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CBSE Class 12 Business Studies Case Studies – Financial Management

CBSE Class 12 Business Studies Case Studies – Financial Management

ESSENTIAL POINTS TO SOLVE CASE STUDIES
Financial Management
Financial Management is the process of acquiring funds optimally (at minimum cost possible keeping the risk factor also low) and utilising them in the best possible manner to maximise shareholders’ wealth.

Objectives of Financial Management
The objective of financial management is maximisation of shareholders’ wealth.
Shareholder’s wealth = No. of shares possessed by a shareholder x Market price of a share.
If there is proper financial management the shareholders’ wealth will maximise.

Role of Financial Management
The role of financial management is very important as the following activities are influenced by financial management:

  1. Size and composition of Fixed Assets (Fixed Capital decisions)
  2. Size and composition of Current Assets (Working Capital Management decisions)
  3. Financing decisions (Amount of Debt or Equity to be used)
  4. Financing decisions (Amount of Long-term funds or Short-term funds to be used for financing)
  5. All items in the Profit & Loss Account (sales expenses, distribution expenses, depreciation of the assets, etc.)

Financial Decisions
Financial decisions are taken under financial management, and directly deal with raising and investing of funds (investment decisions), and distribution of profit earned among the stakeholders (dividend decisions).
Financial decisions are of three types –
I. Investment decisions
II. Financing decisions
III. Dividend decisions

I. INVESTMENT DECISIONS
The decisions which involve the choice how the raised funds will be invested into short-term or long-term assets.
Investment decision are of two types:

  • Long-term investment decisions (also know as Fixed assets decisions or Capital budgeting decisions)
  • Short term investment decisions (also known as Working Capital management decisions)

Factors affecting long-term investment decisions
The Investment criteria involves:

  1. Cash flows of the project. The cash flows which a company expects from an investment decision should be carefully analysed before taking a Capital budgeting decision.
    The Rate of return. The expected rate of return of the project should be taken into consideration before taking Capital budgeting decision.
  2. The investment criteria involved. Financial managers have to carry out a number of calculations regarding cash flows, interest rates, rate of return etc. before taking the Investment decision. Various Capital budgeting techniques are used for the purpose of evaluating investment proposals.

II. FINANCING DECISION
The decisions which involve the choice how the funds will be raised from various sources and simultaneous cost analysis of these sources of funds.
The sources of finance are:

  • Shareholders’ or Owners’ funds:
    Equity Capital and Retained earnings
  • Borrowed funds:
    Debentures, Loans and other forms of Debts.

Factors affecting financing decisions:

  1. Cost. Cheapest source of finance should be preferred. (Debt is generally cheaper than Equity)
  2. Risk. Source involving less risk should be preferred. (Equity is less risky than Debt)
  3. Floatation cost. If a source has high floatation cost it should be avoided (Equity has high floatation costs associated with it).
  4. Cash flow position. The source of funds should also depend on the Cash flow position of
    the firm. A company with healthy Cash flow can go for Debt as it can bear the fixed financial cost of interest on Debt.
  5. Fixed operating cost. A company which has high fixed operating costs (like rent, salary, etc.) already runs high business risk. If such firm goes for Debt as source, it will add on financial risk (as Debt is risky).
  6. Control considerations. A company having control considerations should go for Debt as a source of finance.
  7. State of Capital market. When the Capital market is bullish or active (investors believe that the stock prices will increase), it is a good time for issuing Equity in order to have a good response from the investors. On the other hand, if the Capital market is bearish or sluggish (investors believe that stock prices will decrease) it is better not to issue Equity.
    The company can opt for Debt as a source of funds.

III. DIVIDEND DECISION
The part of profit which is distributed by the company to its shareholders is known as dividend.
For a proper understanding:
Profit before Interest and Tax —> PBIT …[Interest which is to be paid on borrowed money
PBIT – Interest = PBT (Profit before tax)
PBT – Tax = PAT (Profit after tax)
\(\frac{PAT}{No.of\quad Shares}\) = EPS (Earning Per share)
EPS has two parts:
cbse-class-12-business-studies-case-studies-financial-management-1
The decision of how much should be the dividend and how much should be retained is known as Dividend decision.

Factors affecting Dividend decision:

  1. Amount of Earnings. Dividends paid by a company are dependent on the amount of earnings.
  2. Stability of earnings. Apart from amount of earnings, stability of the earnings is as much important for paying good dividends.
  3. Stability of dividend. A stable trend in payment of dividend boosts the confidence of investors and has a good impact on share prices.
  4. Growth opportunities. Generally, companies having high growth opportunities tend to avoid paying high dividends, so that they can invest their retained earnings.
  5. Cashflow position. In order to declare dividends a company should have decent amount of cash. So, a company with good Cash flow position can declare good dividend.
  6. Shareholders’ preference. There are two types of shareholders. One, who want a fixed dividend (Preference dividend) and the others, who are ready to bear risk and want to have high returns (Equity dividend).
  7. Taxation Policy. If tax on dividend is high, companies tend to pay lower dividend and vice-versa.
  8. Stock market reaction. Increased dividends draw positive reaction from the stock market. However, if the dividends are lowered by a company it tends to have a bad impact on the share prices as their demand goes down.
  9. Access to Capital market. Large credit-worthy companies have easy access to the capital market in terms of raising funds. These companies can keep less retained earnings and pay a higher dividend to strengthen the market price of their shares.
  10. Legal constraints. Since the payment of dividend is connected with a large number of shareholders, it should be done within the legal framework and transparency.
  11. Contractual constraints. Generally loan providing bodies ensure through contractual agreements that the borrowing company will be restricted in payment of dividends. This is done to provide financial protection to the lenders who may get in trouble in situation of bankruptcy of the borrower.

Financial Planning
Financial planning is the process of estimating the requirement of funds by an organisation for its various needs and figuring out the sources of these funds.

Objectives of Financial Planning

  • The first objective is to ensure availability of funds, as and when required.
  • The second objective is to confirm that the funds raised are not in excess.

