PRE UNIVERSIT

F I N A N C I A L M A N A G E M E N T

Chapter9

activVities is called busine

ness
out business
for carrying it, to expand or
Business finance: Money required to run it, to nmodernise

a business,
finance. Finance is necded to establish
diversify it. which may be tangible like mank
is required for buying
a variety of assets, oery,
,
Finance patents, technical expertise
buildings, or intangible such as trademarks, etc
Tactories,
operations of busness, buying material.
rial, paying
like
Finance is required for the day-to-day
needed at every stage
in the lite of a business
bills, salaries,
Availability
wages, etc.
of adequate finance is, thus, very crucal for the survival and grouth.of a
ntity

business.
FINANCIAL MANAGEMENT

It is concemed with optimal procurement as well as usage of finance. It aims at ensiuris

availability of enough funds whenever required as well as avoiding idle finance.
suring
Importance of financial management: Financial Management has direct bearing on the
financial health of a business. All items in the financial statements of a business are affected
directly or indirectly through some financial management decisions. Some of the examples
are;

1) The size and composition of fixed assets of the business: An investment in fixed assets
would raise the size of the fixed assets block by this amount.
2) The quantum of current assets and its
break-up in to cash,
receivables: With an increase in the investment in fixed inventory and
assets, there is a
proportionate
increase in working capital
requirement. Decisions about credit and inventory
management affect the amount of debtors and inventory which in turn affect the total
current assets.

3) The amount of
long
term debt and short term
funds to be used: Financial
management involves decisions about the
Long term funds proportion of long term and short term funds.
mean more
there is a choice between
liquidity but Current (short term) liabilities cost less. So
liquidity and profitability.
4) Break-up of long term financing into debt, equity etc.: Of the total long tem tinance,
the proportions to be raised by way of debt and
equity is also a financial nt
decision. This affects amounts
of debt, equity share capital and preference managenc
tal
5) All items in the stna
profit and loss account: e.g., Interest,
Higher amount of debt means Expense her equity means
higher payment higher expense in future, Simila
of dividends. Therefore financial decisions he profit a
account also. affe
Objective of financial management
Wealth Maximization: maximize
The main
shareholders' wealth. It objective
means
mana
of financial
ofequity shares.
The shares.
ket
marke

price of equity
maximisation of the market va value
exceeds
the cost
share
increases, if the benefit from a decisio
financial
decision

88
for Private Circulatian Qnhu
 PRE UNiVERSITY COLLEGE
Chapter 9 -Financial M1anagem1en

ipvolved. Theretore, those financial decisions are taken which will ultimately prove gainful
om the point ofview of the sharcholders.
Cinancial decisions: Every cOmpany is required to take three main financial decisions they
Finar

are: 1 Investment
decision 2. Financing decision 3.
Dividend decision
INVESTMENT DECISION
t relates to how the firm's funds are invested in different asscts. Investment decision can be
long-term or short-term. A long term investment decision is called capital budgeting decision.
involves commiting the finance on a long-term basis. For example, making investment in a
new machine, or opening a new branch, etc.
Investment decisions need
to be taken with utmost
care as they involve huge amounts
and are iTeversible except at a huge cost. While short term investment decisions are called
vorking capital decisions, which affect day to day working of a business.
Factors affecting Investment
Decisions/Capital Budgeting decisions:
A number of projects are often available to a business to invest in. But each project has to De
evaluated carefully on the basis of following factors.
1. Cash flows of the
project: The
series of cash receipts and
investment proposal should be considered and payments over the life of an

2. Rate of Return: The

analysed for selecting the best proposal.
expected rate of
return is another factor affecting
capital budgeting
decision. Usually the project which
gives highest rate of return should be selecteed.
3. Investment Criteria Involved: while
taking capital budgeting decisions, the amount of
investment, interest rate, cash flows and rate of
return are to be considered. There are
different techniques to evaluate
investment proposals which are known as
budgeting techniques. These capital
techniques are
applied to each proposal before selecting a
particular project.
FINANCING DECISION
It relates to the amount of finance to
be raised from various
sources of funds are owner's funds i.e.
long term sources. The main

