Financial Management Class 12 Business Studies Important Questions
Please refer to Financial Management Class 12 Business Studies Important Questions with answers below. These solved questions for Chapter 12 Financial Management in NCERT Book for Class 12 Business Studies have been prepared based on the latest syllabus and examination guidelines issued by CBSE, NCERT, and KVS. Students should learn these solved problems properly as these will help them to get better marks in your class tests and examinations. You will also be able to understand how to write answers properly. Revise these questions and answers regularly. We have provided Notes for Class 12 Business Studies for all chapters in your textbooks.
Important Questions Class 12 Business Studies Chapter 12 Financial Management
All Financial Management Class 12 Business Studies Important Questions provided below have been prepared by expert teachers of Standard 12 Business Studies. Please learn them and let us know if you have any questions.
Very Short answer types questions
Question. Yogesh, a business man is engaged in publishing and selling of Ice-creams. Identify the working capital requirement of Yogesh giving reason in support of your answer.
Answer. Working capital requirements of Yogesh would be less as it is a TRADING business.
Question. Manish is engaged in business of garments manufacturing. Identify the working capital requirement of Manish giving reason in support of your answer.
Answer. Working capital requirements of Manish would be less as it is a manufacturing business.
So raw material needs to be converted into finished goods before any sales can become possible
Question. Amit is running an „Advertising agency‟ and earning a lot by providing this service to big industries. State whether the working capital requirement of the firm will be ‘less‟ or ‘’mor’’. Give reason in support of your answer.
Answer. Less working capital is required as service industries which usually do not have to maintain inventory require less working capital.
Question. ‘’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 „India Logistics‟ will be high or low.
4 Low, as it is a service industry, which usually do not have to maintain inventory.
Question. ‘‘Financial management is concerned with inflow and outflow of money.’’ Do you agree? If yes, How?
Answer. Yes, financial management is concerned with inflow and outflow of money as it is concerned with taking decisions regarding optimal procurement and utilisation of funds. For the effective procurement of funds, different available sources of finance are identified and compared in terms of cost and risk associated with them. Procurement of funds is done for both long-term needs as well as short-term needs. For long-term financing needs, the funds can be sourced through debt and equity. Short-term financing involves management of working capital.
Question. ” Ranbaxy Ltd. has been earning handsome profits since last 15 years. Company enjoy goodwill in the market, so company can easily arrange debt as well equity from the owner whenever needed. Therefore company decided to declare dividend with a hike of 15% from last year.” Which two components affecting dividend decision have been highlighted in the above paragraph.
Answer. (i) Stability of earning. (1) Access to capital markets
Question. REI Agro Food Ltd. is a famous multinational company. Mr. SK Nagi is its finance manager. He is making efforts to increase the market value of capital He already knew it could be possible only when price of the shares increases and price of shares increase only if financing , investment and dividend decisions are taken optimally. He did the same and achieved success. Which objective of financial management has been referred here ? Explain .
Answer. Maximizing the wealth of equity shareholders
Question. Jai Bharat Company Ltd. is an auto part supplier company in Guru Gram , Haryana . Its business is spread over several cities . The CEO of company wants to open a factory in Gujarat near Tata Motors Ltd. but due to recession for the last two years , its business is facing slow down. Company needs capital . Rakesh Gupta is CA and financial advisor of the company . His opinion is that during recession profit falls and investors prefer to invest in debentures to earn fixed income. Therefore, the company should issue debentures. In this paragraph, which factor affecting financing decision has been highlighted? Explain state of capital market.
Answer. State of capital market.
Question. Amit is running an ‘ Advertising agency ‘ and earning a lot by providing this service to big industries. State whether the working capital requirement of the firm will be less or Give reason in support of your answer.
Answer. Less working capital is required as service industries which usually do not have to main inventory require less working capital.
Short answer types questions
Question. Cost of debt is less than cost of equity. Still a company cannot go with entire debt. Why?
Answer. Because debt is riskier for a business, since payment of interest and return principal amount is compulsory for the business. Any default in meeting these commitments may force the business to go into liquidation. That is, increased use of debt increases financial risk of a business
Question. Amar is doing his transport business in Delhi. His buses are generally used for the tourists going to Jaipur and Agra. Identify the working capital requirement of Amar giving reason in support of your answer. Further Amar wants to expand and diversify his Transport business. Enumerate any four factors that will affect his fixed capital requirements.