Importance of Financial Planning

  1. It helps in forecasting. It helps in making correct assessment of future financial situations through proper forecasting.
  2. It helps in preparing for business shocks. The future uncertainties of business can ruin the prospects of a business. Financial planning keeps the firm well prepared to face any business shocks.
  3. It helps in coordination of various business functions. All the other business functions like marketing, purchase, production, etc. can be properly coordinated as a result of of proper financial planning.
  4. It helps in optimum utilization of resources. Optimum utilisation of resources and efforts becomes possible through proper financial planning as the wastages and duplication of efforts are reduced.
  5. It acts as a link between present and future. Financial planning is like a bridge between today and tomorrow, present and future. The financial requirement of present investment decision is fulfilled by future financing decisions.
  6. It helps in evaluation of actual performance. The objectives of all the business units are clearly set through financial planning. That is why it is easy to do proper evaluation of actual performance by these units through financial planning.

Capital Structure
It is the proportion of Debt and Equity in raising funds for doing business. In other words, it is the mixture of Owners’ funds and Borrowed funds.

Factors affecting Capital Structure

  1. Debt service coverage ratio: (DSCR)
    DCSR = \(\frac{Profit\quad after\quad tax+Depreciation+Interest+Non-cash\quad Expences}{Preference\quad Dividend+Interest+Repayment\quad Obligation}\)
    DSCR indicates ability of a firm to service its Debt. It is a better indicator than ICR.
  2. Interest coverage ratio (ICR)
    It is the number of times Earning Before Interest and Tax can cover the Interest on Debt taken by a firm.
    It indicates the firm’s ability to serve the interest on Debt taken.
    ICR = \(\frac{Earning\quad before\quad Intererst\quad and\quad Tax}{Interest}\)
  3. Cash flow position. Debt should be taken only if Cash flow position of a company is good.
  4. Cost of Debt. Debt can be taken if it is available at a lower interest rate.
  5. Cost of Equity. Cost of Equity becomes high in case Debt is taken beyond a level. This happens due to the increased burden of Debt on equity shareholders who expect higher dividend.
  6. Capital structure of other companies. A business firm may observe the capital structure (D/E ratio) of other companies in the same industry but should not blindly follow them. Deciding the capital structure of a company should be based upon its own strengths and weaknesses.
  7. Return on Investment. When the return on investment is greater than the rate of interest, a company can increase its Debt to increase its earning per share (EPS).
  8. Tax rate. With the increase in tax rate Debt becomes cheaper.
  9. Stock market conditions. When market is bullish Equity is preferable, but when market is bearish Debt is a better choice.
  10. Floatation costs. The costs of raising Debt and Equity are different. The high floatation costs of Equity in comparison to Debt make it a costlier source.
  11. Control considerations. Too much of issuing of Equity may result in loss of control of management over the company.
  12. Regulatory framework. In order to raise funds, the company should stay within the legal framework set by bodies like SEBI and RBI.
  13. Flexibility. A company has only limited sources form where it can obtain Debt. In case it exhausts all the possible sources it will lose the flexibility to arrange further Debt.
  14. Risk consideration. Debt is riskier though it is cheaper. A firm has to repay the principal amount as well as regular interest on it. It is bound to do so.

Fixed Capital
Those assets which remain in business for more than a year constitute the Fixed capital of a business firm. The sources which finance Fixed capital are known as Long-term sources of funds. The decisions related to Fixed capital are also known as Fixed capital decisions or Capital budgeting decision.

Importance of Fixed Capital Decisions

  1. Long term growth. They affect the long term growth of business as return on investment comes after a long time in future.
  2. Large amounts of funds involved. The nature of Fixed capital decision is such (like investment in plant and machinery, etc.) that large amounts of funds need to be invested.
  3. Risk involved. Since Fixed capital involves huge amounts of investments with no assured quick returns, it tends to become risky.
  4. Irreversible decision. A company may have to incur heavy losses as reversing such decisions may lead to cancellation of the entire project.

Factors affecting requirement of Fixed Capital

  1. Nature of business. Manufacturing requires more Fixed capital than trading business.
  2. Scale of operations. A firm involving large scale business requires more Fixed capital.
  3. Choice of Technique. Capital intensive business requires more Fixed capital than a labour intensive business.
  4. Upgradation of technology. Business requiring frequent upgradations of technology requires more Fixed capital.
  5. Growth prospects. Companies having higher growth prospects require more investment in Fixed capital.
  6. Diversification. When a firm diversifies into new areas, its requirement of Fixed capital increases.
  7. Financing alternatives. When business firms have an alternative of taking fixed assets on lease, they do not have to purchase fixed assets.
  8. Level of collaboration. Fixed capital requirement of a firm becomes less if it gets into collaboration with another firm, as both the firms can share resources of each other.

Working Capital
The capital needed by a business firm to meet its day to day operations is known as Working capital.
Examples: Cash-in-hand, Raw materials, Prepaid expenses, Work-in-progress, Bills receivable etc.
Such assets are also known as short term assets and they can be easily converted into cash within a period of one year.

Factors affecting working capital requirements

  1. Nature of business. Manufacturing firms have more Working capital requirements than trading firms.
  2. Scale of operations. Higher the scale of operations, more is the Working capital requirement.
  3. Business cycle. More during recovery and boom, less during recession and depression.
  4. Seasonal factors. Businesses that are seasonal in nature need more amount of working capital during the peak season.
  5. Production cycle. Products having longer production cycle need more Working capital.
  6. Credit allowed. More Working capital is required when credit is allowed by the business firm.
  7. Credit availed. Less Working capital is required when credit is availed by the business firm.
  8. Availability of raw material. If raw material is easily available, requirement is less, otherwise more.
  9. Growth prospects. Higher the chances of growth, more will be the requirement.
  10. Level of competition. Higher the level of competition among firms more will be their Working capital requirements.
  11. Inflation. When prices rise (inflation), Working capital requirement also increases.

