CBSE Class 12 Business Studies Financial Management Worksheet Set E

NCERT Solutions for Class 12 Business Studies Chapter 9 Financial Management Short Answer Type Questions

Question. State any four factors that affect the dividend decision of an enterprise.
Answer:  Factors affecting dividend decision are :
(i) Earnings : Earnings are a major determinant of dividend decision as dividends are paid out of current and past earnings.
(ii) Stability of earnings : It is another factor affecting dividend decision as a company having stable earnings is in a position to declare higher dividends.
(iii) Stability of dividends : Companies generally prefer to maintain stability of dividends while taking dividend decision.
(iv) Growth opportunities : If a company has good growth opportunities, it pays out fewer dividends.
(v) Cash flow position : A good cash flow position is necessary for declaration of dividend.
(vi) Shareholders’ preference : It is kept in mind by the management before declaring dividends.
(vii) Taxation policy : It affects the dividend decision as a higher dividend distribution tax will lead to lesser dividend payout.
(viii) Stock market reaction : The possible stock market reaction on the share price to dividend policy is one of the important factors affecting dividend decision.
(ix) Access to capital market : While taking dividend decision, companies take into consideration their access to capital market.
(x) Legal constraints : Certain provision of the Companies Act i.e., legal constraints place restrictions on payout of dividend.
(xi) Contractual constraints : While taking dividend decision, companies keep in mind the restrictions imposed by the lenders i.e., contractual constraints.

Question. What is meant by ‘Financial Planning’? State any two points of importance of Financial Planning.
Answer: Financial Planning : Financial planning refers to the planning regarding financial needs of the enterprise, various sources of raising funds and their optimum utilisation.

Question. Shyam wanted to start a business of selling handicrafts by getting in touch with the craftsmen in the rural areas of Bengal. He wants to make a low investment in fixed capital. Advise him in taking suitable decisions regarding the Nature of Business, Scale of operations and Financing Alternatives (in a developed financial market) that he needs to take for the purpose. 
Answer:  Decisions Shyam should take to ensure low investment in fixed capital requirement with respect to :
(i) Nature of Business : Instead of setting up a manufacturing unit, Shyam should start a trading concern of buying handicrafts from the craftsmen and selling them.
(ii) Scale of operations : Shyam should keep the scale of his organisation small.
(iii) Financing alternatives : A developed financial market may provide for leasing facilities. So instead of making outright purchase of assets, for example of office space, Shyam should take them on lease and reduce his requirement of fixed capital.

Question. 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 :
(i) Nature of business : A trading concern needs a lower investment in fixed assets as compared to a manufacturing concern since it doesn’t require to purchase plant and machinery.
(ii) Scale of operations : A larger organisation operating at a higher scale needs bigger plant and more space and hence higher investment in fixed assets.
(iii) 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.
(iv) Technology upgradation : An industry where assets become obsolete sooner requires higher fixed capital to purchase such assets.
(v) Growth prospects : Higher growth prospects require higher investment in fixed assets to meet anticipated demand quicker.
(vi) Availability of financing alternatives : Like leasing requires lower investment in fixed assets and hence requires less fixed capital.
(vii) Collaboration : Availability of business collaboration reduces the level of investment in fixed assets.
(viii) Diversification : Diversification will increase the fixed capital requirements as the investment in fixed capital will increase.

Question. What is meant by Financial Planning?
Answer: Financial planning is the process of estimating the fund requirements, specifying the sources of funds and utilising them in an optimum manner. Financial planning is basically concerned with preparation of financial blueprint of an organisation’s future operations.

Question. State any four factors except diversification which affects the fixed capital requirements of a company. 
Answer:  Factors which affect the requirements of fixed capital are :
(i) Nature of business, as a trading concern needs a lower investment in fixed assets as compared to a manufacturing concern since it doesn’t require to purchase the plant and machinery.
(ii) Scale of operations, as a larger organisation operating at a higher scale needs bigger plant and more space and hence higher investment in fixed assets.
(iii) Choice of technique, as a capital intensive organisation requires higher investment in plant and machinery and thus requires higher fixed capital than a labour intensive organisation.
(iv) Technology upgradation, as industries where assets become obsolete sooner requires higher fixed capital to purchase such assets.
(v) Higher growth prospects, require higher investment in fixed assets to meet anticipated demand quicker.
(vi) Availability of financing alternatives like leasing requires lower investment in fixed assets and hence requires less fixed capital.
(vii) Collaboration reduces the level of investment in fixed assets.