Debts.
equity/shareholder's funds and the borrowed funds i.e.
Borrowed funds have some amount of financial
risk (i.e. risk of
borrowed funds has to be paid default). Interest on
regardless whether a firm has profit or loss, and also
of
borrowed funds have to be repaid at a fixed time.
This risk of default on
and repayment of debt is known as
financial risk.
payment of interest
On the other
hand, shareholder's funds involve no commitment
dividends or repayment of
capital. regarding payment of
Therefore a firm needs to have mix of both
inmaking financing decisions. debt and equity
Factors Affecting
Financing Decision: The financing decisions are affected by various
factors. Important among them are as
follows:
1. Cost: The
cost of raising
funds from different sources is different. The cheapest
Sotheoretical Knowledgeurce should be selected.
. Risk: The risk associated with
different sources is different. More risk is
borrowed funds as compared to owner's fund as associated with
interest is paid on it and it is to
also. be repaid

for D-
 Chapter 9-Financial ment
ST.CLARET
PRE UNIVERSITY COLLEGE

3. Flotation Cost: The costs involved in issuing securities

called
suchflotation
as brokers
costs.com
Higher the
etc. are calí
mmission,
on prospectus
fees, cxpenses
underwriters'

attractive is the source of finance.

flotation cost, less
of a company is good eno.
business: If cash flow position
4. Cash Mow position of the on time.
borrowed funds and pay interest
then it can casily use
5. State of Capital Markets: During the period when stock market is rising, more people
invest in cquity. So finance can easiy be raised by iSsuing shares. But depressed.
narket may make issue of cquity shares dificult. So during this period, raising finance b
means of debt is easy.
by
6. Fixed Operating Costs: If a business has high fixed operating costs (e.g., building rent
insurance premium, Salaries, etc.), it must reduce tixed financing costs.
Hence, lower
debt financing is better. Similarly, if fixed operating cost is less, more of
debt financing
may be preferred.

7. Control Considerations: Issues of more equity

may lead to dilution of
control over the business. Debt financing has no such management's
losing control can prefer debt than equity.
implication. Companies afraid of

DIVIDEND DECISIOON
Dividend is that part of the profit which is
distributed to shareholders. A
to decide how much of the company is required
profit earned by it should be distributed
among shareholders and
how much should be retained. The
decision regarding dividend should be
view the overall taken keeping in
objective of maximizing shareholders' wealth.
Factors affecting Dividend Decision:
The decision about distribution
after considering the of dividend is taken
1. Amount of
following factors:
Earnings: Companies having high and stable
of dividends as dividends
are paid out of earnings could declare high rate
current and past
2. Stability of
earnings.
Earnings: Other things remaining the same, a
eamings can declare higher dividends. As company having stabie
earnings is likely to pay smaller dividend. against this, a company having unstable
3. Stability of Dividends: Companies
rate of dividend is generally follow the policy of stable dividend. 1ne
not altered in case
of small change in
is
temporary in nature. earnings or increase in earln
4. Growth
Prospects: In case there are growth
then it will retain
its earning and prospects for the company in nc
thus, no or less dividend will be declare.
S. Cash Flow
Positions: Dividends involve an y of
adequate cash is outflow of cash and tnus
foremost requirement for
6. declaration of dividenas
Legal constraints: Under
provisIons of
and the provisions of Companies Act.
Companies all earnings can't be distributed
Act, all ea
company has to provide for
company to declare dividend. various reserves. This n

90
 7. Shareholder eference
nces of the While Chapter 9-Financial Management
certain amountsharcholders indeclaring
at least a ce
this
dividends, manag
8. Taxation } is paid as regard. If the agement must keep
Policy: The choice dividend, the share
archolders in
general
ind in
is. to some
extent, affected between the companies desire tha
idend is higher, it by the difference
tax on divid
payment of dividend
di
and
lsicher
dividends may be is better to pay lessin the tax dividendsrctaining
on
the earning
ings
declared if tax by and capital gains. If
rates are way ofdividends. As
9. Stock Marlrket Reaction: «

stock prices reactInvestors, in

news and stoc relatively lower. compared this. to

ncgative impact on general. view increase in

the sharepositively to it. an
dividend
dividend policy on the prices in the Similarly. decrease
do a
in dividend good as a

nmanagemcnt while takingequity share price is

a
stock market.
one of
Thur
hus, the
may have
possible impact of
a

Access to
10. Access dividend
decision.
the portant
importa factors considered
Capital Market: by the
thecapital market and, Large and reputcd
growth. These companiestherefore, may depend companies generally
enerally have
ha easy access
have tend to
relatively low access to the pay less on retained
higher dividends than the earnings to finance their
to