CASE STUDIES

Question 1.
Ramit is using ICR (Interest Coverage Ratio) as the indicator of the interest paying capacity of his company. However one of his old school days’ friends Shobhit tells him to use DSCR (Debt Service Coverage Ratio) as the indicator to judge it.
Do you agree with his friend?
Give reason for your answer.
Answer:
Yes, I agree with him.
As it is a better indicator of company’s ability to pay fixed financial charges like interest because it completes the shortcoming in ICR. ICR is unable to show the situation of cash balance whereas in DSCR cash profits generated by the operations are compared with the total cash required for the service of the debt.
ICR is the simple ratio of EBIT/Interest.

Question 2.
Identify in the following cases factor affecting the choice of capital:

  1. Raj an has an option of taking loan from his relatives. These people have assured him to give loan at a low interest rate. So he decides to use debt as a source of financing his project. Now he goes to different relatives and friends to see if he can get a cheaper source of debt with even lower rate of interest.
  2. Prerak Iron Ltd. is thinking of raising finance to further its projects overseas. For this the company is observing the other companies’ raising of finance. Their deb^equity ratios are being thoroughly studied by the financial experts of the company.
  3. A company is trying to raise funds after consulting the experts. The owner of the company has decided to find out the banks which can grant loan under norms. He will assure that all norms are followed by the company. He has also decided to gain knowledge about the SEBI guidelines related to public issues of shares and debentures.
  4. The management of a company is very much concerned about the latest happenings in the stock market. They always w’ant to know whether the conditions in the stock market are bullish or bearish so that they may know the feasible time to grow money by issue of shares.
  5. A firm has decided not to issue equity this year. The reason they have given is the involvement of costs like printing charges, brokerage, advertising costs and underwriter’s commission. The company says all these costs will add on to become substantial.
  6. A company already has high fixed operation costs. If it takes loan its fixed financial costs will increase leading to an overall increase in payments. Had the situation been opposite it would have considered taking loan but now the only option is to go for equity.
  7. A company is thinking of taking debt to meet its finance requirements. It is thinking so because interest is a tax deductible expense. Due to the new budget by the government raising debt has become comparatively cheaper and equity is losing its attractiveness.
  8. Mr. Madan Sharma has a company having 10 branches throughout the country. He is thinking of opening a new branch. For this he requires a good amount of investment. He talks to his friends, banks and other sources to raise debt as a source of finance. However he prevents himself from using all possible sources of finance so that he can maintain his borrowing power.
  9. A leading company decides to raise fund. It decides to go for debt as the source of finance. The reason behind this choice is the possibility of losing management’s holding in the company if equity is issued. The company already has been using equity as a source of finance during last couple of years.
  10. A company is no more interested in raising funds in the form of debt. The amount of EBIT that the company has is decreasing in relation to the amount of interest it has to pay on the debt it has borrowed. If it borrows more of debt than this ratio EBIT/ Interest will further go down.
  11. Neelam has decided to consider debt as the source of raising finance. Her decision has come after considering the strong buffer of funds she already has. She has enough amount of funds to cover fixed cash payments. Her business unit has no problem in running normal business operation and it has low business risk. Further the financial risk is also low.
  12. A company has decided to go for trading on equity as an option. This is being done to increase the Earning per Share (EPS). Definitely the ability of the company to use debt is greater.

Answer:

  1. Cost of debt
  2. Capital structure of other companies
  3. Regulatory framework
  4. Stock market conditions
  5. Floatation costs
  6. Risk consideration
  7. Tax rate (As with the new budget the tax rate has increased)
  8. Flexibility
  9. Control
  10. Interest Coverage Ratio (ICR)
  11. Cash flow position
  12. Return on Investment (RoI)

Question 3.
In the previous question case study (b) of Prerak Iron Ltd. what caution do you think that the company should take?
Answer:
The company should not follow the capital structure of other companies in the industry in a blind manner.

Question 4.
In Question No. 2 in case study (l) How Return on Investment would matter?
Answer:
If the Return on Investment (Rol) is lower than Cost of Debt then the company should go for Equity as the option. On the other hand if Return on Investment (Rol) is more than Cost of Debt then the company can rely more on debt. If it will increase more debt in its capital structure then the EPS in this case will increase. However in the earlier case where Rol is less than Cost of Debt the EPS will decrease with increase in the debt component in the capital structure.

Question 5.
Future Business’ is in whole sale business. The manager in charge is taking care of all the operations. The branch in Delhi is earning a lot of revenue these days. It requires fixed capital investment for which it has to borrow money.
What do you think is going to be the size of the investment required?
Answer:
The size of investment required will be low as the ‘Future Business’ is in trading business. The fixed capital requirement generally is low in trading business.

Question 6.
Atul is thinking of opening a scissors manufacturing plant. He requires capital investment. He discusses the project with his father. His father after listening to his project tries to find out the fixed capital requirement for his plant.
What do you think will be the fixed capital requirement for the scissors manufacturing plant of Atul?
Answer:
The fixed capital requirement for the plant of AtuI will be high as it is a manufacturing plant. For a manufacturing plant the fixed capital requirement is high since the purchase of plant and machinery, equipments, etc. is involved.

Question 7.
Vrinda is an MBA pass out from a very good MBA college. Her father has restaurant business. Their company has 15 restaurants in Europe. As soon as Vrinda joins the business she decides to take this number to 25 by opening 10 more restaurants in the major cities of Europe.
What do you think will be the fixed capital requirement here? Why?
Answer:
The fixed capital requirement would be high.
The reason behind the high requirement of fixed capital is ‘scale of operations’. The restaurant business run by them is already being operated at a large scale with 15 restaurants in operation.

Question 8.
Ravi has started a pizza base manufacturing business. The early morning schedule is very busy as the product is dispatched as soon as it is made to keep it fresh and is sent to the various pizza making restaurants or hotels. Daily fresh pizzadbase has to be delivered on the basis of estimated orders as there is no sure shot consumption pattern in the city.
What do you think is going to be the working capital requirement of this business? Why?
Answer:
The working capital requirement of this business will be low.
The reason for this low requirement is that the production cycle for Pizza base is short and as the production is made on estimated order no inventory is required which will further prevent inventory costs.