Question. Mr. Rohit is into transport business. His buses are hired by schools for transportation of students. He is willing to expand and diversify his business to inter-state transportation purposes. Enumerate any six factors that will affect his fixed capital requirements.
Answer: Factors affecting fixed capital requirements are :
(i) Scale of operations
(ii) Financing alternatives
(iii) Growth prospects
(iv) Nature of Business
(v) Diversification
(vi) Level of Collaboration
(vii) Technology Upgradation
(viii) Financing Alternatives

Question. What is meant by Financial Planning ? State any three points of its importance.
Answer: The process of estimating the fund requirements of a business and specifying the sources of funds is called Financial Planning.OR Financial planning is the preparation of a financial blueprint of an organisation’s future operations. Financial planning is important because :
(i) It helps the company to prepare for the future.
(ii) It helps in avoiding business shocks and surprises.
(iii) It helps in co-ordinating various business functions.
(iv) It helps in reducing waste, duplication of efforts, gaps in planning and confusion.
(v) It links the present with the future.
(vi) It provides a link between investment and financing decisions.
(vii) It serves as a control technique.

Question. Sudha is an enterprising business woman who has been running a poultry farm for the past ten years. She has saved ₹ 4 Lakhs from her business. She shared with her family her desire to utilise this money to expand her business. Her family members gave her different suggestions like buying new machinery to replace the existing one, acquiring altogether new equipment with latest technology, opening a new branch of the poultry farm in another city and so on. Since these decisions are crucial for her business, involve a huge amount of money and are irreversible except at a huge cost, Sudha wants to analyse all aspects of the decisions, before taking any final decision.
(i) Identify and explain the financial decision to be taken by Sudha
(ii) Also explain briefly any two factors that affect this decision.
OR
Radha is an enterprising businesswoman who has been running a fishery for the past ten years. She has saved ₹ 10 Lakhs from her business. She shared with her family her desire to utilise this money to expand her business. Her family members gave her different suggestions like buying new machinery to replace the existing one, acquiring altogether new equipment with latest technology, opening a new branch of the fishery in another village and so on. Since these decisions are crucial for her business, involve huge amount of money and are irreversible except at huge cost, Radha wants to analyse all aspects of the decision, before taking any step.
(i) Identify and explain the financial decision to be taken by Radha.
(ii) Also explain briefly any two factors that affect this decision. 
Answer: 
(i) Investment decision/Capital budgeting decision Investment/Capital budgeting decision involves deciding about how the funds are invested in different assets so that they are able to earn the highest possible return for their investors.
(ii) Factors that affect capital budgeting decision are :
(a) Cash flows of the project
(b) Rate of return of the project.
(c) Investment criteria.

Question. State two objectives of financial planning.
Answer:  Objectives of Financial Planning :
(i) To ensure availability of adequate funds at the right time : This includes a proper estimation of funds required for different purposes such as for the purchase of long-term assets or to meet day-to-day expenses of business. It estimates the time at which the funds are to be made available. Based on these facts, funds could be raised from short-term and long-term sources.
(ii) To see that the firm does not raise resources unnecessarily : Excess funding is almost as bad as inadequate funding. So, the financial manager must see to it that the company does not raise more capital than the requirement of the business. In case, there is surplus cash or liquidity, the excess funds should be utilised judiciously.

Question. What is meant by ‘Financial Management’? State the primary objective of Financial Management.
Answer:  Financial Management refers to that part of managerial activity which is concerned withTOPICMprocurement and utilisation of funds for business purposes. In other words, it deals with proper management of funds. The primary and most important objective of financial management is to maximise wealth of equity shareholders, which means maximising the market price of equity shares.

Question. 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 paragraph. Also state the objectives to be achieved by the use of financial concept, so identified.
Answer: Concept- Financial Planning Objectives of financial planning :
(i) To ensure availability of funds whenever required. It involves estimation of the funds required, the time at which these funds are to be made available and the sources of these funds.
(ii) To see that the firm does not raise resources unnecessarily. It ensures that firm does not raise resources unnecessarily as it will increase the costs and the resources will remain idle.