Answer. Working capital requirements of Amar would be less as it is a SERVICE industry. Factors which will affects his fixed capital requirements are:
1. Scale of operations
2. Financing alternatives
3. Growth prospects
Question. The directors of a manufacturing company are thinking of issuing Rs. 20 crores worth additional debentures for expansion of their production capacity. This will lead to an increase in debt equity ratio from 2 : 1 to 3 : 1. What are the risks involved in it? What factors other than risk do you think the directors should keep in view before taking the decision? Name any four factors
Answer. Higher use of debt increases the fixed financial charges of a business because payment of interest and return of principal amount is compulsory. Any default in meeting these commitments may force the business to go into liquidation. As a result, increased use of debt increases the financial risk of a business. Financial risk is the chance that a firm would fail to meet its payment obligations. Other factors affecting this decision are: 1. Cost 2. Cash flow position 3. Control 4. Return on investment (ROI)
Question. In a company profits are high and in future less scope of expansion exists. The company has decided to distribute less amount of share of profits to its shareholders.
1. Identify of share of profits to its shareholders.
2. State any one value which is affected by the company’s decision.
Answer. 1. Dividend decision This decision involves how much of the profit earned by the company (after paying tax) is to be distributed to the shareholder and how much of it should be retained in the business. 1. Value affected: Shareholders’ wealth will not be maximized.
Question. A company’s earnings before interest and tax is Rs. 7 lakhs. It pays 10% interest on its debt.
Total investment of company is rs. 50 lakhs.
1. Advise company whenever it should include debt or equity to raise its capital.
2. Name the concept related to this.
3. Will be company’s decision to raise funds from debt or equity will change if company’s EBIT becomes 3 lakhs.
Answer. 1. Company should prefer debt to raise fund as debt is gainful for equity shareholders’ till
ROI > Rate of Interest.
In the above case ROI = EBIT × 100
= 7 × 100 = 14%
14 > 10 so debt it more suitable.
1. The concept is leverage effect or trading in equity.
2. Yes company’s decision will change if EBIT becomes 3 lac, because with 3 lac ROI will
less than interest.
ROI = EBIT × 100 = 3 × 100 = 6%
Total Income 50
Interest = 10%
6% < 10%
So, now company must prefer equity to raise capital.
Question. Storage Solution Ltd. Is a large warehousing network company operating through a chain of warehouses at 40 different locations across India. The company now intends to undertake computerization of its owned ware houses as it seeks to provide better value added and cost effective solutions for scientific storage and preservation services to the market participants dealing in agricultural products including farmers, traders, etc.
In context of the above case:
1. How is the decision to undertake computerization of owned warehouses likely to affect the fixed capital requirements of its business?
2. Name any two sources that company may use to finance the implementation of this plan
Answer. 1. The decision to undertake computerization of owned warehouses will increase the fixed capital requirements of its business both in present and future as after sometime, the technology being used will become obsolete and need up gradation.
2. The company may use retained earnings and take loans from financial institutions to implement this plan.
Question. Wireworks Ltd. Is a company manufacturing different kinds of wires. Despite fierce competition in the industry, it has been able to maintain stability in its earnings and as a policy, uses its profits to distribute dividends. The small investors are very happy with the company as it has been declaring high and stable dividend over past five years. In context of the above case:
1. State any one reason because of which the company has been able to declare high dividend by quoting line from the paragraph.
2. Why do you think small investors are happy with the company for declaring stable dividend?
Answer. 1. Stability in earnings: “Despite fierce competition in the industry, it has been able to maintain stability in its earnings.” 1. The small investors are happy with the company for declaring stable dividend as they enjoy a regular income on their investment.
Question. Manoj is a renowned businessman involved in export business of leather goods. As a responsible citizen, he chooses to use jute bags for packaging instead of plastic bags. Moreover, on the advice of his friends, he decides to use jute for manufacturing aesthetic handicrafts, keeping in view the growing demand for natural goods. In order to implement his plan, after conducting a feasibility study, he decides to set up a separate manufacturing unit for producing varied jute products. In context of the above case:
1. Identify the type of investment decision taken by Manoj for deciding to set up a separate manufacturing unit for producing jute products.