Question 9.
‘Hot Winters’ is a premium sweater making company. The sweaters are worn in many countries and they are of very high quality. For six months of the year the company is almost without work but the remaining six months it is busy in preparing almost 10 million sweaters for its customers in different parts of the world.
What do you think is going to be the working capital requirement of this company? Why?
Answer:
The working capital requirement of this company will be high.
Though the company is almost without work for six months yet for the remaining six months it produces almost 10 million sweaters thus require a huge working capital since the scale of operations is large.

Question 10.
Dheeraj has opened a company. He has come from Australia to set up a business of his father here in India. He decides to meet a person who owns huge chunks of property. He decides to take a piece of land for his company on lease from him. What do you think is going to be the fixed capital requirement of his company? Why?
Answer:
The fixed capital requirement of Dheeraj’s company will be less.
The reason for this less requirement will be a financial alternative in the form of lease that he has generated saving his funds which otherwise would have been used in purchasing the land.

Question 11.
An AC manufacturing company wants to open a plant in Delhi. The owner of the company called a meeting to find the experts to fix the plant’s requirements. The recruitment process of the potential employees who will be working in the plant will be started soon.
What do you think will be the working capital requirement of this company? Why?
Answer:
The working capital requirement of this company will be high.
The reason for the high requirement of working capital will be that in a manufacturing company the requirement is high. Further the company will have to bear inventory costs as for the ACs an inventory will have to be maintained.

Question 12.
There are two brothers: Shobhit and Mohit. Shobhit starts a tourist and travel agency. His idea is to take his business to great heights. Though he doesn’t have experience in this business yet he wants to give this business a try. He feels that if he gives the best quality services then his business will reach great heights.
Mohit starts a thermometer manufacturing business. He too like his brother wants to take his business towards great success. He is new to this business and is busy getting to know about the technical side of the business as much as possible. He wants to make the best quality thermometers which are ultrasensitive to temperature changes and can resist shocks.
Despite all these good ambitions in mind a sudden shock takes place for both the brothers. The economy shows sign of recession and within a few months is totally engulfed by it.
What will happen to the working capital requirement of the two businesses described in the above case?
Which of the two businesses do you think will see greater impact of this change?
Answer:
Shobhit is doing a trading business and Mohit a manufacturing business.
Whenever recession hits an economy both trading and manufacturing businesses see fall in working capital requirements.
However the manufacturing business is hit more severely by recession. It is hit early by recession and bears a greater impact so the working capital requirement of Mohit’s business will fall rapidly than that of Shobhit.

Question 13.
Bharat Express’ specialises in Courier Services. Its ‘wide range of express package and parcel service’ help business firms to make sure that the goods are made le to the customers at the right place and at the right time.
State with reason, whether the working capital requirements of ‘Bharat Express’ will be high or low.
Answer:
The working capital requirements of ‘Bharat express’ will be low as the firm operates in a service industry and need not invest in buying and maintaining inventory.

Question 14.
‘Indian Logistics’ has its own warehousing arrangements at key locations across the country. Its warehousing services help business firms to reduce their overheads, increase efficiency and cut down distribution time.
State with reason, whether the working capital requirements of ‘Indian Logistics’ will be high or low.
Answer:
The working capital requirement will be ‘low’ as the firm is involved in a service industry which does not have to buy and maintain inventory.

Question 15.
KJ Ltd. is manufacturing trucks at its manufacturing unit in Kolkata. The demand of its trucks is high as the economic growth is about 7% to 8%. The company has estimated a 20% increase in the demand of its trucks. It is planning to set up a new truck manufacturing unit. For this the company will require approximately ?2,000 crores as fixed capital and ?5G0 crores as working capital. The company has already arranged for its fixed capital. State any three factors that the finance manager of the company should keep in mind while arranging its working capital.
Answer:
Factors affecting the requirement of Working Capital:

  1. Nature of business. Nature of business is an important factor that influences the requirement of working capital.
    For example: Public utility services like transport concerns, electricity undertakings where much of the investment is in a fixed form, require less amount of working capital. On the other hand, trading or manufacturing concerns have to invest large amounts in raw materials, wages, etc., hence these require a large amount of working capital.
  2. Scale of operation. An organisation which operates on a higher scale, requires large amount of working capital as compared to the organisation which operates on a lower scale.
  3. Business cycle. Different phases of business cycle affect the requirement of working
    capital of a firm. During boom period, sales as well as production are likely to be higher, therefore more working capital is needed. During depression, sales and production are low, as a result the requirement of working capital would be lower.
  4. Seasonal factors. Industries, which produce and sell seasonal goods, require large working capital during off-season, as this is the period when production is carried on to prepare for the season when the products would be sold in comparison to industries with regular production and sales.
  5. Rapidity of turnover. Business units, which sell their products quickly, such as newspapers, retail shops, bakeries, etc., require a lesser amount of working capital.

Question 16.
Raghu has started a mobile manufacturing company. The company has decided to meet the competitor’s market hold by giving liberal credit terms to their customers. They have decided to check the creditworthiness of their customers before giving them this facility. They will provide this facility to customers having credit cards.

  1. Predict the fixed capital requirement of Raghu’s company.
  2. What do you think will be the working capital requirement of his company?

Answer:

  1. The fixed capital requirement of Raghu’s company will be high because it is a manufacturing company. Secondly a lot of technological upgradation is required for which Raghu will have to prepare for more investment in future.
  2. The working capital requirement of this company will be high because the labour charges will be high as it is a manufacturing business. Secondly the credit allowed by the company would increase its working capital requirement.

Question 17.
Atul Oil Explorers is a high turnover oil extracting company. It has made a lot successful explorations of oil in the past. But recently the company has not been doing so well in the business. The company is trying to diversify in the textile business. The newspapers are flooded with this news. People are also considering this as a smart move by the company.
What do you think will happen to the fixed capital requirement of the company because of this move? Give reason.
Answer:
The fixed capital requirement of the company will increase because of this decision. Diversification of operations by a company results in the increase of fixed capital requirement as more investment will be required in the fixed capital.