Question. Give the meaning of ‘Investment Decision’ and ‘Dividend Decision’.
Answer:  Investment Decision involves deciding about how the funds are invested in different assets so that they are able to earn the highest possible return for their investors. Dividend Decision involves deciding about how much of profit earned by the company is to be distributed to the shareholders and how much of it should be retained in the business.

Question. What is meant by financial planning ? State its objectives.
Answer:  The process of estimating the fund requirements of a business and specifying the sources of funds is called financial planning.OR Financial planning is the preparation of a financial blueprint of an organisation’s future operations. Objectives of financial planning :
(i) To ensure availability of funds whenever required which involves estimation of the funds required, the time at which these funds are to be made available and the sources of these funds.
(ii) To see that the firm does not raise resources unnecessarily as excess funding is almost as bad as inadequate funding. Financial planning ensures that enough funds are available at right time.

Question. State any four factors which affect the requirements of working capital of a company.
Answer:  Factors which affect the requirements of working capital are :
(i) Nature of business, as trading organisation requires smaller amounts of working capital than manufacturing organisations as there is no processing. Service industries require less working capital as they do not have to maintain inventory.
(ii) Scale of operations, as firms operating on a higher scale require more working capital as their quantum of inventory and debtors is generally high.
(iii) Business cycle, as in case of boom, larger working capital is required as the production and sales are more.
(iv) Seasonal factors, as peak season requires higher working capital than lean season due to higher level of activity.
(v) Production cycle, as working capital requirement is higher in firms with longer processing cycle.
(vi) Credit allowed to customers results in higher amount of debtors, increasing the working capital requirement.
(vii) Credit availed from suppliers reduces the working capital requirement.
(viii) Operating efficiency, as firms managing their raw materials efficiently require lesser working capital.
(ix) Free and continuous availability of raw materials, enables the firms to keep lesser stock and hence work with smaller working capital.
(x) Higher Growth prospects, will require larger amounts of working capital so that the firm is able to meet higher production and sales targets
(xi) Level of competition, as higher competition requires larger stocks to meet urgent orders from customers and thus higher working capital.
(xii) Inflation, increases the working capital requirements as larger amount of money is required to maintain a constant volume of production and sales.

NCERT Solutions for Class 12 Business Studies Chapter 9 Financial Management Lonf Answer Type Questions

Question. Explain the concept and objective of Financial Management. 
Answer:  Meaning of Financial Management : Financial Management is concerned with efficient acquisition and allocation of funds. In simple words, it refers to the efficient acquisition of finance, efficient utilisation of finance, and efficient distribution and disposal of surplus for smooth working of a business organisation. Objectives of financial management are as follows :
(i) Profit Maximisation : A finance manager should procure funds at a reasonable cost and invest them in the most profitable channels, ensuring safety and effective utilisation of funds. This in turn will maximise the profits of the business organisation.
(ii) Wealth Maximisation : A company’s funds belong to shareholders and the manner in which they are invested and the return earned by them determines their market value or price. Market price of shares increases if the benefits from a financial decision exceed the cost involved.
(iii) Maintenance of Liquidity : There is always a need to keep adequate cash to pay suppliers and creditors and to meet day-to-day needs of the concern. Liquidity of assets is linked with inflow and outflow of funds. So, the sources of cash and its application should be properly planned to keep a proper balance between inflows and outflows.

Question. ‘Viyo Ltd.’ is a company manufacturing textiles. It has a share capital of ₹ 60 lakh. The earnings per share in the previous year were ₹ 0.50. For diversification, the company requires additional capital of ₹ 40 lakh. The company raised funds by issuing 10% debentures for the same. During the current year the company earned profit of ₹ 8 lakh on capital employed. It paid tax @ 40%.
(i) State whether the shareholders gained or lost, in respect of earning per share on diversification. Show your calculations clearly.
(ii) Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.
OR
Kay Ltd. is a company manufacturing textiles. It has a share capital of ₹ 60 lakh. In the previous year, its earnings per share were ₹ 0.50. For diversification, the company requires additional capital of ₹ 40 lakh. The company raised funds by issuing 10% Debentures for the same. During the year, the company earned profit of ₹ 8 lakh on capital employed. It paid tax @ 40%.
(i) State whether the shareholders gained or lost, in respect of earning per share on diversification. Show your calculations clearly.
(ii) Also, state any three factors that favour the issue of debentures by the company as part of its capital structure.
Answer: 
(i) Earning per share before diversification = ₹ 0.50 Calculation of Earnings per share after issue of Debentures : (assuming face value of ₹ 100 per share

