investors and ordinary retail investors.

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1 Exam series -1 Class xii business studies set-1 1.How does Rate of Return affect the capital structure? 1 ansthe greater return on invt of a company increases its capacity to utilize more debt capital. 2. Indian Logistics has its own warehousing arrangements at key locations across the country. Its warehousing services help business firms to reduce their overheads, increase and cut down distribution time. State with reason, whether the working capital requirement of Indian Logistics will be high or low. (1) Ans. Low as it is a service industry-do not have to maintain inventory Q3. Mr Neeraj Aggarwal is the finance manager of Kejri Limited. Company is in need of Rs 50 crore. To arrange this much of capital he has two options; issue of equity shares or debentures. He has to select one of the two. After due delebriation he decided in favour of issuing debentures. He puts his decision before the CEO. The latter asked him why he had ignored equity shares capital. Mr Aggarwals reply was; Debenture is a source of finance by whose payment in future company can save itself from fixed financial costs. In the above paragraph, which component affecting financing decision has been highlighted? Ans. Flexibility Q4.name the financial decision which affects the liquidity as well as the profitability of the business. 1. Ans. Short term investment decision Q5.What are the components of capital market? 1 Ans. Primary market and Secondary market Q6.name the money market instrument used as alternative to bank borrowing for large companies. 1 Ans. Commercial paper Q7.Differentiate between capital market and money market. 3 Differences between Capital Market and Money Market Basis Capital market Money market 1.participants Financial institutions, banks, RBI, banks financial institutions corporate entities, foreign and finance companies. investors and ordinary retail investors. 2.instruments Equity shares, preference T- bills, commercial paper (CP), shares, debentures etc. certificate of deposit CD, trade bills etc. 3.investment outlay The value of securities is low Ex., Rs. 10, Rs and so is the In the money market, transactions entail huge sums of money as the instruments are quite expensive. 4.duration Capital market deals in Money market deals in short-term medium and long term securities. securities ranging one day toone year. 5.liquidity Capital market securities Money market securities have

2 6.safety 7.expected return have less liquidity; a share may not be actively traded. Capital market securities are riskier both with respect to return and principal repayment. : Capital market instruments yield a high return for investors high liquidity as there is a formal arrangement for this. Money market instruments are much safer with a minimumrisk of default. Money market instruments give less return to investors. Q8 How are shareholders likely to gain with loan components in capital employed? Explain with suitable example. 3 Ans. Trading on equity is the usage of debt component along with equity shares in the capital structure with a view to increase Earnings Per Share (EPS) Company X Ltd. Total Funds used Rs. 30 lakh Interest rate 10% p.a. Tax rate 30% EBIT Rs. 4 lakh Usage of Debt component Situation I Nil Situation II Rs. 10 lakh Situation III Rs. 20 lakh EBIT EPS Analysis Situation I II III EBIT 4,00,000 4,00,000 4,00,000 Interest NIL 1,00,000 2,00,000 EBT 4,00,000 3,00,000 2,00,000 Tax 1,20,000 90,000 60,000 EAT 2,80,000 2,10,000 1,40,000 No. of shares of Rs. 10 each 3,00,000 2,00,000 1,00,000 Earnings per share 2,80,000= ,00,000 Thus we can observe that more usage of debt component DPS increase to Rs as compared to an unlevered company where EPS is Q9. sound financial planning is essential for the success of any business enterprise. Explain this statement by giving any three reasons ans.the importance of financial planning:- 1. It tries to forecast what may happen in future under different business situations. By doing so, it helps the firms to face the eventual situation in a better way. The management may decide what must be done in each of these situations. 2. It helps in avoiding business shocks and surprises and helps the company in preparing for the future. 3. It helps in coordinating various business functions eg. sales and production function, by providing clear policies and procedures. 4. Detailed plan of actions prepared under financial planning reduce waste duplication of errors and gaps in planning. 5. It tries to link the present with the future. 6. It provides a link between investment and financing decisions on a continuous basis. 7. By spelling out detailed objectives for various business segments, it makes the evaluation of actual performance easier.

