Formation of a Company Short Answer Type Questions

Formation of a Company Short Answer Type Questions

Question 1.
Explain briefly different types of debentures?
Following are the types of debentures –

  • Registered debentures
  • Unregistered or bearer debentures
  • Unsecured debentures
  • Secured debentures
  • Redeemable debentures
  • Irredeemable debentures
  • Convertible debentures
  • Non convertible debentures

(a) Registered debentures:
In means debenture holders name are entered in the register of debenture holders kept by the company. These registered debenture holders are entitled to receive payment of interest and repayment of debenture amount. These debentures are not. possible to transfer like a negotiable instrument. It can be transferred only in the manner specified in the condition endorsed on them.

(b) Unregistered or bearer debentures:
It is a bearer debentures. These debenture holder name is not recorded in the register of v debenture holders maintained by the company. These debentures are considered as negotiable instrument and it can be transferred by mere deliver.

(c) Unsecured debentures:
It is a simple debenture. These debenture holders do not have any charge on the assets of the company. These debenture holders are like unsecured creditors of the company.

(d) Secured debentures or Mortgage debentures:
These debenture holders are secured by a charge on the assets of the company. These debenture holders amount is used by the company for purchase of some specific immovable property.

(e) Redeemable debentures:
These debenture amount is refunded by the company as per terms and conditions after a specified period of time.

(f) Irredeemable debentures:
These debenture holders amount is not repaid by the company according to the demand of debenture holders. It is repaid by the company whenever it is convenient for repayment and it is repaid during the existence of the company.

(g) Convertible debentures:
These debentures have an option to convert their debt document into equity or preference shares after expiry of certain period. But this option must be exercised with in given period of time only.

(h) Non convertible debentures:
These debentures have no option to convert into equity as preference shares. Therefore they are continued as a debenture holders during the existence of the company.

Question 2.
State the difference between share and debenture?
Difference between shares and debentures Shares:

Shares Debentures
(a) It is issued by the company to start the business. (a) It is issued by the company to expand the business.
(b) It is owner ship capital. (b) It is loan capital.
(c) Share holders have voting rights. (c) Debentures holders donot have voting rights.
(d) Payment of dividend is not fixed and regular. (d) Payment of interest is regular and fixed.
(e) Share holders are not secured by a charge on the assets of the company. (e) Debentures holders are secured by charge on the assets of the company.
(f) Shares can be forfeited. (f) Debentures are not forfeited.
(g) Shares may be fully or partly paid. (g) Debentures are fully paid.
(h) Share amount is not returned by the company during its existence. (h) Debentures amount is returned during the existence of the company.

Question 3.
Explain different types of preference shares.
Types of preference shares:

  • Cumulative preference shares
  • Non-cumulative preference shares
  • Participating preference shares
  • Non-participating preference shares
  • Convertible preference shares
  • Non convertible preference shares
  • Redeemable preference shares
  • Irredeemable preference shares

(a) Cumulative preference shares: These share holders are entitled to receive – i) fixed parentage of dividend before anything is given to other kinds of share holders and ii) arrears of dividend out of future profits.

b) Non-cumulative preference shares: These share holders are entitled to receive only fixed percentage of dividend and they have no right over arrears of dividend.

c) Participating preference shares: These share holders are entitled to receive i) fixed percentage of dividend on their shares and ii) percentage of dividend recommended to the equity share holders.

d) Non-participating preference shares: These share holders are having right to get fixed percentage of dividend declared on their share and are not eligible for participate in the surplus profit of the company:

e) Convertible preference shares: These are all eligible for converting into equity shares after certain period of time.

f) Non convertible preference shares: These shares are not given right to convert into equity shares.

g) Redeemable preference shares: These shares are redeemed and amount is paid back to share holders as per the terms of issue after a stipulated period of time.

h) Irredeemable preference shares: These share holders are continued as preference share holder-until the company is wound up.

Question 4.
State difference between equity shares and preference shares.
Following are the difference between equity shares and preference shares.

Equity shares Preference shares
(a) These share holders do not have priority in payment of dividend and repayment of Capital. (a) These shareholders have priority over the payment of dividend and repayment of capital
(b) Rate of dividend is fixed. (b) Rate of dividend is not fixed.
(c) These shares have full voting rights. (c) These share have restricted voting rights.
(d) It is ownership shares of the company. (d) It is not enjoying such ownership.
(e) It cannot be redeemed during the existence of the company. (e) It can be redeemed during the existence of the company according term and conditions.
(f) It is not possible to convert into other form. (f) It can be convert into ordinary shares.

Question 5.
What are the guidelines issued by SEBI on Book Building?
SEBI guidelines came into operational with effect from sept. 1997. Following are the guidelines issued by SEBI:

  • The option of 100% book building shall be receivable to issuer company which propose to make an issue of capital of more than 100 crores.
  • SEBI registers the name of merchant beakers to carry on activity as the under writer.
  • Issuing company must take permission from SEBI to give advertisement in news paper about the date of opening and closing of the bidding.
  • Issuing company shall appoint category one merchant bankers as book runner. And this name must be mentioned to SEBI.
  • The book runner shall determine the issue price based on the bids received through syndicate members
  • SEBI shall have the right to carryout an inspection of the records books documents relating to book building process.

Question 6.
Discuss briefly the steps in capital Subscription stage of the company.
Capital subscription is the third stage in the formation of a public limited company. Promoters of a company fulfills following steps in this stage:

  • Director are conducting meeting to appoint a secretary of the company.
  • Bankers auditors solicitor, brokers are appointed to mention their name in the prospectus of the company.
  • Pre-incorporation contracts are rectified by the promotrs to give legal touch to all contracts.
  • Resolution is passed by the directors of the company to list their share in recognized stock exchange market.
  • Promoters enters into agreement with underwrites to issue shares to public easily
  • If company’s offer to the public for subscription of shares for more than one crore had to obtain the permission of the controller of capital issues before offering the shares to the public.

Question 7.
Explain the relationship between memorandum and articles of association.
(1) Articles of Association are subsidiary to the Memorandum of: Association. Articles of Association can be made only within the limits as decided by the Memorandum of Association. Articles cannot go beyond the Memorandum of Association.