This clearly shows that the shareholders have gained after the issue of debentures since the Earning per share has increased from ₹ 0.50 to ₹ 4.
OR
Calculation of Earnings per share after issue of Debentures : (assuming face value of ₹10 per share) 

This clearly shows that the shareholders have lost after the issue of debentures since the Earning per share has decreased from ₹ 0.50 to ₹ 0.40. [Note : In case, a student has calculated Return on Investment as 8%(8,00,000/1,00,00,000) and compared it with the rate of interest which is 10% and concluded that the shareholders have lost after the issue of Debentures since the interest rate is greater than the Return of Investment, 1 mark is to be awarded.] [In case the examinee has assumed any other face value and has shown correct calculations and given the correct conclusion, full credit be given]
(ii) Factors that favour issue of debentures by the company :
(a) A good cash flow position makes debt funding more viable.
(b) High Interest Coverage ratio lowers the risk of company failing to meet its interest payment obligations.
(c) High debt service coverage ratio indicates better ability to meet the debt service obligations.
(d) If Return on Investment of the company is higher than the interest rate on debt, its ability to use debt is greater.
(e) Lower the cost of debt, higher is the ability to employ debt.
(f) High tax rate makes debt relatively cheaper.
(g) If the stock market conditions are bearish, a company may be able to easily raise funds through debt.
(h) If the company does not want dilution of control, it will favour debt as a source of finance.
(i) Inclusion of debt in the capital structure makes the capital structure flexible.
(j) If the business risk is lower, its capacity to use debt is higher.
(k) Raising funds through debt involves low floatation costs.

Question. What is meant by long-term investment decision? State any three factors which affect the long-term investment decisions. 
Answer:  Investment decisions : It related to investment of firm’s funds in long-term assets to earn the highest possible returns is called long term investment or capital budgeting decisions.
The factors affecting long-term investment decisions are :
(i) Cash Flows of the Project : The cash flows in the form of cash receipts and cash payments from each investment proposal should be carefully analysed before considering capital budgeting decision.
(ii) Rate of Return : The expected rate of return over the investment proposal and the risk involved should be analysed and that proposal should be accepted which contains least risk and cost but maximum ROI.
(iii) Investment Criteria Involved : The amount of investment, cash flows, interest rate, tax benefits, rate of returns, cost of financing should be kept in mind as the criteria for selecting best decision after their evaluation on these points.

