FM Theory & MCQ Book by Yours - AmitBhai

Introduction to Financial Management
CA Amit Sharma
1 INTRODUCTION TO FINANCIAL
MANAGEMENT
CHAPTER
Q.N. Questions
1. Management of all matters related to an organisation's finances is called
(a) Cash inflows and outflows (b) Allocation of resources

(c) Financial management (d) Finance
2. Which of the following activities are performed by CFOs now in addition to those performed by
past CFOs
(a) Budgeting (b) Forecasting

(c) Risk Management (d) Treasury management
3. Which of the following need not be followed by the finance manager for measuring and
maximising shareholders' wealth
(a) Accounting profit analysis (b) Cash Flow approach

(c) Cost benefit analysis (d) Application of time value of money
4. "Shareholders Wealth" in a firm is reflected by
(a) the number of people employed in the firm

(b) the book value of the firm's assets less the book value of its liabilities
(c) the amount of salary paid to its employees
(d) the market price per share of the firm
5. Financial Management is mainly concerned with the
(a) Acquiring and developing assets to forfeit its overall benefit

(b) Acquiring, financing and managing assets to accomplish the overall goal of a business enterprise
(c) Efficient management of the business
(d) Sole objective of profit maximisation
6. Which of the following are microeconomic variables that help define and explain the discipline
of finance
(a) Risk and return

(b) Capital structure
(c) Inflation
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Introduction to Financial Management CA Amit Sharma
(d) All of the above
7. Which of the following is the common connection in financing, investing decisions
(a) Investment instruments type should be same as financing instrument type

(b) Investments will definitely grow in line with financing
(c) Debt Equity ratio should be same for investments and financing actions
(d) Risk Return Trade off
8. The main objective of financial management is to
(a) Secure profitability (b) Maximise shareholder wealth

(c) Enhancing the cost of debt (d) None of above
9. Wealth maximisation approach is based on the concept of
(a) Cost benefit analysis (b) Cash flow approach

(c) Time value of money (d) All of the above
10. The shareholder value maximisation model holds that the primary goal of the firm is to
maximise its
(a) Accounting profit (b) Liquidity

(c) Market value (d) Working capital
11. Which of the following is the disadvantage of having shareholders wealth maximisation goals
(a) Emphasizes the short-term gains

(b) Ignores the timing of returns
(c) Requires immediate resources
(d) Offers no clear relationship between financial decisions and share price
12. Decision about mergers, takeovers, expansion, liquidiation were covered in financial
management under phase of Financial Management
(a) Traditional (b) Transitional

(c) Modern (d) None
13. Reserves & Surplus are which form of financing
(a) Security Financing (b) Internal Financing

(c) Loans Financing (d) International Financing
14. Which of following activities will not lead to increase in shareholders wealth?
(a) Investing in projects with high cash flows

(b) Raising funds through sources which have low cost
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(c) Regular growth in dividends

(d) Maintaining high levels of cash at bank
15. Focus of financial management is mainly concerned with the decision related to
(a) Financing (b) Investing

(c) Dividend (d) All of above
1. (c) 2. (c) 3. (a) 4. (d) 5. (b)
6. (d) 7. (d) 8. (b) 9. (d) 10. (c)
11. (d) 12. (a) 13. (b) 14. (d) 15. (d)
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Q. N THEORY QUESTIONS
1. For starting business what are the major decisions an entrepreneur has to go through ?
The Various Stages are:-

Stage 1:- Decide which assets (premises, machinery, equipment etc.) to buy.
Stage 2:- Determining what is total investment (since assets cost money) required for buying assets.
Stage 3:- Apart from buying assets the entrepreneur would also need to determine how much cash he
would need to run the daily operations (payment for raw material, salaries, wages etc.). In other words
this is also defined as Working Capital requirement.
Stage 4:- The next stage is to decide what all sources, does the entrepreneur need to tap to finance the
total investment (assets and working capital). The sources could be Share Capital (Including
Entrepreneur’s own funds) or Borrowing from Banks or Investment from Financial Institutions etc.
2. What is the meaning of Financial Management & What are the three major decisions in
Financial Management?
Financial management is that managerial activity which is concerned with planning and controlling of
the firm’s financial resources. In other words it is concerned with acquiring, financing and managing
assets to accomplish the overall goal of a business enterprise (mainly to maximise the shareholder’s
wealth).
“Financial Management comprises of forecasting, planning, organizing, directing, co-ordinating and

controlling of all activities relating to acquisition and application of the financial resources of an
undertaking in keeping with its financial objective.
Any business enterprise requiring money and the 3 key questions being enquired into
1. Where to get the money from? (Financing Decision)
2. Where to invest the money? (Investment Decision)
3. How much to distribute amongst shareholders to keep them satisfied? (Dividend Decision)
3. What are various sources of raising funds?
Some of the sources of funds:-

(a) Equity: The funds raised by the issue of equity shares are the best from the risk point of view for
the firm, since there is no question of repayment of equity capital except when the firm is under
liquidation.
(b) Debentures: Debentures as a source of funds are comparatively cheaper than the shares because
of their tax advantage. The interest the company pays on a debenture is free of tax, unlike a dividend
payment which is made from the taxed profits.
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(c) Funding from Banks: Commercial Banks play an important role in funding of the business
enterprises. Apart from supporting businesses in their routine activities (deposits, payments etc.) they
play an important role in meeting the long term and short term needs of a business enterprise.
(d) International Funding: Funding today is not limited to domestic market. With liberalization and
globalization a business enterprise has options to raise capital from International markets also.
Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII) are two major routes for
raising funds from foreign sources besides ADR’s (American depository receipts) and GDR’s (Global
depository receipts).
(e) Angel Financing: Angel Financing is a form of an equity-financing where an angel investor is a
wealthy individual who provides capital for start-up or expansion, in exchange for an
ownership/equity in the company. Angel investors have idle cash available and are looking for a higher
rate of return than what is given by traditional investments.
4. What do you mean by effective utilisation of Funds ?
The finance manager is also responsible for effective utilisation of funds. He has to point out situations
where the funds are being kept idle or where proper use of funds is not being made. All the funds are
procured at a certain cost and after entailing a certain amount of risk. If these funds are not utilised in
the manner so that they generate an income higher than the cost of procuring them, there is no point
in running the business. Hence, it is crucial to employ the funds properly and profitably. Some of the
aspects of funds utilization are:
(a) Utilization for Fixed Assets: The funds are to be invested in the manner so that the company can
produce at its optimum level without endangering its financial solvency. For this, the finance manager
would be required to possess sound knowledge of techniques of capital budgeting.
(b) Utilization for Working Capital: The finance manager must also keep in view the need for
adequate working capital and ensure that while the firms enjoy an optimum level of working capital
they do not keep too much funds blocked in inventories, book debts, cash etc
5. Explain evolution of Financial Management or various stages of financial management.
The three stages of its evolution are:

The Traditional Phase: During this phase, Financial Management was considered necessary only
during occasional events such as takeovers, mergers, expansion, liquidation, etc. Also, when taking
financial decisions in the organisation, the needs of outsiders (investment bankers, people who lend
money to the business and other such people) to the business was kept in mind.
The Transitional Phase: During this phase, the day-to-day problems that financial managers faced
were given importance. The general problems related to funds analysis, planning and control were
given more attention in this phase.
The Modern Phase: Modern phase is still going on. The scope of Financial Management has greatly
increased now. It is important to carry out financial analysis for a company. This analysis helps in
decision making. During this phase, many theories have been developed regarding efficient markets,
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capital budgeting, option pricing, valuation models and also in several other important fields in
financial management.
6. Explain Long term and Short term Finance Functions.

Value of a firm will depend on various finance functions/decisions. It can be expressed as :
The finance functions are divided into long term and short term functions/decisions
Long term Finance Function Decisions
(a) Investment decisions (I): These decisions relate to the selection of assets in which funds will
be invested by a firm. Funds procured from different sources have to be invested in various kinds of
assets. Long term funds are used in a project for various fixed assets and also for current assets. The
investment of funds in a project has to be made after careful assessment of the various projects
through capital budgeting.
(b) Financing decisions (F): These decisions relate to acquiring the optimum finance to meet
financial objectives and seeing that fixed and working capital are effectively managed. The financial
manager needs to possess a good knowledge of the sources of available funds and their respective
costs and needs to ensure that the company has a sound capital structure, i.e. a proper balance between
equity capital and debt.
(c) Dividend decisions (D): These decisions relate to the determination as to how much and how
frequently cash can be paid out of the profits of an organisation as income for its
owners/shareholders. The owner of any profit-making organization looks for reward for his
investment in two ways, the growth of the capital invested and the cash paid out as income; for a sole
trader this income would be termed as drawings and for a limited liability company the term is
dividends.
All three types of decisions are interrelated, the first two pertaining to any kind of organisation while
the third relates only to profit-making organisations, thus it can be seen that financial management is
of vital importance at every level of business activity, from a sole trader to the largest multinational
corporation.
Short-term Finance Decisions/ Function

Working Capital Management (WCM): Generally short term decision are reduced to management of
current asset and current liability (i.e., working capital Management)
7. Explain importance of Financial Management
The best way to demonstrate the importance of good financial management is to describe some of the
tasks that it involves:-
• Taking care not to over-invest in fixed assets.
• Balancing cash-outflow with cash-inflows
• Ensuring that there is a sufficient level of short-term working capital.
• Setting sales revenue targets that will deliver growth.
• Increasing gross profit by setting the correct pricing for products or services
• Controlling the level of general and administrative expenses by finding more cost-efficient ways of
running the day-to-day business operations
• Tax planning that will minimize the taxes a business has to pay.
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8. What are responsibilities of Finance Executive ?
His responsibilities include:

(a) Financial analysis and planning: Determining the proper amount of funds to employ in the firm,
i.e. designating the size of the firm and its rate of growth.
(b) Investment decisions: The efficient allocation of funds to specific assets.
(c) Financing and capital structure decisions: Raising funds on favourable terms as possible i.e.
determining the composition of liabilities.
(d) Management of financial resources (such as working capital).
(e) Risk management: Protecting assets.
9. Explain role of Finance executive in today’s world
Today, the role of Financial Executive, is no longer confined to accounting, financial reporting and risk
management. Some of the key activities that highlight the changing role of a Finance Executive are as
follows:-
• Budgeting
• Forecasting
• Managing M & As
• Profitability analysis relating to customers or products
• Pricing Analysis
• Decisions about outsourcing
• Overseeing the IT function.
• Overseeing the HR function.
• Strategic planning (sometimes overseeing this function).
• Regulatory compliance.
• Risk management.
10. What is scope of Financial Management
Based on financial management guru Ezra Solomon’s concept of financial management, following
aspects are taken up in detail under the study of financial management:
(a) Determination of size of the enterprise and determination of rate of growth.
(b) Determining the composition of assets of the enterprise.
(c) Determining the mix of enterprise’s financing i.e. consideration of level of debt to equity, etc.
(d) Analysis, planning and control of financial affairs of the enterprise.
11. Explain two objectives of Financial Management

The two objectives are (i) profit Maximisation and (ii) Wealth Maximisation
Profit Maximisation
It has traditionally been argued that the primary objective of a company is to earn profit; hence the
objective of financial management is also profit maximisation. This implies that the finance manager
has to make his decisions in a manner so that the profits of the concern are maximised. Each
alternative, therefore, is to be seen as to whether or not it gives maximum profit. However, profit
maximisation cannot be the sole objective of a company. It is at best a limited objective. If profit is
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given undue importance, a number of problems can arise. Some of these have been discussed
below:
(i) The term profit is vague. It does not clarify what exactly it means. It conveys a different
meaning to different people. For example, profit may be in short term or long term period; it may be
total profit or rate of profit etc.
(ii) Profit maximisation has to be attempted with a realisation of risks involved. There is a direct
relationship between risk and profit. Many risky propositions yield high profit. Higher the risk, higher
is the possibility of profits. If profit maximisation is the only goal, then risk factor is altogether ignored.
(iii) Profit maximisation as an objective does not take into account the time pattern of returns.
Proposal A may give a higher amount of profits as compared to proposal B, yet if the returns of
proposal A begin to flow say 10 years later, proposal B may be preferred which may have lower overall
profit but the returns flow is more early and quick.
(iv) Profit maximisation as an objective is too narrow. It fails to take into account the social
considerations as also the obligations to various interests of workers, consumers, society, as well as
ethical trade practices. If these factors are ignored, a company cannot survive for long. Profit
maximization at the cost of social and moral obligations is a short sighted policy.
Wealth Maximisation/ Value Creation

Wealth = Present value of benefits – Present Value of Costs
We will first like to define what is Wealth Maximization Model. Shareholders wealth are the result of
cost benefit analysis adjusted with their timing and risk i.e. time value of money.
So, It is important that benefits measured by the finance manager are in terms of cash flow. Finance
manager should emphasis on Cash flow for investment or financing decisions not on Accounting profit.
The shareholder value maximization model holds that the primary goal of the firm is to maximize its
market value and implies that business decisions should seek to increase the net present value of
the economic profits of the firm. So, for measuring and maximising shareholders wealth finance
manager should follow:
 Cash Flow approach not Accounting Profit
 Cost benefit analysis
 Application of time value of money.
12. Explain Advantages & Dis-advantages of Profit & Wealth maximisation method
Goal Objective Advantages Disadvantages
Profit Large amount
(i) Easy to calculate (i) Emphasizes the
Maximization of profits
profits short term gains
(ii) Easy to determine (ii) Ignores risk or
the link between uncertainty
financial decisions (iii) Ignores the timing of
andprofits. returns
Requires immediateresources.
Shareholders Highest market
(i) Emphasizes the (i) Offers no clear relationship
Wealth value of shares.
long term gains between financial
Maximisation
(ii) Recognises risk or decisionsand share price.
uncertainty Can lead to management anxiety
and frustration.
(iii) Recognises the
timing of returns
(iv) Considers
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shareholders’
return.
13. Why Wealth Maximisation works ?
To answer this question it is important to first understand and know what other goals a business
enterprise may have. Some of the other goals a business enterprise may follow are:-
 Achieving a higher growth rate
Attaining a larger market share
 Gaining leadership in the market in terms of products and technology
 Promoting employee welfare
 Increasing customer satisfaction
 Improving community life, supporting education and research, solving societal problems, etc.
14. Explain linking of FM with Accounts.

The relationship between financial management and accounting are closely related to the extent that
accounting is an important input in financial decision making. In other words, accounting is a
necessary input into the financial management function.
Financial accounting generates information relating to operations of the organisation. The outcome of
accounting is the financial statements such as balance sheet, income statement, and the statement of
changes in financial position. The information contained in these statements and reports helps the
financial managers in gauging the past performance and future directions of the organisation.
Though financial management and accounting are closely related, still they differ in the treatment of
funds and also with regards to decision making. Some of the differences are:-
Treatment of Funds
In accounting, the measurement of funds is based on the accrual principle i.e. revenue is recognised
at the point of sale and not when collected and expenses are recognised when they are incurred rather
than when actually paid. The accrual based accounting data do not reflect fully the financial conditions
of the organisation.
Decision–making
The purpose of accounting is to collect and present financial data of the past, present and future
operations of the organization. The financial manager uses these data for financial decision making. It
is not that the financial managers cannot collect data or accountants cannot make decisions, but the
chief focus of an accountant is to collect data and present the data while the financial manager’s
primary responsibility relates to financial planning, controlling and decision making. Thus, in a way it
can be stated that financial management begins where accounting ends.
15. How to address agency problem?

The agency problem arises if manager’s interests are not aligned to the interests of the debt lender and
equity investors. The agency problem of debt lender would be addressed by imposing negative
covenants i.e. the managers cannot borrow beyond a point. This is one of the most important concepts
of modern nday finance and the application of this would be applied in the Credit Risk Management of
Bank, Fund Raising, Valuing distressed companies. Agency problem between the managers and
shareholders can be addressed if the interests of the managers are aligned to the interests of the share-
holders. It is easier said than done.
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However, following efforts have been made to address these issues:

 Managerial compensation is linked to profit of the company to some extent and also with the long
term objectives of the company.
 Employee is also designed to address the issue with the underlying assumption that maximisation
of the stock price is the objective of the investors.
 Effecting monitoring can be done.
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TYPES OF FINANCING
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2 TYPES OF FINANCING
CHAPTER
QUESTIONS
Q.N
______ bonds give the investor an option back to the company before maturity.
1.
(a) Callable (b) Puttable
(c) Both (d) Foreign
Marketable securities are primarily
2.
(a) short-term debt instruments (b) short-term equity securities
(c) long-term debt instruments (d) long-term equity securities
Equity Share
3.
(a) Have an unlimited life, and voting rights and receive dividends
(b) Have a limited life, with no voting rights but receive dividends
(c) Have a limited life, and voting rights and receive dividends
(d) Have an unlimited life, and voting rights but receive no dividends
Debt capital refers to:
4.
(a) Money raised through the sale of shares. (b) Funds raised by borrowing & must be repaid
(c) Factoring accounts receivable (d) Inventory loans
Which of the following marketable securities is the obligation of a commercial bank

5.
(a) Commercial paper (b) Negotiable certificate of deposit
(c) Repurchase agreement (d) T-bills
External sources of finance do not include
6.
(a) Debentures (b) Retained earnings
(c) Overdrafts (d) Leasing
External Commercial Borrowings can be accessed through ..............
7.
(a) only automatic route
(b) only approval route
(c) both automatic and approval route
(d) neither automatic nor approval route
The most popular source of short-term funding is
8.
(a) Factoring (b) Trade credit
(c) Family and friends (d) Commercial banks
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Reserves & Surplus are which form of financing

