Distinguish between the following.

Question 1.
Fixed Capital and Working Capital
Answer:

Points Fixed Capital Working Capital

Fixed capital refers to any kind of
Working capital refers to the sum of
1. Meaning physical asset, a portion of total capital
current assets or gross working capital.
that is invested in fixed assets.
It stays in the business almost Working capital is circulatory capital. It
2. Nature
permanently. keeps changing.
Working capital is invested in short-
It is invested in fixed assets such as land,
3. Purpose term assets such as cash, account
building, equipment, etc.
receivable, inventory, etc.
Fixed capital funding can come from Working capital can be funded with
4. Sources selling shares, debentures, bonds, long- short-term loans, deposits, trade
term loans, etc. credit, etc.
5. Objectives of Investors invest money in fixed capital Investors invest money in working
investors hoping to make a future profit. capital for getting immediate returns.
Investment in working capital is less
Investment in fixed capital implies more
6. Risk risky. Eg. Land, building, plant and
risk.
machinery
Decisions relating to fixed capital
Decisions relating to working capital
investment are generally made by top-
7. Decisions needs are generally made by middle-
level management. Eg. Cash, bills
level or lower-level management.
receivable, inventories, cash at the bank
5. Answer in brief:

Question 1.
Define capital structure and state its components.
Answer:
Definition: R.H. Wessel “The long term sources of funds employed in a
business enterprise.”
John H. Hampton “A firm’s capital structure is the relation between the debt
and equity securities that make up the firm’s financing of its assets.” Thus,
the term capital structure means security mix. It refers to the proportion of
different securities raised by a firm for long-term finance.

Components/Parts of Capital Structure:

There are four basic components of capital structure. They are as follows:
(i) Equity Share Capital:

 It is the basic source of financing activities of the business. Equity

share capital is provided by equity shareholders.
 They buy equity shares and help a business firm to raise necessary
funds. They bear the ultimate risk associated with ownership.
 Equity shares carry dividends at a fluctuating rate depending upon
profit.

ii) Preference Share Capital:

 Preference shares carry preferential rights as to payment of dividends

and have priority over equity shares for return of capital when the
company is liquidated.
 These shares carry dividends at a fixed rate.
 They enjoy limited voting rights.

(iii) Retained earnings:

 It is an internal source of financing.

 It is nothing but ploughing back of profit.

(iv) Borrowed capital: It comprises of the following:

 Debentures: A debenture is an acknowledgment of a loan raised by

the company. The company has to pay interest at an agreed rate.
  Term Loan: Term loans are provided by the bank and other financial
institutions. They carry fixed rate of interest.

Question 2.

State any four factors affecting fixed capital requirements?

Answer:
(i) Nature of business:

 The nature of business certainly plays a role in determining fixed

capital requirements. They need to invest a huge amount of money in
fixed assets.
 e.g. Rail, road, and other public utility services have large fixed
investments.
 Their working capital requirements are nominal because they supply
services and not the product.
 They deal in cash sales only.

(ii) Size of business:

The size of a business also affects fixed capital needs. A general rule applies
that the bigger the business, the higher the need for fixed capital. The size
of the firm, either in terms of its assets or sales, affects the need for fixed
capital.

(iii) Scope of business:

Some business firms that manufacture the entire range of their production
would require a huge investment in fixed capital. However, those
companies that are labour intensive and who do not use the latest
technology may require less fixed capital and vice versa.

(iv) Extent of lease or rent:

Companies who take their assets on a lease basis or on a rental basis will
require less amount of funds for fixed assets. On the other side, firms that
purchase assets will naturally require more fixed capital in the initial stages.
Question 3.
What are Corporate Finance and State’s two decisions which are basic of
corporate finance?
OR
Write short note on Corporate Finance
Answer:
Corporate finance deals with the raising and using of finance by a
corporation. It includes various financial activities like capital structuring
and making investment decisions, financial planning, capital formation, and
foreign capital, etc. Even financial organisations and banks play a vital role
in corporate financing.

Henry Hoagland expresses, “Corporate Finance deals primarily with the

acquisition and use of capital by the business corporation”.