(2) Supplementary to Each Other : These two documents are not competitors to each other but they are supplementary to each other. Memorandum directs for the limit and power of the company whereas Articles of Association guides for the internal Management of the company.

(3) Articles of Association cannot amend a memorandum of Association, because articles of Association are subsidiary of the Memorandum. They cannot control/amend the memorandum.

(4) Memorandum states objects while articles provide the manner in which objects may be attained.

(5) Memorandum can be explained as constitution or foundation stone where as articles are relating to internal regulations.

Question 8.
Who is a promoter? Explain the various types of promoter.
As per Section 2(69) of Companies Act, 2013 the term Promoters is defined as:
“Promoter” means a person:

  • who has been named as such in a prospectus or is identified by the Company in the annual return referred to in section 92; or
  • who has control over the affairs of the Company, directly or indirectly whether as a shareholder, director or otherwise; or
  • in accordance with whose advice, directions or instructions the Board of Directors of the Company is accustomed to act:

(1) Professional Promoters:
These are the persons who specialise in promotion of companies. They hand over the companies to shareholders when the business starts. In India, there is lack of professional promoters. In many other countries, professional promoters have played an important role and helped the business community to a great extent. In England, Issue Houses; In U.S. A., Investment Banks and in Germany, Joint Stock Banks have played the role of promoters very appreciably.

(2) Occasional Promoters:
These promoters take interest in floating some companies. They are not in promotion work on a regular basis but take up the promotion of some company and then go to their earlier profession. For instance, engineers, lawyers, etc. may float some companies.

(3) Financial Promoters:
Some financial institutions of financiers may take up the promotion of a company. They generally take up this work when financial environment is favourable at the time.

(4) Managing Agents as Promoters:
In India, Managing Agents played ah important role in promoting new companies. These persons used to float new companies and then got their Managing Agency rights.
Managing Agency system has since long been abolished in India.

Question 9.
State the functions of promoter.
Functions of a Promoter:
The Promoter Performs the following main functions:
(1) To conceive an idea of forming a company and explore its possibilities.

(2) To conduct the necessary negotiation for the purchase of business in case it is intended s to purchase as existing business. In this context, the help of experts may be taken, if considered necessary.

(3) To collect the requisite number of persons (i.e. seven in case of a public company and two in case of a private company) who can sign the ‘Memorandum of Association’ and ‘Articles of Association’ of the company and also agree to act as the first directors of the company.

(4) To decide about the following:

  • The name of the Company.
  • The location of its registered office.
  • The amount and form of its share capital.
  • The brokers or underwriters for capital issue, if necessary.
  • The bankers.
  • The auditors.
  • The legal advisers.

(5) To get the Memorandum of Association (M/A) and Articles of Association (A/A) drafted and printed.

(6) To make preliminary contracts with vendors, underwriters, etc.

(7) To make arrangement for the preparation of prospectus, its filing, advertisement and issue of capital.

(8) To arrange for the registration of company and obtain the certificate of incorporation.

(9) To defray preliminary expenses.

(10) To arrange the minimum subscription

Question 10.
State the steps involved in efiling under the companies act 2013.
A) Register Your Self ( Step – I):
Only registered users are allowed to do E-Fling. Registration is a Simple, One time process.

B) Download E-Form ( Step – II):
Go to the Annual filling corner following the link provided at the home page of the MCA portal & download the applicable E-forms following the Link “Downloads E-form”

C) Complete E-Form ( Step – III):
Download e-form MGT-7 & AOC- 4 and fill the complete e-forms and attach respective attachments. Affix DSC of Director and Professional and complete the e-form.

D) Submit E-Form ( STEP – IV ) :
A connection to the internet will be required to carry out- e-filling submission will need to be made at the MCA21 Portal using Specialized Functionality that is provided.

E) Make Payment (Step – V ):
Fees calculation will be done automatically by the system as applicable under the law & the Fee for the services will be displayed to the user. The filling fees will be paid through credit card & internet Banking. The system will generate a receipt that one can retain as a part of your records.

Question 11.
State the documents to be filed at the time of incorporation under the companies act 2013.
Following documents have to be filled at the time of incorporation:

  • Self attested PAN Card (2 Copies) ( attested by gazetted officer or bank manager)
  • Self attested Address Proof – Voter ID/Adhaar Card/ Driving License/Passport (2 Copies) (attested by gazetted officer or bank manager)
  • 5 passport size photographs
  • Self attested Bank Statement/ Electricity Bill/ Mobile Bill/ telephone Bill not older than one month (passbook copy is not accepted)
  • Rental agreement and electricity bill of office address(Electricity bill not older than 1 month) if rented premises
  • NOC (No Objection Certificate)
  • BBMP tax paid receipt and electricity bill of office address (Electricity bill not older than 1 month) if own premises.
  • Nature of Business
  • 6 unique names of company
  • Mail Id and Mobile Number of the Directors/Designated Partners

Question 12.
Give a brief note-on commencement of business under the companies act 2013.
The provisions with regard to Certificate of Commencement of business have been dispensed with under the Companies Bill, 2013. Only declaration and verification is required by the Public Company under the Companies Bill, 2013.

These provisions were as follows:
A company having a share capital shall not commence any business or exercise any borrowing powers unless:
(a) a declaration is filed by a director in such form and verified in such manner as may be prescribed, with the Registrar that every subscriber to the memorandum has paid the value of the shares agreed to be taken by him and the paid-up share capital of the company is not less than five lakh rupees in case of a public company and not less than one lakh rupees in case of a private company on the date of making of this declaration.

(b) the company has filed with the Registrar a verification of its registered office as provided in sub-section (2) of section 12. If any default is made in complying with the requirements of this section, the company shall be liable to a penalty which may extend to five thousand rupees and every officer who is in default shall be punishable with fine which may extend to one thousand rupees for every day during which the default continues.

Where no declaration has been filed with the Registrar under clause (a) of subsection: (1) within a period of one hundred and eighty days of the date of incorporation of the company and the Registrar has reasonable cause to believe that the company is not carrying on any business or operations, he may, without prejudice to the provisions of sub-section (2), initiate action for the removal of the name of the company from the register of companies under Chapter XVIII.