11. Contractual market. smaller companies whichn

Constraints: While
impose certain restrictions on
granting loans to
the compa a
pany, sometimes the lender
required to ensure that the payment dividends
of
in future. The may
this regard. dividend does not companies are
violate the terms of the
loan agreement in
The process of estimating the fund
FINANCIAL PLANNING
funds is called financial requirement of
planning. It ensures that business
a
and
that a firm could honour its enough
specifying the sources of
funds are available at
achieve twin objectives. Theycommitments and carry out its right time so
are: plans. Financial planning strives to
a) To ensure availability of funds
whenever required.
b) Tothat the firm does not raise
see
resources
unnecessarily.
Importance of Financial Planning: Financial
planning of any business enterprise. The importanceplanning
can be
is an
important part of overall
explained follows: as
1. Financial
planning tries to link the present with the future:
It helps in
requirements of funds based on present situations. forecasting the
2. Linking investment and financing decisions: It provides a link between
investment and
financing decisions on a continuous basis.
3. It helps the company in preparing for the future: It helps in avoiding business shocks
and surprises and helps the
company in preparing for the future.
4. It helps in coordinating various business funetions:
e.g., co-ordination of sales and
production functions by providing clear policies and procedures.
S. Financial planning reduce waste, duplication of efforts: Detailed plans of action
prepared under financial planning reduce waste, duplication of efforts, and gaps in

planning.
 Chapter 9-Financial Managen
ST.CLARET
PRE UNIVERSITY COLLEGE
gemen
future under different

helps in forecasting
future: It helps in
forecasting
eventual situation in a better business
6. It
it helps the
firms to face the way.
7.
situations. By doing so,

It makes the
evaluation of performance
casier:

evaluation
By spelling
ofactual
out detailed

performance easier
bjectives for
obiecti.

various business segments,

it makes the
CAPITAL STRUCTURE

owner's funds and borrowed funds. On th

Capital structure refers to the mix between
finance can be broadlyinto two Cata
classified
of ownership. the sources of business
viz., 'owners' funds and 'borrowed funds. Owners funds consist of equity share canit

preference share capital and reserves and surpluses or retained earnings. Borrowed fund
can
be in the form of loans, debentures, public deposits etc. These may be borrowed from hot
other financial institutions, debenture holders and public.
banks,
It can be calculated as debt-equity ratio i.e., Debt OR Debt
Equity Debt +equity
Debt is cheaper but is more business because the payment of interest and the
risky for a
return of principal is obligatory for the business. So increased use of debt
increases the
financial risk of a company. Financial risk is the chance that a firm would
fail to meet its
payment obligations.
Equity is therefore, considered riskless for the business.
Capital structure of a company, thus, affects both the
profitability and the financial risk. A
capital structure is said to be optimal when the
increase in the value of the proportion of debt and equity results in an
equity share.
Financial Leverage: The proportion of debt in the overall capital of a fim is
Leverage or Capital Gearing. called Financial
Financial leverage is calculated as D/E
or D/ D+E when
D Debt and E =

When the proportion of debt in

the total capital is equity =

levered firm but when the high then the firm will be called
highly
called low levered.
proportion of debts in the total
capital is less, then the firm will be
Trading on Equity: It refers to the
increase in profit earned the
to the presence of fixed by equity shareholders due
financial charges like interest.
rate of
earming is higher than the cost of borrowed Trading on equity happens when tne
higher rate of dividend funds. As a result equity shareholders
per share. g
The use of more debt
along with the equity
carries fixed amount of increases EPS (Earning Per Share)
interest which is tax deductible.
as tne
udebt
Factors affecting capital structure:
structure are follows:
as Important factors which determine tnc
1. Cash Flow
Position: Size of the
borrowing. Cash flows must not projected cash flows must D
be sufficient buffer only cover fixed cash hut there must
also. payment obug ons
2. Interest
Coverage Ratio (ICR): It before
interest
and taxes of a refers to the number of earnings
company times
indicates that company can covers the interest obligation. Hign Taterest cove
mes

