customers also determines the quantum working capital.

2nd PUC Business Studies Important Questions