9.
(a) Security Financing (b) Internal Financing
(c) Loans Financing (d) International Financing
Commercial paper is a issued by ____ interest rate of which is linked to ______
10.
(a) Debenture, Corporates, 1 Year Gov Securities Yield
(b) Promissory Note, Corporates, 1 Year Gov Securities Yield
(c) Promissory Note, Banks, 1 Year Gov Securities Yield
(d) Promissory Note, Banks, RBI Repo rate
In preference shares
11.
(a) Dividends are not available (b) Limited voting rights are available
(c) Are not part of a company's share capital (d) Interest can be received
A company has an existing EPS of Rs. 7.5; it makes an FPO of 15000 shares issued at a price of
12.
Rs. 25 per share. The funds thus raised are expected to earn a post-tax return of 28%. What will
be the expected impact on EPS?
(a) EPS will remain 7.5 (b) EPS will be greater than 7.5
(c) EPS will be below 7.5 (d) Information not sufficient for calculation
With reference to 'IFC Masala Bonds', which of the statements given below is/are correct
13.
1. The International Finance Corporation, which offered these bonds, is an arm of the World
Bank.
2. They are rupee-denominated bonds and are a source of debt financing for the public and
private sector.
(a) 1 only (b) 2 only
(c) Both 1 and 2 (d) Neither 1 nor 2
A debenture
14.
(a) Is a long-term loan (b) Does not require security
(c) Is a short-term loan (d) Receives dividend payments
Internal sources of finance do not include
15.
(a) Better management of working capital (b) Ordinary shares
(c) Retained earnings (d) Reserve and Surplus
The venture capital financing is a financing of new high risky venture promoted by skilled
16.
entrepreneurs who lack and funds but have
(a) Society (b) Government
(c) Competitors (d) Technology
1. (b) 2. (a) 3. (a) 4. (a) 5. (b)
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6. (b) 7. (c) 8. (b) 9. (b) 10. (b)
11. (b) 12. (c) 13. (c) 14. (a) 15. (b)
16. (b)
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QUESTIONS
Q.N
What are various types of Financing Needs?
1.
Business enterprises need funds to meet their different types of requirements. All the financial needs
of a business may be grouped into the following three categories:
(i) Long-term financial needs: Such needs generally refer to those requirements of funds which are
for a period exceeding 5-10 years. All investments in plant, machinery, land, buildings, etc., are
considered as long-term financial needs. Funds required to finance permanent or hardcore
working capital should also be procured from long term sources.
(ii) Medium-term financial needs: Such requirements refer to those funds which are required for a
period exceeding one year but not exceeding 5 years. This might be needed for stores and spares,
critical spares, tools, dies, moulds.
(iii) Short-term financial needs: Such type of financial needs arise to finance current assets such as
stock, debtors, cash etc. Investment in these assets are known as meeting of working capital
requirements of the concern. The main characteristic of short-term financial needs is that they arise
for a short period of time not exceeding the accounting period. i.e., one year.
What is general rule for Financing of Assets?
2.
General rule for financing of different assets would take place. These rules can be changed depending
on the nature of borrower i.e. depending on the borrower’ level of operation Besides, the stage of
development of the business and nature of business would also decide the type of borrowing.
Generally, it can be as follows:
Stage Nature of Business Sources of Fund
Early stage High Uncertainty Equity; mainly Angel fund
High to moderate Uncertainty Equity; Venture capital; Debt
Growth Stage Moderate to Low Uncertainty Debt; Venture Capital; Private Equity
Stable stage Low Uncertainty Debt

3. What are various long term sources of Finance??
There are different sources of funds available to meet long term financial needs of the business. These
sources may be broadly classified into:
 Share capital (both equity and preference) &
 Debt (including debentures, long term borrowings or other debt instruments).
Explain Equity Shares, its advantages and disadvantages ??
4.
A public limited company may raise funds from promoters or from the investing public by way of
owner’s capital or equity capital by issuing ordinary equity shares. Some of the characteristics of
Owners/Equity Share Capital are:
 It is a source of permanent capital. The holders of such share capital in the company are called equity
shareholders or ordinary shareholders.
 Equity shareholders are practically owners of the company as they undertake the highest risk.
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Advantages of raising funds by issue of equity shares are:

(i) It is a permanent source of finance. Since such shares are not redeemable, the company has no
liability for cash outflows associated with its redemption. In other words, once the company has issued
equity shares, they are tradable i.e. they can be purchased and sold. So, a company is in no way
responsible for any cash outflows of investors by which they become the shareholders of the company
by purchasing the shares of existing shareholders.
(ii) Equity capital increases the company’s financial base and thus helps to further the borrowing
powers of the company. In other words, by issuing equity shares, a company manage to raise some
money for its capital expenditures and this helps it to raise more funds with the help of debt. This is
because; debt will enable the company to increase its earnings per share and consequently, its share
prices.
(iii) A company is not obliged legally to pay dividends. Hence in times of uncertainties or when the
company is not performing well, dividend payments can be reduced or even suspended.
(iv) A company can make further increase its share capital by initiating a right issue.
Disadvantages of raising funds by issue of equity shares are:

Apart from the above mentioned advantages, raising of funds through equity share capital has some
disadvantages in comparison to other sources of finance. These are as follows:
(i) Investors find ordinary shares riskier because of uncertain dividend payments and capital gains.
(ii) The issue of new equity shares reduces the earning per share of the existing shareholders until
and unless the profits are proportionately increased.
(iii) The issue of new equity shares can also reduce the ownership and control of the existing
shareholders.
Explain Preference Share Capital, its advantages and disadvantages??
5.
These are special kind of shares; the holders of such shares enjoy priority, both as regard to the
payment of a fixed amount of dividend and also towards repayment of capital on winding up of the
company. Some of the characteristics of
Preference Share Capital are as follows:
 Long-term funds from preference shares can be raised through a public issue of shares.
 Such shares are normally cumulative, i.e., the dividend payable in a year of loss gets carried over to
the next year till there are adequate profits to pay the cumulative dividends.
Advantages of raising funds by issue of preference shares are:

(i) No dilution in EPS on enlarged capital base – On the other hand if equity shares are issued it reduces
EPS, thus affecting the market perception about the company.
(ii) There is also the advantage of leverage as it bears a fixed charge (because companies are required
to pay a fixed rate of dividend in case of a issue of preference shares). Non-payment of preference
dividends does not force a company into liquidity.
(iii) There is no risk of takeover as the preference shareholders do not have voting rights except where
dividend payment are in arrears.
Disadvantages of raising funds by issue of preference shares are:
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(i) One of the major disadvantages of preference shares is that preference dividend is not tax
deductible and so does not provide a tax shield to the company. Hence preference shares are costlier
to the company than debt e.g. debenture.
(ii) Preference dividends are cumulative in nature. This means that if in a particular year preference
dividends are not paid they shall be accumulated and paid later. Also, if these dividends are not paid,
no dividend can be paid to ordinary shareholders. The non-payment of dividend to ordinary
shareholders could seriously impair the reputation of the concerned company.
Explain Debentures, its advantages and disadvantages??
6.
Loans can be raised from public by issuing debentures or bonds by public limited companies. Some of
the characteristics of debentures are:
 Debentures are normally issued in different denominations ranging from Rs100 to Rs1,000 and
carry different rates of interest.
 Normally, debentures are issued on the basis of a debenture trust deed which lists the terms and
conditions on which the debentures are floated.
 Debentures are basically instruments for raising long-term debt capital.
 The period of maturity normally varies from 3 to 10 years and may also increase for projects having
high gestation period.
Debentures can be divided into the following three categories based on their convertibility:
(i) Non-convertible debentures – These types of debentures do not have any feature of conversion
and are repayable on maturity.
(ii) Fully convertible debentures – Such debentures are converted into equity shares as per the
terms of issue in relation to price and the time of conversion. Interest rates on such debentures are
generally less than the non-convertible debentures because they carry an attractive feature of
getting themselves converted into shares at a later time.
(iii) Partly convertible debentures – These debentures carry features of both convertible and non-
convertible debentures. The investor has the advantage of having both the features in one debenture.
Advantages of raising finance by issue of debentures are:

(i) The cost of debentures is much lower than the cost of preference or equity capital as the interest is
tax-deductible. Also, investors consider debenture investment safer than equity or preferred
investment and, hence, may require a lower return on debenture investment.
(ii) Debenture financing does not result in dilution of control.
(iii) In a period of rising prices, debenture issue is advantageous. The fixed monetary outgo decreases
in real terms as the price level increases. In other words, the company has to pay a fixed rate of interest.
Disadvantages of debenture financing are:

(i) Debenture interest and the repayment of its principal amount is an obligatory payment.
(ii) The protective covenants associated with a debenture issue may be restrictive.
(iii) Debenture financing enhances the financial risk associated with the firm because of the reasons
given in point (i).
(iv) Since debentures need to be paid at the time of maturity, a large amount of cash outflow is needed
at that time.
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TYPES OF FINANCING
CA Amit Sharma
Explain Bridge Finance??

7.
Bridge Finance: Bridge finance refers to loans taken by a company normally from commercial banks
for a short period because of pending disbursement of loans sanctioned by financial
institutions. Though it is of short-term nature but since it is an important step in the facilitation of
long-term loan, therefore it is being discussed along with the long term sources of funds.
Normally, it takes time for financial institutions to disburse loans to companies. However, once the
loans are approved by the term lending institutions, companies, in order not to lose further time in
starting their projects, arrange short term loans from commercial banks. The bridge loans are repaid/
adjusted out of the term loans as and when disbursed by the concerned institutions. Bridge loans are
normally secured by hypothecating movable assets, personal guarantees and demand promissory
notes. Generally, the rate of interest on bridge finance is higher as compared with that on term loans.
Explain Venture Capital Financing & its characteristics??

8.
The venture capital financing refers to financing of new high risky venture promoted by qualified
entrepreneurs who lack experience and funds to give shape to their ideas. In broad sense, under
venture capital financing, venture capitalist make investment to purchase equity or debt securities
from inexperienced entrepreneurs who undertake highly risky ventures with potential to succeed in
future.
Characteristics
Some of the characteristics of Venture Capital financing are:
 It is basically an equity finance in new companies.
 It can be viewed as a long-term investment in growth-oriented small/medium firms.
 Apart from providing funds, the investor also provides support in form of sales strategy, business
networking and management expertise, enabling the growth of the entrepreneur.
Explain methods of Venture Financing.
9.
Some common methods of venture capital financing are as follows:
(i) Equity financing: The venture capital undertakings generally require funds for a longer period but
may not be able to provide returns to the investors during the initial stages. Therefore, the venture
capital finance is generally provided by way of equity share capital. The equity contribution of venture
capital firm does not exceed 49% of the total equity capital of venture capital undertakings so that the
effective control and ownership remains with the entrepreneur.
(ii) Conditional loan: A conditional loan is repayable in the form of a royalty after the venture is able
to generate sales. No interest is paid on such loans. In India venture capital financiers charge royalty
ranging between 2 and 15 per cent; actual rate depends on other factors of the venture such as
gestation period, cash flow patterns, risk and other factors of the enterprise.
Some Venture capital financiers give a choice to the enterprise of paying a high rate of interest (which
could be well above 20 per cent) instead of royalty on sales once it becomes commercially sound.
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\
(iii) Income note: It is a hybrid security which combines the features of both conventional loan and
conditional loan. The entrepreneur has to pay both interest and royalty on sales but at substantially
low rates. IDBI’s VCF provides funding equal to 80 – 87.50% of the projects cost for commercial
application of indigenous technology.
(iv) Participating debenture: Such security carries charges in three phases — in the start-up phase
no interest is charged, next stage a low rate of interest is charged up to a particular level of operation,
after that, a high rate of interest is required to be paid.
Explain Debt Securitisation?
10.
Securitisation is a process in which illiquid assets are pooled into marketable securities that can be
sold to investors. The process leads to the creation of financial instruments that represent ownership
interest in, or are secured by a segregated income producing asset or pool of assets. These assets are
generally secured by personal or real property such as automobiles, real estate, or equipment loans
but in some cases are unsecured.
Example:- A finance company has given a large number of car loans. It needs more money so that it is
in a position to give more loans. One way to achieve this is to sell all the existing loans. But, in the
absence of a liquid secondary market for individual car loans, this is not feasible.
So, this process of debt securitization helps the finance company to raise funds and get the loans off its
Balance Sheet. These funds also help the company disburse further loans. Similarly, the process is
beneficial to the investors also as it creates a liquid investment in a diversified pool of car loans, which
may be an attractive option to other fixed income instruments. The whole process is carried out in
such a way that the original debtors i.e. the car loan borrowers may not be aware of the transaction.
They might have continued making payments the way they are already doing. However, these
payments shall now be made to the new investors who have emerged out of this securitization process.
Explain difference between Financial & Operating Lease.
11.
Financial Lease Operating Lease
1. The risk and reward incident to ownership The lessee is only provided the use of the
are passed on to the lessee. The lessor only asset for a certain time. Risk incident to
remains the legal owner of the asset. ownership
belong wholly to the lessor.
2. The lessee bears the risk of obsolescence. The lessor bears the risk of obsolescence.
3. The lessor is interested in his rentals and not As the lessor does not have difficulty in
in the asset. He must get his principal back leasing the same asset to other willing lessee,
along with interest. Therefore, the lease is the lease is kept cancellable by the lessor.
non-cancellable by either party.
4. The lessor enters into the transaction only as Usually, the lessor bears cost of repairs,
financier. He does not bear the cost of maintenance or operations.
repairs, maintenance or operations.
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TYPES OF FINANCING
CA Amit Sharma
5. The lease is usually full payout, that is, the The lease is usually non-payout, since the
single lease repays the cost of the asset lessor expects to lease the same asset over
together with the interest. and over
again to several users.
Explain various types of Leases.
12.
(a) Sales and Lease Back: Under this type of lease, the owner of an asset sells the asset to a party (the
buyer), who in turn leases back the same asset to the owner in consideration of a lease rentals. Under
this arrangement, the asset is not physically exchanged but it all happen in records only. The main
advantage of this method is that the lessee can satisfy himself completely regarding the quality of an
asset and after possession of the asset convert the sale into a lease agreement.
(b) Leveraged Lease: Under this lease, a third party is involved besides lessor
and the lessee. The lessor borrows a part of the purchase cost (say 80%) of the asset from the third
party i.e., lender and asset so purchased is held as security against the loan. The lender is paid off from
the lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to
the lessor. The lessor is entitled to claim depreciation allowance.
(c) Sales-aid Lease: Under this lease contract, the lessor enters into a tie up with a manufacturer for
marketing the latter’s product through his own leasing operations, it is called a sales-aid lease. In
consideration of the aid in sales, the manufacturer may grant either credit or a commission to the
lessor. Thus, the lessor earns from both sources i.e. from lessee as well as
the manufacturer.
(d) Close-ended and Open-ended Leases: In the close-ended lease, the assets get transferred to the
lessor at the end of lease, the risk of obsolescence, residual value etc., remain with the lessor being the
legal owner of the asset. In the open-ended lease, the lessee has the option of purchasing the asset at
the end of the lease period.
Explain various short term sources of Finance.
13.
There are various sources available to meet short-term needs of finance. The different sources are
discussed below:
(i) Trade Credit: It represents credit granted by suppliers of goods, etc., as an incident of sale. The
usual duration of such credit is 15 to 90 days. It generates automatically in the course of business and
is common to almost all business operations. It can be in the form of an 'open account' or 'bills payable'.
(ii) Accrued Expenses and Deferred (Unearned) Income: Accrued expenses represent liabilities
which a company has to pay for the services which it has already received like wages, taxes, interest
and dividends. Such expenses arise out of the day-to-day activities of the company and hence
represent a spontaneous source of finance.
(iii) Advances from Customers: Manufacturers and contractors engaged in producing or
constructing costly goods involving considerable length of manufacturing or construction time usually
demand advance money from their customers at the time of accepting their orders for executing their
contracts or supplying the goods. This is a cost free source of finance and
really useful.
(iv) Commercial Paper: A Commercial Paper is an unsecured money market instrument issued in the
form of a promissory note. The Reserve Bank of India introduced the commercial paper scheme in the
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\
year 1989 with a view to enabling highly rated corporate borrowers to diversify their sources of short-
term borrowings and to provide an additional instrument to investors.
(v) Treasury Bills: Treasury bills are a class of Central Government Securities. Treasury bills,
commonly referred to as T-Bills are issued by Government of India to meet short term borrowing
requirements with maturities ranging between 14 to 364 days.
(vi) Certificates of Deposit (CD): A certificate of deposit (CD) is basically a savings certificate with a
fixed maturity date of not less than 15 days up to a maximum of one year.
(vii) Financing of Export Trade by Banks: Exports play an important role in accelerating the
economic growth of developing countries like India. Out of the several factors influencing export
growth, credit is a very important factor which enables exporters in efficiently executing their export
orders.
(viii) Inter Corporate Deposits: The companies can borrow funds for a short period, say 6 months,
from other companies which have surplus liquidity. The rate of interest on inter corporate deposits
varies depending upon the amount involved and the time period.
(ix) Certificate of Deposit (CD): The certificate of deposit is a document of title similar to a time
deposit receipt issued by a bank except that there is no prescribed interest rate on such funds.
The main advantage of CD is that banker is not required to encash the deposit before maturity period
and the investor is assured of liquidity because he can sell the CD in secondary market.
(x) Public Deposits: Public deposits are very important source of short-term and medium term
finances particularly due to credit squeeze by the Reserve Bank of India. A company can accept public
deposits subject to the stipulations of Reserve Bank of India from time to time upto a maximum
amount of 35 per cent of its paid up capital and reserves..
Explain various facilities available to exporter.
14.
Other facilities extended to the exporters are as follows:
(i) On behalf of approved exporters, banks establish letters of credit on their overseas or up country
suppliers.
(ii) Guarantees for waiver of excise duty, etc. due performance of contracts, bond in lieu of cash
security deposit, guarantees for advance payments etc., are also issued by banks to approved
clients.
(iii) To approved clients undertaking exports on deferred payment terms, banks also provide finance.
(iv) Banks also endeavour to secure for their exporter-customers status reports of their buyers and
trade information on various commodities through their correspondents.
(v) Economic intelligence on various countries is also provided by banks to their exporter clients.
Name some facilities given by banks.
15.
Some of the facilities provided by banks are:
(a) Short Term Loans: In a loan account, the entire advance is disbursed at one time either in cash or
by transfer to the current account of the borrower. It is a single advance and given against securities
like shares, government securities, life insurance policies and fixed deposit
receipts, etc.
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TYPES OF FINANCING
CA Amit Sharma
(b) Overdraft: Under this facility, customers are allowed to withdraw in excess of credit balance
standing in their Current Account. A fixed limit is, therefore, granted to the borrower within which the
borrower is allowed to overdraw his account.
(c) Clean Overdrafts: Request for clean advances are entertained only from parties which are
financially sound and having reputation for their integrity. The bank has to rely upon the personal
security of the borrowers. Therefore, while entertaining proposals for clean advances; banks exercise
a good deal of restraint since they have no backing of any tangible security.
(d) Cash Credits: Cash Credit is an arrangement under which a customer is allowed an advance up to
certain limit against credit granted by bank. Under this arrangement, a customer need not borrow the
entire amount of advance at one time; he can only draw to the extent of his
requirements and deposit his surplus funds in his account. Interest is not charged on the full amount
of the advance but on the amount actually availed by him.
(e) Advances against goods: Advances against goods occupy an important place in total bank credit.
They provide a reliable source of repayment.
(f) Bills Purchased/ Discounted: Under this head, banks give advances against the security of bills
which may be clean or documentary. Bills are sometimes purchased from approved customers in
whose favour limits are sanctioned.
What are various other sources of Financing??
16.
(i) Seed Capital Assistance: The Seed Capital Assistance scheme is designed by IDBI for
professionally or technically qualified entrepreneurs and/or persons possessing relevant experience,
skills and entrepreneurial traits but lack adequate financial resources. All the projects eligible for
financial assistance from IDBI, directly or indirectly through refinance are eligible under the scheme.
(ii) Internal Cash Accruals: Existing profit-making companies which undertake an expansion
diversification programme may be permitted to invest a part of their accumulated reserves or cash
profits for creation of capital assets. In such cases, past performance of the company permits the
capital expenditure from within the company by way of disinvestment of
working/invested funds. In other words, the surplus generated from operations, after meeting all the
contractual, statutory and working requirement of funds, is available for further capital expenditure.
(iii) Unsecured Loans: Unsecured loans are typically provided by promoters to meet the promoters'
contribution norm. These loans are subordinate to institutional loans. The rate of interest chargeable
on these loans should be less than or equal to the rate of interest on institutional loans and interest
can be paid only after payment of institutional dues. These loans cannot be repaid without the prior
approval of financial institutions. Unsecured loans
are considered as part of the equity for the purpose of calculating debt equity ratio.
(iv) Deferred Payment Guarantee: Many a time suppliers of machinery provide deferred credit
facility under which payment for the purchase of machinery can be made over a period of time. The
entire cost of the machinery is financed and the company is not required to contribute any amount
initially towards acquisition of the machinery. Normally, the supplier of machinery insists that bank
guarantee should be furnished by the buyer. Such a facility does not have a moratorium period for
repayment. Hence, it is advisable only for an existing profit-making company.
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\
(v) Capital Incentives: The backward area development incentives available often determine the
location of a new industrial unit. These incentives usually consist of a lump sum subsidy and exemption
from or deferment of sales tax and octroi duty. The quantum of incentives is determined by the degree
of backwardness of the location.
Explain Sources of External Financing.
17.
The sources of external financing include:
(i) Commercial Banks: Like domestic loans, commercial banks all over the world extend Foreign
Currency (FC) loans also for international operations. These banks also provide to overdraw over and
above the loan amount.
(ii) Development Banks: Development banks offer long & medium term loans including FC loans.
Many agencies at the national level offer a number of concessions to foreign companies to invest
within their country and to finance exports from their countries e.g. EXIM Bank of USA.
(iii) Discounting of Trade Bills: This is used as a short-term financing method. It is used widely in
Europe and Asian countries to finance both domestic and international business.
(iv) International Agencies: A number of international agencies have emerged over the years to
finance international trade & business. The more notable among them include The International
Finance Corporation (IFC), The International Bank for Reconstruction and Development (IBRD), The
Asian Development Bank (ADB), The International Monetary Fund (IMF), etc.
(v) International Capital Markets: Today, modern organisations including MNC's depend upon
sizeable borrowings in Rupees as well as Foreign Currency (FC). In order to cater to the needs of such
organisations, international capital markets have sprung all over the globe such as in London.
Explain ADR, GDR, IDR
18.
(a) American Depository Receipts (ADRs): These are securities offered by non-US companies who
want to list on any of the US exchange. Each ADR represents a certain number of a company's regular
shares. ADRs allow US investors to buy shares of these companies without the costs of investing
directly in a foreign stock exchange.
The Indian companies have preferred the GDRs to ADRs because the US market exposes them to a
higher level of responsibility than a European listing in the areas of disclosure, costs, liabilities and
timing. The regulations are somewhat more stringent and onerous, even for
companies already listed and held by retail investors in their home country. The most onerous aspect
of a US listing for the companies is to provide full, half yearly and quarterly accounts in accordance
with, or at least reconciled with US GAAPs.
(b) Global Depository Receipts (GDRs): These are negotiable certificates held in the bank of one
country representing a specific number of shares of a stock traded on the exchange of another
country. These financial instruments are used by companies to raise capital in
either dollars or Euros. These are mainly traded in European countries and particularly in London.
Chapter - 02
TYPES OF FINANCING
CA Amit Sharma
ADRs/GDRs and the Indian Scenario: Indian companies are shedding their reluctance to tap the US
markets. Infosys Technologies was the first Indian company to be listed on Nasdaq in 1999. However,
the first Indian firm to issue sponsored GDR or ADR was Reliance industries Limited. Beside these two
companies there are several other Indian firms which are also listed in the overseas bourses. These
are Wipro, MTNL, State Bank of India, Tata Motors, Dr. Reddy's Lab, etc.
(c) Indian Depository Receipts (IDRs): The concept of the depository receipt mechanism which
is used to raise funds in foreign currency has been applied in the Indian Capital Market through the
issue of Indian Depository Receipts (IDRs). IDRs are similar to ADRs/GDRs in the sense that foreign
companies can issue IDRs to raise funds from the Indian Capital Market in the same lines as an Indian
company uses ADRs/GDRs to raise foreign capital. The IDRs are listed and traded in India in the same
way as other Indian securities are traded.
What are contemporary sources of crowd funding.
19.
(i) Crowd funding: In simple terms, crowdfunding means raising money for a individual or
organisation from a group of people to fund a project, typically via internet (social media and
crowdfunding websites). It generally involves collecting funds from family, friends, strangers,
corporates and many more in exchange of equity (known as Equity funding), loans (known as P2P
lending) or nothing at all (i.e. donation). This source of funding also helps start-up to substantiate
demand for their product before entering into production.
(ii) Equity funding: Equity crowdfunding is a mechanism where investor invests money in an
organisation and receive securities of that organisation in return. Every investor would be entitled to
a stake in the organisation depending on their investment. The digital nature of crowdfunding targets
large number of investors with small contributions. This type of funding is mostly adopted by startups.
Some of the platforms offering equity crowdfunding are StartEngine, EquityNet, SeedInvest, etc.
(iii) Peer-to-Peer (P2P) lending: It is that category of crowdfunding where lenders match with the
borrowers in order to provide unsecured loans through online platform. The fund raised are paid back
by the borrowers with interest, though this kind of lending involves certain risk of defaults.
(iv) Start-up funding: A start-up company being newly formed needs fund before starting any project.
However, as a start-up, it is difficult to manage loans from bank, leaving crowdfunding as one of the
sources of finance. Through crowdfunding, a start-up company can raise money from large group of
people. The crowdfunding may be in the form of equity funding,
P2P lending or both.
(v) Donation-based Crowdfunding: It is a source of finance where large group of people donate
money as a charity for some cause with no expectation of any ownership or debt. Some of the platforms
that are used for donation based crowdfunding are GoFundMe (used for donations against medical
needs, education, etc.), Ketto (used for donation against medical needs), FuelADream (used for
donation against charity projects, new ideas), etc.
Different types of Packaging Credit.
20.
(a) Clean packing credit: This is an advance made available to an exporter only on production of a
firm export order or a letter of credit without exercising any charge or control over raw material
or finished goods.
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(b) Packing credit against hypothecation of goods: Export finance is made available on certain
terms and conditions where the exporter has pledge able interest and the goods are hypothecated to
the bank as security with stipulated margin.
(c) Packing credit against pledge of goods: Export finance is made available on certain terms and
conditions where the exportable finished goods are pledged to the banks with approved clearing
agents who will ship the same from time to time as required by the exporter.
(d) E.C.G.C. guarantee: Any loan given to an exporter for the manufacture, processing, purchasing, or
packing of goods meant for export against a firm order qualifies for the packing credit guarantee
issued by Export Credit Guarantee Corporation.
(e) Forward exchange contract: Another requirement of packing credit facility is that if the export
bill is to be drawn in a foreign currency, the exporter should enter into a forward exchange contact
with the bank, thereby avoiding risk involved in a possible change in the rate of exchange.
Different Types of post Shipment Finance.
21.
It takes the following forms:
(a) Purchase/discounting of documentary export bills: Finance is provided to exporters by
purchasing export bills drawn payable at sight or by discounting usance export bills covering
confirmed sales and backed by documents including documents of the title
of goods such as bill of lading, post parcel receipts, or air consignment notes.
(b) E.C.G.C. Guarantee: Post-shipment finance, given to an exporter by a bank through purchase
negotiation or discount of an export bill against an order, qualifies for post-shipment export
credit guarantee.
(c) Advance against export bills sent for collection: Finance is provided by banks to exporters by
way of advance against export bills forwarded through them for collection, taking into account the
creditworthiness of the party, nature of goods exported, usance, standing of drawee etc.
(d) Advance against duty draw backs, cash subsidy, etc.: To finance export losses sustained by
exporters, bank advance against duty draw-back, cash subsidy etc., receivable by them against export
performance. Such advances are of clean nature; hence necessary precaution should be exercised.
Chapter - 02
RATIO ANALYSIS
CA Amit Sharma
3 RATIO ANALYSIS
CHAPTER
QUESTIONS
Q.N
Gross Profit= ₹60,000, GP Ratio=20%, Stock Velocity=6 times then find out what is average
1.
stock ?
(a) 40,000 (b) 300,000
(c) 240,000 (d) 37,500
Observing changes in the financial variables across the years is
2.
(a) Vertical analysis (b) Horizontal Analysis
(c) Peer-firm Analysis (d) Industry Analysis
Total sales=3000000, Cash sales 25% of credit sales, Debtors Turnover is 8times then what are
3.
the average debtors?
(a) 2400000 (b) 300000
(c) 600000 (d) 900000
The______ is useful in evaluating credit and collection policies.
4.
(a) Average payment period
(b) Current ratio
(c) Average collection period
(d) Inventory turnover ratio
Which of the following is not true about ratio analysis
5.
(a) It is affected by price level changes
(b) It is difficult to evolve a standard ratio
(c) It can give false and misleading results
(d) It is not useful in inter-firm & intra firm comparison
Inventory ratio is a relationship between ______.
6.
(a) Cost of goods purchased and cost of average inventory
(b) Cost of goods sold & cost of average inventory, cost of goods purchased & cost of average inventory
(c) Cost of goods sold and cost of average inventory
(d) None of the options is correct
If Working capital of company is ₹1,35,000, Current ratio=2.5, Liquid ratio=1.5, reserve &
7.
surplus is=₹90,000 then what are the Quick assets of the company?
(a) 90,000 (b) 1,35,000
(c) 1,45,000 (d) 60,000
Ratio of net profit before interest and tax to sales is
8.
Chapter - 03
RATIO ANALYSIS CA Amit Sharma
(a) Gross profit ratio (b) Net profit ratio