Question 13.
Explain in detail doctrine of ‘ultra vires’.
‘Ultra’ means beyond and ‘vires’ means powers. The term ultra vires a company means that the doing of the act is beyond the legal power and authority of the company. The doctrine of ultra vires is important in defining the limits of the powers conferred on the company by its Memorandum of Association. According to this doctrine, the vires (power) of a company to enter into a contract or transaction is limited by the ambit of the Objects Clause of the Memorandum and the provisions of the Companies Act.

Whatever is not permitted by the Objects Clause and the Act, is prohibited by the doctrine of ultra vires. If a company engages in any activity or enters into any contract which is ultra vires (outside the power conferred by) the Memorandum or Act, it will be null and void so far as the company is concerned and it cannot be subsequently ratified or validated even if all the shareholders give their consent. Thus under this doctrine, a company has powers to engage in only such activities or enter into such transactions:

  • Which are essential to the attainment of the objects specified in the Memorandum.
  • Which are reasonably and fairly incidental to the main objects.
  • Which are permitted by the provisions of the Companies Act.

Effects of Ultra Vires Transactions:
If a company enters into transactions, which are ultra vires, it will have the following effects:
(1) Injunction: Whenever a company goes beyond the scope of the object clause, any of its members can get an injunction from the court to restrain the company from undertaking the ultra vires act.

(2) Personal Liability of Directors: If the transaction is ultra vires, for instance, if the fundsofthecompany are misapplied, the directors will be held personally liable. ‘

(3) Ultra Vires Contracts: Contracts entered into by a company, which are ultra vires, are void ab initio and unenforceable.

(4) Property Acquired Ultra Vires: If a company acquires any property under an ultra vires transaction, it has the right to hold the property and protect it against damage by other persons.

(5) Ultra Vires Torts: A company is not liable for torts committed by its agents or employees in the course of ultra vires transactions.

Question 14.
Give a brief note on book building.
Book building is a systematic process of generating, capturing, and recording investor demand for shares during an initial public offering (IPO), or other securities during their issuance process, in order to support efficient price discovery. Usually, the issuer appoints a major investment bank to act as a major securities underwriter or book runner. Book Building is an alternative method of making a public issue in which applications are accepted from large buyers such as financial institutions, corporations or high net-worth individual, almost on firm allotment basis, instead of asking them to apply in public offer.

Book building is essentially a process used by companies raising capital through public offerings – both initial public offers (IPOs) and follow-on public offers (FPOs) to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process.

Question 15.
State the role of promoters in formation of company.
The role of a promoter is as follows :

  • Discovery a business idea: The promoter identifies the areas of profitable avenues of investment after making preliminary analysis of risk involved, capital required, etc.
  • Detailed investigation: The promoter undertakes detailed investigation of all aspects of the business with the help of experts/specialists, etc. He prepares a project report on its technical, economical and financial feasibility.
  • Assembling of resources: After being satisfied about the project, the promoters make . contacts for the purchase of land,’plant, machines, etc.
  • Preparing preliminary documents: The promoter prepares the essential documents required for the registration of the company.

Question 16.
Discuss the objects of prospectus.
Prospectus refers to any document inviting deposits from the public for the subscription of shares or debentures of a company.
It is the statement which gives all material and essential information about the affairs of the company, indicates the future prospects of the company arouses the interests of the investor in the proposed company and induces them to subscribe to the shares of debentures of the company.

The main objects of issuing a prospectus are:

  • To inform the public about the formation of a new company.
  • To state the prospectus of the company and to induce the public to subscribe to the shares or debentures of the company.
  • To invite offers from the public for the subscription of shares or debentures of the company.
  • To create confidence in the public about the company by providing complete accurate and reliable information and by making the directors responsible for the information given in the prospects.
  • To have an authenticated record of the terms and conditions on which the shares and debentures are issued by the company.

Financial System Very Short Answer Type Questions

Financial System Very Short Answer Type Questions

Question 1.
What is a financial system?
Financial system is a set of inter – related activities or services working together . to achieve some predetermined purpose or goal.

Question 2.
State the components of Indian financial systems.
The components of Indian financial system includes the following:

  • Financial market
  • Financial instruments
  • Financial intermediation
  • Financial service

Question 3.
What is a financial market?
A Financial Market can be defined as the market in which financial assets are created or transferred. It is a place or mechanism where funds or savings are transferred from one section to another section of financial system.

Question 4.
What is financial asset?
Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of interest or dividend.

Question 5.
What is a money market?
The money market is a wholesale debt market for low-risk, highly-liquid, short term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions.

Question 6.
What is a capital market?
A capital market is a market for securities (debt or equity), where business enterprises (companies) and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market includes the stock market (equity securities) and the bond market (debt). The capital market is designed to finance the long-term investments. The ransactions taking place in this market will be for periods over a year

Question 7.
Define financial system.
According to Robinson the primary function of the system is “to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of existing wealth.

Question 8.
What is forex market?
The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe.

Question 9.
What is credit market?
Credit market is a place where banks, FIs and NBFCs provide short, medium and long-term loans to corporate and individuals

Question 10.
What is a commercial paper?
CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery.

Question 11.
What is a call money?
Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is “Call Money”.

Question 12.
Define money market.
According to Geottery Crowther money market is defined as “The market is a i collective name given to the various firms and institutions that deal in the various grader of near money”.

Question 13.
What is treasury bill?
Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder.

Question 14.
What are hybrid instruments?
Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible debentures, warrants etc.

Question 15.
State the various money market instruments.
The various money market instruments are:

  • Call/Notice Money
  • Treasury Bills
  • Term Money
  • Certificate of Deposit
  • Commercial Papers

Question 16.
What do you mean by inter bank term money?
Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

Question 17.
What is primary market?
The primary market is that part of the capital markets that deals with the issuance of new securities Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue.

Question 18.
Distinguish between primary and secondary market.
In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. Secondary market is an equity trading venue in which already existing/pre-issued securities are traded among investors: Secondary market could be either auction or dealer market. While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.

Question 19.
Name any two objectives of money market.
Objectives of money market are:

  • To provide an equilibrium mechanism for solving problems relating to short term surplus and deficits.
  • To provide access to users of short term money to meet their requirements at a reasonable price.