have more of
borrowed funds.
 PRE OLLEGE

Formula for calculating ICR Chapter 9 -Financial Managenment

=

EBIT
3 pebt servIce coverage
ratio
Interest
compared with the
total (DSCR):
cash The cash
profits generated by the
capital. rcquired for the
servicing
ng of debt and the operations u
Profit after tax preference shar
DSCR= +
Depreciation+ interest +
Non- cash
Preference dividend + expenses
Return on
Investment: interest +
4.
Repayment
will be bencficial for return on investment is higher than obligations.
If
then it
tho
a firmm
to raise the rate of interest on
finance through borrowed funds. deb
Capital Market Conditions:
securities to be issued. Like Capital market conditions
influence the
interested in equity shares butduring depression, people do not like to takedetermination
risk, so are
ot
during boom, investors are ready to no
6. Cost of debt: A firm's invest in equity shares.
ability to
higher debt. Thus, more debt can beborrow at a lower rate increases its capacity to employ
used if debt can be
raised at a lower rate.
7. Tax Rate: Since interest is a
deductible expense, cost of debt is
A higher tax rate, thus, makes debt affected by the tax rate.
equity. relatively cheaper and increases its attraction over
8, Cost of Equity: Shareholders expect a rate of
return from the equity which
proportionate with the risk. Increased debt results in incCrease in the financial risk
1s

the equity holders. faced by

Consequently,
their desired rate of return
may increase which
increases cost of equity. Therefore a
company cannot use debt beyond a point.
9. Floatation Costs: Public issue of shares and
debentures requires considerable
expenditure. Getting a loan from a financial institution may not cost so much. These
considerations may also affect the choice between debt and and hence the equity capital
structure.

10. Risk Consideration: Use of debt increases the financial risk of a business. Apart from
the financial risk, every business has some operating risk (or business risk). The total risk
depends upon both the business risk and the financial risk. If a fim's business risk is
lower, its capacity to use debt is higher and vice-versa.

11. Flexibility: If a firm uses its debt potential to the full, it loses flexibility to issue further
debt. To maintain flexibility, it must maintain some borrowing power to take care of

unforeseen circumstances.
are bullish (i.e., more demand for
12. Stock Market Conditions: If the stock markets
However, during a bearish phase, a company,
shares), Use of equity is often preferred.
more difficult and
it can opt for debt.
may find raising of equity capital
investment in long-term projects or fixed assets. E.g.,
Ixed Capital: Fixed capital refers to modernisation etc.,
of land, building machinery etc.), expansion,
aCquisition (i.e., purchase funds and are not reversible without
to fixed capital involve huge capital
sions relating
incurring heavy losses.
93
For Private Circulation Only
 Chapter 9-Financial Manager
ST.CLARET
PRE UNIVERSITY COLLEGE

The management of fixed c a n i t .

mportance of management
of Fired Capital: pital or
.

reasons:
Investment is important for the following
on the long-term growth. The f .
iLong-term growth: Thesc
decisions have bearing
future. These will
funds
Invested in long-term assets are likely yield returns in the
to affect the
future prospccis of the business.