3 10. Ganesh Steel Ltd. s is a large and credit-worthy company manufacturing steel for the Indian market. It now wants to cater to the Asian market and decides to invest in new hitech machines. Since the investment is large, it requires long-term finance. It decides to raise funds by issuing equity shares. The issue of equity shares involves huge floatation cost. To meet the expenses of floatation cost the company decides to tap the money market. (a) Name and explain the money-market instrument the company can use for the above purpose. (b) What is the duration for which the company can get funds through this instrument? (c) State any other purpose for which this instruments can be used. 4 Ans. 1.Commercial paper.it is a unsecured promissory note issued by large companies to raise short term funds at a lower rate of interst than the prevailing market rates days to one year 3. it can be used for seasonal and working capital needs. 11.SABU Ltd. is in liquidity crunch. Working capital is in shortage and it is finding difficult to pay the suppliers in time. Credit period which is allowed by suppliers is two months. Finance Manager is of the opinion that for atleast three months, company will not have sufficient funds to pay off creditors. Although, it has good financial reputation in market. (i) Which short-term financial instrument company should use? (1) (ii) In which market short-term financial instruments are issued? (1) (iii) Explain any three factors affecting requirement of working capital? (3) ans(i) Commercial Paper (ii) Money Market (iii) Any three factors affecting working capital requirements. 12. Peeyush Ltd. manufactures woolen garments. Sale of company is increasing from last many years and company has very good demand of its garments in market. By keeping in mind all these company decided to increase its production which will require more amount of working capital. Company will use this working capital to purchase raw material and to make payment to workers. On the basis of above discussion explain the concept of working capital and also give four factors that affect working capital. (6) ans. Working Capital refers to the capital required for day to day working of an organisation. Apart from the investment in fixed assets every business organisation needs to invest in current assets, which can be converted into cash or cash equivalents within a period of one year. They provide liquidity to the business. Working capital is of two types - Gross working capital and Net working capital. Investment in all the current assets is called Gross Working Capital whereas the excess of current assets over current liabilities is called Net Working Capital The factors affecting working capital requirement are: - a) Nature of business : A trading organisation usually needs a lower amount of working capital compared to manufacturing organisations. This is because usually there is no processing, therefore, there is no destination between raw material s and finished goods. b) Scale of operation : For organisation which operate on a higher scale of operations, the quantum of inventory, debtors required is generally high. c) Business cycle : Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom the sales as well as production are likely to be higher and therefore, higher amount of working capital is required. d) Seasonal factors : In peak season because of higher level of activities higher amount of working capital is required. During lean period less amount of working capital would be required. e) Production cycle : Production cycle is the time span between the receipt of raw material and their conversion into finished goods. Working capital requirement is

4 higher inform with longer processing cycle and lower in firms with shorter processing cycle. f) Credit allowed : Different firms allow different credit terms to their customers. A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital. g) Credit availed : To the extent, an organisation avails the credit on its purchases, the working capital requirement is reduced. h) Operating efficiency : Firms manage their operations with varied degrees of efficiency e.g. a better debtors turnover ratio may be achieved reducing the amount tied up in receivable. Better sales effort may reduce the average time for which finished goods inventory is held. Such efficiencies may reduce requirement of working capital. i) Availability of raw material : I f raw materials do not have a record of un interrupted availability, higher stock levels may be required. The time lag between the placement of order and actual receipt of the material is also relevant. Higher the lead time, higher the quantity of material to be stand and higher is the amount of working capital requirement. j) Growth prospects : I f the growth potential of a concern is perceived to be higher, it will require higher amount of working capital so that is able to meet higher production and sales target whenever required.