Question 20.
Name any four features of Indian money market.
Features of Indian money market are:

  • Highly organized banking system
  • Presence of a central bank
  • Availability of proper credit instruments
  • Existence of sub markets
  • Demand and supply of funds
  • Ample resources

Question 21.
What is secondary market?
Secondary market, also called aftermarket, is the financial market in which previously issued financial instruments such as stock, bonds,options, and futures are bought and sold.

Question 22.
What is a repo market?
The repo market is one in which two participants agree that one will sell securities to another and make a commitment to repurchase equivalent securities on a future specified date, or on call, at a specified price. In effect, it is a way of borrowing or lending stock for cash, with the stock serving as collateral.

Question 23.
State any two functions of financial market?

  • It provides a channel through which new savings flow into capital market which facilitates smooth capital formation in the economy.
  • It facilitates the transfer of real economic resources from lenders to ultimate borrowers in financial system.
  • It provides the borrowers with funds which they will invest in some productive purpose.
  • It provides liquidity in the market through which the claims against money can be resold by investors at any time and there by assets can be converted in to cash.

Question 24.
State the components of Indian financial system.
The components of Indian financial system are:

  • Financial institutions
  • Financial instruments
  • Financial markets
  • Financial services

Question 25.
State the characteristics of treasury bills.

  • These are issued as a promissory note at discount over their face value.
  • It is used to raise short term funds to bridge seasonal/temporary gaps between receipt and expenditure of the Govt.
  • It is a negotiable instrument.
  • Assured yield and low transaction cost.
  • Eligibility for inclusion in SLR.

Question 26.
What is acceptance market?
Investment market based on short-term credit instruments is termed as acceptance market. An acceptance is a time draft or bill of exchange that is accepted as payment for goods. A banker’s acceptance, for example, is a time draft drawn on and accepted by a bank, which is a common method of financing short-term debts in international trade including import-export transaction.

Question 27.
What is a financial asset?
Financial Assets of Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of interest or dividend.

Question 28.
What is a discount market?
A discount market is the part of the money market consisting of banks, discount houses and brokers on which bills are discounted.

Question 29.
Explain the components of unorganized money market.
The components of unorganized money market comprises of indigenous bankers, money lenders, chit funds, nidhis, loan companies and finance brokers.

Question 30.
Write two differences between money market and capital market.
Money Market:

  • It is market for short – term loanable funds for a period of not exceeding one year.
  • This market supplies funds for financing current business operation, working capital requirements of industries and short – period requirements of the government.

Capital Market:

  • It is a market for long-term funds exceeding a period one year.
  • This market supplies funds for financing the fixed capital requirements of trade and commerce as well as the long-term requirements of the Government.

Question 31.
What is call money market?
Call money market refers to market for very short term funds not exceeding 7 days.

Question 32.
What do you mean by “ Financial Dualism”?
The process which helps in economic development and encourages investment and savings by establishing continuous effective relationship between savings and investment Of the people is called financial dualism.

Question 33.
What do you mean by the malpractice, “Insider Trading”?
The process of creating fraud in capital market by some executives in organizations by making use of unpublished information. They make assumption about these information and misuse their positions in the organization.

Question 34.
Expand Repo.
Repurchase Agreement.

Question 35.
Who are the important players or participant of money market.
Govt, RBI, Banks, Discount and Finance House of India, Financial Institutions, Mutual Funds etc.

Question 36.
What are capital market instruments?
Capital market instruments are broadly divided into two types:

  • Equity instruments
  • Debt instruments

Question 37.
Give the meaning of equity instruments.
Equity instruments are also called as ownership funds comprises equity shares, preference shares and deferred shares.

Question 38.
What is debt instruments?
Debt instruments are also called as creditor ship securities comprises of all interest bearing securities like debentures, bonds, public deposits, bank loans, etc.

Business Finance Notes

Business Finance Notes

Sources of long term financing: The sources of long term financing include ordinary share capital, preference share capital, debentures, long term borrowings form financial institutions and retained earnings.

Equity Shares: Equity shares are also known as ordinary shares or common shares and represent the owners capital in a company. The holders of these shares are the real owners of the company.

Preference Shares: Preference shares have a preference over the equity shares in the event of liquidation of company. The preference dividend rate is fixed and known. A company may issue preference shares with a maturity period (redeemable preference shares). A preference share may also, provide for the accumulation of dividend. It is called cumulative preference share.

Trading on equity: Trading on equity means to raise fixed cost capital such as borrowed capital and preference share capital, on the basis of equity share capital so as to increasing the income of equity shareholders.

Debenture: According to Section 2(12) of the companies act of 1956. “Debenture is an instrument issued by a company under its common seal, acknowledging the debt to the holder, and containing an undertaking to repay the debt on or after a specified period and to pay interest on the debt at a fixed rate at regular intervals usually, half yearly etc. until the debt is paid.”

Retained earning: Retained Earnings is a technique of financial management under which all profits of a company are not distributed amongst the shareholders as dividend but a part of the profits is retained in the company. This is also known as ploughing back of profits.

Term loan: Term loan refers to loan given for a particular period of time. It , may be short or long period. Short term, which is less than a year. Medium term, which lies between two to five years. Long term, which is„ more than 5 years upto 20 years.

Cost of capital: Cost of capital is defined as the minimum rate of return that a firm must earn on its investments so that market value per share remains unchanged.

Cost of equity capital: It refers to the minimum rate of return that a company must earn on the equity share capital financed portion of an investment project so that the market price of share does not change.

Cost of preferred capital: Cost of preference share capital is the rate of return that must be earned on preference capital financed investments, to keep unchanged the earnings available to the equity shareholders.

Cost of debt capital: Cost of debt refers to the minimum rate of return expected by the suppliers of debt capital.

Weighted average cost of capital: Weighted average cost of capital is nothing but overall cost of capital. In other words in case of WACC proper weightage is given to the cost of each and every source of funds i.e. proper assessment Of relative proportion of each source of funds, to the total, is ascertained by considering either the book value or the market value of each source, of funds.

Capital structure: Capital structure is basically focussed towards the objective of profit maximisation? Capital structure is nothing but the financial structure of a firm, which consists of different combinations of securities. In other words it represents the relationship between the various long term forms of financing such as debentures, preference shares capital on equity etc.