involved: These decisions

result in a substantial DOr:
iiLarge amount of funds n of
capital funds being blocked in long-lerm projects. Theretore, these investmente .
are
planned after a detailed analysis.
ii Risk involved: Fixed capital involves investment of huge amounts. It affects the ret
returns
of the fim as a whole in the long-term.
iv Irreversible decisions: Thesc decisio taken, are not reversible without
once
hea y losses. incurring
Abandoning a project after heavy investment results in waste of funds
herctore. these decisions should be taken only after a careful evaluation.
Factors affecting
requirement of fixed capital
1. Nature of Business:
Manufacturing concerns require huge investment in fixed assets &
thus huge fixed capital is
required
for them but trading concerns need less fixed capital.
2. Scale of
Operations: An organization operating on large scale requires more
capital
compared to an organization operating on small scale.
as fixed
3. Choice of Technique: An
organization using capital intensive techniques requires more
investment in plant & machinery as
compared to an organization using labour intensive
techniques.
4.
Technology upgradation: Organizations using assets which
require more fixed capital as compared to other become obsolete faster
5. Growth Prospects:
organizations.
order to expand
Companies having more growth plans require more fixed
production capacity more plant & capital. In
6. machinery are required.
Diversification: In case a company
goes for
diversification then it will require more fixed
capital to invest in fixed assets like
plant and machinery.
7.
Financing Alternatives: A developed financial
market
outright purchase. When an asset is may provide leasing facilities a
an alternative to

rentals and uses it. taken on lease, the firm pays

By doing so, it avoids iea
huge sums required to purchase it. Availapluy
of leasing
facilities, thus, may reduce the fixed
8. Level of requirements. capital
Collaboration: At times, certain other's
facilities. For
example, a bank may use business organisations sharc .intl
ntly
establish a particular another's ATM or some of the
facility. Such collaboration redhuces the level of
.
ved
fixed
assets. investmeu
Working Capital: Working Capital refers to of
an organization. Apart from the investment the capital
in fixed assetsrequired
every busi day working
for dayorgan
ivalents
anization
w needs
e theinvestm
to
capital required ro
to
p a t irom
invest in current
assets, which
ets every business organization
within a

period of one year. can be converted into cash or cash

equivalents

ca
 E

apter 9 -Financie
They provide liquidity to the business Management
Insufficient investment in
but
contribute less to
organisation to meet
current assets profit.
its may make it more
ence, a balance necds to payment
obligations. difficult for an
be
Camc part of current assets struck between liquidity and
is
usually financed throughprofitability.
liabilities. The rest 1s financed through short-term
Thius, NWC =CA -CL (i.c. Current long-term sources and is calledsources, i.c. current
Assets Current net working capital.
may be defined
as the excess of currcnt
assets over current Liabilities.) Thus, net working capital
Eactors affecting the working
liabilities.
capital requirements:
1, Nature of Business: A
trading organization needs lower amount of
compared to
manufacturing organization,
a
a
working capital as

processing work. as
trading organization undertakes no

2. Scale of Operations: An
organization operating on large scale will require more
inventory and thus, its working capital
organization.
requirement will be more as compared to small

3. Business Cycle: In the time of boom more production will be undertaken and so more
working capital will be required during that time as compared to
depression.
4. Seasonal Factors: During peak season, demand of a product will be high and thus high
working capital will be required as compared to lean season.
5. Credit Allowed: If liberal credit is allowed by a concern to its customers then it will
require more working capital but if goods are sold on cash basis then less working capital
is required.
6. Credit Availed: Just as a firm allows credit to its customers it also may get credit from its
suppliers. To the extent it avails the credit on purchases, the working capital requirement
is reduced.

7. Operating Efficiency: Firms manage their operations with varied degrees of efficiency.
firm managing its raw materials efficiently may be able to manage with a
For example, a

smaller balance. In such case working capital requirement is less.

raw materials and other required
materials are
8. Availability of Raw Material: If the
levels may sufficient. So less working
available freely and continuously, lower stock
between the placement of order and the actual receipt
capital requirement. If the time lag
shall be the amount of working
of the materials (also called lead time) is longer, larger
capital required.
is perceived to be higher, it will
Prospects: If the growth potential of a
concern
9. Growth
and
require larger amount of working capital so that it is able to meet higher production
sales target whenever required.
necessitate larger stocks or
10. Level of Competition: Higher level of competitiveness may
gOOds to meet urgent orders from customers. This increases the working cap1tal
Tinisncd
requirement. Competition may also force the firm to extend liberal creant.