5 Exam series -1 Class xii business studies set-2 1Explain how cost of debt affect the choice of capital structure? 1 Ans. a companys ability to borrow at a lower rate increases its capacity to employ more debt. 2. lotus Foods limited is a multinational company (MNC). Mr Raghav Chadda is its finance manager. He is making efforts to increase the market value of the capital invested by its equity shareholders. He had already read in 10+2 business studies text book that it could be possible only when market price of the shares increases. And the market price of the share could increase only when he takes optimum investment decision, optimum financing decision and optimum dividend decision. He did the same and achieved success. Which objective of financial management has been referred to in the above paragraph? Ans. Wealth maximisation 3.Name the two major alternative mechanisms through which allocation of funds can be done. 1 4.Why are treasury bills known as zero coupon bonds? 1 Ans. Zero coupon bonds mean a financial instrument for which no interest is paid but it is issued at a discount. 5.From the point of control which source of finance should be avoided. 1 Ans. Equity share capital 6.What is certificate of Deposit? 1 Ans Certificates of deposit (CD) are unsecured negotiable, short term instruments in bearer form issued by commercial banks and development financial institutions. They can be issued to individuals, corporations and companies during period of tight liquidity when the deposit growth of banks is slow but the demand for credit is high. 7. Differentiate between primary market and secondary market 3 Difference between Primary Market and Secondary Market Primary Market Secondary Market 1. It is the market for new securities. It is the market for existing securities. 2. Securities are exchanged between company and the investors. Securities are exchanged between investors. 3. It promotes capital formation It promotes capital formation directly. indirectly. 4. Only buying of securities takes place. Securities cannot besold here. Both buying and selling of securities can take place in the stock exchange / stock market. 5. There is no fixed geographical There is a specified location. location. 6. Prices are determined and decided by the managementof the company. Prices are determined by demand and supply for the security in the stock exchange. Securities may be bought and sold many times but not the first time. 7. Securities are issued to investors for the first time. 8. Financial market plays an important role in the allocation of scarce resources in an economy by performing various functions. Explain any three functions of financial market.3 Ans. 1. Mobilisation of saving and channeling them into the most productive uses: A financial market facilitates the transfer of saving from savers to investors. It

6 gives savers the choice of different investments and thus helps to channelise surplus funds into the most productive use. 2. Facilitate price discovery: In financial market, the households are suppliers of funds and business firms represent the demand. The interaction between them helps to establish a price for the financial asset which is being traded in that particular market. 3. Provide liquidity to financial assets: Financial markets facilitate easy purchase and sale of financial assets. By doing so they provide liquidity to financial assets, so they can be easily converted into cash whenever required. 4. Reduce the cost of transactions: Financial markets provide valuable information about securities being traded in the market. It helps to save time, effort and money of buyers and sellers. It is a common platform where buyers and sellers can meet for fulfillment of their needs. 9 Explain the term trading on equity..why when and how it can be used by a business organisation? 3 Ans.Trading on equity is the usage of debt component along with equity shares in the capital structure with a view to increase Earnings Per Share (EPS) Company X Ltd. Total Funds used Rs. 30 lakh Interest rate 10% p.a. Tax rate 30% EBIT Rs. 4 lakh Usage of Debt component Situation I Nil Situation II Rs. 10 lakh Situation III Rs. 20 lakh EBIT EPS Analysis Situation I II III EBIT 4,00,000 4,00,000 4,00,000 Interest NIL 1,00,000 2,00,000 EBT 4,00,000 3,00,000 2,00,000 Tax 1,20,000 90,000 60,000 EAT 2,80,000 2,10,000 1,40,000 No. of shares of Rs. 10 each 3,00,000 2,00,000 1,00,000 Earnings per share 2,80,000= ,00,000 Thus we can observe that more usage of debt component DPS increase to Rs as compared to an unlevered company where EPS is If a company's current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. The worst-case scenario is bankruptcy. A declining working capital ratio over a longer time period could also be a red flag that warrants further analysis. For example, it could be that the company's sales volumes are decreasing and, as a result, its accounts receivables number continues to get smaller and smaller. Working capital also gives investors an idea of the company's underlying operational efficiency. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations. So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another; slow collection may signal an underlying problem in the company's operations. The above discussion about the company leads to various factors which decide how much of working capital requirements should be maintained by the