Optimal capital structure: “OCS refers to that Capital structure or combination of debt and equity that leads to the maximum value of the firm”. Hence thereby the wealth of its owners also increases with the minimisation of cost of capital.

Flexible capital structure: Flexible capital structure means the capital structure of the firm should be flexible, so that without much practical difficulties, a firm can change the securities in capital structure.

Capital expenditure: Capital expenditure refers to investment that Involves huqe amount, associated with high risk and the benefits from such investment are derived over a longer period of time.

Leverage: Leverage is the employment of fixed assets or funds for which a firm has to meet fixed costs or fixed rate of interest obligation irrespective of the level of activities attained or profit earned.

Types of leverages:

  • Operating leverage
  • Financial leverage.
  • Combined leverage.

Personal leverage: Personal, leverage refers to an individual replicating the advantages of corporate debt by borrowing on personal account and subscribing for an equivalent amount of shares in an unlevered company.

Financial leverage: The use of long term fixed interest and dividend bearing securities like debentures and preference shares along with equity is called financial leverage or trading on equity.

Operating Leverage: The operating leverage occurs when a firm has fixed costs which must be recovered irrespective of sales volume. The fixed costs remaining same the percentage change in operating revenue will be more than the percentage change in sales. This occurrence is known as operating leverage.

Net income approach (NIA): Under this approach, the cost of equity capital and cost of debt capital are assumed to be independent to the capital structure.

Net operating income approach (NOIA): Under this approach, the cost of equity increases in accordance with leverage. Due to which the weighted average cost of capital remains constant and the value of the firm also remains constant as leverage is changed.

Traditional approach of capital structure: The traditional approach of capital structure states that when the Weighted Average Cost of Capital (WACC) is minimized, and the market value of assets are maximized, an optimal structure of capital exists.

MM approach of capital structure: The Modigliani – Miller (MM) hypothesis is identical to the net operatinq income approach. MM arque, that in the absence of taxes, a firm’s market value and the cost of capital remain invariant to the capital structure changes.

Advantages of equity shares:

  • It is a good source of long – term finance
  • It serves as a permanent source of capital
  • Issuance of equity share capital creates no charge on the assets of the company.

Disadvantages of equity shares:

  • The cost of issuance of equity shares is high
  • Trading on equity is not possible
  • Excessive issue of equity shares may result in over-capitalization..

Advantages of Preference Shares are:

  • Fixed return
  • Absence of charge on assets
  • Capital structure flexibility
  • Widening of the capital market
  • Less capital losses.

Disadvantages of Preference Shares are:

  • Dilution of claim over assets
  • Tax disadvantages
  • Increase in financial burden.

Advantages of debentures:

  • Less costly
  • Tax deduction
  • No ownership dilution
  • Fixed interest
  • Reduced real obligation.

Limitations of debentures:

  • Obligatory payment.
  • Financial risk associated with debenture is higher than equity share’s.
  • Cash out flow on maturity is very high.

Merits of long – term loan:

  • Cash Flow.
  • Save time.
  • Increase flexibility
  • Lower interest rates
  • Build credit.

Disadvantages of long – term loans:

  • Liquidation
  • Risk.
  • Collateral
  • Contract contents.

Basic qualities which a sound capital structure should possess:

  • Profitability.
  • Solvency.
  • Flexibility.

Assumptions of MM Hypothesis:

  • There are perfect capital markets
  • Investors behave rationally
  • Information about the company is available to all without arty cost
  • There are no floatation and transaction costs
  • No investor is large enough to effect the market price of shares
  • There is no risk or uncertainty in regard to the future of the firm.
  • The firm has, a rigid investment policy

Business Finance Long Answer Type Questions

Business Finance Long Answer Type Questions

Question 1.
Explain various Long Term Sources of Finance.
Explain in detail long term sources of raising capital.
The various sources of finance have been classified as follows:
(A) Security/External Financing: Corporate securities can be classified under two categories:

  • Ownership Securities or Capital Stock
  • Creditorship securities or Debt Capital

(i) The term Ownership securities represents shares. Shares are the most universal form of raising long term funds from the market. The capital of a company is’ divided into a number of equal parts known as shares. Companies issue different types of shares to mop up funds from investors. The various kinds of shares are discussed as follows:
(a) Equity Shares: Equity shares are also known as ordinary shares or common shares and represent the owners capital in a company. The holders of these shares are the real owners of the company. They control the working of the company. The rate of dividend on these shares depends upon the profits of the company. Equity capital is paid after meeting all other claims including that of preference shareholders. Equity share capital cannot be redeemed during the lifetime of the company.

Public Issue of Equity means raising of share capital directly from the public. As per the existing norms, a company with a track record is free to determine the issue price for its shares. Thus, it can issue shares at a premium. However, a new company has to issue its shares at par.

Private Placement involves sale of shares by a company to few selected investors, particularly the institutional investors like UTI, LIC and IDBI.

Rights issue involves selling of ordinary shares to the existing shareholders of the company. Law in India requires that new ordinary shares must be first issued to existing shareholders on a pro-rata basis. This pre-emptive right can be forfeited by shareholders through a special resolution.

(b) Preference Shares: These shares have certain preferences as compared to other types of shares. There is a preference for payment of dividend and there is a preference for repayment of capital at the time of liquidation of the company. A fixed rate of dividend is paid on preference share capital. Preference shareholders do not have any voting rights and hence they have no say in the management of the company. However, they can vote if their own interests are affected.

(c) Deferred Shares: Also known as Founders Shares, these shares were earlier issued to promoters or founders for services rendered to the company. These shares rank last so far as payment of dividend and repayment of capital is concerned. These shares are generally of a small denomination.

(ii) Creditorship Securities, also known as ‘debt capital’, represents debentures and bonds. A debenture is an acknowledgement of a debt. It is a long-term promissory note for raising loan capital. A debenture or bondholder is a creditor of the company. A fixed rate of interest is paid on debentures. The debentures are generally given a floating Charge over the assets of the company. They are paid on priority in comparison to all other creditors.