2. State any two factors that he is likely to consider while taking this decision.
Answer. 11. Capital budgeting decision has been taken by Manoj.
2. The factors affecting Capital
Budgeting Decision are as follows:
1. Cash inflows: 2. Rate of return
Question. Well-being Ltd. Is a company engaged in production of organic foods. Presently, it sells its products through indirect channels of distribution. But, considering the sudden surge in the demand for organic products, the company is now inclined to start its online portal for direct marketing. The financial managers of the company area planning to use debt in order to take advantage of trading on equity. In order to finance its expansion plans, it is planning to raise a debt capital of Rs. 40 lakhs through a loan @ 10% from an industrial bank. The present capital base of the company comprises of Rs. 9 lakh equity shares of Rs. 10 each. The rate of tax is 30%. In the context of the above case:
1. What are the two conditions necessary for taking advantage of trading on equity?
2. Assuming the expected rate of return on investment to be same as it was for the current year i.e. 15%, do you think the financial managers will be able to meet their goal. Show your workings clearly.
Answer. 1. The two conditions necessary for taking advantage of trading on equity are:
• The rate of return on investment should be more than the rate of interest.
• The amount of interest paid should be tax deductible.
2. Yes, the financial managers will be able to meet their goal as the projected EPS, with the issue of debt, is higher than the present EPS.
Question. ‘Ganesh Steel Ltd.‟ is a large and credit-worthy company manufacturing steel for the Indian market. It now wants to cater to the Asian market and decides to invest in new hi-tech machines.
Since the investment is large, it requires long-term finance. It decides to raise funds by issuing equity shares. The issue of equity shares involves huge floatation cost. To meet the expenses of floatation cost the company decides to tap the money-market. 1. Name and explain the money market instrument the company can use for the above purpose. 2. What is the duration for which the company can get funds through this instrument? 3. State any other purpose for which this instrument can be used.
Answer. 1. Commercial Paper: It is a unsecured promissory note issued by large and credit worthy companies to raise short terms funds at lower rates of interest than the prevailing market rates.
1. 15 days to one year. 2. It can also be used for seasonal and working capital needs.
Long answer types questions
Question. Arun is a successful businessman in the paper industry. During his recent visit to his friend’s place in Mysore, he was fascinated by the exclusive variety of incense sticks available there.
His friend tells him that Mysore region is known as a pioneer in the activity of Agarbatti manufacturing because it has a natural reserve of forest products especially Sandalwood to provide for the base material used in production. Moreover, the suppliers of other types of raw material needed for production follow a liberal credit policy and the time required to manufacture incense sticks is relatively less. Considering the various factors, Arun decides to venture into this line of business by setting up a manufacturing unit in Mysore. In context of the above case:
1. Identify of the above case:
2. Identify the three factors mentioned in the paragraph which are likely to affect the working capital requirements of his business.
Answer. Investment decision has been taken by Arun. Investment decision seeks to determine as to how the firm’s funds are invested in different assets. It helps to evaluate new investment proposals and select the best option on the basis of associated risk and return. Investment decision can be long term or short-term.
A long-term investment decision is also called a Capital Budgeting decision
2. The three factors mentioned in the paragraph which are likely to reduce the working capital requirements of his business are as follows:
1. Available of raw material:
2. Production cycle:
3. Credit availed:
Question. ‘’Adwitiya‟ is a company enjoying market leadership in the food brands segment. It’s portfolio includes three categories in the Foods business namely Snack Foods, Juices and Confectionery. Keeping in mind, the growing demand for packaged food it now plans to introduce ready-To- Eat Foods. Therefore, the company has planned to undertake investments of nearly Rs. 450 crores for its new line of business. As per the current financial report, the interest coverage ratio of the company and return on investment is higher. Moreover, the corporate tax rate is high. In context of the above case:
1. As a financial manager of the company, which source of finance will you opt for debt or equity, to raise the required amount of capital? Explain by giving any two suitable reasons in support of your answer.
2. Why are the shareholder’s of the company like to gain from the issue of debt by the company?
Answer. ‘’1. As a financial manager of the company, I will opt for debt to raise the required amount of capital.
I support my decision by giving the following reasons:
1. Interest coverage ratio:
2. Tax rate:
1. The shareholders of the company are likely to gain from the issue of debt by the company because the return on investment is higher. It helps a company to take advantage of trading on equity to increase the earnings per share.