Question. The Capital of India has been declared as the most polluted city in the world. Bengaluru, Mumbai, Patna, Ahmedabad, Lucknow, Kanpur and Ludhiana are also the highly polluted Indian cities. This has resulted into a dramatic increase in the sale of home air purifiers. The prices of these devices range from ₹ 2,000 to ₹ 25,000 depending upon the type of pollutant these purifiers remove. Looking at the increasing demand of these air purifiers, ‘Pure Air Technology India Ltd.’ has developed a low cost home air purifier in its R & D Lab. The company has estimated that a commercial production of 1,00,000 units per year may cost the company `500 per unit. For this, capital of ₹ 100 crores will be required. The company decided to have both equity and debt in its capital structure. Explain any four factors that the company should consider while deciding its capital structure.
Answer:  Factors affecting capital Structure :
(i) Cash Flow Position : Decision regarding capital structure depends upon the ability of business to generate enough cash flow. If company is sure of generating enough cash flow, it may have more of debt securities whereas if there is shortage of cash, it may go for equity.
(ii) Interest Coverage Ratio (ICR) : It shows how many times the earning before interest and tax is available to the payment of interest. Higher ICR means company has less of borrowed funds whereas, it is possible that inspite of better ICR the cash flow position of the company may be weak.
(iii) Debt Service Coverage Ratio (DSCR) : It is one step ahead of ICR. It takes care of return of interest as well as principal repayment. Higher DSCR means, company can have more of debt and lower DSCR means, company should go for equity capital.
(iv) Return on Investment : If return on investment is more than rate of interest then company can prefer debt in its capital structure but if return on investment is less than rate of interest then, company should prefer equity as it will not be able to pay interest.
(v) Cost of Debt : If rate of interest is less, i.e., cost of debt, more debt can be utilised in the capital structure.
(vi) Tax Rate : Interest on debt is tax deductible which makes debt cheaper. So high end tax means prefer equity in capital structure.
(vii) Cost of equity : More of debt capital increases the cost of equity as it increase the risk of the equity shareholders. So, debt, should be used to a limited level as increased cost of equity adversly affect the market value of shares.
(viii) Floatation Costs : These costs involve the expenses incurred while issuing securities, e.g., underwriters' commission, brokerage, stationery expenses, etc. Generally the cost of issuing debt capital is less than the share capital. So, company may prefer debt in its capital structure.
(ix) Risk Consideration : There are two types of risk, operating risk, e.g., rent of the building, payment of salary, insurance instalment, etc. and financial risk e.g., risk related to interest, preference dividend, payment to creditors, etc. If firms risk is low, capital can be raised by issuing debt securities and vice versa.
(x) Flexibility : Excess of debt may restrict the Firm's capacity to borrow further. To maintain flexibility, company must maintain some borrowing power to take care of unforeseen circumstances.

Question. Explain briefly any four factors that affect the fixed capital requirements of a company.] 
OR
Explain any four factors affecting fixed capital requirements of a company.
OR
Explain the following factors affecting the requirements of fixed capital :
(i) Nature of business
(ii) Growth Prospects
(iii) Diversification
(iv) Level of collaboration.
OR
Explain the following as factors affecting the requirements of fixed capital.
(i) Scale of operations
(ii) Choice of technique
(iii) Technology upgradation
(iv) Financing alternatives. 
OR
Explain any six factors which affect the fixed capital requirement of a company. 
OR
Explain any four factors which determine the fixed capital requirements of an organisation. 
OR
Explain briefly any four factors affecting the fixed capital requirements of an organisation. 
Answer:  Factors affecting fixed capital requirements of a company :
(i) Nature of business : A manufacturing concern requires more fixed capital to purchase fixed assets. For example, plant and machinery, etc. as compared to a trading concern.
(ii) Scale of operations : A larger organisation operating at a higher scale needs bigger plant, more space, etc., and therefore requires more fixed capital as compared to the smaller organisations.
(iii) Choice of technique : The business organisations using capital intensive techniques require more fixed capital whereas companies using labour-intensive techniques require less capital.
(iv) Technology upgradation : Industries in which technology upgradation is fast need more amount of fixed capital as when new technology is invented, old machines become obsolete and they need to buy new plants and machinery whereas companies where technological upgradation is slow they require less fixed capital as they can manage with old machines.
(v) Growth prospects : Companies which are expanding and have high growth plan require more fixed capital, to invest in more plant and machinery and other fixed assets in comparison to the companies having slow growth track or less growth prospects.
(vi) Diversification : Companies which have plans to diversify their business activities by including more range of products require more fixed capital. For producing more products they require more plants and machinery which means more fixed capital is required in comparison to the companies having no diversification plans. 
(vii) Level of Collaboration : If companies are preferring collaborations, joint ventures then companies will need less fixed capital as they can share plant and machinery with their collaborations but if company prefers to operate as independent unit then there is more requirement of fixed capital.
(viii) Financing alternatives : Availability of leasing facility reduces the requirement of fixed capital to be invested in outright purchase of the fixed asset.

Question. Manish is engaged in the business of garments manufacturing. Generally, he used to sell his garments in Delhi. Identify the working capital requirements of Manish giving reasons in support of your answer. Further, Manish wants to expand and diversify his manufacturing business. Explain any two factors that will affect his fixed capital requirements.
Answer: The working capital requirement of Manish will be high as he is engaged in ‘manufacturing industry’ in which raw material needs to be converted into finished goods before sale. Factors which will affect his fixed capital requirements are :
(i) Scale of operations
(ii) Growth prospects
(iii) Financial alternatives
(iv) Diversification.