(B) Internal Financing
(i) Retained Earnings is a technique of financial management under which all profits of a company are not distributed amongst the shareholders as dividend but a part of the profits is retained in the company. This is also known as ploughing back of profits. A part of the profits is ploughed back or re-employed into the business and is regarded as an ideal source of financing expansion and modernisation schemes as there is no immediate pressure to pay a- return on this portion of stockholders equity. A part of total profits is transferred to reserves such as General Reserve, Reserve Fund, Replacement Fund etc.

(ii) Depreciation as a source of funds Depreciation may be regarded as the capital cost of assets allocated over the life of the asset. It is a gradual decrease in the value of asset due to wear and tear, use and passage of time. In reality depreciation is simply a book entry having the effect of reducing the book value of the asset and profits of the current year for the same amount.

It is a non fund item. Hence, although depreciation is an operating cost there is no actual outflow of cash and so the amount of depreciation charged during the year is added back to profits while finding funds from operations. It is an indirect source of fund as it helps a concern to effect savings in taxes and dividends. However this is true only if the concern is making profits.

Question 2.
Explain the factors influencing the determination of the capital structure of a company.
The following factors have practical implications for-capital structure of a business enterprise.
Control: The management control over the firm is one of the major determinants of capital structure decisions. The equity shareholders are considered as the real owners of the company, since they can participate in the decision making through the BOD. Preference shareholders and debentures holders cannot participate in decision making.

Risk: Risk and return always go hand in hand. Business risks are influenced by demand price, input costs, fixed costs, business cycles, competition etc. The business risk of a firm is determined by the accumulated investments the firm makes over time. A firm with high business risk prefer to have low levels of debt, since the volatility of its earnings is-more. A firm with low level of business risk can have higher debt component in capital structure, since the risk of variations in expected earnings is lower.

Income: Increase of return on equity shareholders depends on the method of financing and its impact on EPS and ROE. If the levels of EBIT is low from EPS point of view, equity is preferable to debt. If the EBIT is high from EPS point of view, debt financing is preferable. IF the ROI is less than the cost’ of debt, financial leverage depress ROE. When the ROI is more than cost of debt, financial leverage enhances ROE.

Tax Consideration: Under the provisions of the IT Act,, the dividend payable on equity capital and preference capital is not tax deductible, causing the high cost of such funds. Interest paid on debt is deductible from income and reduces a firm’s tax liabilities. The tax saving on interest charges reduces the cost of debt funds, Debt, thus, has tax advantage over equity.

Cost of capital: Cost of different components of capital will influence the capital structuring decisions. A firm should possess earning power to generate revenues to meet its cost of capital and finance its future growth. The cost of debt funds are cheaper as compared to cost of equity funds due to tax advantage. . But increased gearing causes the increase in expectations of debt providers for accepting more risk.

Trading on Equity: The basic objective of financial management is to enhance the wealth of the firm by increasing the market value of the share. The firm’s wealth is increased, if after tax earnings are increased. A company raises debt at low cost with a view to enhance the earnings of the equity shareholders.

Investors attitude: In a segmented market, different sets of investors measure risk differently or by simply charging different rates on the capital that they invest. By. choosing the instrument that taps the cheapest market, firms lower their cost of capital.

Flexibility: Debt capital has got the characteristic of greater flexibility than equity capital and this influences the capital structure decisions. As and when required, debt may be raised and it can be paid off as and when desired.

But in case of equity, once the funds are raised through the issue of equity shares, it cannot ordinarily be reduced except with the permission of the court and compliance with a lot of legal obligations.

Market conditions: In times of boom, it is easier to raise equity, but in times of recession, the equity investors will not show much interest and the firm has to rely on debt funds.

Legal Provisions: Raising of equity capital is mote complicated than raising debt.

Profitability: A company with higher profitability will have low reliance on outside debt and it will meet its additional requirements through internal, generation.

Growth Rate:Fast growing companies reply more on debt than on equity.

Government policy: Monetary and fiscal policies of the government also affect capital structure decisions.

marketability: The company’s ability to market its securities will affect the capital structure decisions.

Company size: Companies with small capital base rely more on owner’s funds and internal earnings.

Purpose of financing: Long term projects are financed through long term sources and in the form of equity. Short term projects are financed by issue of debt instruments and by raising of term loans from banks and financial institutions.

Question 3.
Explain two different theories or approaches of capital structure.
As far as the concept of capital structure is concerned a number of eminent scholars have made th^ir respective contributions. Few among them are David Durand, Ezra Solomon, Modigliani and Miller etc.

According to David Durand who has rightly said that there cannot be an optimal capital structure. He classifies the theory of capital structure into two extreme views. They are: (a) Net income approach (b) Net operating income approach

(a) Net income approach (NIA): Under this approach, the cost of equity capital and cost of debt capital are assumed to be independent to the capital structure. The value of the firm rises by the use of more and more leverage and the weighted average cost of capital declines.

The crucial assumptions of this approach are:

  • The use of debt does not change the risk perception of investors, as a result, the equity capitalisation rate and the debt capitalisation rate remain constant with changes in leverage.
  • The debt capitalisation rate is less than the equity capitalisation rate
  • Corporate income taxes do not exist

(b) Net operating income approach (NOIA): Under this approach, the cost of equity increases in accordance with leverage. Due to which the weighted average cost of capital remains constant and the value of the firm also remains constant as leverage is changed.

The critical assumptions of the NOIA approach are:

  • The market capitalises the value of the firm as a whole. Thus the split between debt and equity is not important.
  • The market uses an overall capitalisation rate to capitalise the net operating income. This rate depends on the business risk. If business risk is assumed to remain unchanged, the capitalisation rate is a constant.
  • The use of the costly debt funds increases the risk of shareholders. This causes the equity capitalisation rate to increase. There the advantage of debt is offset exactly by the increase in equity capitalisation rate.
  • The debt capitalisation rate is a constant
  • Corporate income taxes do not exist.