For Private Circulation Only 95

 ST.CLARET Chapter 9 -Financial
PRE UNIVERSITY COLLEGBE
nagemen
EXERCISES

I Fill in the blanks:

I. decision relates to how the firm's funds are invested in
in
different assets.
2 Corus' a British Steel Co. was acquired by
3. The CEO of TATA Steel is
4. The cost
of issuing shares is COst
S. Financial decision that relates to
disposal of profits is
6. Capital Structure is the mix
between Equity and
7.
represer investment in current assets required
operations of the business. for day-to-day
8. The time lag between the
called as
placement of order and the actual
receipt of the
materials ic
9. The lender's risk is lower than
10. equity shareholder's risk. (True/False)
Financing decision is the decision about dividend
False). payment and retained earnings (True/
II
Multiple Choice Questions:
1.
Business finance is needed
to
(a) Establish a business
(c) Expand a business (b) Run a business
2. Wealth maximisation (d) All of the above
(a) market price depends on
per share.
(c) market price of (b) market price of finished
inventory (d) market price of fixed good.
3. The cheapest source of finance is assets
(a) Debenture
(c) Preference share b) Equity share
4. The
capital
(d) Retained earnings
decision of
acquiring a
(a) Financing decision new machine or opening a
new branch is an
(c) Investment decision (6) Working capital decision e.g., for
5. The (d) None of the above
decision of how much
(a) Financing decision to be raised from which
source is an
(c) Investment decision example ror
(6) Working capital decision
6. The
inability of a (d) None of the above
interest, is known asbusiness to meet its fixed financial
(a) Business risk obligations, like payment oof
(c) Long-term risk
(6) Financial risk
7.
Companies with (d) Market risk
a) to pay lower higher growth pattern are
hat dividendsdividends
()Tha likely
are not (b) to pay higher dividends
affected by grow
owth issues (d) none of the

Far Pcita Cirn

. Current assets are those asscts which get converted into cash
(a) within six months (b) within one year
I and 3 ycars
(c) betwcen (d) between 3 and 5 years
A fixed asset should be financed through
9.
term liability
(a) a long (6) a short term liability
(c) a mix of long and short term liabilities (d) None of the above
10. Other things remaining same, an increase in the tax rate on corporate profits will
(a) Make the debt relatively cheaper (b) Make the debt relatively dearer
(c) Has no impact on the cost of debt (d) We can't say

11, Financial leverage is called favourable if:

(a) ROI is lower than the cost of debt (b) ROI is higher than the cost of debt
(c) Debt is easily available (d) degree of existing leverage is low
debt equity ratio results in:
12. Higher
(a) lower
financial risk (b) higher degree of operating risk
(c) higher degree of financial risk (d) higher EPS

13. Higher working capital usually results in:

(a) Higher current ratio, higher risk and higher profits
b) Lower current ratio, higher risk and profits
(c) Higher equity, lower risk and lower profits
(d) Lower equity, lower risk and higher profits
14. Higher dividend per share is associated with:
and higher growth opportunities
(a) High earnings, high cash flows, unstable earnings
and high growth opportunities
(b) High earnings, high cash flows, stable earnings
(c) High earnings, high cash flows, stable earnings and lower growth opportunities
(d) High earnings, low cash flows, stable earnings and higher growth opportunities.

15. Current assets of a business should be financed through:

(a) current iability only b) long tem liability only
(d) short term loans only.
(c) both long and short term liabilities

Im One word / sentence answer type questions (1 mark)

1. What is Business Finance?
Ans: Money required for carrying out business activities is called business finance.

2. State the primary objective/aim of financial management.

Ans: The primary aim of financial management is to maximise shareholders' wealth.
3. What do you understand
by 'Capital Structure'?
Ans: apital structure refers to the mix between and borrowed funds i. e.,
owners equity
and debt.
4. The cost of debt is lower than the cost of
Ans: True
equity. True/kalse:
ST.CLARET PRE
UNIVERSITY COLIL E OE hapter 9-F'inancial anagement
5. Write the
meaning of Financial Risk'.
Ans: Financial risk refers to a
position when a
company 1s unable to
meet itits fixed
finaneial charges namely interest and repayment obligations.
. Give an
example for fixed asset.
Ans: Land and
building.
6. Give an
example for current asset.
Ans: Cash in hand,
cash at bank, debtors.
7. How do you
calculate Net Working Capital?
Ans: Net
working capital may bc defined the excess of
liabilities. It is
calculated
as
current assets
as under. NWC 0ver cir ent
Liabilitics.) =
CA CL (i.c.
-