Question. Explain briefly any four factors that affect the working capital requirements of a company.
OR You are the Financial Manager of a newly established company. The Directors have asked you to determine the amount of working capital requirement for the company. Explain any four factors that you will consider while determining the working capital requirements of the company.
OR
Explain any four factors which determine the working capital requirements of an organisation.
OR
Explain the following as factors affecting the requirement of working capital :
(i) Business cycle
(ii) Operating efficiency
(iii) Availability of raw material
(iv) Level of competition.
OR
Explain how the following factors affect the working capital requirements of a business :
(i) Inflation.
(ii) Business cycle
(iii) Level of competition and
(iv) Nature of business.
OR Explain the following as factor affecting the requirements of working capital
(a) Nature of business
(b) Scale of operations
(c) Seasonal factors
(d) Production cycle. 
Answer:  Following are the factors affecting working capital of a company :
(i) Length of Operating cycle/Production cycle: Operating cycle refers to the length of the manufacturing cycle, i.e., the periods taken to convert raw materials into finished products. Longer period means more working capital requirement and vice versa.
(ii) Credit policy/Credit allowed : If liberal credit terms are given and a liberal policy is followed, then the company would require more working capital as there is less cash inflow and vice versa.
(iii) Nature of business : Manufacturing firm requires higher amount of working capital as compared to a trading organisation, to convert raw materials into the finished goods.
(iv) Scale of operations : Large amount of working capital is required by firms operating on a large scale of operations in terms of debt, inventory, etc. as compared to the small scale firms.
(v) Seasonal factor : Higher amount of working capital is required by the organisation during its peak season as the level of activities is higher as compared to the lean season.
(vi) Business cycle : During boom period, when sales are high, higher amount of working capital is required as compared to the depression period.
(vii) Credit availed : If it is difficult to avail credit by the firm (on its purchases) from suppliers, then higher amount of working capital is required.
(viii) Availability of raw material : Higher lead time (i.e. time lag between the placement of order and actual receipt of the materials) and interrupted availability of raw materials will raise the requirement of working capital.
(ix) Operating efficiency : Less requirement of working capital will be there in a firm in the presence of best sales effort, ideal debtors turnover ratio and higher inventory turnover ratio.
(x) Level of competition : Working capital require-ments will be more if level of competition is high.
(xi) Inflation : At a higher rate of inflation, working capital requirement will also be higher.
(xii) Growth prospects : If an organisation has planned for higher growth prospects then its requirement for working capital will be higher.

Question. ‘Sarah Ltd.’ is a company manufacturing cotton yarn. It has been consistently earning good profits for many years. This year too, it has been able to generate enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well-managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of ₹ 40 lakh 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.
OR
‘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 enough profits. There is availability of enough cash in the company and good prospects for growth in future. It is a well-managed organisation and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of `50 lakhs from ICICI 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 dividend decision :
(i) Stability of earnings : ‘It has been consistently earning good profits for many years’ Stability of earning effects dividend decision as a company having stable earnings is in a position to declare higher dividends.
(ii) Cash flow position : ‘There is availability of enough cash in the company.’ A good cash flow position is necessary for declaration of dividend.
(iii) Growth prospects : ‘Growth prospects for growth in the future.’ If a company has good growth opportunities, it pays out fewer dividends.
(iv) Shareholders’ preference : ‘It has many shareholders who prefer to receive regular income from their investments.’ Shareholders' preference is kept in mind by the management before declaring dividends.
(v) Contractual constraints : ‘It has taken a loan of ₹ 50 Lakh from ICICI Bank and ...agreement’. While taking dividend decision, companies keep in mind the restrictions imposed by the lenders in the loan agreement.