(c) Operating profit ratio (d) Interest coverage ratio
If Gross Profit=54000, GP Ratio=20%, Average collection period is 18 days (360 Days year),
9.
then find out Average Debtors considering that credit sales are 20% of total sales?
(a) 13500 (b) 10800
(c) 12000 (d) 14000
Long-term solvency is indicated by
10.
(a) Debt/equity ratio
(b) Current Ratio
(c) Operating ratio
(d) Net profit ratio
Current Ratio is 2.5:1 and Liquid Ratio is 1.5:1. If inventory is ₹ 9,60,000, then the amount of
11.
current assets will be:
(a) ₹ 9.6 Lakh
(b) ₹ 14.40 Lakh
(c) ₹ 24 Lakh
(d) ₹ 38.40 Lakh
Which of the following is not true about ratio analysis?
12.
(a) It is affected by price level changes.
(b) It is difficult to evolve a standard ratio.
(c) It can give false and misleading results.
(d) It is not useful in inter-firm and intra firm comparison
Which of the following is not a part of Quick Assets
13.
(a) Disposable investments
(b) Receivables
(c) Cash and Cash equivalents
(d) Prepaid expenses
From the following information, calculate P/E ratio:
14.
Equity share capital of ` 10 each `8,00,000
9% Preference share capital of `10 each `3,00,000
Profit (after 35% tax) `2,67,000
Depreciation `67,000
Market price of equity share `48
(a) 15 times (b) 16 times
(c) 17 times (d) 18 times
Capital Gearing ratio is the fraction of
15.
(a) Preference Share Capital and Debentures to Equity Share Capital and Reserve & Surplus.
(b) Equity Share Capital and Reserve & Surplus to Preference Share Capital and Debentures.
(c) Equity Share Capital to Total Assets.
(d) Total Assets to Equity Share Capital
Chapter - 03
RATIO ANALYSIS
CA Amit Sharma
The Receivable-Turnover ratio helps management to

16.
(a) Managing resources (b) Managing inventory
(c) Managing customer relationship (d) Managing working capital
Calculate operating expenses from the information given below
17.
Sales `75,00,000
Rate of income tax 50%
Net profit to sales 5%
Cost of goods sold `32,90,000
Interest on debentures `60,000
(a) ` 41,00,000
(b) ` 8,10,000
(c) ` 34,00,000
(d) ` 33,90,000
Which ratio not include fictitious assets and losses
18.
(a) Cost of goods purchased and cost of average inventory
(b) Cost of goods sold & cost of average inventory, cost of goods purchased & cost of average inventor
(c) Cost of goods sold and cost of average inventory
(d) None of the options is correct
A company has average accounts receivable of `10,00,000 & annual credit sales of ` 60,00,000.
19.
Its average collection period would be
(a) 60.83 days (b) 6.00 days
(c) 1.67 days (d) 0.67 days
Which of the following is a liquidity ratio
20.
(a) Equity ratio (b) Proprietary ratio
(c) Net Working Capital (d) Capital Gearing ratio
1. (a) 2. (b) 3. (b) 4. (c) 5. (d)
6. (c) 7. (b) 8. (c) 9. (b) 10. (a)
11. (c) 12. (d) 13. (d) 14. (b) 15. (a)
16. (d) 17. (c) 18. (a) 19. (a) 20. (c)
Chapter - 03
THEORY QUESTIONS
Q.N
What sources of information for financial statement analysis are:
1.
The sources of information for financial statement analysis are:
i. Annual Reports
ii. Interim financial statements
iii. Notes to Accounts
iv. Statement of cash flows
v. Business periodicals.
vi. Credit and investment advisory services
Explain Return on Equity using the Du Pont Model.
2.
There are various components in the calculation of return on equity using the traditional DuPont
model- the net profit margin, asset turnover, and the equity multiplier. By examining each input
individually, the sources of a company's return on equity can be discovered and compared to its
competitors. The components are as follows:
(i) Profitability/Net Profit Margin: The net profit margin is simply the after-tax profit a company
generates for each rupee of revenue. Net profit margin varies across industries, making it important
to compare a potential investment against its competitors.
Profitability or Net Profit margin = (Profit or Net Income) / (Sales or Revenue)
(ii)Investment Turnover/ Asset Turnover/ Capital Turnover: The asset turnover ratio is a
measure of how effectively a company converts its assets into sales. It is calculated as follows:
Investment / Asset / Capital Turnover = (Sales or Revenue) /Investment or Assets or Capital
(iii) Equity Multiplier: It is possible for a company with terrible sales and margins to take on excessive
debt and artificially increase its return on equity. The equity multiplier, a measure of financial
leverage, allows the investor to see what portion of the return on equity is the result of debt. The
equity multiplier is calculated as follows:
Equity Multiplier = (Investment or Assets or Capital) / Shareholders' Equity

What is Financial Analysis
3.
It may be of two types: - Horizontal and vertical.
Horizontal Analysis: When financial statement of one year are analysed and interpreted after
comparing with another year or years, it is known as horizontal analysis. It can
be based on the ratios derived from the financial information over the same
time span.
Vertical Analysis: When financial statement of single year is analyzed then it is called vertical
analysis. This analysis is useful in inter firm comparison. Every item of Profit
Chapter - 03
RATIO ANALYSIS
CA Amit Sharma
and loss account is expressed as a percentage of gross sales, while every item
on a balance sheet is expressed as a percentage of total assets held by the firm.
Explain Limitations of Financial Ratios
4.
The limitations of financial ratios are listed below:
(i) Diversified product lines: Many businesses operate a large number of divisions in quite different
industries. In such cases ratios calculated on the basis of aggregate data cannot be used for inter-firm
comparisons.
(ii) Financial data are badly distorted by inflation: Historical cost values may be substantially
different from true values. Such distortions of financial data are also carried in the financial ratios.
(iii) Seasonal factors: It may also influence financial data.
(iv) To give a good shape to the popularly used financial ratios (like current ratio, debt-equity
ratios etc.): The business may make some year-end adjustments. Such window dressing can change the
character of financial ratios which would be different had there been no such change.
(v) Differences in accounting policies and accounting period: It can make the accounting data of
two firms non-comparable as also the accounting ratios.
(vi) No standard set of ratios against which a firm’s ratios can be compared: Sometimes a firm’s
ratios are compared with the industry average. But if a firm desires to be above the average, then
industry average becomes a low standard. On the other hand, for a below average firm, industry
averages become too high a standard to achieve.
Financial ratios provide clues but not conclusions. These are tools only in the hands of experts because
there is no standard ready-made interpretation of financial ratios.
What are different Financial Ratios for evaluating performance ?
5.
(a) Liquidity Position: With the help of ratio analysis one can draw conclusions regarding liquidity
position of a firm. The liquidity position of a firm would be satisfactory if it is able to meet its obligations
when they become due. This ability is reflected in the liquidity ratios of a firm. The liquidity ratios are
particularly useful in credit analysis by banks and other suppliers of short- term loans.
(b) Long-term Solvency: Ratio analysis is equally useful for assessing the long- term financial viability
of a firm. This aspect of the financial position of a borrower is of concern to the long term creditors,
security analysts and the present and potential owners of a business.
(c) Operating Efficiency: Ratio analysis throws light on the degree of efficiency in the management
and utilisation of its assets. The various activity ratios measure this kind of operational efficiency. In
fact, the solvency of a firm is, in the ultimate analysis, dependent upon the sales revenues generated by
the use of its assets – total as well as its components.
(d) Overall Profitability: Unlike the outside parties which are interested in one aspect of the financial
position of a firm, the management is constantly concerned about the overall profitability of the
enterprise. That is, they are concerned about the ability of the firm to meet its short-term as well as
long-term obligations to its creditors, to ensure a reasonable return to its owners and secure optimum
utilisation of the assets of the firm. This is possible if an integrated view is taken and all the ratios are
considered together.
Chapter - 03
(e) Inter-firm Comparison: Ratio analysis not only throws light on the financial position of a firm but
also serves as a stepping stone to remedial measures. This is made possible due to inter-firm
comparison/comparison with industry averages.
(f) Financial Ratios for Budgeting: In this field ratios are able to provide a great deal of assistance.
Budget is only an estimate of future activity based on past experience, in the making of which the
relationship between different spheres of activities are invaluable.
Different users of Ratio Analysis and their objectives.
6.
Users Objectives Ratios Used
1. Shareholders Being owners of the organisation Mainly Profitability Ratios [In
they are interested to know about particular Earning per share (EPS),
profitability and growth of the Dividend per share (DPS), Price
organization Earnings (P/E), Dividend Payout
ratio (DP)]
2. Investors They are interested to know overall • Profitability Ratios
financial health of the • Capital structure Ratios
organisation particularly future • Solvency Ratios
perspective of the organisations. • Turnover Ratios
3. Lenders They will keep an eye on the safety • Coverage Ratios
perspective of their money lent to the • Solvency Ratios
organisation • Turnover Ratios
• Profitability Ratio
4. Creditors They are interested to know liability • Liquidity Ratios
position of the organisation • Short term solvency Ratios/
particularly in short term. Creditors Liquidity Ratios
would like to know whether the
organisation will be able to pay the
amount on due date.
5. Employees They will be interested to know the • Liquidity Ratios
overall financial wealth of the • Long terms solvency Ratios
organization and compare it with • Profitability Ratios
competitor company. • Return on investment
6. Government They will analyse the financial • Profitability Ratios
statements to determine taxations
and other details payable to
the government.
7. Production They are interested to know about • Input output Ratio
Manager data regarding input output, • Raw material consumption ratio.
production quantities etc.
8. Sales Data related to units sold for various • Turnover ratios (basically
Manager years, other associated figures and receivable turnover ratio)
predicted future sales figure will be • Expenses Ratios
an area of interest for them
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RATIO ANALYSIS
CA Amit Sharma
9. Finance They are interested to know various • Profitability Ratios (particularly