7 company Quoting the lines from the above discussion identify and explain any four such factors. Ans. The factors affecting working capital requirement are: - a) Nature of business : A trading organisation usually needs a lower amount of working capital compared to manufacturing organisations. This is because usually there is no processing, therefore, there is no destination between raw material s and finished goods. b) Scale of operation : For organisation which operate on a higher scale of operations, the quantum of inventory, debtors required is generally high. c) Business cycle : Different phases of business cycles affect the requirement of working capital by a firm. In case of a boom the sales as well as production are likely to be higher and therefore, higher amount of working capital is required. d) Seasonal factors : In peak season because of higher level of activities higher amount of working capital is required. During lean period less amount of working capital would be required. e) Production cycle : Production cycle is the time span between the receipt of raw material and their conversion into finished goods. Working capital requirement is higher inform with longer processing cycle and lower in firms with shorter processing cycle. f) Credit allowed : Different firms allow different credit terms to their customers. A liberal credit policy results in higher amount of debtors, increasing the requirement of working capital. g) Credit availed : To the extent, an organisation avails the credit on its purchases, the working capital requirement is reduced. h) Operating efficiency : Firms manage their operations with varied degrees of efficiency e.g. a better debtors turnover ratio may be achieved reducing the amount tied up in receivable. Better sales effort may reduce the average time for which finished goods inventory is held. Such efficiencies may reduce requirement of working capital. i) Availability of raw material : I f raw materials do not have a record of un interrupted availability, higher stock levels may be required. The time lag between the placement of order and actual receipt of the material is also relevant. Higher the lead time, higher the quantity of material to be stand and higher is the amount of working capital requirement. j) Growth prospects : I f the growth potential of a concern is perceived to be higher, it will require higher amount of working capital so that is able to meet higher production and sales target whenever required. 11.Ravi was a trader dealing in woollen garments. His business flourished and he was maintained a good reserve of retained earnings. Ravi expanded his business and started production of shawls. Operating cycle period off shawls was quite long as Ravi made a policy for Credit allowed of four months to attract more customers. He was able to produce a good number of shawls with good quality and hand work. (i) Name the market, through which working capital needs are satisfied. (ii) What quantum of working capital was required when he was when he was trader? As a producer how his need for working capital requirement has changed? (iii) Apart from working capital, explain any three other factors, affecting equirement of working capital. (5) Ans (i) Money Market (ii) As a trader less working capital was required in comparison to as a producer because operating cycle period was comparatively small. (iii) - Nature of concern - Size of business - Seasonal Business (or any other)

8 12. Sarah Ltd. is a company manufacturing cotton yarn. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of Rs. 40 lakhs from IDBI and is bound by certain restrictions on the payment of dividend according to the terms of loan agreement. The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company. Quoting the lines from the above discussion identify and explain any four such factors. (6) ans. Dividend is that portion of profit which is distributed to shareholders. The decision involved here is how much of the profit earned by company is to be distributed to the shareholders and how much of it should be retained in the business for meeting the investment requirements. The decision regarding dividend should be taken keeping in view the overall objective of maximizing shareholders wealth. Factors affecting dividend decision: - 1. Earnings: Dividends are paid out of current and past earnings. Earnings is therefore, a major determinant of the decision about dividend. 2. Stability of earnings: Other things remaining the same a company having stable earning is in a position to declare higher dividends. A company having unstable earnings is likely to pay smaller dividends. 3. Stability of dividends: It has been found that the companies generally follow a policy of stabilizing dividend per share. Dividend per share is not altered if the change in earnings is small or seen to be temporary in nature. 4. Growth opportunities: Companies having good growth opportunities retain more money out of their earnings so as to finance the required investment. The dividend in growth companies is therefore, smaller, than that is the non-growth companies. 5. Cash flow position: Dividends involve an out flow of cash. A company may be profitable but short on cash. Availability of enough cash in the company is necessary for declaration of dividend by it. 6. Shareholder preference: While declaring dividends, managements usually keep in mind the preferences of the shareholders in this regards. There are always some shareholders who depend upon a regular income from their investments. 7. Taxation policy : If tax on dividend is higher it would be better to pay less by way of dividends. As compared to this, higher dividends may be declared if tax rates are relatively lower. Under the present tax policy, shareholders are likely to prefer higher dividends. 8. Stock market reaction: Investors in general view an increase in dividend as a good news and stock prices react positively to it. The impossible impact of dividend policy on the equity share price is one of the important factors while taking a decision about it. 9. Access to capital market: Large and reputed companies generally have easy access to the capital market and therefore may depend less on retained earnings to finance their growth. These companies tend to pay higher dividends. 10. Legal constraints: Certain provisions of the Company s Act place restrictions on payouts as dividend. Such provisions must be adhered to while declaring the dividends. 11. Contractual constraints: While granting loans to a company, sometimes the lender may impose certain restrictions on the payment of dividends in future. The companies are required to ensure that the dividends does not violate the terms of the loan agreement in this regard.