Current Assets
Cur
Current
-

IV Short
answer
1. What
do you
questions (2marks)
understand by
Ans: It is
concemed with Financial Management?
ensuring availability of optimal procurement as well as
2. enough funds whenever usage of finance.
Financial required as well It aims
Ans: management is based on three as
avoiding idle finance.at
a.
Investment
decision broad financial
b. Financing decision decisions. What are
c. Dividend decision these?
3. Give the
meaning Investment
Ans: It means
how the fim's Decision with an
possible return. For
branch, etc.
funds are
investedexample.
example, making investment different assets to
in
in new earn the
3. What is machine,
a
highest
Ans: ThisFinancing Decision?
or
opening new a
decision is about the Give an example.
sources. E.g,
decision of quantum of
4. Give the raising finance finance to be raised from various
Ans: The meaning of Dividend
through issue of shares or long-term
decision involved Decision. debentures.
paying tax) is to be
here is how
5. State the twin distributed to the much of the profit earned by a
Ans: (a) To objectives of shareholders and how much ofof itit company (after
ensure Financial should be
De
retained.
retaine
(b) Not to raiseavailability of funds Planning.
6. What is resources whenever required
Ans: The Financial
Leverage? unnecessarily.
proportion of debt
leverage is computedor Write the mula to
in the overall formula to
calculate Financial
D as: capital calcula Leverage.
is called financial
financial
leverage.
*

E or D leverage. Financial
D+E
For Private Circulation Only
7. Give he meaning of 'rading on
: Equity'.
Trading on Equity rciers to the
the presence of fixed increase in
due to
financial charges likeprofit earned by the equity sharenoid
write the formula to
interest.
calculate Debt
Profit Service Coverage Ratio.
after tax +
psCR Depreciation +
Interest +
Non -

Cash expens
Preference Dividend +
Interest +Repayment
Answer Questions obligation
Iy Long
What is financial
1.
management? Explain its
importance.
2. What is Capital Budgeting decision?
Explain briefly the factors affecting capita
budgeting decisions.
3. Explain the factors affecting financing decisions.
4. Explain the factors affecting dividend decisions.
5. Explain the importance of financial planning.
6. State the factors which determine the choice of capital structure.
7. Explain the factors affecting the fixed capital requirement of an organisation.
8. Explain the factors affecting the working capital requirement of an organisation.

V Practical oriented question (5 marks)

choice of
1. As a Financial Consultant, give the list of any ten factors which affect the
Capital Structure.
 Chapter 09
FINANCIAL MANAGEMENT

aims at (b) Keeping the risk under control

1. Financial Management
of funds procured above
(a) Reducing the
cost
of such funds
(d) All of the
effective deploy1ment
(c) Achieving are all affected by
profitability and competitiveness
The size of assets, the decision
2.
decision
(b) Capital budgeting
(a) Working capital (d) Dividend decision
(c) Financing decision
as well as profitability of a business.
3. These decisions affect the liquidity (b) Financing decision
decision
(a) Capital budgcting (d) Dividend decision
(c) Working capital decision
amount of risk is involved in both
B in hand. The same the
4. Dev has two projects A and
of project A and B is 20% and 15% respectively, then unde
projects. 1f the rate of return projects is likely to be selected?
of the two
normal circumstance, which
None of the above
Both project A and project B (d)
(c)
(a) ProjectA (b) Project B
cost of capital and the financial risk of the
5. This decision determines the overall
enterprise,
(a) Dividend decision (b) Capital budgeting decision
(d) Financing decision
(c) Investment decision
6. Which of the following sources of capital should not be selected by a business if its fixed

cost is high?
(a) Equity shares (b) Preference shares (c) Debentures (d) All of the above
When the stock market index is rising, a company may issue in order to meet its

financial requirements.
(a) Debentures (b) Bonds (c) Equity shares (d) None of the above
8. Name the process that enables the management to foresee the fund requirements, both
the quantum as well as the timing.
(a) Financial management b) Capital budgeting decisions
(c) Dividend decision (d) Financial planning
the years, the
9. Kapil Limited is a company dealing in ready-to-eat food products. Over
The
earning potential of the company has gone up and it enjoys a good reputation.
Financial Manager is confident of the fact that not just the earnings of the current year,