Question 18.
MM Ltd. is manufacturing small cars at its manufacturing unit in Pune. The demand of its cars is increasing at the rate of 20% annually. It is planning to set up a new car manufacturing unit at Indore. For this the company will require approximately ?1,500 crores as fixed capital and ?400 crores as working capital. The company has already arranged for its working capital. State any three factors that the finance manager should keep in mind while arranging its fixed capital.
Answer:
Factors affecting the requirements of fixed capital:

  1. Nature of business. A trading concern needs lower investment in fixed assets as 152 44 Business Studies—Case Studies Tapan Pathak
    compared to a manufacturing concern since it doesn’t require to purchase plant and machinery.
  2. Scale of operations. A larger organisation operating at a higher scale needs bigger plant and more space and hence higher investment in fixed assets.
  3. Choice of technique. A capital intensive organisation requires higher investment in plant and machinery and thus requires higher fixed capital than a labour intensive organisation.
  4. Technology upgradation. Industries where assets quickly become obsolete require higher fixed capital in order to replace such assets.

Question 19.
‘Hamara Bank’ has over 1.5 million satisfied customers. However, recently some of them started leaving the clientele of bank. The reason behind this was that the services of the bank were extremely good, people always complained about lack of ATM facility in the bank. To overcome this problem and stop the clients go away, the bank decided to go for collaboration with ‘Tumhara Bank’. ‘Tumhara Bank’ is a new bank and is no way near to the competency of Core services of ‘Hamara Bank’ but it has exceptional ATM facilities.
What do you think is going to be the impact of this collaboration on the fixed capital investment of ‘Hamara Bank’? Give reason.
Answer:
The result of this will lower the fixed capital requirement of ‘Hamara Bank’.
As both the banks will share each other’s facilities the requirement of the banks to invest in fixed capital will come down. Like here in this case ‘Hamara Bank’ will not have to spend on any fixed capital investment for its requirement of ATM facility which will be accomplished by collaboration with ‘Tumhara Bank’.

Question 20.
Radhika and Vani who are young fashion designers left their job with a famous fashion designer chain to set-up a company ‘Fashionate Pvt. Ltd.’ They decided to run a boutique during the day and coaching classes for entrance examination of National Institute of Fashion Designing in the evening. For the coaching centre they hired the first floor of a nearby building. Their major expense was money spent on photocopying of notes for their students. They thought of buying a photocopier knowing fully that their scale of operations was not sufficient to make full use of the photocopier.
In the basement of the building of ‘Fashionate Pvt. Ltd.’ Praveen and Ramesh were carrying on a printing and stationery business in the name of ‘Neo Prints Pvt. Ltd.’ Radhika approached Praveen with the proposal to buy a photocopier jointly which could be used by both of them without making separate investment, Praveen agreed to this.
Identify the factor affecting fixed capital requirements of ‘Fashionate Pvt. Ltd.’
Answer:
Level of Collaboration.

Question 21.
Rizul Bhattacharya after leaving his job wanted to start a Private Limited Company with his son. His son was keen that the company may start manufacturing of mobile-phones with some unique features. Rizul Bhattacharya felt that the mobile phones are prone to quick obsolescence and a heavy fixed capital investment would be required regularly in this business. Therefore he convinced his son to start a furniture business.
Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya to choose furniture business over mobile phones
Answer:
Technology Upgradation.

Question 22.
Ramesh is running a real estate construction company. He has to meet clients on a regular basis in order to make deals. For every decision he makes he has to be really cautious as he knows once he has made a decision he can’t go back which will mean abandoning of the project. So he evaluates every decision before he makes it. That is why he pays a lot of attention to what his clients are saying and figures out which portion of the deal is in his capacity and favour. Recently his company pumped an amount of Rs.50 crores in a project and he knows this project can affect the returns of the firms in the long run both positively as well as negatively. All this is a part of the business in which he has established himself. He knows that the funds invested are only likely to give returns in the future and impact the future prospects of his business. The chances of success in any business are more when one does a lot of research. He has to involve a considerable portion of his funds and block them in long term projects. A thorough research is required in order to grow funds at the lowest cost possible. He is a very stable minded entrepreneur.

  1. Which concept of management has been highlighted in the above case?
  2. Identify its types highlighted in the above case.

Answer:

  1. The concept of management highlighted in the above case is ‘Importance of fixed capital investment’.
  2. The reasons for the importance of fixed capital decisions highlighted in the above case are:
    • Irreversible decisions. For every decision he makes he has to be really cautious as he knows once he has made a decision he can’t go back which will mean abandoning of the project.
    • Risk involved. Recently his company pumped an amount of Rs.50 crores in a project and he knows this project can affect the returns of the firms in the long run both positively as well as negatively.
    • Long-term growth. He knows that the funds invested are only likely to give returns in the future and impact the future prospects of his business.
    • Large amount of funds involved. He has to involve a considerable portion of his funds and block them in long term projects.

Question 23.
Identify the type of decisions:

  1. Ravi wants to open a restaurant and is looking for a proper place to open it. He is also thinking of the amount of funds which will be required for some of the set ups like food making and storing machineries.
  2. Ravindra is running a toy manufacturing company. He thinks of expanding his business. He meets his uncle and asks him for a sum of Rs. 2 crores. His uncle asks for a high interest rate. He agrees to it and promises to pay the money back within 2 years.
  3. A leading marketing company has decided to raise money through the stock market. It issued IPO in the market last year. The company knows there are going to be sizeable floatation costs involved in it.
  4. A company which has 10 branches in the city has decided to open its 11th branch. The company has taken this branch on rent. In this way the company has saved money which it would otherwise have invested in purchasing it.
  5. A company has decided to plough back the money in the form of retained earnings. This decision will save the company at least ‘50 crores. These funds can be used for the long term growth of the business.
  6. ‘Rakesh Iron Works’ has been doing a great job in the area of manufacturing iron. Within two years the company has reached among the top 3 performers of the industry. The company has made a lot of profit and decided to distribute its profits to the shareholders who stood with it during the hard times.
  7. Raj an Powerlooms, a leading company in its industry has decided not to issue equity shares this year as they want to keep the management control in their own hands. The company’s management already has only 60% shares in the company. So it would avoid any further dilution of its stake in the company. Company would prefer taking loan.
  8. A company has decided to issue debentures as it knows that it will not lead to any additional costs. These debentures will be carrying a very low rate of return for the debenture holders but will be a surety for them to get their money back. Investors who want financial safety would like to go for this option as there will be an assured definite return. ,
  9. Shuddhi Steel Manufacturers has been a brand but due to some HR related issues it came into limelight for bad reasons. The issue was related with non-payment of salaries of the employees but now the company wants to sort this issue out. The company has decided to pay the salary of all the employees which were not paid their emoluments since last six months. The company has done so to avoid any image spoiling to take place.
  10. A soft drink company has decided to run an advertisement campaign. It will hire many famous Bollywood celebrities for this purpose. The advertisement campaign could involve more than ‘150 crores. Every major newspaper is mentioning about it.
  11. Tarachand and Sons has decided to open a new branch in the middle of the city in order to increase its business.

Answer:

  1. Investment decision
  2. Financing decision
  3. Financing decision
  4. Investment decision (short-term investment decision/working capital)
  5. Dividend decision (As out of the EPS one portion will be dividend and the other retained earnings. This is decided by dividend decision).
  6. Dividend decision
  7. Financing decision
  8. Financing decision
  9. Investment decision (Working capital or short term investment decision)
  10. Investment decision (Long-term investment decision. Remember running an ad campaign is not a short term investment decision which confuses the students. It is a long-term investment decision)
  11. Investment decision (Long-term investment decision)

Question 24.
Bharat Steel Ltd., an Indian company producing 50 million tonnes of steel annually and generating revenue of 38 billion US dollars has recently acquired the 5 second largest steel producing company, ‘German Steels.’ After this acquisition Bharat Steels Ltd. will become the World’s largest steel producer. For this acquisition Bharat Steels Ltd. had to arrange about 50,000 crores of rupees through debt and equity. State the function performed by the company for arranging the funds through debt and equity.
Answer:
Financing function or Financing decision. It refers to the decision about quantum of finance to be raised from various long term sources.

Question 25.
‘Trucks India Ltd.’ producing 1,00,000 trucks and generating revenue of Rs.1,000 crores annually, has recently acquired the world’s second largest truck icturing company. After this acquisition, ‘Trucks India Ltd.’ will become the world’s largest truck manufacturer. For financing the acquisition the company had to arrange about Rs.41,000 crores through debt and equity. State the function performed by the company for arranging the funds through debt and equity.
Answer:
Financing function or Financing decision.
Financing decision refers to the decision about the quantum of finance to be raised from various long term sources.

Question 26.
Identify the factors involved in the following dividend decisions:

  1. A company is growing by leaps and bounds. Every year it is opening new branches in the major cities of the country. There are chances that in a few years to come it will be the market leader in its industry. Newspapers appreciate the steps taken by the management. However in the field of financial decisions the company takes a defensive stand. Every year it declares less than expected dividend for the shareholders.
  2. The new government in accordance with its new policy has decided to levy more taxes on dividends. A company which pays good dividend every year to its shareholders has decided to keep the retained earnings high this year. This step will definitely bring the dividend down in comparison to the expectations of the shareholders.
  3. ‘Mitra, my neighbour’ is a real estate company. The company has always done well on the stock market indices. Recently the company has shown good profit but it is still short of cash. The company has decided to come with a lower dividend than expected. (d) One of the leading companies of the services sector has decided to keep the dividend portion of the EPS stable. The decision has been taken keeping in view the fact that the earning potential of the company has not gone up since last three years. So, the company has decided not to change the dividend per share.
  4. A lending company ‘A’ has decided to put some constraints on the company ‘B’ to which it has extended loan. The constraints are related to the declaring of dividends by the company ‘B’. They have signed a contract which puts restrictions on company ‘B’. So unless and until it pays back the amount taken from company ‘A’ it can’t enjoy freedom in this regard.
  5. A leading telecom giant always gives good dividend to its shareholders. The company is a great performer on the stock exchange. The shareholders are very confident of its good performance. It has the liberty to give high dividends as it has less dependency on retained earnings.
  6. A company takes care of the needs of its shareholders. Many of the shareholders are such who need a constant and stable source of income. Their dependence is met by the declaring of a stable and permanent dividend. Unlike other companies w’hich let the market decide the amount of dividend to be paid and the payment of which is based on the company’s performance the company wants to keep its shareholders satisfied majority of whom are retired persons.
  7. ‘Heartbeat Denim’ is the number one performing jeans manufacturing company since last 30 years. The company has several branches at different locations of the world. The revenue of the company has increased over the years. This has made this company a very stable firm. It is on the stock market since last 15 years. The shareholders of the company are extremely satisfied with its dividend policy. They never feel insecure about the dividends given as the company’s products always sell in the market and have a great demand.
  8. A newly formed petrochemical company is performing absolutely great. The firm has listed itself on the stock market. Due to the huge revenue earned by the organisation it has been able to give high dividend to the shareholders.
  9. A company has decided to improve its image in the stock market and wants the investors to pump more money in its shares. The highly ambitious organisation has planned to increase the dividends on its shares for the third successive year. The increase has also been substantial. The idea is to send great news in the market regarding the performance of the company in order to bolster its image.

Answer:
The factors involved in the above mentioned dividend decisions are:

  1. Growth opportunities.
  2. Taxation policy.
  3. Cash flow position.
  4. Stability of dividends.
  5. Contractual constraints.
  6. Access to capital market.
  7. Shareholder’s preference.
  8. Stability of earnings.
  9. Amount of earnings.
  10. Stock market reaction.