Manager ratios for their future predictions of related to Return on investment)
financial requirement. • Turnover ratios
• Capital Structure Ratios
10. CEO/ They will try to assess the complete • All Ratios
General perspective of the company, starting
Manager from Sales, Finance, Inventory,
Human resources, Production etc.
11. Telecom Finance Manager/ Analyst will • Ratio related to ‘call’
calculate ratios of their company and • Revenue and expenses per
compare it with Industry norms. customer
12. Bank Finance Manager/ Analyst will • Loan to deposit Ratios
calculate ratios of their company and • Operating expenses and income
compare it with Industry norms. ratios
13. Hotel Finance Manager/ Analyst will • Room occupancy ratio
calculate ratios of their company and • Bed occupancy Ratios
compare it with Industry norms.
14. Transport Finance Manager/ Analyst will • Passenger-kilometre
calculate ratios of their company and • Operating cost-per passenger
compare it with Industry norms. kilometre
Chapter - 03
COST OF CAPITAL CA Amit Sharma
4 COST OF CAPITAL
CHAPTER
QUESTIONS
Q.N
Cost of Capital refers to
1.
(a) Floatation Costs (b) Dividend
(c) Minimum Required Rate of Return (d) Opportunity cost
While issuing new equity shares, the cost of issue is known as
2.
(a) WACC (b) Cost of Equity
(c) Cost of Debt (d) Floatation Cost
An organization can affect its WACC through changing
3.
(a) Capital Structure (b) Dividend Policy
(c) Investment Policy (d) All of these
Interest on government bonds is also known as
4.
(a) Beta of the security (b) Market Rate of Return
(c) Market Price of the Security (d) Risk Free Rate of Return
Cost of capital is lowest in case of debt because of
5.
(a) Tax Deductibility (b) Lower Stated rate
(c) Time Value of Money (d) All of the above
In order to find cost of equity under CAPM, which of these is not required
6.
(a) Risk free rate (b) Beta
(c) Market Price of the Security (d) Market Rate of Return
Cost of capital is that minimum ___which a firm must and is expected to earn on its_ so as to
7.
maintain the market value of its shares
(a) investments, rate of return (b) rate of return, investments
(c) expenditure, rate of return (d) rate of return, expenditure
Increase in which of the following would not increase cost of equity calculated on CAPM model?
8.
(a) Market Risk premium (b) Expected market rate of interest
(c) Beta (d) Effective tax rate
A company recently issued 9% preferred shares. The preferred shares sold for Rs. 40 a share
9.
with a par of Rs. 20. The cost of issuing the stock was Rs. 5 a share. What is the company's cost
of preferred share
(a) 9% (b) 4.5%
(c) 5.1% (d) 10.3%
Chapter - 04
COST OF CAPITAL
CA Amit Sharma
Capital Structure weights can be based on

10.
(a) Market Values of Debt & Equity (b) Market Value of Equity & Face value of Debt
(c) Initial Issue Price of Debt & Equity (d) Book Value of Assets
Equity financing may be considered better than debt financing because of the fact that
11.
(a) Issuance cost of equity is lesser than that of debt
(b) It is more attractive for investors because of potential for higher returns
(c) Dividend is tax deductible
(d) It is less expensive than debt
A company's equity share is currently selling for 50 per share. Current year's dividend was Rs.
12.
2 per share and the earnings of the company is expected to increase by 5%. What is the firm's
cost of existing equity
(a) 9.2% (b) 4.2%
(c) 14% (d) 9%
Which of the following has an implicit cost of capital
13.
(a) Equity Shares (b) Preference Shares
(c) Retained Earnings (d) Debentures
Cost of capital is highest in case of
14.
(a) Debt
(b) Equity
(c) Loans
(d) Bonds
A company is considering a project with an initial cost of Rs.1 million. The project is expected
15.
to generate cash flows of Rs.500,000 per year for 5 years. The company's cost of capital is 12%.
What is the project's net present value?
(a) 7,99,610.00
(b) 10,24,323.00
(c) 10,93,515.00
(d) 11,68,916.00
Which of the following statement is false
16.
(a) Retained earnings do not involve any cost
(b) Weightage average cost of capital is sum total of cost of debt and equity
(c) Cost of equity is impacted by tax effects
(d) All of the above
A company's debt equity ratio is 3:5. Pretax cost of debt and equity are 7% and 10%
17.
respectively. What is the weighted average cost of capital if the tax rate is 30%?
(a) 12.21% (b) 17%
(c) 14.9% (d) 8.09%
With retention ratio of 60% and return on equity of 15.5%, the growth rate shall be
18.
Chapter - 04
\
(a) 14. 90% (b) 9.30%

(c) 25.84% (d) 16.10%
The cost of equity capital is all of the following except
19.
(a) The minimum rate that a firm should earn on the equity- financed part of an investment
(b) A return on the equity-financed portion of an investment that, at worst, leaves the market price of
the stock unchanged
(c) By far, the most difficult component cost to estimate
(d) Generally, lower than the before-tax cost of debt
1. (c) 2. (d) 3. (d) 4. (d) 5. (a)
6. (c) 7. (b) 8. (d) 9. (c) 10. (a)
11. (b) 12. (a) 13. (c) 14. (b) 15. (a)
16. (d) 17. (d) 18. (b) 19. (d)
Chapter - 04
COST OF CAPITAL
CA Amit Sharma
THEORY QUESTIONS
Q.N
What is Cost of Capital
1.
Cost of capital is the return expected by the providers of capital (i.e. shareholders, lenders and the debt-
holders) to the business as a compensation for their contribution to the total capital. When an entity
(corporate or others) procured finances from either source as listed above, it has to pay some
additional amount of money besides the principal amount. The additional money paid to these
financiers may be either one off payment or regular payment at specified intervals. This additional
money paid is said to be the cost of using the capital and it is called the cost of capital. This cost of
capital expressed in rate is used to discount/ compound the cash flow or stream of cash flows. Cost of
capital is also known as ‘cut-off’ rate, ‘hurdle rate’, ‘minimum rate of return’ etc.
It is used as a benchmark for:
• Framing debt policy of a firm. • Taking Capital budgeting decisions.
Significance of Cost of Capital
2.
(i) Evaluation of investment options: The estimated benefits (future cash flows) from available
investment opportunities (business or project) are converted into the present value of benefits by
discounting them with the relevant cost of capital.
(ii) Financing Decision: When a finance manager has to choose one of the two sources of finance, he
can simply compare their cost and choose the source which has lower cost. Besides cost, he also
considers financial risk and control.
(iii) Designing of optimum credit policy: While appraising the credit period to be allowed to the
customers, the cost of allowing credit period is compared against the benefit/ profit earned by
providing credit to customer of segment of customers.
Features of Bonds or Debentures
3.
(i) Face Value: Debentures or bonds are denominated with some value, this denominated value is
called face value of the debenture. Interest is calculated on the face value of the debenture.
(ii) Interest (Coupon) Rate: Each debenture bears a fixed interest (coupon) rate (except Zero coupon
bond and Deep discount bond). Interest (coupon) rate is applied to face value of debenture to calculate
interest, which is payable to the holders of debentures periodically (annually, semi-annually, etc.).
(iii) Maturity period: Debentures or Bonds has a fixed maturity period for redemption. However, in
case of irredeemable debentures maturity period is not defined and it is taken as infinite.
(iv) Redemption Value: Redeemable debentures or bonds are redeemed on its specified maturity
date. Based on the debt covenants, the redemption value is determined. Redemption value may vary
from the face value of the debenture.
(v) Benefit of tax shield: The payment of interest to the debenture holders are allowed as expenses
for the purpose of corporate tax determination. Hence, interest paid to the debenture holders save the
tax liability of the company.
Chapter - 04
\
A security is exposed to two risks, what are they?

4.
The risk to which a security is exposed, can be classified into two groups:
(i) Unsystematic Risk: This is also called company specific risk as the risk is related with the
company’s performance. This type of risk can be reduced or eliminated by diversification of the
securities portfolio. This is also known as diversifiable risk.
(ii) Systematic Risk: It is the macro-economic or market specific risk under which a company
operates. This type of risk cannot be eliminated by the diversification hence, it is non-diversifiable. The
examples are inflation, Government policy, interest rate etc.
As diversifiable risk can be eliminated by an investor through diversification, the non-diversifiable risk
is the risk which cannot be eliminated; therefore, a business should be concerned as per CAPM method,
solely with non-diversifiable risk.
Explain CAPM Method & its drawback
5.
• The idea behind CAPM is that the investors need to be compensated in two ways- (i) Time value of
money and (ii) Risk.
• The time value of money is represented by the risk-free rate in the formula and compensates the
investors for placing money in any investment over a period of time.
• The other half of the formula represents risk and calculates the amount of compensation the investor
needs for taking on additional risk. This is calculated by taking a risk measure (beta) which compares
the returns of the asset to the market over a period of time and compares it with the market premium.
The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free
security plus risk premium. If this expected return does not meet or beat the required return, then the
investment should not be undertaken.
The shortcomings of this approach are:

(a) Estimation of beta with historical data is unrealistic; and
(b) Market imperfections may lead investors to unsystematic risk.
Despite these shortcomings, the CAPM is useful in calculating cost of equity, even when the firm is
suffering losses.
DISCUSS the meaning of weighted average cost of capital. ILLUSTRATE with an example.
6.
WACC is also known as the overall cost of capital which includes the cost of different sources of capital
as explained above. WACC of a company depends on the capital structure of a company. It weighs the
cost of capital of a particular source of capital with its proportion to the total capital. Thus, weighted
average cost of capital is the weighted average after-tax costs of the individual components of firm’s
capital structure. That is, the after-tax cost of each debt and equity is calculated separately and added
together to a single overall cost of capital
To show the example, just make any example and show how to calculate WACC.
Chapter - 04
COST OF CAPITAL
CA Amit Sharma
DISCUSS the dividend price approach, and earnings price approach to estimate cost of equity
7.
capital.
This is also known as Dividend Valuation Model. This model makes an assumption that the dividend
per share is expected to remain constant forever. Here, cost of equity capital is computed by dividing
the expected dividend by market price per share as follows:
Cost of Equity = D / P0
Ke= Cost of equity
D = Expected dividend (also written as D1)
P0 = Market price of equity (ex- dividend)
The advocates of this approach co-relate the earnings of the company with the market price of its share.
Accordingly, the cost of equity share capital would be based upon the expected rate of earnings of a
company. The argument is that each investor expects a certain amount of earnings, whether distributed
or not from the company in whose shares he invests. Thus, if an investor expects that the company in
which he is going to subscribe for shares should have at least a 20% rate of earning, the cost of equity
share capital can be construed on this basis.
Cost of Equity = EPS / MPS
What is the DIFFERENCE between Book Value and Market Value weights?
8.
Book Value (BV): Book value weight is operationally easy and convenient. While using BV, reserves
such as share premium and retained profits are included in the BV of equity, in addition to the nominal
value of share capital. Here, the value of equity will generally not reflect historic asset values, as well
as the future prospects of an organisation.
Market Value (MV): Market value weight is more correct and represent a firm’s capital structure. It is
preferable to use MV weights for the equity . While using MV, reserves such as share premium and
retained profits are ignored as they are in effect incorporated into the value of equity. It represents
existing conditions and also take into consideration the impacts of changing market conditions and the
current prices of various security. Similarly, in case of debt, MV is better to be used rather than the BV
of the debt, though the difference may not be very significant.
There is no separate market value for retained earnings. Market value of equity shares represents both
paid up equity capital and retained earnings. But cost of equity is not same as cost of retained earnings.
Hence to give market value weights, market value of equity shares should be apportioned in the ratio
of book value of paid up equity capital and book value of retained earnings.
DISCUSS Marginal Cost of Capital.
9.
The marginal cost of capital may be defined as the cost of raising an additional rupee of capital. Since
the capital is raised in substantial amount in practice, marginal cost is referred to as the cost incurred
in raising new funds. Marginal cost of capital is derived, when the average cost of capital is calculated
using the marginal weights.
Chapter - 04
\
The marginal weights represent the proportion of funds the firm intends to employ. Thus, the problem
of choosing between the book value weights and the market value weights does not arise in the case of
marginal cost of capital computation.
To calculate the marginal cost of capital, the intended financing proportion should be applied as
weights to marginal component costs. The marginal cost of capital should, therefore, be calculated in
the composite sense. When a firm raises funds in proportional manner and the component’s cost
remains unchanged, there will be no difference between average cost of capital (of the total funds) and
the marginal cost of capital. The component costs may remain constant upto certain level of funds
raised and then start increasing with amount of funds raised.
EXPLAIN YTM approach of calculating Cost of Debt.
10.
The cost of redeemable debt (Kd) is also calculated by discounting the relevant cash flows using
Internal rate of return (IRR). Here, YTM is the annual return of an investment from the current date till
maturity date. So, YTM is the internal rate of return at which current price of a debt equals to the
present value of all cash-flows.
The relevant cash flows are as follows:
Year Cash flows

0 Net proceeds in case of new issue/ Current market price in case of
existing debt (NP or P0)
1 to n Interest net of tax[I(1-t)]
n Redemption value (RV)
Steps to calculate relevant cash flows:

Step-1: Identify the cash flows.
Step-2: Calculate NPVs of cash flows as identified above using two discount rates (guessing).
Step-3: Calculate IRR.
Chapter - 04
CAPITAL STRUCTURE
CA Amit Sharma
5 CAPITAL STRUCTURE
CHAPTER
QUESTIONS
Q.N
Assertion(A):- Risk principle of capital structure is one that minimize cost of capital structure.
1.
Reason(R):- According to this principle ,reliance is placed more on equity for financial purpose.
(a)Both A & R are true and R is correct explanation of A
(b) Both A & R are true but R is not correct explanation of A
(c) A is true but R is false
(d) A is false, but R is true
Financial Structure refers to
2.
(a) All financial resources
(b) Short-term funds
(c) Long-term funds
(d) None of these
To have optimal capital structure the firm must have fulfill the following condition –
3.
(a) Return on investment should be greater than cost of investment.
(b) There should be minimum financial risk.
(c) Cost of investment should be greater than return of investment.
(d) All the above.
Which of the following steps may be adopted to avoid the negative consequences of over-
4.
capitalisation
(a) The shares of the company should be split up. This will reduce dividend per share, though EPS shall
remain unchanged
(b) Issue of Bonus Shares
(c) Revising upward the par value of shares in exchange of the existing shares held by them
(d) Reduction in claims of debenture-holders and creditors
The cost of monitoring management is considered to be a (an)
5.
(a) Bankruptcy cost
(b) Transaction cost
(c) Agency cost
(d) Institutional cost
Which of the following statements regarding Modigliani and Miller’s propositions (assuming
6.
perfect capital markets and homogenous expectations) is most accurate?
(a) Firm value is maximized with a capital structure consisting of 100% equity.
(b) The cost of equity increases as the firm increases its financial leverage
Chapter - 05
CAPITAL STRUCTURE CA Amit Sharma
(c) The use of debt financing increases the firm’s weighted average cost of capital
(d) None of the above
Which of the following is irrelevant for optimal capital structure
7.
(a) Flexibility
(b) Solvency
(c) Liquidity
(d) Control
Statement 1: If our corporate tax rate increases from 25% to 30%, our weighted average cost
8.
of capital is likely to decline.
Statement 2: What is happening in the stock or bond markets is irrelevant to our decisions for
how to raise capital. We should always seek to raise capital in the exact proportions called for
by our optimal capital structure Which of the Statements 1 and 2, correct or incorrect?
(a) Correct, Correct
(b) Incorrect, correct
(c) Incorrect, Incorrect
(d) Correct, Incorrect
Ram Verse Ltd is an all equity financed company. It is considering replacing Rs. 275 lakhs equity
9.
shares with 15% debentures of the same amount. Current Market value of the company is 1750
lakhs with cost of capital at 20%. Future EBITs are going to be constant and entire earnings are
going to be distributed. Corporate Tax Rate can be assumed to be 30%. What will be the new
market value of the firm?
(a) Rs.1832.5 lakhs
(b) Rs.82.50 lakhs
(c) Rs.1750 lakhs
(d) Rs.1732.50 lakhs
The number of indifference points possible between 5 financial plans are
10.
(a) 5
(b) 8
(c) 3
(d) 10
Mr. Dashan recently came back from a conference titled Capital Structure Theory and was
11.
extremely excited about what he learned concerning Modigliani and Miller’s capital structure
propositions. He has been trying to choose between three potential capital structures for his
firm, Dashmart Corporation, and believes that Modigliani and Miller’s work may guide him in
the right direction. The capital structures Munn is considering are:
CSI: 100% equity. CS II: 50% equity and 50% debt. CS III: 100% debt.
If he uses Modigliani and Miller’s propositions and includes all of their assumptions including
the assumption of no taxes, which capital structure is he most likely to choose?
Which capital struture would be choosen in case of tax regime?
(a) CS I and CS II (b) CS I and CS III
(c) CS II and CS III (d) Any CS and CS III
Chapter - 05
CAPITAL STRUCTURE
CA Amit Sharma
A critical assumption of the Net Operating Income (NOI) approach to valuation is

12.
(a) That debt and equity levels remain unchanged
(b) That dividends increase at a constant rate
(c) That ko remains constant regardless of changes in leverage
(d) That interest expense and taxes are included in the calculation
Consider the below mentioned statements:-
13.
(i) A company is considered to be over-capitalised when its actual capitalisation is lower than
the proper capitalisation as warranted by the earning capacity.
(ii) Both over-capitalisation and under-capitalisation are detrimental to the interests of the
society.
State True or False:
(a) 1-True, 2-True
(b) 1-False, 2-True
(c) 1-False, 2-False
(d) 1-True, 2-False
An EBIT-EPS indifference analysis chart is used for
14.
(a) Evaluating the effects of business risk on EPS
(b) Examining EPS results for alternative financial plans at varying EBIT levels
(c) Determining the impact of a change in sales on EBIT
(d) Showing the changes in EPS quality over time
A firm's optimal capital structure
15.
(a) Is the debt-equity ratio that results in the minimum possible weighted average cost of capital
(b) 40 percent debt and 60 percent equity
(c) When the debt-equity ratio is 0.50
(d) When Cost of equity is minimum
If the debt component in the capital structure is predominant
16.
(a) The fixed interest cost of the firm will be minimum thereby decreasing its risk.
(b) Earning per share (EPS)will be very low.
(c) Dividend expectation of the equity shareholders are also & PE ratio may decrease.
(d) The fixed interest cost of the firm increases thereby increasing its risk.
The assumptions of MM hypothesis of capital structure do not include the following
17.
(a) Capital markets are imperfect
(b) Investors have homogeneous expectations
(c) All firms can be classified into homogeneous risk classes
(d) The dividend-payout ratio is cent percent, and there is no corporate tax
Which one of the following approaches of the capital structure pleads that debt financing
18.
initially increases the value of the firm;however excess debt financing beyond a particular
point reduces the value of the firm?
Chapter - 05
(a) Net income approach (b) Net operating income approach