Question. Computer Tech Ltd., is one of the leading information technology outsourcing services providers in India. The company provides business consultancy and outsourcing services to its clients. Over the past five years the company has been paying dividends at high rate to its shareholders. However, this year, although the earnings of the company are high, its liquidity position is not so good. Moreover, the company plans to undertake new ventures in order to expand its business.
In context of the above case:
1. Give any three reasons because of which you think Computer Tech Ltd. Has been paying dividends at high rate to its shareholders over the past five years.
2. Comment upon the likely dividend policy of the company this years by stating any two reasons in support of your answer.
Answer. 1. Computer Tech Ltd. has been paying dividends at high rate to its shareholders over the past five years because of the following reasons:
2. Cash flow position:
3. Access to capital market:
1. This year the company is likely to follow a conservative dividend policy because of the following reasons:
1. The cash flow position of the company is not god and dividends are paid in cash.
2. The company may like to retain profits to finance its expansion projects. Retained profits do not involve any explicit cost and are considered to be the cheapest source of finance.
Question. Krishna Ltd. Is manufacturing steel at its plant at Noida. Due to economic growth, the demand for steel is also growing. The company is planning to set up a new steel plant at Gurgaon. It needs Rs. 800 crore to start the new plant. It decides to raise Rs. 300 crore through debentures, Rs. 200 crore through long-term loan from banks and Rs. 200 crore by issue of equity share to the public. It is decided to finance the remaining amount by utilizing its reserves and surplus.
1. State the importance of financial planning for this company.
2. What is the capital structure of this company? Explain.
3. Identify the financial decision involved when the company decides to raise Rs. 800 crore from different sources of funds.
4. How will the dividend decision of Krishna Ltd. Be affected? Explain.
Answer. 1. Financial planning will help the company in avoiding business shocks and surprises. It will reduce waste and duplication of efforts.
2. Capital structure refers to the mix between owner’s funds and borrowed funds. It is calculated as debt equity ratio
For Krishna Ltd. Debt = Debentures + Long term loans from banks = 300 + 200 = Rs. 500 crore.
Equity = Share capital + Reserves and surplus (or retained earnings)
= 200 + 100 = Rs. 300 crores.
Therefore, debt equity ratio = 500 = 1.67 : 1
1. Financing decision
2. Since the company have growth opportunities of setting up a new steel plant at Gurgaon, it retains Rs. 100 crore out of profits to finance the required investment. So, it is likely to pay less dividend. However, since the company makes more debt financing than funding through equity, it implies that cash flow position of the company is strong. Therefore, it can pay higher dividend.
Question. Tata International Ltd. Earned a net profit of Rs. 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. Ans. Dividend decision Factors affecting dividend decision.
1. Earnings: 2. Stability of earnings: 3. Stability of dividends 4. Growth opportunities: 5. Cash flow position:
Question. Shalini, after acquiring a degree in Hotel Management and Business administration took over her family food processing company of manufacturing pickles, jams and squashes. The business was established by her great grandmother and was doing reasonably well. However, the fixed operating costs of the business were high and the cash flow position was week. She wanted to undertake modernization of the existing business to introduce the latest manufacturing processes and diversify into the market of chocolates and candies. She was very enthusiastic and approached a finance consultant, who told her that approximately Rs. 50 lakhs would be required for undertaking the modernization and expansion programme. He also informed her that her stock market was going through a bullish phase.
1. Keeping the above considerations in mind, name the source of finance Shalini should not choose for financing the modernization and expansion of her food processing business. Give one reason in support of your answer.
2. Explain any two other factors, apart from those stated in the above situation, which Shalini should keep in mind while taking this decision.
Answer. 1. Debt
Any one reason
1. Due to weak cash flow position, the firm may not be able to honour fixed cash payment obligations.
2. Increased fixed operating cost will increase the business risk therefore debt should not be issued as it further increases the financial risk.
3. The stock market condition being bullish, the investors will prefer to buy equity shares.
1. Other factors which Shalini would keep in mind are:
1. Return on Investment 2. Tax rate
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 wellmanaged organization and believes in quality, equal employment opportunities and good remuneration practices. It has many shareholders who prefer to receive a regular income from their investments. It has taken a loan of Rs. 40 lakhs from IDBI and is bound by certain restrictions on the payment of dividend according to the terms of loan agreement. The above discussion about the company leads to various factors which decide how much of the profits should be retained and how much has to be distributed by the company. Quoting the lines from the above discussion identify and explain four such factors.