Following two decisions are the basis of corporate finances:

(i) Financing decision:
Every business firm must carefully estimate its capital needs i.e. working
capital and fixed capital. The firm needs to mobilize funds from the right
sources also maintaining the right combination of debt capital and equity
capital. For this balance, a company may go for or raise equity capital or
even opt for borrowed funds by way of debentures, public deposits term
loans, etc. to raise funds.

(ii) Investment decision:

Once the capital needs are accessed, the finance manager needs to take
correct decisions regarding the use of the funds in a systematic manner,
productively, using effective cost control measures to generate high profits.
Finding investments through proper decisions and using them successfully
in business is called ‘capital budgeting

6. Justify the following statements.

Question 1.
The firm has multiple choices of sources of financing.
Answer:

 Business firms require finance in terms of working capital and fixed

capital.
  Funds are required at different stages of business.
 The company can raise funds from various sources i.e. from internal
and external sources.
 Internal sources could be cash inflows on sales turnover, income from
investments, and retained earnings.
 External sources can be obtained for short-term requirements
through cash credit, overdraft trade credit, discounting bills of
Exchange issues of commercial paper, etc.
 For long-term needs, a firm can meet its financing needs through the
issue of shares, debentures, bonds, public deposits, etc. Thus, it is
rightly said that the firm has multiple choices of sources of financing.

Question 2.
There are various factors affecting the requirements of fixed capital.
Answer:

 Fixed capital being long-term capital is required for the development

and expansion of the company.
 The nature and size of a business have a great impact on fixed
capital. Manufacturing businesses require huge fixed capital whereas
trading organizations like retailers require less fixed capital.
 Methods of acquiring assets on rentals or on a lease/installment basis
will require less amount of fixed assets.
 If fixed assets are available at low prices and concessional rates then
it would reduce the need for investment in fixed assets.
 International conditions and economic trends like a boom period will
require high investment in fixed assets and a recession will lead to
less requirement.
 Similarly, consumer preferences, competition, and highly demanded
goods and services will require a large amount of fixed capital. E.g.
Mobile phones. Thus, it is rightly said that there are various factors
affecting the requirements of fixed capital.

Question 3.
Fixed capital stays in the business almost permanently.
Answer:
Factors determining fixed capital requirements are:

 Fixed capital refers to capital invested for acquiring fixed assets.

  These assets are not meant for resale.
 Fixed capital is capital used for purchasing land and building,
furniture, plant, and machinery, etc.
 Such cap al is usually required at the time of the establishment of a
new company.
 Existing companies may also need such capital for their expansion
and development, replacement of equipment, etc.
 Modern industrial processes require the increased use of heavy
automated machinery. Thus, it is rightly said that fixed capital stays in
the business almost permanently.

Question 4.
Capital structure is composed of owned funds and borrowed funds.
Answer:

 Capital structure means to mix up of various sources of funds in

desired proportions.
 To decide capital structures means to decide upon the ratio of
different types of capital.
 A firm’s capital structure is the relation between the debt and equity
securities that make up the firm’s financing of its assets.
 The capital structure is composed of own funds which include share
capital, free serves, and surplus, and borrowed funds which represent
debentures, bank loans, and long-term loans provided by financial
institutions.
 Thus capital structure = Equity share capital + preference share
capital + reserves + debentures.
 Thus, it is rightly said that capital structure is composed of owned
funds and borrowed funds.

Question 5.
There are various factors affecting the requirement of working capital.
Answer:

 The nature and size of a business affect the requirement of working

capital. Trading or merchandising firms and big retail enterprises
need a large amount of capital compared to small firms which need a
small amount of working capital.
 If the period of the production cycle is longer then the firm needs
more amount of working capital. If the manufacturing cycle is short, it
requires less working capital.
 During the boom period sales will increase leading to increased
investment in stocks, thus requiring additional working capital and
during the recession, it is vice versa.
 Along with the expansion and growth of the firm or company in
terms of sales and fixed assets, the requirement of working capital
increases.
 If there is proper coordination, communication, and co-operation
between production and sales departments then the requirement of
working capital is less.
 A liberal credit policy increases the possibility of bad debts and in
such cases, the requirement of working capital is high, whereas a firm
making cash sales requires less working capital.