(c) Traditional approach (d) M&M Approach
The term "capital structure" means
19.
(a) Long-term debt, preferred stock, and equity shares
(b) Current assets and current liabilities
(c) Net working capital
(d) Shareholder’s equity
1. (d) 2. (a) 3. (d) 4. (d) 5. (c)
6. (b) 7. (b) 8. (d) 9. (a) 10. (d)
11. (a) 12. (d) 13. (d) 14. (a) 15. (c)
16. (d) 17. (a) 18. (c) 19. (a)
Chapter - 05
CAPITAL STRUCTURE
CA Amit Sharma
THEORY QUESTIONS
Q.N
What is Capital structure?
1.
Capital structure is the combination of capitals from different sources of finance. The capital of a
company consists of equity share holders’ fund, preference share capital and long term external debts.
The source and quantum of capital is decided keeping in mind the following factors:
i. Control: Capital structure should be designed in such a manner that existing shareholders continue
to hold majority stake.
ii. Risk: Capital structure should be designed in such a manner that financial risk of a company does
not increase beyond tolerable limit.
iii. Cost: Overall cost of capital remains minimum.
Financial Structure refers to
2.
The following approaches explain the relationship between cost of capital, capital structure and value
of the firm:
(a) Net Income (NI) approach
(b) Traditional approach.
(c) Net Operating Income (NOI) approach
(d) Modigliani-Miller (MM) approach
What assumptions are made to understand this relationship between Cost of Capital, Capital
3.
Structure & Value of Firm
Following assumptions are made to understand this relationship:
• There are only two kinds of funds used by a firm i.e. debt and equity.
• The total assets of the firm are given. The degree of leverage can be changed by selling debt to
purchase shares or selling shares to retire debt.
• Taxes are not considered.
• The dividend payout ratio is 100%.
• The firm’s total financing remains constant.
• Business risk is constant over time.
• The firm has perpetual life.
Explain net Income Approach
4.
According to this approach, capital structure decision is relevant to the value of the firm. An increase
in financial leverage will lead to decline in the weighted average cost of capital (WACC), while the value
of the firm as well as market price of ordinary share will increase. Conversely, a decrease in the
leverage will cause an increase in the overall cost of capital and a consequent decline in the value as
well as market price of equity shares.
Where, Ke is Cost of Equity, Kw is Weighted Average Cost of Capital and Kd is Cost of Debt.
As debt increases, it causes weighted average cost of capital (WACC) to decrease.

The value of the firm on the basis of Net Income (NI) Approach can be ascertained as follows:
Chapter - 05
V= S + D
Where,
V = Value of the firm
S = Market value of equity
D = Market value of debt
Market Value of Equity = NI / Ke

Where,
NI = Earnings available for equity shareholders
Ke = Equity Capitalisation rate
Under NI approach, the value of the firm will be maximum at a point where weighted average cost of
capital (WACC) is minimum. Thus, the theory suggests total or maximum possible debt financing for
minimising the cost of capital. The overall cost of capital under this approach is:
Overall Cost of Capital = EBIT / Value of firm
Explain Traditional Approach
5.
This approach favours that as a result of financial leverage up to some point, cost of capital comes
down and value of firm increases. However, beyond that point, reverse trends emerges. The principle
implication of this approach is that the cost of capital is dependent on the capital structure and there
is an optimal capital structure which minimises cost of capital.
Under this approach:
i. The rate of interest on debt remains constant for a certain period and thereafter with an increase in
leverage, it increases.
ii. The expected rate by equity shareholders remains constant or increase gradually. After that, the
equity shareholders starts perceiving a financial risk and then from the optimal point, the expected
rate increases speedily.
iii. As a result of the activity of rate of interest and expected rate of return, the WACC first decreases
and then increases. The lowest point on the curve is optimal capital structure.
Optimum capital structure occurs at the point where value of the firm is highest and the cost of capital
is the lowest. According to net operating income approach, capital structure decisions are totally
irrelevant. Modigliani-Miller supports the net operating income approach but provides behavioural
justification. The traditional approach strikes a balance between these extremes.
Main Highlight of Traditional Approach

The firm should strive to reach the optimal capital structure and its total valuation through a judicious
use of both the debt and equity in capital structure. At the optimal capital structure, the overall cost of
capital will be minimum and the value of the firm will be maximum.
Explain NOI Approach
6.
Chapter - 05
CAPITAL STRUCTURE
CA Amit Sharma
NOI means Earnings before interest and tax (EBIT). According to this approach, capital structure
decisions of the firm are irrelevant.
Any change in the leverage will not lead to any change in the total value of the firm and the market
price of shares, as the overall cost of capital is independent of the degree of leverage. As a result, the
division between debt and equity is irrelevant.
As per this approach, an increase in the use of debt which is apparently cheaper is offset by an increase
in the equity capitalisation rate. This happens because equity investors seek higher compensation as
they are opposed to greater risk due to the existence of fixed return securities in the capital structure.
Explain MM without tax approach
7.
This approach describes, in a perfect capital market where there is no transaction cost and no taxes,
the value and cost of capital of a company remain unchanged irrespective of change in the capital
structure. This approach is based on further following additional assumptions:
• Capital markets are perfect. All information is freely available and there are no transaction costs.
• All investors are rational.
• Firms can be grouped into ‘Equivalent risk classes’ on the basis of their business risk.
• Non-existence of corporate taxes.
The shortcoming of this approach is that the suggested arbitrage process will fail to work because of
imperfections in capital market, existence of transaction cost and presence of corporate income taxes.
Explain Tradeoff Theory
8.
The trade-off theory of capital structure refers to the idea that a company chooses how much debt
finance and how much equity finance to use by balancing the costs and benefits. Trade-off theory of
capital structure basically entails offsetting the costs of debt against the benefits of debt.
Trade-off theory of capital structure primarily deals with two concepts - cost of financial distress and
agency costs. An important purpose of the trade-off theory of capital structure is to explain the fact
that corporations usually are financed partly with debt and partly with equity.
It states that there is an advantage to financing with debt, the tax benefits of debt and there is a cost of
financing with debt, the costs of financial distress including bankruptcy costs of debt and non-
bankruptcy costs (e.g. staff leaving, suppliers demanding disadvantageous payment terms,
bondholder/ stockholder infighting, etc).
The first element of Trade-off theory of capital structure, considered as the cost of debt is usually the
financial distress costs or bankruptcy costs of debt. The direct cost of financial distress refers to the
cost of insolvency of a company. Once the proceedings of insolvency start, the assets of the firm may
be needed to be sold at distress price, which is generally much lower than the current values of the
assets. A huge amount of administrative and legal costs is also associated with the insolvency. Even if
the company is not insolvent, the financial distress of the company may include a number of indirect
costs like - cost of employees, cost of customers, cost of suppliers, cost of investors, cost of managers
and cost of shareholders.
Chapter - 05
What is Pecking Order Theory

9.
This theory is based on Asymmetric information, which refers to a situation in which different parties
have different information. In a firm, managers will have better information than investors. This theory
states that firms prefer to issue debt when they are positive about future earnings. Equity is issued
when they are doubtful and internal finance is insufficient.
The pecking order theory argues that the capital structure decision is affected by manager’s choice of
a source of capital that gives higher priority to sources that reveal the least amount of information.
Myers has given the name ‘PECKING ORDER’ theory as here is no well-defined debt-equity target and
there are two kind of equity internal and external. Now Debt is cheaper than both internal and external
equity because of interest. Further internal equity is less than external equity particularly because of
no transaction/issue cost, no tax etc.
Pecking order theory suggests that managers may use various sources for raising of fund in the
following order:
1. Managers first choice is to use internal finance.
2. In absence of internal finance, they can use secured debt, unsecured debt, hybrid debt etc.
3. Managers may issue new equity shares as a last option.
What are the factors that affect Capital Structure?
10.
While choosing a suitable financing pattern, certain fundamental principles should be kept in mind, to
design capital structure, which are discussed below:
(1) Financial leverage or Trading on Equity: The use of long-term fixed interest bearing debt and
preference share capital along with equity share capital is called financial leverage or trading on
equity. The use of long-term debt increases the earnings per share if the firm yields a return higher
than the cost of debt.
(2) Growth and stability of sales: The capital structure of a firm is highly influenced by the growth
and stability of its sales. If the sales of a firm are expected to remain fairly stable, it can raise a higher
level of debt. Stability of sales ensures that the firm will not face any difficulty in meeting its fixed
commitments of interest repayments of debt.
(3) Cost Principle: According to this principle, an ideal pattern or capital structure is one that
minimizes cost of capital structure and maximizes earnings per share (EPS). For e.g. Debt capital is
cheaper than equity capital from the point of its cost and interest being deductible for income tax
purpose, whereas no such deduction is allowed for dividends.
(4) Risk Principle: According to this principle, reliance is placed more on common equity for
financing capital requirements than excessive use of debt. Use of more and more debt means higher
commitment in form of interest payout. This would lead to erosion of shareholders’ value in
unfavorable business situation. With increase in amount of Debt, financial risk increase and vice versa.
Chapter - 05
CAPITAL STRUCTURE
CA Amit Sharma
(5) Control Principle: While designing a capital structure, the finance manager may also keep in mind
that existing management control and ownership remains undisturbed. Issue of new equity will dilute
existing control pattern and it also involves higher cost.
(6) Flexibility Principle: By flexibility, it means that the management chooses such a combination of
sources of financing which it finds easier to adjust according to changes in need of funds in future too.
While debt could be interchanged (If the company is loaded with a debt of 18% and funds are available
at 15%, it can return old debt with new debt, at a lesser interest rate), but the same option may not be
available in case of equity investment.
(7) Other Considerations: Besides above principles, other factors such as nature of industry, timing
of issue and competition in the industry should also be considered. Industries facing severe
competition also resort to more equity than debt.
What are different analysis to choose Optimum Capital Structure?
11.
Objective of financial management is to maximize wealth. Therefore, one should choose a capital
structure which maximizes wealth. For this purpose, following analysis should be done:
(1) EBIT-EPS-MPS analysis: Chose a capital structure which maximizes market price per share. For
that, start with same EBIT for all capital structures and calculate EPS. Thereafter, either multiply EPS
by price earning ratio or divide it by cost of equity to arrive at MPS.
(2) Indifference Point analysis: In above analysis, we have considered value at a given EBIT only.
What will happen if EBIT changes? Will it change your decision also? To answer this question, you can
do indifference point analysis.
(3) Financial Break-Even Point (BEP) analysis: With change in capital structure, financial risk also
changes. Though this risk has already been considered in PE ratio or in cost of equity in point one
above, but one may calculate and consider it separately also by calculating Financial BEP.
Explain EBIT -EBT-MPS Analysis.
12.
The basic objective of financial management is to design an appropriate capital structure which can
provide the highest wealth, i.e., highest MPS, which in turn depends on EPS.
Given a level of EBIT, EPS will be different under different financing mix depending upon the extent of
debt financing. The effect of leverage on the EPS emerges because of the existence of fixed financial
charge i.e., interest on debt, financial fixed dividend on preference share capital. The effect of fixed
financial charge on the EPS depends upon the relationship between the rate of return on assets and
the rate of fixed charge. If the rate of return on assets is higher than the cost of financing, then the
increasing use of fixed charge financing (i.e., debt and preference share capital) will result in increase
in the EPS. This situation is also known as favourable financial leverage or Trading on Equity.
On the other hand, if the rate of return on assets is less than the cost of financing, then the effect may
be negative and, therefore, the increasing use of debt and preference share capital may reduce the EPS
of the firm.
Chapter - 05
The fixed financial charge financing may further be analysed with reference to the choice between the
debt financing and the issue of preference shares. Theoretically, the choice is tilted in favour of debt
financing for two reasons: (i) the explicit cost of debt financing i.e., the rate of interest payable on debt
instruments or loans is generally lower than the rate of fixed dividend payable on preference shares,
and (ii) interest on debt financing is tax-deductible and therefore the real cost (after-tax) is lower than
the cost of preference share capital.
Thus, the analysis of the different types of capital structure and the effect of leverage on the expected
EPS and eventually MPS will provide a useful guide to selection of a particular level of debt financing.
The EBIT-EPS analysis is of significant importance and if undertaken properly, can be an effective tool
in the hands of a financial manager to get an insight into the planning and designing of the capital
structure of the firm.
Explain Financial BEP & Indifference Point Analysis
13.
Financial break-even point is the minimum level of EBIT needed to satisfy all the fixed financial charges
i.e. interests and preference dividends. It denotes the level of EBIT for which the company’s EPS equals
zero.
If the EBIT is less than the financial break-even point, then the EPS will be negative but if the expected
level of EBIT is more than the break-even point, then more fixed costs financing instruments can be
taken in the capital structure, otherwise, equity would be preferred.
EBIT-EPS break-even analysis is used for determining the appropriate amount of debt a company
might carry.
Another method of considering the impact of various financing alternatives on earnings per share is
to prepare the EBIT chart or the range of Earnings chart. This chart shows the likely EPS at various
probable EBIT levels. Thus, under one particular alternative, EPS may be ` 2 at a given EBIT level.
However, the EPS may go down if another alternative of financing is chosen even though the EBIT
remains at the same level. At a given EBIT, earnings per share under various alternatives of financing
may be plotted. A straight line representing the EPS at various levels of EBIT under the alternative may
be drawn. Wherever this line intersects, it is known as break-even point. This point is a useful guide in
formulating the capital structure. This is known as EPS equivalency point or indifference point since
this shows that, between the two given alternatives of financing (i.e., regardless of leverage in the
financial plans), EPS would be the same at the given level of EBIT.
Indifference Point can be calculated by
(EBIT-I1)(1-t) (EBIT-I2)(1-t)
=
Where,
EBIT = Indifference point
E1 = Number of equity shares in Alternative 1
E2 = Number of equity shares in Alternative 2
Chapter - 05
CAPITAL STRUCTURE
CA Amit Sharma
I1 = Interest charges in Alternative 1

I2 = Interest charges in Alternative 2
t = Tax-rate
An EBIT-EPS indifference analysis chart is used for
14.
If amount of equity share capital is same under two financial plans, then one of the following two
situations will arise:
1. No indifference point: If after tax cost of the source other than equity shares is not same under
both plans then there will be no indifference point between the two. Because one plan will be better
than other at all levels of EBIT. For example, if two plans have equity shares of ` 1,00,000 each. Plan 1
has 10% debentures of ` 50,000 while plan 2 has 8% Term loan of ` 50,000. Then plan 2 will be better
than plan 1 at any level of EBIT and there will be no indifference point.
2. Many indifference points: If after tax cost of the source other than equity shares is same under
both plans then each EBIT will be an indifference point.
What is over-capitalisation?
15.
It is just reverse of over-capitalisation. It is a state, when its actual capitalisation is lower than its
proper capitalisation as warranted by its earning capacity. This situation normally happens with
companies which have insufficient capital but large secret reserves in the form of considerable
appreciation in the values of the fixed assets not brought into the books.
Consequences of Under-Capitalisation: Under-capitalisation results in the following consequences:

(i) The dividend rate will be higher in comparison to similarly situated companies.
(ii) Market value of shares will be higher than value of shares of other similar companies because their
earning rate being considerably more than the prevailing rate on such securities.
(iii) Real value of shares will be higher than their book value.
Effects of Under-Capitalisation: Under-capitalisation has the following effects:

(i) It encourages acute competition. High profitability encourages new entrepreneurs to come into
same type of business.
(ii) High rate of dividend encourages the workers’ union to demand high wages.
(iii) Normally common people (consumers) start feeling that they are being exploited.
(iv) Management may resort to manipulation of share values.
(v) Invite more government control and regulation on the company and higher taxation also.
Remedies for Under-Capitalisation: Following steps may be adopted to avoid the negative
consequences of under-capitalization:
(i) The shares of the company should be split up. This will reduce dividend per share, though EPS shall
remain unchanged.
(ii) Issue of Bonus Shares is the most appropriate measure as this will reduce both dividend per share
and the average rate of earning.
(iii) By revising upward the par value of shares in exchange of the existing shares held by them.
What is over-capitalisation?
16.
Chapter - 05
It is a situation where a firm has more capital than it needs or in other words assets are worth less
than its issued share capital, and earnings are insufficient to pay dividend and interest. This situation
mainly arises when the existing capital is not effectively utilized on account of fall in earning capacity
of the company while company has raised funds more than its requirements. The chief sign of over-
capitalisation is the fall in payment of dividend and interest leading to fall in value of the shares of the
company.
Causes of Over-Capitalisation: Over-capitalisation arises due to following reasons:

(i) Raising more money through issue of shares or debentures than company can employ profitably.
(ii) Borrowing huge amount at higher rate than rate at which company can earn.
(iii) Excessive payment for the acquisition of fictitious assets such as goodwill etc.
(iv) Improper provision for depreciation, replacement of assets and distribution of dividends at a
higher rate.
(v) Wrong estimation of earnings and capitalisation.
Consequences of Over-Capitalisation: Over-capitalisation results in the following consequences:

(i) Considerable reduction in the rate of dividend and interest payments.
(ii) Reduction in the market price of shares.
(iii) Resorting to “window dressing”.
(iv) Some companies may opt for reorganization. However, sometimes the matter gets worse and the
company may go into liquidation.
Remedies for Over-Capitalisation: Following steps may be adopted to avoid the negative
consequences of over-capitalisation:
(i) Company should go for thorough reorganization.
(ii) Buyback of shares.
(iii) Reduction in claims of debenture-holders and creditors.
(iv) Value of shares may also be reduced. This will result in sufficient funds for the company to carry
out replacement of assets.
Chapter - 05
LEVERAGE
CA Amit Sharma
6 LEVERAGE
CHAPTER
QUESTIONS
Q.N
From the following information, calculate combined leverage:
1.
Sales `20,00,000
Variable Cost 40%
Fixed Cost `10,00,000
Borrowings `10,00,000 @ 8%
(a) 10 times (b) 6 times
(c) 1.667 times (d) 0.10 times
Output (units)= 3,00,000 Fixed cost =`3,50,000 Unit variable cost= `1.00 Interest expenses=
2.
`25,000 Unit selling price = `3.00 Applicable tax rate is 35% Calculate Financial Leverage.
(a) 1.11 (b) 2.40
(c) 2.67 (d) 1.07
If degree of financial leverage is 3 and there is 15% increase in Earning per share (EPS), then
3.
EBIT will be
(a) Decrease by 15% (b) Increase by 45%
(c) Decrease by 45% (d) Increase by 5%
Which of the following is correct
4.
(a) CL= OL + FL (b) CL= OL - FL
(c) CL = OL x FL (d) OL = OL / FL
Degree of combined leverage is the fraction of
5.
(a) Degree of combined leverage is the fraction of
(b) Percentage change in EPS on Percentage change in Sales
(c) Percentage change in Sales on Percentage change in EPS
(d) Percentage change in EPS on Percentage change in EBIT
Operating fixed costs `20,000
6.
Sales `1,00,000
P/ V ratio 40%
The operating leverage is:
(a) 2.00 (b) 2.50
(c) 2.67 (d) 2.47
Operating leverage is 7 and financial leverage is 2.2858. How much change in sales will be
7.
required to bring 70% change in EBIT?
(a) 10% (b) 70%
(c) 11.429% (d) 30%
If EBIT is `15,00,000, interest is `2,50,000, corporate tax is 40%, DFL is;
8.
Chapter - 06
LEVERAGE CA Amit Sharma
(a) 1.11 (b) 1.20

(c) 1.31 (d) 1.41
Which of the following indicates business risk
9.
(a) Operating leverage
(b) Financial leverage
(c) Combined leverage
(d) Total leverage
If Margin of Safety is 0.25 and there is 8% increase in output, then EBIT will be:
10.
(a) Decrease by 2% (b) Increase by 32%
(c) Increase by 2% (d) Decrease by 32%
There is no operating leverage if there is no ............
11.
(a) Profit (b) Sales
(c) Fixed cost (d) EPS
A firm has a DOL of 4.5 at Q units. What does this tell us about the firm?
12.
(a) If sales rise by 4.5%, then EBIT will rise by 1%
(b) If EBIT rises by 4.5%, then EPS will rise by 1%.
(c) If EBIT rises by 1 %, then EPS will rise by 4.5%.
(d) If sales rise by 1 %, then EBIT will rise by 4.5%
A firm with high operating leverage is characterized by............. while one with high financial
13.
leverage is characterized by ...........State True or False:
(a) Low fixed cost of production; low fixed financial costs
(b) High variable cost of production; high variable financial costs
(c) High fixed costs of production; high fixed financial costs
(d) Low costs of production; high fixed financial costs
Financial Leverage is calculated as
14.
(a) EBIT / Contribution (b) EBIT + PBT
(c) EBIT / Sales (d) EBIT / Variables Cost
If DOL is 1.24 and DFL is 1.99, DCL would be
15.
(a) 2.14 (b) 2.18
(c) 2.31 (d) 2.47
Total assets of Alpha Company are `3,00,000. The company's total assets turnover ratio is 3, its
16.
fixed operating cost is `1,50,000 and its variable operating cost ratio is 50%.
The income-tax rate is 50%. It also has long term debts of `1,20,000 on which interest@ 10%
is payable. Operating, Financial & Combined Leverages of the company are -
(a) 1.5; 1.042; 1.563 respectively (b) 1.05; 1.42; 1.05625 respectively
(c) 1.50; 1.42; 2.13 respectively (d) 1.55; 1.042; 1.6151 respectively
The cash required during a specific period to meet interest expenses and principal payments
17.
is referred to as the:
Chapter - 06
LEVERAGE
CA Amit Sharma
(a) Debt capacity (b) Debt-service burden

(c) Adequacy capacity (d) Fixed-charge burden
A firm has sales of `75,00,000, variable cost of `42,00,000 and fixed cost of `6,00,000. It has a
18.
debt of `45,00,000 at 9% and equity of `55,00,000. Does it have favourable financial leverage?
(a) ROI is less than interest on loan funds and hence it has no favourable financial leverage."
(b) ROI is equal to interest on loan funds and hence it has favourable financial leverage.
(c) ROI is greater than interest on loan funds and hence it has favourable financial leverage.
(d) ROI is greater than interest on loan funds and hence it has unfavourable financial leverage.
Operating Leverage is calculated as
19.
(a) Contribution + EBIT (b) EBIT/ PBT
(c) EBIT / Interest (d) EBIT / Tax
There is no operating leverage if there is no ............
20.
(a) Profit (b) Sales
(c) Fixed cost (d) EPS
1. (a) 2. (a) 3. (d) 4. (c) 5. (b)
6. (c) 7. (d) 8. (c) 9. (b) 10. (d)
11. (d) 12. (b) 13. (d) 14. (b) 15. (b)
16. (a) 17. (b) 18. (c) 19. (a) 20. (c)
Chapter - 06
LEVERAGE CA Amit Sharma
THEORY QUESTIONS
Q.N
Explain Difference between Business & Financial Risk.
1.
Business Risk: It refers to the risk associated with the firm's operations. It is the uncertainty about
the future operating income (EBIT) i.e., how well can the operating income be predicted?
Financial Risk: It refers to the additional risk placed on the firm's shareholders because of use of debt
i.e., the additional risk, a shareholder bears when a company uses debt in addition to equity financing.
Companies that issue more debt instruments would have higher financial risk than companies
financed mostly or entirely by equity.
What is Leverage & Different types of Leverage?
2.
The term leverage represents influence or power. In financial analysis, leverage represents the
influence of one financial variable over some other related financial variable. These financial variables
may be costs, output, sales revenue, Earnings Before Interest and Tax (EBIT), Earning Per Share (EPS)
etc.
Generally, if we want to calculate the impact of change in variable X on variable Y, it is termed as
Leverage of Y with X, and it is calculated as follows:
Change in Y divided by Y
Change in X divided by X
There are three commonly used measures of leverage in financial analysis. These are:
(i) Operating Leverage: It is the relationship between Sales and EBIT and indicates business risk.
(ii) Financial Leverage: It is the relationship between EBIT and EPS and indicates financial risk.
(iii) Combined Leverage: It is the relationship between Sales and EPS and indicates total risk i.e.,
both business risk and financial risk.
What is Trading on Equity?
3.
Financial leverage indicates the use of funds with fixed cost like long term debts and preference share
capital along with equity share capital which is known as trading on equity. The basic aim of financial
leverage is to increase the earnings available to equity shareholders using fixed cost fund.
A firm is known to have a positive/favourable leverage when its earnings are more than the cost of
debt. If earnings are equal to or less than cost of debt, it will be an negative/unfavourable leverage.
When the quantity of fixed cost fund is relatively high in comparison to equity capital it is said that the
firm is ‘’trading on equity”.
Financial Leverage is Double Edged Sword, Explain,
4.
When the cost of ‘fixed cost fund’ is less than the return on investment, financial leverage will help to
increase return on equity and EPS. The firm will also benefit from the saving of tax on interest on debts
etc. However, when cost of debt will be more than the return it will affect return of equity and EPS
Chapter - 06
LEVERAGE
CA Amit Sharma
unfavourably and as a result firm can be under financial distress. Therefore, financial leverage is also
known as “double edged sword”.
Effect on EPS and ROE:

When, ROI > Interest – Favourable – Advantage
When, ROI < Interest – Unfavourable – Disadvantage
When, ROI = Interest – Neutral – Neither advantage nor disadvantage
*Financial BEP is the level of EBIT at which earning per share is zero. If a company has not issued
preference shares, then Financial BEP is simply equal to amount of Interest.
When EBIT is much higher than Financial BEP, DFL will be slightly more than one. With decrease in
EBIT, DFL will increase. At Financial BEP, DFL will be infinite. When EBIT is slightly less than Financial
BEP, DFL will be negative infinite. With further reduction in EBIT, DFL will move towards zero. At zero
EBIT, DFL will also be zero.
“Operating risk is associated with cost structure, whereas financial risk is associated with
5.
capital structure of a business concern.” Critically EXAMINE this statement.
Business Risk: It refers to the risk associated with the firm's operations. It is the uncertainty about
the future operating income (EBIT) i.e., how well can the operating income be predicted?
Financial Risk: It refers to the additional risk placed on the firm's shareholders because of use of debt
i.e., the additional risk, a shareholder bears when a company uses debt in addition to equity financing.
Companies that issue more debt instruments would have higher financial risk than companies
financed mostly or entirely by equity.
Chapter - 06
CAPITAL BUDGETING CA Amit Sharma
7 CAPITAL BUDGETING
CHAPTER
QUESTIONS
Q.N
A project's net present value, ignoring income tax considerations, is normally affected by the
1.
(a) Proceeds from the sale of the asset to be replaced
(b) Carrying amount of the asset to be replaced by the project
(c) Amount of annual depreciation on the asset to be replaced
(d) Amount of annual depreciation on fixed assets used directly on the project
Which of these methods of capital budgeting are based on cash flows
2.
(a) Payback Method (b) NPV
(c) Profitability Index (d) All of the above
Capital Budgeting is important for the below reasons except
3.
(a) They are irreversible (b) They involve substantial investment
(c) They are for short period of time (d) They are complex & futuristic
With initial investment of" 100,000 and yearly cash inflows of" 27,000 for 5 years, the NPV of
4.
the project with cost of capital of 10% shall be approximately
(a) 35,000 (b) -2,357
(c) 2,357 (d) -35,000
With IRR criteria and no limitation on funds, one can accept projects which have
5.
(a) IRR more than cost of capital (b) IRR less than cost of capital
(c) IRR being equal to borrowing rate (d) All of the above
Using capital budgeting techniques, A project is accepted when
6.
(a) Net Present Value is positive (b) Profitability Index is more than 1
(c) Its IRR is greater than Cost of Capital (d) Any of the above
Which of the following is not followed in discounting techniques of capital budgeting
7.
(a) Cash Flow Principal (b) Accrual Principal
(c) Interest Exclusion (d) Post Tax Principal
The Reinvestment assumption under NPV method assumes that the cash flows are reinvested
8.
at the
(a) Marginal Cost of Capital (b) Internal Rate of Return
(c) Discount rate used to calculate NPV (d) Bank Borrowing rate
Which of the following events would decrease the internal rate of return of a proposed asset
9.
purchase?
(a) Decrease related working capital requirements
(b) Shorten the payback period
Chapter - 07
CAPITAL BUDGETING
CA Amit Sharma
(c) Decrease tax credits on the asset

(d) Use accelerated, instead of straight-line depreciation
With limited capital & number of available projects, one should select the project with
10.
(a) IRR less than Cost of Capital (b) Profitability Index less than 1
(c) Lowest Internal Rate of Return (d) Highest Net Present Value
Which of these methods of capital budgeting are based on cash flows
11.
(a) Payback Method (b) NPV
(c) Profitability Index (d) All of the above
Discounted payback period for a project shall be_____ the payback period of the same project.
12.
(a) Equal to (b) More Than
(c) Less Than (d) Half
The best methods to evaluate the projects with unequal lives can be
13.
(a) ARR or Payback Period
(b) Replacement Chain or Equivalent Annualized Criteria
(c) NPV or Discounted Payback
(d) None of these
In considering the payback period for three projects, Sun Corp. gathered the following data
14.
about cash flows:
Year 1 Year 2 Year 3 Year4 Year 5
Project X {20,000} 6,000 6,000 6,000 6,000
Project Y {50,000) 30,000 30,000 10,000 5,000
Project Z {20,000} 10,000 10,000 5,000
(a) Projects X, Y and Z. (b) Projects Y and Z.
(c) Project Y only. (d) Projects X and Z
Which of the following statement is not true for capital budgeting
15.
(a) Irreversible decisions (b) Sunk Cost is Relevant cost
(c) Affect future stability of firm (d) Can relate to Business Expansion
Which of the following is one of the steps in capital budgeting process
16.
(a) Controlling Selling Expenses (b) Determination of Price
(c) Deciding the capital structure (d) Estimation of Project cash flows
Bhaskar Ltd. estimated that a proposed project's 8-year net cash benefit will be `4,000 peryear
17.
for years 1 to 8, with an additional terminal benefit of `8,000 at the end of the eighth year.
Assuming that these cash inflows satisfy exactly the required rate of return of 8 percent, the
project's initial cash outflow is closest to which of the following four possible answers?
(a) `27,308 (b) `25,149
(c) `14,851 (d) `40,000
Which of the following is not a capital budgeting decision
18.
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(a) Inventory Control (b) Business Expansion

(c) Acquisition of Long Term Asset (d) Replacement of Existing Asset
Depreciation is taken into consideration in capital budgeting because
19.
(a) It reduces Tax liability (b) It is unavoidable
(c) It is a cash outflow (d) t is a cash inflow
1. (a) 2. (d) 3. (c) 4. (c) 5. (a)
6. (d) 7. (b) 8. (c) 9. (c) 10. (d)
11. (d) 12. (b) 13. (d) 14. (b) 15. (b)
16. (d) 17. (a) 18. (a) 19. (a)
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CA Amit Sharma
THEORY QUESTIONS
Q.N
Explain Capital Budgeting or Investing Decision.
1.
Investment decision is concerned with optimum utilization of fund to maximize the wealth of the
organization and in turn the wealth of its shareholders. Investment decision is very crucial for an
organization to fulfil its objectives; in fact, it generates revenue and ensures long term existence of the
organization. Even the entities which exist not for profit are also required to make investment decision
though not to earn profit but to fulfil its mission.
It requires a proper planning for capital, and it is done through a proper budgeting. A proper budgeting
requires all the characteristics of budget. Due to this feature, investment decisions are very popularly
known as Capital Budgeting, which means applying the principles of budgeting for capital investment.
In simple terms, Capital Budgeting involves:

(i) Identification of investment projects that are strategic to business’ overall objectives;
(ii) Estimating and evaluating post-tax incremental cash flows for each of the investment proposals;
(iii) Selection of an investment proposal that maximizes the return to the investors.
Explain purpose of Capital Budgeting.
2.
The capital budgeting decisions are important, crucial and critical business decisions due to the
following reasons:
(i) Substantial Investment : Investment decisions are related with fulfillment of long-term objectives
and existence of an organization. To invest in a project(s), a substantial capital investment is required.
Based on size of capital and timing of cash flows, sources of finance are selected.
(ii) Long time period: The capital budgeting decision has its effect over a long period of time. These
decisions not only affect the future benefits and costs of the firm but also influence the rate and
direction of growth of the firm.
(iii) Irreversibility: Most of the investment decisions are irreversible. Once the decision is
implemented, it is very difficult and reasonably and economically not possible to reverse the decision.
The reason may be upfront payment of amount, contractual obligations, technological impossibilities.
(iv) Complex decisions: The capital investment decision involves an assessment of future events,
which in fact is difficult to predict. Further, it is quite difficult to estimate in quantitative terms, all the
benefits or the costs relating to a particular investment decision.
What is entire process of Capital Budgeting?
3.
(i) Planning: The capital budgeting process begins with the identification of potential investment
opportunities. The opportunity then enters the planning phase when the potential effect on the firm's
fortunes is assessed and the ability of the management of the firm to exploit the opportunity is
determined.
(ii) Evaluation: This phase involves the determination of proposal and its investments, inflows and
outflows. Investment appraisal techniques, ranging from the simple payback method and accounting
rate of return to the more sophisticated discounted cash flow techniques, are used to appraise the
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proposals. The technique selected should be the one that enables the manager to make the best
decision in the light of prevailing circumstances.
(iii) Selection: Considering the returns and risks associated with the individual projects as well as the
cost of capital to the organisation, the organisation will choose among the projects which maximises
the shareholders’ wealth.
(iv) Implementation: When the final selection is made, the firm must acquire the necessary funds,
purchase the assets, and begin the implementation of the project.
(v) Control: The progress of the project is monitored with the aid of feedback reports. These reports
will include capital expenditure progress reports, performance reports comparing actual performance
against plans set and post completion audits.
(vi) Review: When a project terminates, or even before, the organisation should review the entire
project to explain its success or failure. This phase may have implication for firm's planning and
evaluation procedures.
What are various Capital Budgeting Decisions on basis of Firm’s Existence?
4.
The capital budgeting decisions are taken by both newly incorporated firms as well as by existing
firms. The new firms may require decision making in respect of the selection of a plant to be installed.
Whereas the existing firm may require taking decisions to meet the requirements of new environment
or to face the challenges of competition. These decisions may be classified as follows:
(i) Replacement and Modernisation decisions: The replacement and modernisation decisions aims
to improve operating efficiency and reduce cost. Generally, all types of plant and machinery require
replacement either because the economic life of the plant or machinery is over or because it has
become technologically outdated. The former decision is known as replacement decision and latter is
known as modernisation decision. Both replacement and modernisation decisions are called as cost
reduction decisions.
(ii) Expansion decisions: Existing successful firms may experience growth in demand of their
product line. If such firms experience shortage or delay in the delivery of their products due to
inadequate production facilities, they may consider proposal to add capacity to existing product line.
(iii) Diversification decisions: These decisions require evaluation of proposals to diversify into new
product lines, new markets etc. for reducing the risk of failure by dealing in different products or by
operating in several markets.
Both expansion and diversification decisions are called revenue expansion decisions.
What are various Capital Budgeting Decisions on basis of Situations?
5.
The capital budgeting decisions on the basis of situations are classified as follows:
(i) Mutually exclusive decisions: The decisions are said to be mutually exclusive if two or more
alternative proposals are such that the acceptance of one proposal will exclude the acceptance of the
other alternative proposals. For instance, a firm may be considering proposal to install a semi-
automatic or highly automatic machine. If the firm installs a semi-automatic machine, it excludes the
acceptance of proposal to install highly automatic machine.
(ii) Accept-Reject decisions: The accept-reject decisions occur when proposals are independent and
do not compete with each other. The firm may accept or reject a proposal on the basis of a minimum
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CA Amit Sharma
return on the required investment. All those proposals which give a higher return than certain desired
rate of return are accepted and the rest are rejected.
(iii) Contingent decisions: The contingent decisions are made when the proposals are dependable
proposals. The investment in one proposal requires investment in one or more other proposals. For
example, if a company accepts a proposal to set up a factory in remote area, it will have to invest in
infrastructure, like building of roads, houses for employees etc. also.
Mention steps for Capital Budgeting.
6.
1. Estimation of Cash flows over the entire life for each of the projects under consideration.
2. Evaluate each of the alternative, using different decision criteria.
3. Determining the minimum required rate of return (i.e., WACC) to be used as discount rate.
What are Advantages & Disadvantages of Payback Period?
7.
Time required to recover the initial cash-outflow is called pay-back period. The payback period of an
investment is the length of time required for the cumulative total net cash flows from the investment
to equal the total initial cash outlays.
Advantages of Payback period

(i) It is easy to compute.
(ii) It is easy to understand as it provides a quick estimate of the time needed for the organization to
recoup the cash invested.
(iii) The length of the payback period can also serve as an estimate of a project’s risk; the longer the
payback period, the riskier the project as long-term predictions are less reliable. In some industries
with high obsolescence risk like software industry or in situations where an organization is short on
cash, short payback periods often become the determining factor for investments.
Limitations of Payback period