Question 27.
Company ‘A’ has the debt-equity ratio of 3 :1. Another Company ‘B’ has the debt-equity ratio of 2.5 : 1. Both the companies are part of an industry where the operating costs are high. Many of the companies in this industry are vulnerable to high business risk.
Which one of the two companies is going to have higher chances of financial risk?
Why do you think the financial risk in the above mentioned industry is going to be dangerous for the companies?
Answer:
The Company A is going to have higher chances of financial risk as the debt component is higher. Due to the higher debt component there will be an increase in the fixed financial costs. In case a company is unable to bear fixed financial costs the financial risk increases.
If a company is unable to bear operating costs then business risk gets generated. In an industry where there is already a chance of higher business risk an additional financial risk will increase the Total risk to a dangerous level.

Question 28.
In the Question No. 26(b) case where do you think taxes are charged on dividend? What is its significance with respect to the shareholders?
Answer:
The taxes are charged on companies in the form of dividend distribution tax whereas the dividend in the hands of the shareholders is tax free.
The significance with respect to the shareholders is that they may prefer higher dividend as in present taxation policy the dividends are taxed lower.

Question 29.
An organisation is busy preparing its financial blueprint for its future operations. The idea is to create satisfactory amount of money which should be there in the reach of the organisation at the right time.

  1. Which concept of financial management has been highlighted in the above case?
  2. What are the financial plans made for a year known as?
  3. What are the twin objectives of financial planning?

Answer:

  1. The concept of financial management highlighted is ‘Financial Planning’.
  2. The financial plans made for a year are known as ‘Budgets’.
  3. The twin objectives of financial planning are:
    • To ensure proper availability of funds whenever the need arises.
    • To ensure that there is no unnecessary raising of funds by the organisaiton.

Question 30.
A company was expecting a sale increase of 20% in comparison to the last year. However, due to poor support from the economic situations around the increase turned out to be only 10%. The company however had prepared itself for this situation. It knew how to change its expenses in financial case the sales increase goes down in comparison to the expectations.

  1. Identify the concept of financial management which is highlighted in thaabove case.
  2. What should have been the action taken by the company if the situation had been different like increase in revenue by 30%.

Answer:

  1. The concept of financial management highlighted in the above case is ‘financial planning’.
  2. The company would keep different items of expenditure in the case of 30% as it would be having more cash in hand. It could start new projects and involve more man power in its new projects. High revenue may help streamline operations in a better manner. The company definitely is going to have more freedom in deciding future courses of action.

Question 31.
A company ‘White White Sheets’ is a successful bed sheet selling company. It sells Rs.1 crore worth sheets to a corporate customer. The company gives a period of 2 months to the client to pay for the sheets. The company send an invoice to the customer and the inventory account gets reduced by Rs.1 crore. The account receivable is increased by Rs.1 crore. When its corporate client pays within the period of 2 months the cash is increased by Rs.1 crore and the account receivable is reduced by Rs.1 crore.

  1. In the above financial transaction the essential ingredients of which concept of ‘financial management’ have been highlighted?
  2. What is the other term used for long term investment decision?
  3. Which concept of financial management is related to selection of the best financing or investment alternative?

Answer:

  1. In the above case the essential ingredients of ‘sound working capital management’ have been highlighted. They are Accounts receivables, Cash and Inventory.
  2. The other term used for long term investment is ‘Capital Budgeting Decision’.
  3. The concept of financial management related is ‘financial decisions’.

Question 32.
In the following cases identify the type of financial decision. Also identify the factors affecting the decisions:

  1. A company has decided to issue equity but it is concerned about the control management will lose. So after a lot of brainstorming the board of directors decide to take loan from a bank and debt from other sources.
  2. Keeping the concern of raising funds alive a company decides to go for debenture as the final choice. The people who will be purchasing the debentures would be assured a definite return after a definite period of time. The company’s credibility is good so they should not worry about the A company issues equity shares but the expenses involved are quite a lot. The organisation has to be aware about the printing charges, advertisement related expenses, underwriter’s commission and brokerage asked by the middle men.
  3.  ‘Dheeraj Plants’, a manufacturing company, thinks of starting a project in South America. The company knows that the project will be a successful venture in the years to come. It tries to figure out the revenue generated by the project and the expenses which will be involved in it.
  4. Suyash tries to evaluate two projects. The projects have equal level of risk. According to this parameter he finds both projects at par. However, when it corhes to knowing the rate of return of the two projects he finds that Project A will yield a rate of return of 10% and Project B will yield a rate of return of 12%. So he decides to go ahead with the project B.
  5. Shobhit wants to start a movie hall so he decides to evaluate the feasibility of starting the project. He finds that at place A the movie hall will cost ?20 crore and at place B it will cost ?30 crore. He decides to go for the first option—Project A.

Answer:

  1. Type of financial decision: Financing decision
    Factor affecting: Control considerations
  2. Type of financial decision: Financing decision
    Factor affecting: Cost
  3. Type of financial decision: Financing decision
    Factor affecting: Floatation cost
  4. Type of financial decision: Investment decision
    Factor affecting: Cash flows of the project
  5. Type of financial decision: Investment decision
    Factor affecting: Rate of return
  6. Type of financial decision: Investment decision
    Factor affecting: Amount of investment

Question 33.
‘Abhishek Ltd.’ is manufacturing cotton clothes. It has been consistently earning good profits for many years. This year too, it has been able to generate ^ 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 form their investments.
It has taken a loan of Rs.50 lakhs from I.C.I.C.I Bank and is bound by certain restrictions on the payment of dividend according to the terms of the 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.
Answer:
Factors affecting divided decision:

  1. ‘Consistently earning good profits’. It relates to the stability of earnings of the company as a company having stable income is always in a better position to pay higher dividend. Companies having inconsistent and unstable earnings do not prefer declaring high rate of dividend.
  2. ‘There is availability of enough cash in the company’. The above line reflects the cash flow position of the business which is another major factor influencing the dividend decision. In order to declare higher rate of dividend the company should have enough cash. A company remaining short of cash finds it difficult to pay dividend.
  3. ‘It has many shareholders who prefer to receive a regular income’. Shareholders’ preference is highlighted in the above statement. The management of the company should keep in mind the preferences of shareholders while they declare dividend. Some shareholders prefer to receive a regular income in the from of dividend.
  4. ‘It has taken a loan of Rs.50 lakhs from I.C.I.C.I Bank and is bound by certain restrictions on the payment of dividend’. The above statement highlights contractual constraints due to which the company is bound by certain restrictions on the payment of dividend. If a company has taken loan, the lender may impose few restrictions on the declaration of dividend in future. The dividend policy of the firm should not violate the terms and conditions of the loan agreement.