Question. Tata International Ltd. earned a net profit of ₹ 50 crores. Ankit, the finance manager of Tata International Ltd., wants to decide how to appropriate these profits. Identify the decision that Ankit will have to take and also discuss any five factors which help him in taking this decision.
Answer: 
(i) Dividend Decision.
(ii) Factors affecting dividend decision :
(a) Earnings : The dividend is paid out of the present and reserved profits. Therefore, greater amount of total profit will ensure greater dividend.
(b) Stability of Earnings : A company having stable earnings is in a position to declare more dividends and vice-versa.
(c) Stability of Dividend : Generally companies follow a policy of stable dividend per share. It is increased only when there is a confidence that their earning potential has gone up permanently and is of large amount.
(d) Growth opportunities : Companies having high growth opportunities retain more earnings to capitalise these opportunities. While companies with no growth plans can declare more dividends.
(e) Cash flow position : The payment of dividend results in outflow of cash. The better the cash flow position of company, the better will be the capacity of company to pay dividends.
(f) Stock market reactions : Share prices react positively and negatively on increase and decrease in dividend respectively. This possible impact on share prices should be considered while declaring dividend.
(g) Shareholders’ preference : Generally it is observed that retired and middle-class shareholders prefer regular and stable amount of dividend whereas young and wealthy shareholders prefer capital gain.
(h) Taxation policy : If tax on dividend is higher, the companies would prefer to pay fewer dividends whereas higher dividends may be declared if tax rates are relatively lower.
(i) Access to capital market : Companies having easy access to capital market may depend less on retain earnings and declare more dividends. While companies having less access to capital market will retain more and pay low dividends.
(j) Legal constraints : Certain provisions of the Companies Act place restrictions on payouts of dividends. Such provisions have to be followed while declaring dividend.
(k) Contractual constraints : While granting loans to a company sometimes the lender may impose certain restriction on the payment of dividends in future which should not be violated by the company.

Question. Every Manager has to take three major decisions while performing the finance function. State these decisions.
OR
Every Manager has to take three major decisions while performing the finance function. Explain them.
OR
“Financial Management is based on three broad financial decisions.” Explain these decisions. 
Answer:  Three major decisions are :
(i) Investment Decision : It relates to how the firm’s funds are invested in different assets in the long-term and the short-term.
(ii) Financing Decision : It relates to the quantum of finance to be raised from various long-term sources. It determines the overall cost of capital and financial risk of the enterprise.
(iii) Dividend Decision : It relates to how much of the profit earned by the company (after paying tax) is to be distributed to the shareholders and how much of it should be retained in the business.

Question. Explain the following factors affecting financing decision :
(i) Cost
(ii) Cash flow position of business
(iii) Level of fixed operating cost and
(iv) Control considerations.
OR
What is meant by Financing Decision? State any four factors affecting the financing decision. 
Answer:  Financing Decision : It refers to the determination as to how the total funds required by the business will be obtained from various long-term sources.
Long-term financial sources chiefly include equity share capital, preference share capital, retained earnings, debentures, long-term loan, etc. The following factors affect the financing decision :
(i) Cost of Funds : Different financial sources have different cost like interest on debt, dividend of shares. A company chooses a source which proves to be the cheapest.
(ii) Risk : From companies point of view debt is more risky than equity. So, company should analyse its financial risk bearing capacity and choose a source accordingly.
(iii) Floatation Cost : Higher the floatation cost of a source, less attractive it appears to the management.
(iv) Cash Flow Position : A stronger cash flow position makes debt financing more viable than funding through equity.
(v) Level of Fixed Operating Cost : If a business has high fixed operating costs (For example, rent, insurance premium etc.), it should opt for less fixed financing cost (interest) by using less debt financing. Similarly, if fixed operating cost is less, more debt financing can be done.
(vi) Control Consideration : Issue of more equity may lead to dilution of management control over the business companies which may afraid them of a takeover bid. So it may prefer debt to equity.
(vii) State of Capital Markets : A depressed capital market makes issue of equity shares difficult and less attractive source of finance in comparison to debt. Similarly, a rising capital market makes equity more viable source of finance than debt.
(viii) Return on Investment : If the ROI for a company is higher, it will use more debt to take advantage of trading on equity.
(ix) Tax Rate : Since interest is a tax deductible expense, a higher tax rate makes debt relatively cheaper and increases its attraction vis-a-vis equity.
(x) Flexibility : If a firm uses its debt potential to the full capacity, it losses flexibility to issue further debt. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances.
(xi) Regulatory Framework : Different sources of finance have different regulatory framework provided by the law. The relative ease with which these norms can be met has a good effect on the choice of the source of finance.