(i) It ignores the time value of money. As long as the payback periods for two projects are the same,
the payback period technique considers them equal as investments, even if one project generates most
of its net cash inflows in the early years of the project while the other project generates most of its net
cash inflows in the latter years of the payback period.
(ii) A second limitation of this technique is its failure to consider an investment’s total profitability; it
only considers cash inflows up-to the period in which initial investment is fully recovered and ignores
cash flows after the payback period.
(iii) Payback technique places much emphasis on short payback periods thereby ignoring long-term
projects.
What are Advantages & Disadvantages of ARR?
8.
The accounting rate of return of an investment measures the average annual net income of the project
(incremental income) as a percentage of the investment.
Advantages of ARR
(i) This technique uses readily available data that is routinely generated for financial reports and does
not require any special procedures to generate data.
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(ii) This method may also mirror the method used to evaluate performance on the operating results
of an investment and management performance. Using the same procedure in both decision-making
and performance evaluation ensures consistency.
(iii) Calculation of the accounting rate of return method considers all net incomes over the entire life
of the project and provides a measure of the investment’s profitability.
Limitations of ARR
(i) The accounting rate of return technique, like the payback period technique, ignores the time value
of money and considers the value of all cash flows to be equal.
(ii) The technique uses accounting numbers that are dependent on the organization’s choice of
accounting procedures, and different accounting procedures, e.g., depreciation methods, can lead to
substantially different amounts for an investment’s net income and book values.
(iii) The method ignores cash flows; while net income is a useful measure of profitability, the net cash
flow is a better measure of an investment’s performance.
(iv) Furthermore, inclusion of only the book value of the invested asset ignores the fact that a project
can require commitments of working capital and other outlays that are not included in the book value
of the project.
What are Advantages & Disadvantages of NPV Mehod?
9.
The net present value technique is a discounted cash flow method that considers the time value of
money in evaluating capital investments. An investment has cash flows throughout its life, and it is
assumed that an amount of cash flow in the early years of an investment is worth more than an amount
of cash flow in a later year.
The net present value method uses a specified discount rate to bring all subsequent cash inflows after
the initial investment to their present values (the time of the initial investment is year 0).
The net present value of a project is the amount, in current value of amount, the investment earns after
paying cost of capital in each period.
Net present value = Present value of net cash inflow - Total net initial investment
Advantages of NPV
(i) NPV method takes into account the time value of money.
(ii) The whole stream of cash flows is considered.
(iii) The net present value can be seen as the addition to the wealth of shareholders. The criterion of
NPV is thus in conformity with basic financial objectives.
(iv) The NPV uses the discounted cash flows i.e., expresses cash flows in terms of current rupees. The
NPVs of different projects therefore can be compared. It implies that each project can be evaluated
independent of others on its own merit.
Limitations of NPV
(i) It involves difficult calculations.
(ii) The application of this method necessitates forecasting cash flows and the discount rate. Thus,
accuracy of NPV depends on accurate estimation of these two factors which may be quite difficult in
practice.
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CA Amit Sharma
(iii) The decision under NPV method is based on absolute measure. It ignores the difference in initial
outflows, size of different proposals etc. while evaluating mutually exclusive projects.
Explain Advantages & Disadvantages of PI Method.
10.
In certain cases, we have to compare a number of proposals, each involving different amounts of cash
inflows.
One of the methods of comparing such proposals is to work out what is known as
the ‘Desirability factor’, or ‘Profitability Index’ or ‘Present Value Index Method’. Mathematically:
The Profitability Index (PI) is calculated as below:
Profitability Index Sum of discounted cash in flows

(PI)= Initial cash outlay or Total discounted cash outflow
Decision Rule:
If PI ≥ 1 Accept the Proposal
If PI ≤ 1 Reject the Proposal
Advantages of PI
(i) The method also uses the concept of time value of money.
(ii) In the PI method, since the present value of cash inflows is divided by the present value of cash
outflow, it is a relative measure of a project’s profitability.
Limitations of PI
(i) Profitability index fails as a guide in resolving capital rationing where projects are indivisible.
(ii) Once a single large project with high NPV is selected, possibility of accepting several small projects
which together may have higher NPV than the single project is excluded.
(iii) Also, situations may arise where a project with a lower profitability index selected may generate
cash flows in such a way that another project can be taken up one or two years later, the total NPV in
such case being more than the one with a project with highest Profitability Index.
The Profitability Index approach thus cannot be used indiscriminately but all other type of alternatives
of projects will have to be worked out.
What are Advantages & Disadvantages of IRR Method?

11.
Internal rate of return for an investment proposal is the discount rate that equates the present value
of the expected cash inflows with the initial cash outflow.
Advantages of IRR
(i) This method makes use of the concept of time value of money.
(ii) All the cash flows in the project are considered.
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(iii) IRR is easier to use as instantaneous understanding of desirability can be determined by

comparing it with the cost of capital
(iv) IRR technique helps in achieving the objective of maximisation of shareholder’s wealth.
Limitations of IRR
(i) The calculation process is tedious if there is more than one cash outflow interspersed between the
cash inflows; there can be multiple IRR, the interpretation of which is difficult.
(ii) The IRR approach creates a peculiar situation if we compare two projects with different
inflow/outflow patterns.
(iii) It is assumed that under this method all the future cash inflows of a proposal are reinvested at a
rate equal to the IRR. It ignores a firm’s ability to re-invest in portfolio of different rates.
(iv) If mutually exclusive projects are considered as investment options which have considerably
different cash outlays. A project with a larger fund commitment but lower IRR contributes more in
terms of absolute NPV and increases the shareholders’ wealth. In such situation decisions based only
on IRR criterion may not be correct.
Explain Replacement Chain & Equivalent Annualised Criterion when life of projects are
12.
different.
(i) Replacement Chain (Common Life) Method: Since the life of the Project A is 6 years and Project
B is 3 years, to equalize lives, we can have second opportunity of investing in project B after one time
investing. The position of cash flows in such situation shall be as follows:
NPV of extended life of 6 years of Project B shall be ` 8,82,403 and IRR of 25.20%. Accordingly, with
extended life NPV of Project B it appears to be more attractive.
(ii) Equivalent Annualized Criterion: The method discussed above has one drawback when we have
to compare two projects with one has a life of 3 years and other has 5 years. In such case, the above
method shall require analysis of a period of 15 years i.e. common multiple of these two values. The
simple solution to this problem is use of Equivalent Annualised Criterion involving following steps:
(a) Compute NPV using the WACC or discounting rate.
(b) Compute Present Value Annuity Factor (PVAF) of discounting factor used above for the period of
each project.
(c) Divide NPV computed under step (a) by PVAF as computed under step (b) and compare the values.
Explain MIRR method.
13.
As we know there are several limitations attached with the concept of the conventional Internal Rate
of Return (IRR). The MIRR addresses some of these deficiencies e.g., it eliminates multiple IRR rates;
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CA Amit Sharma
it addresses the reinvestment rate issue and produces results which are consistent with the Net
Present Value method. This method is also called Terminal Value method.
Under this method, all cash flows, apart from the initial investment, are brought to the terminal value
using an appropriate discount rate (usually the Cost of Capital). This results in a single stream of cash
inflow in the terminal year. The MIRR is obtained by assuming a single outflow in the zeroth year and
the terminal cash inflow as mentioned above. The discount rate which equates the present value of the
terminal cash inflow to the zero year outflow is called the MIRR .
The decision criterion of MIRR is same as IRR i.e. you accept an investment if MIRR is larger than
required rate of return and reject if it is lower than the required rate of return.
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DIVIDEND DECISIONS CA Amit Sharma
8 DIVIDEND DECISIONS
CHAPTER
QUESTIONS
Q.N
Mature companies having few investment opportunities will show high payout ratios, this
1.
statement is
(a) False (b) True
(c) Partial true (d) None of these
Determine the market price of share of XYZ ltd as per gordon's model, given equity
2.
capitalisation rate =11% expected earning =Rs. 20 rate of return on investement =10% &
retention ratio =30%
(a) 165 (b) 175
(c) 185 (d) 195
Compute EPS according to Graham & Dodd approach from the given information:
3.
Market Price Rs 56
Dividend Payout 60%
Multiplier 2
(a) Rs 30
(b) Rs 56
(c) Rs 28
(d) Rs 84
If the company's D/P ratio is 60% & ROI is 16%, what should be the growth rate
4.
(a) 5%
(b) 7%
(c) 6.4%
(d) 9.6%
If the financing requirements are to be executed through debt (relatively cheaper source of
5.
finance), then it would be preferable to distribute……………
(a) More Dividend
(b) Less dividend
(c) No Dividend
The cost of capital of a firm is 12% & its expected earning per share at the end of the year is Rs
6.
20. Its existing payout ratio is 25%. the company is planning to increase its payout ratio to 50%
what will be the effect of this change on the market price of equity share (MPS) of the company
as per Gordon model ,If the reinvestment rate of the company is 15%
(a) lt will increase by Rs 444.45 (b) It will decrease by Rs 444.45
(c) lt will increase by Rs 222.22 (d) It will decrease by Rs 222.22
Which of the following is the limitation of Linter's model
7.
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DIVIDEND DECISIONS
CA Amit Sharma
(a) This model does not offer a market price for the shares
(b) The adjustment factor is an arbitrary number and not based on any scientific criterion or methods
(c) Both (a) & (b)
According to the residual dividend theory ,dividend payment is determined based on
8.
(a) The availability of excess fund after all investment opportunities with positive NPV are undertaken
(b) The preference of shareholder for a consistent dividend payout ratio
(c) The desire to maintain a stable dividend payout ratio regardless of investment opportunity.
(d) The goal of maximizing shareholder wealth by paying out all available earning as dividend
Determine the market price of share of XYZ ltd as per gordon's model, given equity
9.
capitalisation rate =11% expected earning =Rs. 20 rate of return on investment =10% &
retention ratio =30%
(a) 165 (b) 175
(c) 185 (d) 195
All of the following are true of stock splits except:
10.
(a) More Dividend (b) Less dividend
(c) No Dividend (d) None of the above
Which of the following is the irrelevance theory?
11.
(a) Walter model (b) Gordon model
(c) M.M. hypothesis (d) Linter's model
If the shareholders prefer regular income, how does this affect the dividend decision
12.
(a) It will lead to payment of dividend
(b) It is the indicator to retain more earnings
(c) It has no impact on dividend decision
(d) Can't say
Which one of the following is the assumption of Gordon's Model
13.
(a) Ke > g (b) Retention ratio,once decide upon is constant
(c) Firm is an all equity firm (d) All of the above
The 'Dividend-Payout Ratio' is equal to
14.
(a) The Dividend yield plus the capital gains yield (b) DPS divided by Earning per Equity Share
(c) DPS divided by par value per share (d) DPS divided by current price per share
What should be the optimum Dividend pay-out ratio, when r = 15% & Ke= 12%:
15.
(a) 100% (b) 50%
(c) Zero (d) None of the above
What are the different options other than cash used for distributing profits to shareholders
16.
(a) Bonus shares (b) Stock split
(c) Both (a) and (b) (d) None of the above
Chapter - 08
Which of the following is the limitation of Linter's mode

17.
(a) Market price per share is reduced after the split. (b) the number of o/s shares is increased.
(c) Retained earnings are changed. (d) Proportional ownership is unchanged.
If a firm declared 25% dividend on share of face value of Rs 10 its growth rate is 5% & its rate
18.
of capitaliation is 12% its expected price would be Rs...
(a) 31.2 (b) 33.50
(c) 36 (d) 37.50
Which of the following statement is correct with respect to Gordon's model
19.
(a) When IRR > cost of capital, the price per share increases and dividend pay-out decreases.
(b) When IRR > cost of capital, the price per share decreases and dividend pay-out increase
(c) When IRR = cost of capital, the price per share increases and dividend pay-out decreases
(d) When IRR < cost of capital, the price per share increases and dividend pay-out decreases
1. (b) 2. (b) 3. (a) 4. (c) 5. (a)
6. (b) 7. (c) 8. (a) 9. (b) 10. (a)
11. (c) 12. (a) 13. (d) 14. (b) 15. (c)
16. (a) 17. (c) 18. (d) 19. (a)
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DIVIDEND DECISIONS
CA Amit Sharma
THEORY QUESTIONS
Q.N
Mature companies having few investment opportunities will show high payout ratios, this
1.
statement is
(a) False (b) True
(c) Partial true (d) None of these
What are various types of Dividend?
2.
Generally, the dividend can be of the following forms
1. Cash dividend: It is the most common form of dividend. Cash here means cash, cheque, warrant,
demand draft, pay order or directly through Electronic Clearing Service (ECS) but not in kind.
2. Share repurchases: A share repurchase is transaction in which company buys back its own shares
using corporate cash. This is done by lot of corporates these days.
The bought back shares as above can be classified as
a. treasury shares which are kept for re-issuance in future or
b. cancelled shares if they would be retired from issued share capital. Share repurchases are also
viewed as one form dividend distribution
3. Stock dividend (Bonus Shares): It is a distribution of shares in lieu of cash dividend. When the
company issues new shares to its existing shareholders without any consideration it is called bonus
shares. Such shares are distributed proportionately thereby retaining proportionate ownership of the
company.
What are conditions of Bonus Isuue or Stock Issue?
3.
To issue Bonus shares, a Company needs to fulfil all the conditions given by Security Exchange Board
of India (SEBI). As per SEBI, the bonus shares are issued not in lieu of cash dividends. A bonus issue
should be authorised by Article of Association (AOA) and not to be declared unless all partly paid-up
shares have been converted into fully paid-up shares. The Company should not have defaulted in re-
payment of loan, interest and any statutory dues. Bonus shares are to be issued only from share
premium and free reserves and not from capital reserve on account of fixed assets revaluation.
Bonus shares are used by companies to prevent investors from selling its shares as short term capital
gains is 15% and long term capital gains is 10% and the period of holding for bonus shares starts from
date of issue of bonus shares. In such a scenario an investor would not immediately sale bonus shares
as they might lose 5% on account of taxation.
This generally helps companies indirectly as their prices would not fall further due selling activity
from investor’s end.
Explain Advantages of Stock Dividend.
4.
There are many advantages both to the shareholders and company. Some of the main advantages are
listed as under:
(1) To Shareholders:
(a) No tax is payable by shareholders on stock dividend received from domestic company as it is not
treated as dividend but capital asset under Income Tax Act, 1961.
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(b) Policy of paying fixed dividend per share and its continuation even after declaration of stock
dividend will increase total cash dividend of the shareholders in future.
(c) Bonus shares improves liquidity in the hands of shareholders as bonus shares leads to breaking
down of higher priced shares into lower priced shares and hence give a choice to shareholders to sell
some of the lower priced shares and get some liquidity.
(2) To Company:
(a) Conservation of cash for meeting profitable investment opportunities.
(b) Suitable in case of cash deficiency and restrictions imposed by lenders to pay cash dividend.
What are Limitations of Stock Dividend?
5.
Limitations of stock dividend to shareholders and company are as follows:
1. To Shareholders: Stock dividend does not affect the wealth of shareholders and therefore it has no
value for them. This is because the declaration of stock dividend is a method of capitalising the past
earnings of the shareholders and is a formal way of recognising earnings which the shareholders
already own. It merely divides the company's ownership into a large number of share certificates.
James Porterfield regards stock dividends as a division of corporate pie into a larger number of pieces.
Stock dividend does not give any extra or special benefit to the shareholder. His proportionate
ownership in the company does not change at all. Stock dividend creates a favourable psychological
impact on the shareholders and is greeted by them on the ground that it gives an indication of the
company's growth.
2. To Company: Stock dividends are costlier to administer than cash dividends. It is disadvantageous
if periodic small stock dividends are declared by the company as earnings.
Explain Significance of Dividend Policy.
6.
Dividend policy of a firm is governed by:
(i) Long Term Financing Decision:
As we know that one of the financing options is ‘Equity’. Equity can either be raised externally through
issue of new equity shares or can be generated internally through retained earnings. For Equity,
retained earnings are preferable because they do not involve any floatation costs (issue expenses).
But whether to retain or distribute the profits, forms the basis of this decision. Further, payment of
cash dividend reduces the amount of funds required to finance profitable investment opportunities
thereby restricting its financing options.
In this backdrop, the decision is based on the following:
1. Whether the organization has opportunities in hand to invest the profit, if retained?
2. Whether the return on such investment (ROI) will be higher than the expectations of shareholders
i.e. Ke?
(ii) Wealth Maximization Decision:

Under this decision, we are facing the problem as to what amount of dividend shall be distributed i.e.
the Dividend Payout ratio (D/P) in relation to Market price of the shares (MPS)? This decision is based
on the following:
1. Because of market imperfections and uncertainty, shareholders give more importance to near
dividends than future dividends and capital gains. Payment of dividends influences the market price
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DIVIDEND DECISIONS
CA Amit Sharma
of the share directly. Higher dividends increase the value of shares and low dividends decrease it. A
proper balance has to be struck between these two approaches.
2. When the firm increases its retained earnings, shareholders' dividends decreases and consequently
market price is affected. Use of retained earnings to finance profitable investments increases the
future earnings per share. This is because, shareholders expect that profitable investments made by
the company may lead to higher return for them in future. On the other hand, increase in dividends
may cause the firm to forego investment opportunities for lack of funds and thereby decrease the
future earnings per share.
Thus, management should develop a dividend policy which divides net earnings into dividends and
retained earnings in an optimum way so as to achieve the objective of wealth maximization for
shareholders. Such a policy will be influenced by investment opportunities available to the firm and
value of dividends as against capital gains to shareholders.
Which of the following is the limitation of Linter's model
7.
The dividend policy is affected by the following factors:
1. Availability of funds: If the business is in requirement of funds, then retained earnings could be a
good source. The reason being the saving of floatation cost and prevention of dilution of control which
happens in case of new issue of equity shares to public.
2. Cost of capital: If the financing requirements are to be executed through debt (relatively cheaper
source of finance), then it would be preferable to distribute more dividend. On the other hand, if the
financing is to be done through fresh issue of equity shares, then it is better to use retained earnings
as much as possible.
3. Capital structure: An optimum Debt Equity ratio should also be considered for the dividend
decision.
4. Stock price: Stock price here means market price of the shares. Generally, higher dividends
increase market value of shares and low dividends decrease the value.
5. Investment opportunities in hand: The dividend decision is also affected if there are investment
opportunities in hand. In that situation, the company may prefer to retain more earnings.
6. Trend of industry: The investors depend on some industries for their regular dividend income.
Therefore, in such cases, the firms have to pay dividend in order to survive in the market.
7. Expectation of shareholders: The shareholders can be categorised into two categories: (i) those
who invests for regular income, & (ii) those who invests for growth. Generally, the investor prefers
current dividend over the future growth.
8. Legal constraints: Section 123 of the Companies Act, 2013 which provides for declaration of
dividend sates that Dividend shall be declared or paid by a company for any financial year only:
(a) out of the profits of the company for that year arrived at after providing for depreciation in
accordance with the relevant provisions , or
(b) out of the profits of the company for any previous financial year or years arrived at after providing
for depreciation in accordance with the relevant provisions and remaining undistributed, or
(c) out of both, or
(d) out of money provided by the Central Government or a State Government for the payment of
dividend by the company in pursuance of a guarantee given by that Government.
Chapter - 08
According to the residual dividend theory ,dividend payment is determined based on