Question 34.
Raghav is trying to co-ordinate the functioning of various departments like sales and production. He has been trying to do this with the help of a concept of financial management. He quite often calls people of both departments and tells them to work
within means. He has even prescribed a budget for it. During the time, when he is doing a lot of analysis he connects the decision of present with the outcomes of future. This can especially he seen in two of the prominent decisions. One is the investment and the other is the financing decision- so the interlinking of these two decisions is assumed by him. When the year ends it is easy for him to take some strong decisions. This happens because he is able to evaluate the performance of various departments in terms of revenue generated and the expenses incurred. No business is risk proof. However, he knows that at least business shocks which a business can suffer can be minimised thus laying foundation for a better future. His involvement in the work is definitely appreciable.

  1. Which concept of financial management has been highlighted in the above case?
  2. Identify the types of this concept highlighted in the above case.

Answer:

  1. The concept of financial management which is highlighted in the above case is ‘Importance of financial planning’.
  2. The importance of financial planning highlighted in the above case are:
    • It helps in coordinating various business functions like purchase, production and sales. Raghav is trying to coordinate the functioning of various departments like sales and production.
    • It helps in linking, the present with the future. During the time when he is doing a lot of analysis he connects the decision of present with the outcomes of future.
    • It helps in linking the investment decision with the financing decision. One is the investment and the other is the financing decision- so the interlinking of these two decisions is assumed by him.
    • It helps in the evaluation of actual performance easier. This happens because he is able to evaluate the performance of various departments in terms of revenue generated and the expenses incurred.
    • It helps in avoiding business shocks and thus prepares the company for future.
      However, he knows that at least business shocks which a business can suffer can be minimised thus laying foundation for a better future.

Question 35.
‘Yiyo Ltd.’ is a company manufacturing textiles. It has a share capital of Rs.60 lakhs. The earning per share in the previous year was Rs.0.50. For diversification, the company requires additional capital of ?40 lakhs. The company raised funds by issuing 10% debentures for the same. During the current year the company earned a profit of Rs.8 lakhs on capital employed. It paid tax @ 40%.
(a) State whether the shareholders gained or lost, in respect of earning per share on diversification. Show your calculations clearly.
(b) Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.
Answer:

cbse-class-12-business-studies-case-studies-financial-management-2
cbse-class-12-business-studies-case-studies-financial-management-3
(b) Following are the factors that favour the issue of debentures:

  • Managerial control. The company has already issued a share capital of ?60 lakhs. Further use of equity can completely dilute the control into the hands of the shareholders. Hence to have a certain degree of say in management the company issued debentures.
  •  Tax deductibility. Interest paid by the company to its debenture holders is tax deductible. The company is paying 40% tax. Therefore it is better for the company to issue debentures. High tax rate makes debt relatively cheaper.
  • Cost consideration. Raising capital through debentures is cheaper as compared to equity shares. Raising funds through debt involves low floatation costs. Moreover interest paid on debentures is a deductible expense. The interest is deducted from firm’s earnings and then the net amount is used for calculating tax liabilities. Hence more debt in the capital structure means low cost of overall capital.

Question 36.
‘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 loan of 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.
Answer:

  1. ‘It has been consistently earning good profits for many years’.
    It relates to the stability of earnings of the company as a company having stable income is always in a better position to pay higher dividend. Companies having inconsistent and unstable earnings prefer not to declare a high rate of dividend.
  2.  ‘There is availability of enough cash in the company’.
    The above line reflects the cash flow position of the business which is another major factor influencing the dividend decision. In order to declare higher rate of dividend, the company should have enough cash. A company remaining short of cash finds it difficult to pay dividend.
  3. ‘It has many shareholders who prefer to receive a regular income from their investments’.
    Shareholder’s preference is highlighted in the above statement. The management of the company should keep in mind the preferences of shareholders while they declare dividend. Some shareholders prefer to receive a regular income in the from of dividend.
  4.  ‘It has taken a loan of 40 lakhs from IDBI and is bound by certain restrictions on the payment of dividend’.
    The above statement highlights contractual constraints due to which the company is bound by certain restrictions on the payment of dividend. If a company has taken loan, the lender may impose few restrictions on the declaration of dividend in future. The dividend policy of the firm should not violate the terms and conditions of the loan agreement.

Question 37.
Somnath Ltd. is engaged in the business of export of garments. In the past, the performance of the company had been upto the expectations. In line with the latest technology, the company decided to upgrade its machinery. For this, the Finance Manager, Dalmia estimated the amount of funds required and the timings. This will help the company in linking the investment and the financing decisions on a continuous basis. Dalmia therefore, began with the preparation of a sales forecast for the next four years. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds he is trying to find out alternative sources from outside.
Identify the financial concept discussed in the above para. Also state the objectives to be achieved by the use of financial concept, so identified.
Answer:
Financial planning concept has been discussed in the above para.
Following are the two objectives of Financial planning:

  1. To ensure availability of funds when required. Financial planning ensures that sufficient funds are available with the enterprise as and when required. For this purpose proper estimation of funds are carried out for different purposes like for the purchase of long-term assets or for meeting day-to-day expenses of business.
  2. To see that the firm does not raise resources unnecessarily. Financial planning makes sure that an enterprise is adequately funded. It also ensures that firms do not raise funds unnecessarily. It aims at the best possible use of financial resources.

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