Answer. Factors affecting dividend decision: (Any four)
1. Stability of earnings
It has been consistently earning good profits for many years‟.
Stability of earnings affects dividend decision as a company having stable earnings is in a position to declare higher dividends.
1. Cash Flow position
„There is available of enough cash in the company‟.
A good cash flow positions is necessary for declaration of dividend.
1. Growth Prospects
„Good prospects for growth in the future.‟
If a company has good growth opportunities, it pays out less dividend.
1. Shareholders’ preference
„It has many shareholders who prefer to receive regular income from their investments.‟ Shareholder’s preference is kept in mind by the management before declaring dividends.
1. Contractual constraints
„It has taken a loan of Rs. Rs. 40 Lakhs from IDBI and … agreement.‟ Which taking dividend decision, companies keep in mind the restrictions imposed by the lenders in the loan agreement.
Question. Shubh Ltd. Is manufacturing steel at its plant in India. It is enjoying great demand for its products as economic growth is about 7%-8% and the demand for steel is growing. The company has decided to set up a new steel plant to encash the increased demand. It is estimated that it will require about Rs. 2000 crore to set up and about Rs. 500 crores of working capital to start the new plant.
1. State the objective of financial management for this company.
2. Identify and state the decision taken by the finance manager in the above case.
3. State any two common factors affecting the fixed and working capital requirements of Shubh Ltd.
Answer. 1. Objectives of financial management of this company are:
1. To ensure availability of sufficient funds from different sources at reasonable costs.
2. To ensure effective utilization of such funds.
3. To ensure safety of funds procured by creating reserves, reinvesting profits, etc.
Value: Maximisation of shareholders’ wealth.
1. Investment decision
It relates to how the firm’s funds are invested in different assets – fixed assets and working capital.
1. Factors affecting fixed and working capital requirements of Shubh Ltd.:
1. Nature of business:
2. Scale of operations:
Question. ‘G Motors’ is the manufacturer of sophisticated cranes. The production manager of the company, reported to the chief executive officer, Ashish Jain that one of the machines used in manufacturing sophisticated cranes had to be replaced to compete in the market, as other competitors were using automatic machines for manufacturing cranes. After a detailed analysis, it was decided to purchase a new automatic machine having the latest technology. It was also decided to finance this machine through long-term sources of finance. Ashish Jain compared various machines and decided to invest in the machine which would yield the maximum returns to its investors.
(i) Identify the financial decision taken by Ashish Jain.
(ii) Explain any three factors affecting the decision identified in above (i).
Answer. (i) Financial decision taken by Ashish Jain is investment
(Long-term/Capital budgeting) decision.
(ii) The factors affecting investment decision are given below
(a) Cash Flow of the Project- When a firm takes an investment decision involving huge amount, it expects to generate some cash flows (inflow or outflow) over a period. Thus, the inflows and outflows of cash in the business should be considered before making capital budgeting decisions.
(b) Rate of Return- Each project is selected after comparing expected returns of different projects and the degree of risk involved in them.
(c) The Investment Criteria Involved -The decision to invest in a particular project involves a number of calculations regarding the amount of investment, interest rate, cash flows and rate of return.
Question. “Sound financial planning is essential for the success of any enterprise.” Explain this statement by giving any five reasons.
Answer. ‘‘Sound financial planning is essential for the success of any enterprise.’’ The following points explain the importance of financial planning
(i) It helps in forecasting what may happen in future under different business situations. By doing so, it helps the firms to face the eventual situation in a better way. In other words, it makes the firm better prepared to face the future. By preparing a blueprint of these situations, the management may decide what must be done in each of these situations. This preparation of alternative financial plans to meet different situations is clearly of immense help in running the business smoothly.
(ii) It helps in avoiding business shocks and surprises and helps the company in preparing for the future.
(iii) It helps in coordinating various business functions, e.g. sales and production functions, by providing clear policies and procedures.
(iv) It provides a link between investment and financing decisions on a continuous basis.
(v) Detailed plans of action prepared under financial planning reduce waste, duplication of efforts and gaps in planning.