8.
(a) The availability of excess fund after all investment opportunities with positive NPV are undertaken
(b) The preference of shareholder for a consistent dividend payout ratio
(c) The desire to maintain a stable dividend payout ratio regardless of investment opportunity.
(d) The goal of maximizing shareholder wealth by paying out all available earning as dividend
Chapter - 08
Working Capital
CA Amit Sharma
9 WORKING CAPITAL
CHAPTER
Q.N QUESTIONS
1. Increase in which of the following shall reduce the net operating cycle
(a) Accrued Income (b) Cash & Bank

(c) Short term advances to creditors (d) Bank Overdraft
(a) Work in Process holding period (b) Raw Material Storage period
(c) Receivables collection period (d) Credit period allowed by Suppliers
3. As per Miller-Orr cash management model, when cash balance reaches lower limit then
(a) It may be invested in securities (b) Loan may be taken

(c) Some marketable securities may be liquidated (d) Creditor payments should be put on hold
4. Operating in double shifts may not impact which of the below (in terms of units at least)
(a) Work in Process Inventory (b) Raw Material Inventory

(c) Finished Goods Inventory (d) Receivables
(a) Work in Process holding period (b) Raw Material Storage period
(c) Receivables collection period (d) Credit period allowed by Suppliers
6. What is the relationship between the allowance for doubtful accounts and working capital
(a) When bad debts expense is recorded for the period, working capital decreases.
(b) When bad debts expense is recorded for the period, cash increases
(c) When an account is written off against the allowance, working capital decreases
(d) When an account is written off against the allowance, cash decreases
7. Which of the following is not a determinant of working capital
(a) Nature of Business

(b) Target Profit
(c) Type of Product
(d) Credit Policy
Chapter - 09
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WORKING CAPITAL CA Amit Sharma
8. Strict credit policy with customers may not result in
(a) Faster Collections (b) Decline in Sales

(c) Increase in Sales (d) Lower Collection Period
9. Electronic funds transfer may eliminate most types of floats except
(a) Billing Float (b) Mail Float

(c) Cheque Processing Float (d) Bank Processing Float
10. Which of these ratios could be a better indicator of Working Capital
(a) Current Assets to Fixed Assets (b) Interest Coverage Ratio

(c) Debt Equity Ratio (d) Financial Leverage
11. Need for cash can be categorized as any of these except
(a) Transaction (b) Entertainment

(c) Speculative (d) Precautionary
12. An organization carrying higher levels of inventory is most probably following which policy of
working capital management
(a) Conservative (b) Aggressive

(c) Moderate (d) Opportunistic
13. Which of these components of Working Capital require consideration of Cash Cost
(a) Raw Material Inventory (b) Receivables

(c) Work in Progress Inventory (d) Trade Payables
14. Current Liabilities can be settled by
(a) Creation of a new current liability (b) Use of Non-current assets

(c) Creation of Non-Current Liability (d) Proceeds of Long-Term Investments
15. Gross Working Capital refers to
(a) Current Assets - Current Liabilities (b) Current Liabilities - Current Assets
(c) Current Assets (d) Current Liabilities
16. How can a company improve its accounts receivable turnover?
(a) Extend payment terms for customers (b) Increase credit limits for customers
(c) Offer discounts for early payment (d) All of the above
Chapter - 09
Working Capital
CA Amit Sharma
17. If a company has profits with a certain cash conversion or net operating cycle, considering
reducing cash conversion cycle further, with other things remaining the same, would
(a) Increase the profits which might not be in the same proportion as the number of days reduced in
cash conversion cycle.
(b) Reduce the profits in the same proportion as the number of days reduced in cash conversion cycle.
(c) Convert profits to losses which might not be in the same proportion as the number of days reduced
in cash conversion cycle
(d) Increase profits in the same proportion as the number of days reduced in cash conversion cycle
18. An organization carrying higher levels of inventory is most probably following which policy of
working capital management
(a) Conservative (b) Aggressive

(c) Moderate (d) Opportunistic
19. All of these are methods of cash budgeting except
(a) Adjusted Balance Sheet Method (b) Adjusted Income Method

(c) Receipts & Payment Method (d) Taxable Income Method
20. Strict credit policy with customers may not result in
(a) Faster Collections (b) Decline in Sales

(c) Increase in Sales (d) Lower Collection Period
ANSWERS
1. (d) 2. (d) 3. (c) 4. (a) 5. (d)
6. (a) 7. (b) 8. (c) 9. (a) 10. (a)
11. (b) 12. (a) 13. (b) 14. (a) 15. (c)
16. (c) 17. (a) 18. (a) 19. (d) 20. (c)
Chapter - 09
\
Q.N THEORY QUESTIONS
1. Discuss the factors to be taken into consideration while determining the requirement of
working capital.
Some of the factors which need to be considered while planning for working capital requirement are:
1. Need for Cash: Identify the cash balance which allows for the business to meet day-to-day expenses
but reduces cash holding costs (example – loss of interest on long term investment had the surplus
cash invested therein).
2. Desired level of Inventory: Identify the level of inventory which allows for uninterrupted
production but reduces the investment in raw materials and hence increases cash flow. The
techniques like Just in Time (JIT) and Economic order quantity (EOQ) are used for this.
3. Receivables: Identify the appropriate credit policy, i.e., credit terms which will attract customers,
such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue
and hence Return on Capital (or vice versa). The tools like Early Payment Discounts and allowances
are used for this.
4. Short-term Financing Options: Inventory is ideally financed by credit granted by the supplier.
However, depending on the cash conversion cycle, it may be necessary to utilize a bank loan (or
overdraft), or to “convert debtors to cash” through “factoring” in order to finance working capital
requirements.
5. Nature of Business: For e.g. in a business of restaurant, most of the sales are in Cash. Therefore,
need for working capital is very less. On the other hand, there would be a higher inventory in case of
a pharmacy or a bookstore.
6. Market and Demand Conditions: For e.g. if an item’s demand far exceeds its production, the
working capital requirement would be less as investment in finished goods inventory would be very
less with continuous sales.
7. Technology and Manufacturing Policies: For e.g. in some businesses the demand for goods is
seasonal, in that case a business may follow a policy for steady production throughout the whole year
or rather may choose a policy of production only during the demand season.
8. Operating Efficiency: A company can reduce the working capital requirement by eliminating
waste, improving coordination, process improvements etc.
9. Price Level Changes & Exchange Rate Fluctuations: For e.g. rising prices necessitate the use of
more funds for maintaining an existing level of activity. For the same level of current assets, higher
cash outlays are required.
2. Discuss the liquidity vs. profitability issue in management of working capital.

Advantages of Higher Trade off between Advantages of lower
Components of
side profitability profitabiloity & side liquidity
Working Capital
liquidity
Inventory Less stock out increase Use techniques like Lower inventory
profitability EOQ, JIT requires less capital
but there are chances
Chapter - 09
Working Capital
CA Amit Sharma
of stock out & loss of

goodwill.
Receivables High credit period Evaluate credit policy Cash sales provide
attract customers & use services of debt liquidity but fail to
increase revenue but management. boost sales
can lead to more bad
debt
Prepay of Expenses Reduce uncertainty & Cash benefit analysis Improves or maintains
profitable in required liquidity.
inflationary env.
Cash & Cash Eq Payables are honoured Cash Budget & Other Cash can be used in
in time, improves good techniques may be some other investment
will & helps in getting used avenues
discounts
Payables & Exp Capital can be used in Evaluate credit policy Payables are honoured
some other investment & related cost. in time, improve
avenues goodwill & help in
getting discount.
3. Discuss the estimation of working capital need based on operating cycle process.
Operating cycle is one of the most reliable methods of Computation of Working Capital. However,
other methods like ratio of sales and ratio of fixed investment may also be used to determine the
Working Capital requirements. These methods are briefly explained as follows:
(i) Current Assets Holding Period: To estimate working capital needs based on the average holding
period of current assets and relating them to costs based on the company’s experience in the previous
year. This method is essentially based on the Operating Cycle Concept.
(ii) Ratio of Sales: To estimate working capital needs as a ratio of sales on the assumption that current
assets change with changes in sales.
(iii) Ratio of Fixed Investments: To estimate Working Capital requirements as a percentage of fixed
investments.
A number of factors will, however, be impacting the choice of method of estimating Working Capital.
Factors such as seasonal fluctuations, accurate sales forecast, investment cost and variability in sales
price would generally be considered. The production cycle and credit and collection policies of the
firm will have an impact on Working Capital requirements. Therefore, they should be given due
weightage in projecting Working Capital requirements.
4. Explain briefly the functions of Treasury Department.
The treasury department have evolved in importance over number of years from being responsible
for only cash handling issues to technical areas revolving around hedging forex risks, composition of
capital structure etc. The fundamental tasks for which treasury department of any enterprise is
responsible are :-
Chapter - 09
\
1. Cash Management: It involves efficient cash collection process and managing payment of cash both
inside the organisation and to third parties. There may be complete centralization within a group
treasury or the treasury may simply advise subsidiaries and divisions on policy matter viz.,
collection/payment periods, discounts, etc.
2. Currency Management: The treasury department manages the foreign currency risk exposure of
the company. In a large multinational company (MNC) the first step will usually be to set off intra-
group indebtedness.
3. Fund Management: Treasury department is responsible for planning and sourcing the company’s
short, medium and long-term cash needs. They also facilitate temporary investment of surplus funds
by mapping the time gap between funds inflow and outflow.
4. Banking: It is important that a company maintains a good relationship with its bankers. Treasury
department carry out negotiations with bankers with respect to interest rates, foreign exchange rates
etc. and act as the initial point of contact with them.
5. Corporate Finance: Treasury department is involved with both acquisition and divestment
activities within the group. In addition, it will often have responsibility for investor relations. The
latter activity has assumed increased importance in markets where share-price performance is
regarded as crucial and may affect the company’s ability to undertake acquisition activity or, if the
price falls drastically, render it vulnerable to a hostile bid.
5. Explain Baumol’s Model of Cash Management
According to this model, optimum cash level is that level of cash where the carrying costs and
transactions costs are the minimum.
The carrying costs refer to the cost of holding cash, namely, the opportunity cost or interest foregone
on marketable securities. The transaction costs refer to the cost involved in getting the marketable
securities converted into cash. This happens when the firm falls short of cash and has to sell the
securities resulting in clerical, brokerage, registration and other costs.
The optimum cash balance according to this model will be that point where these two costs are
minimum. The formula for determining optimum cash balance is:
2𝑋𝑈𝑋𝑃
√
𝑆
Where,
C = Optimum cash balance
U = Annual (or monthly) cash disbursement
P = Fixed cost per transaction.
S = Opportunity cost of one rupee p.a. (or p.m.)
The model is based on the following assumptions:
(i) Cash needs of the firm are known with certainty.
(ii) The cash is used uniformly over a period of time and it is also known with certainty.
Chapter - 09
Working Capital
CA Amit Sharma
(iii) The holding cost is known and it is constant.

(iv) The transaction cost also remains constant.
6. State the advantage of Electronic Cash Management System.
Electronic-scientific cash management results in:

1. Significant saving in time.
2. Increase in interest earned & decrease in interest expense.
3. Reduces paper-work & hence manpower.
4. Greater accounting accuracy as it allows easy detection of book-keeping errors.
5. More control over time and funds.
6. Supports electronic payments.
7. Faster transfer of funds from one location to another, where required.
8. Speedy conversion of various instruments into cash.
9. Making available funds wherever required, whenever required.
10. Reduction in the amount of ‘idle float’ to the maximum possible extent.
11. Ensures no idle funds are placed at any place in the organization.
12. It makes inter-bank balancing of funds much easier.
13. It is a true form of centralized ‘Cash Management’.
14. Produces faster electronic reconciliation.
15. Reduces the number of cheques issued.
7. Discuss Miller-Orr Cash Management model
According to this model the net cash flow is completely stochastic. When changes in cash balance occur
randomly the application of control theory serves a useful purpose. The Miller-Orr model is one of
such control limit models.
This model is designed to determine the time and size of transfers between an investment account
and cash account. In this model control limits are set for cash balances. These limits may consist of h
as upper limit, z as the return point; and zero as the lower limit.
1. When the cash balance reaches the upper limit, the transfer of cash equal to h – z is invested
in marketable securities account.
2. When it touches the lower limit, a transfer from marketable securities account to cash account
is made.
3. During the period when cash balance stays between (h, z) and (z, 0) i.e. high and low limits no
transactions between cash and marketable securities account is made.
The high and low limits of cash balance are set up on the basis of fixed cost associated with the
securities transactions, the opportunity cost of holding cash and the degree of likely fluctuations in
cash balances. These limits satisfy the demands for cash at the lowest possible total costs.
Chapter - 09
\
The MO Model is more realistic since it allows variations in cash balance within lower and upper limits.
The finance manager can set the limits according to the firm’s liquidity requirements i.e., maintaining
minimum and maximum cash balance.
8. Describe Factoring.
Factoring: Factoring is a relatively new concept in financing of accounts receivables. This refers to
outright sale of accounts receivables to a factor or a financial agency. A factor is a firm that acquires
the receivables of other firms. The factoring lays down the conditions of the sale in a factoring
agreement. The factoring agency bears the risk of collection and services the accounts for a fee.
Factoring arrangement can be either on a recourse basis or on a non-recourse basis:

- Recourse: In case factor is unable to collect the amount from receivables then, factor can turn back
the same to the organization for resolution (which generally is by replacing those receivables with
new receivables)
- Non-Recourse: The factor bears the ultimate risk of loss in case of default and hence in such cases
they charge higher commission.
There are a number of financial institutions providing factoring services in India. Some commercial
banks and other financial agencies provide this service. The biggest advantages of factoring are the
immediate conversion of receivables into cash and predicted pattern of cash flows. Financing
receivables with the help of factoring can help a company having liquidity without creating a net
liability on its financial condition and hence no impact on debt equity ratio. Besides, factoring is a
flexible financial tool providing timely funds, efficient record keepings and effective management of
the collection process. This is not considered as a loan. There is no debt repayment and hence no
compromise to balance sheet, no long-term agreements or delays associated with other methods of
raising capital. Factoring allows the firm to use cash for the growth needs of business.
9. Describe the various forms of bank credit in financing the working capital of a business
organization.
The bank credit will generally be in the following forms:

• Cash Credit: This facility will be given by the banker to the customers by giving certain
amount of credit facility on continuous basis. The borrower will not be allowed to exceed the
limits sanctioned by the bank.
• Bank Overdraft: It is a short-term borrowing facility made available to the companies in case
of urgent need of funds. The banks will impose limits on the amount they can lend. When the
borrowed funds are no longer required they can quickly and easily be repaid. The banks issue
overdrafts with a right to call them in at short notice.
• Bills Discounting: The Company which sells goods on credit will normally draw a bill on the
buyer who will accept it and sends it to the seller of goods. The seller, in turn discounts the bill
with his banker. The banker will generally earmark the discounting bill limit.
• Bills Acceptance: To obtain finance under this type of arrangement a company draws a bill of
Chapter - 09
Working Capital
CA Amit Sharma
exchange on bank. The bank accepts the bill thereby promising to pay out the amount of the
bill at some specified future date.
• Line of Credit: Line of Credit is a commitment by a bank to lend a certain amount of funds on
demand specifying the maximum amount.
• Letter of Credit: It is an arrangement by which the issuing bank on the instructions of a
customer or on its own behalf undertakes to pay or accept or negotiate or authorizes another
bank to do so against stipulated documents subject to compliance with specified terms and
conditions.
• Bank Guarantees: Bank guarantee is one of the facilities that the commercial banks extend
on behalf of their clients in favour of third parties who will be the beneficiaries of the
guarantees.
Chapter - 09
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Introduction to Financial Management

1. Management of all matters related to an organisation's finances is called

(a) Cash inflows and outflows (b) Allocation of resources

(a) Budgeting (b) Forecasting

(a) Accounting profit analysis (b) Cash Flow approach

4. "Shareholders Wealth" in a firm is reflected by

(a) the number of people employed in the firm

5. Financial Management is mainly concerned with the

(a) Acquiring and developing assets to forfeit its overall benefit

(a) Risk and return

(d) All of the above

7. Which of the following is the common connection in financing, investing decisions

(a) Investment instruments type should be same as financing instrument type

8. The main objective of financial management is to

(a) Secure profitability (b) Maximise shareholder wealth

9. Wealth maximisation approach is based on the concept of

(a) Cost benefit analysis (b) Cash flow approach

(a) Accounting profit (b) Liquidity

(a) Emphasizes the short-term gains

(a) Traditional (b) Transitional

13. Reserves & Surplus are which form of financing

(a) Security Financing (b) Internal Financing

(a) Investing in projects with high cash flows

(c) Regular growth in dividends

(a) Financing (b) Investing

1. (c) 2. (c) 3. (a) 4. (d) 5. (b)

6. (d) 7. (d) 8. (b) 9. (d) 10. (c)

The Various Stages are:-

“Financial Management comprises of forecasting, planning, organizing, directing, co-ordinating and

3. What are various sources of raising funds?

Some of the sources of funds:-

4. What do you mean by effective utilisation of Funds ?

5. Explain evolution of Financial Management or various stages of financial management.

The three stages of its evolution are:

6. Explain Long term and Short term Finance Functions.

Short-term Finance Decisions/ Function

7. Explain importance of Financial Management

8. What are responsibilities of Finance Executive ?

His responsibilities include:

9. Explain role of Finance executive in today’s world

10. What is scope of Financial Management

11. Explain two objectives of Financial Management

Wealth Maximisation/ Value Creation

14. Explain linking of FM with Accounts.

15. How to address agency problem?

However, following efforts have been made to address these issues:

Which of the following marketable securities is the obligation of a commercial bank

Reserves & Surplus are which form of financing

1. (b) 2. (a) 3. (a) 4. (a) 5. (b)

6. (b) 7. (c) 8. (b) 9. (b) 10. (b)

Stable stage Low Uncertainty Debt

Advantages of raising funds by issue of equity shares are:

Disadvantages of raising funds by issue of equity shares are:

Advantages of raising funds by issue of preference shares are:

Disadvantages of raising funds by issue of preference shares are:

Advantages of raising finance by issue of debentures are:

Disadvantages of debenture financing are:

Explain Bridge Finance??

Explain Venture Capital Financing & its characteristics??