Practical Problems

Problems on Cost of Capital:

Question 1.
AB Ltd. issues ₹ 1,00,000 9% debentures at a premium of 10%.
Cost of Debt = Ki = \(\frac { I }{ Np }\) x (1 – T)
Np = 1,00,000 + 10% premium – Floatation cost
= 1,00,000 + 10,000 – 2,500 = 1,07,500
Ki = 9,000/1,07,500 (1 – 0.5) x 100 = 4.18 %

Question 2.
What is the net benefit cost ratio when benefit cost ratio is 1.40:1?
Benefit cost ratio = 1.40:1
Total revenue = 1.40
Cost = 1
Therefore Net benefit = 1.40 – 1
= 40
Therefore Net benefit cost ratio = 0.4 : 1

Question 3.
The Market price of the equity of a Ltd. Co. is ₹ 160. The dividend expected after a year is ₹ 12 per Share. The dividend is expected to grow at a constant rate of 4 percent per annum. Find the rate of return required by shareholders.
γe = \(\frac{\mathrm{D} 1 \mathrm{~V}_{1}}{\mathrm{P}_{0}}\)
Where γe = Rate of return required by shareholders
D1V1 = Expected dividend
P0 = Current market price
g = Growth rate of dividends.
∴ ye = \(\frac { 12 }{ 160 }\) + 0.04 = 0.075 + 0.04
ye = 0.115 or 11.5%
Hence the rate of return required by shareholders is 11.5%

Question 4.
The expected average earnings per share of a company are ₹ 16 and the current market price of the shares is ? 160. Find out the cost of equity.

Question 5.
The market price of a share is ₹ 255. A company anticipated earnings of ₹ 3,00,000 to be distributable among 30000 shareholders. The tax rate is 30 per cent. Find out the cost of internally generated retained earnings.

Question 6.
The shares of a leather Company are selling at 60 per shares. The firm has paid dividend at the rate of ₹ 3 per share. The growth rate is 9%. Compute cost of equity capital of the company.
Kc = \(\frac { D }{ P }\) + g
= \(\frac { 3 }{ 60 }\) + 0.09
= 0.05 + 0.09
= 0.14 x 100
= 14%

Question 7.
20 years 20% debentures of a firm are sold at a rate of ₹ 180. The face value of the debenture is 200, 50% tax is assumed. Find the cost of debt.

Question 8.
A Ltd, company with net operating earnings ₹ 6,00,000 you want to evaluate possible capital structures, shown below, Which capital structure you will select? Why?

Question 9.
XYZ Ltd. Co; has the following securities In its capital structure.
Source – Amount(₹)
Debt – 6,00,000
Preference capital – 4,00,000
Equity capital – 10,00,000
Total – 20,00,000
The after tax cost of capital is as follows
After tax cost
Cost of debt – 8%
Cost of preference shares – 14%
Cost of equity capital – 17%
From the above information compute weighted average cost of capital by using the book value weights.

Question 10.
Mr. Kiran is considering to purchase 20% ₹ 2,000 preference share redeemable after 6 years at par. What should he be willing to pay now to purchase the share assuming that the required rate of return is 14%.

Question 11.
A company issues a new 15% debentures of ₹ 1,000 face value to be redeemed after 10 years. The debentures are expected to be sold at 5% discount. It will also involve flotation cost of 5%. The company’s tax rate is 30%. What would be the cost of debt?

Question 12.
XYZ Company has debentures outstanding with 5 years left before maturity. The debentures are currently selling for ₹ 90 (face value is 100 ₹) The debentures are to be redeemed at 5% premium. The interest is paid annually at a rate of interest of 12%. The firm’s tax rate is 35%. Calculate Kd.

Question 13.
Alfa Ltd., with net operating earnings of ₹ 3 lakhs is attempting to evaluate a ,number of capital structures given below. Which of the capital structure will you recommend and why?

Question 14.
Kishan Limited wishes to raise additional finance of ₹ 20 Lakh for meeting its investment plans. It has ₹ 4,20,000 in the form of retained earnings available for Investment purposes. The following details are available.
1. Debt /equity mix 30% : 70%
2. Cost of debt upto ₹ 3,60,000 – 10% (Before tax)
Cost of debt beyond ₹ 3,60,000 – 16% (Before tax)
3. Earnings per share: 4
4. Dividend payout : 50% of earnings
5. Expected growth rate of dividend: 10%
6. Current market price: 44
7. Tax rate: 50%
You are required:
a. To determine the pattern for raising the additional finance.
b. To determine the post-tax average cost of additional cost.
c. To determine the cost of retained earnings and cost of equity.
d. Compute the overall weighted average after tax cost of additional finance.

Question 15.
Varsha Ltd. wishes to raise additional finance of ₹ 10 lakhs for meeting its investment plans. It has ₹ 2,10,000 in the form of retained earnings available for investment purposes. The following are the further details.
(a) Debt / Equity mix – 30% 70%
(b) Cost of debt
up to 1,80,000 – 10% (before tax)
beyond ₹ 1,80,000 – 16% (before tax)
(c) Earnings per share – ₹ 4
(d) Dividend payout – 50%
(e) Expected growth rate in dividend – 10%
(f) Current market price per share – ₹ 44
(g) Tax rate – 50%
You are required.
(a) To determine the pattern for raising additional finance.
(b) Compute the weighted average cost of capital.

Question 16.
Thee companies A,B, and C are in the same business and hence have similar operating risks. However, the capital structure of each firm is different.

Problems On Capital Structure

Question 1.
It is proposed to start a business requiring capital of ₹ 10 lakhs and expected return is 15%. Calculate EPS if
(a) Total capital required is financed by was of ₹ 100 equity.
(b) Is financed by way of 50% equity and 50% debt (10% Interest)
Note Tax rate 50%

Question 2.
The P Ltd, has equity share capital of ₹ 10,00,000 in shares of ₹ 10 each and debt capital of ₹ 10,00,000 at 20% interest rate. The output of the company is increased by 50% from 1,00,000 units to 1,50,000 units. Selling price per unit – ₹ 20, Variable cost per unit – ₹ 10, Fixed cost – ₹ 5,00,000, Tax rate – 40%.
You are required to calculate: (a) Percentage increase in EPS (b) Degree of operating leverage at 1,00,000 units and 1,50,000 units (c) Degree of financial leverage at 1,00,000 units and 1,50,000 units.

Question 3.
Determine the earnings per share of a company which has operating profit of ₹ 4,80,000. Its capital structure consists of the following securities.
Securities – Amount
10% debentures – 15,00,000
12% preference shares – 3,00,000
Equity shares of 100 ₹ each
The company is in the 55% tax bracket.
(1) Determine the company’s EPS (2) Determine the percentage change in EPS, associated with 30% increase and 30% decrease in EBIT. (3) Determine the degree of financial leverage.