but of our future years are likely to be high. Identify the related factor of dividend decision
being described in the given lines.
(a) Earnings (b) Stability of earnings (c) Stability of dividend (d) Growth prospects
will be
10. If dividend portion of total earnings is high, portion of retained earnings
(a) high b) low (c) moderate (d) equal
11. Gamble Limited is a company dealing in healthcare products. The company 1s e a 5

current
less dividends in the
high profits but is short on cash, so it has decided to declare in the aDove described
financial year. Identify the factor related to dividend decision being
lines. aints
Contractual consua
(a) Preference of shareholders(b) Earning (c) Cash flow position (d)

184

For Private Circulation Only

 Test Your Understunding
nany must adhere to the
provisions of the Compani.
ies Act
cision. Identify the related factor of dividend decision while takin
line. ioned dividend
in the above
(a) Contractual constraints
(b) Legal constraints
capital market
(c)
Access to (d) Preferences of
Which of the following is not an objective of financial planning?
sharcholders
13.
(a) Ensuring cnough funds are available at the right timec
smooth business operations
(b) Ensuring
excess availabilit of funds at the right time
(c) Ensuring
the above
(d) All of
is not a part of owners' funds?
14, Which of the following
(a) Fauity shares (b) Rescrves and surplus (c) Debentures (d) Preference shares

not a sourcc of borrowed funds?

of the following is
15, Which
financial institutions (b) Debentures
Loan from
(a) (d) Public depo s
(c)Retaincdcarnings
an additional capital of ?50 lacs, Yudhister Limited has used deht
t6. In order to raise
because
of capital
use of debt lowers the overall cost
(a) Increased of capital
of debt lowers overall
cost
in use
(b) Decrease increases the overall cost of capital
use of debt
(c) Increase in
the above
(d) None of
affects both the profitability
and the financial risk.
decision which
17. Name the Capital budgeting decision
decision (b)
(a) Financial planningdecision (d) All of the above
structure
(c) Capital
it leads to
financial leverage
of a company increases,
18. As the an increase in
the financial risk
decline in the cost of funds but
(a) A decline in the financial risk
increase in the cost
of funds but a
(b) An
and financial risk
an increase
in the cost of funds
(c) Both financial risk
decline in the cost of funds and
(d) Both a
with higher debt?
share (EPS) rise
the earnings per
19. When does investment is higher
than the rate of interest.
of return on
the rate
than the rate of
interest.
(a) When inve[tment is lower
of return on
(b) When the rate more than the
rate of return.
When the rate of interest is
(c)
(d) None of the above. The amount of debt is Rs.20
Limited is Rs.50 lacs.
Uranium Private current financial year. Its
20. The total capital of
of Rs.10 lacs during the
lacs. The company has earned a profit
is
return on investment (ROI) for the present year (d) 80%
(c) 10%
(a) 20% (b) 40%
increased use o
with the
share (EPS) falls
. l1 n a particular situation, the earnings per
debt, it indicates that
cost of debt.
less than the
a) The rate of return on investment (Rol) is debt.
D) Ihe rate of return on investment is more
than the cost of
C)The cost of debt is less than the rate of return on investment.
(d) None of the above
185

vate Circulation Only

 not likely to be low when
ne
working capital requirement of a business is
(a) The scale of the business operation is small
(6) When the growth prospects of the business are high
() When the raw material is casily available
(d) When the rate of inflation is low

Case Problem
S Limited is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its
products as economic growth is about 7%-8% and the demand for steel is grOWing. It is planning
to set up a new steel
plant to cash on the increased demand. It is estimated that it will require
about Rs. 5000 crores to set
up and about Rs 500 crores of working capital to start the new
plant.
Questions
1. Describe the role and
objectives of financial management for this company.
2. Explain the importance of having a financial plan for this company. Give an imaginary plan
to support your answer.
3. What the factors which will affect the capital structure of this company?
are
4. in mind that it is a highly
Keeping
and working capital. Give reasons in
capital-intensive sector, what factors will affect the fixed
support of your answer.