Question 4.
A company needs ₹ 10,00,000 for construction of a new plant.
The following three financial plans are feasible.
(1) The company may issue 1,00,000 ordinary shares at ₹ 10 per share.
(2) The company may issue 50,000 ordinary shares at ₹ 10 per share and 5,000 debentures of ₹ 100 denomination bearing 8% rate of interest.
(3) The company may issue 50,000 ordinary shares at ₹ 10 per share and 5,000 preference shares at ₹ 100 per share bearing a 8% rate of dividend.
If the company’s earnings before interest and taxes are ₹ 20,000, ₹ 40,000, ₹ 80,000, ₹ 1,20,000 and ₹ 2,00,000 share. What are the earnings per share under each of the three financial plans? Which alternative would be recommended and why. Assume a corporate tax @ 50%.

Question 5.
The following information of a business concern is available who close their books of accounts on Dec 31st of every year. Calculate EPS and return on equity capital.
(a) 10,000 equity shares of 10 each and ₹ 8 paid up Rs 80,000
(b) 10% 12,000 preference shares of 10 each ₹ 1,20,000
(c) Profit before tax ₹ 80,000
(d) Rate of tax applicable 50%

Question 6.
The capital structure of ABC Ltd. consists of the following securities.
10% Debenture ₹ 5,00,000
12% Preference shares ₹ 1,00,000
Equity shares of ₹ 100 each ₹ 4,00,000
Operating profit (EBIT) of ₹ 1,60,000 and the company is in 50% tax bracket.
(1) Determine the company’s EPS.
(2) Determine the percentage change in EPS associated with 30% increse and 30% decrease in EBIT.
(3) Determine the financial leverage.

Question 7.
The Balance sheet of ABC company Ltd as on 31-12-2003 gives the following details.

Question 8.
A company has a capital of ₹ 2,00,000 divided into shares of ₹ 10 each It has major expansion programme requiring an investment of another ₹ 1,00,000. The management is considering the following alternatives for raising this amount.
(1) Issue of 10,000 shares of ₹ 10 each
(2) Issue of 10,000 12% preference shares of ₹ 10 each
(3) Issue of 10% debentures of ₹ 1,00,000
The, company’s present earnings before interest tax (EBIT) is ₹ 60,000 p.a. You are required to calculate the effect of each of the above modes of financing on the earnings per share (EPS) presuming:
(a) EBIT continues to be the same even after expansion
(b) EBIT increases by 20,000
(c) Assume tax liability as 50%

Question 9.
The Balance sheet of key Ltd on 31/12/2002
Balance Sheet

Liabilities Assets
Equity capital ₹ 10 per share 10% Debenture Retained earnings 1,20,000
Net fixed assets Current Assets 3,00,000
4,00,000 4,00,000

The company’s total turnover ratio is 3. Its fixed operating cost are ₹ 2,00,000 and the variable cost ratio is 40% The income tax rate is 50% a) Calculate for the company all the there types of leverages b) Determine the likely level of EBIT if EPS is ₹ 5.

Question 10.
The Balance Sheet of a company is as follows:

Liabilities Amount Assets Amount
Equity shares ₹ 10 each 10% Debenture P & L A/c Creditors 6,00,000
Fixed assets
Current Assets
20,00,000 20,00,000

The company’s total assets turnover ratio is 5 times. Its fixed operating expenses are ₹ 10,00,000 and variable cost is 30%. Income Tax 50%.
1) Calculate all the leverages
2) Show the likely level of EBIT if EPS is a) 5 b) 3 c) 2

Question 11.
Compare two companies in terms of its financial, operating leverages and combined leverage.

Question 12.
The Capital Structure of the Progressive Corporation Ltd. Consist of an Equity Share capital of ₹ 10,00,000 (shares of ₹ 10 par value) and ₹ 10,00,000 of 20% Debentures. Sales increased by 25% from 2,0, 000 units to 2,50,000, the selling price is ₹ 10 per unit, variable cost amount to ₹ 6 per unit and fixed expenses amount to ₹ 2,50,000. Income tax rate is assumed to be 50%.
You are required to calculate the following:
i) The percentage increase in EPS
ii) The DFL at 2,00,000 units and 2,50,000 units.
iii) The DOL at 2,00,000 units and 2,50,000 units.

Question 13.
A company has EBIT of 4,80,000 and its capital structure consists of the following securities.

Equity Share Capital (₹ 10 each) – 4,00,000
12% preference shares – 6,00,000
14.5% debentures – 10,00,000
The company is facing fluctuations in its sales. What would be the change in EPS.
(a) If EBIT of the company incresed by 25% and
(b) If EBIT of the company decreased by 25%. The corporate tax is 35%.

Question 14.
Omax Auto Ltd. has an equity share capital of ₹ 5,00,000 divided into shares of ₹ 1oo each. It wishes to raise further ₹ 3,00,000 for modernization. The company plans the following financing schemes:
(a) All equity shares
(b) ₹ 1,00,000 in equity shares and ₹ 2,00,000 in 10% debentures
(c) All in 10% debentures
(d) ₹ 1,00,000 in equity shares and ₹ 2,00,000 in 10% preference shares. The company’s EBIT is ₹ 2,00,000. The corporate tax is 50%. Calculate EPS in each case. Give a comment as to which capital structure is suitable.

Question 15.
A companys capital structure consists of the following:
Equity shares of ₹ 100 each ₹ 10,00,000
Retained earnings ₹ 5,00,000
9% Pref. shares ₹ 6,00,000
7% debentures ₹ 4,00,000
Total ₹ 25,00,000
The company earns 12% on its capital, the income tax rate is 50%. The company requires a sum of ?12,50,000 to finance its expansion programme for which the following alternatives are available.
(i) Issue of 10,000 equity shares at a premium of ₹ 25 per share.
(ii) Issue of 10% preference shares
(iii) Issue of 8% debentures.
It is estimated that the P/E ratios for equity, preference and debenture financing would be 21.4,17 and 15.7 respectively. Which of the three financing alternatives would you recommend and why?