Case studies
Ch-8
Case 1: Faulad Steel Ltd.
Faulad Steel Ltd. is a multi-product company, manufacturing steel
pipes in wide range for wide spectrum of application. Recently the
company received a big order from an MNC for which it requires
additional funds. The finance manager reported that the company is
not in a position to bear extra burden of explicit cost and equity
shareholders insisted not to issue more shares as it can affect their
control consideration. Now, the company has only one option, i.e.,
ploughing back of profit.
Q1: ‘Company is not in a position to bear extra burden of explicit
cost.’ Identify the meaning of explicit cost in the context of equity
shares.
(a) Dividend
(b) Interest
(c) Market value of shares
(d) Operating expenses
Correct Answer: Option (a)
Explicit cost in the context of equity shares refers to the direct financial
obligation a company incurs. For equity, this is primarily the dividend,
which is a portion of profits paid to shareholders. The finance
manager's concern is that paying dividends would increase the
financial burden on the company. Unlike interest on debt, dividends
are not mandatory but are expected by shareholders. Issuing new
equity could dilute ownership and control, thus dividends are
considered a cost. Explicit costs are typical business costs that appear
in the general ledger and have a direct impact on the profitability of a
company. Examples of explicit costs include salaries, raw materials,
utilities, lease payments, and other direct costs.
Q2: Right to control is enjoyed by which of the following sources
of finance?
(a) Debentures
(b) Equity shares
(c) Retained earnings
(d) Preference shares
Correct Answer: Option (b)
Equity shares are long-term financing sources for any company.
These shares are issued to the general public and are
non-redeemable in nature. Investors in such shares hold the right to
vote, share profits and claim assets of a company.
Q3: ’.............. can affect their control consideration.’ What is the
meaning of control consideration in this context?
(a) Control over funds
(b) Control over management
(c) Control over risks
(d) Control over the activities of the company
Correct Answer: Option (d)
Control Consideration means the amount per Company Share to be
received by Company Shareholders in connection with a Change of
Control Transaction, with any non-cash consideration valued as
determined by the value ascribed to such consideration by the parties
to such transaction.
Q4: In the above case, which of the following sources of finance
is most suitable?
(a) Shares
(b) Debentures
(c) Retained earnings
(d) Bank loans
Correct Answer: Option (c)
Retained earnings are funds generated from the company's profits,
not distributed as dividends, and reinvested in the business. This
source does not incur explicit costs like interest or dilute ownership,
maintaining existing shareholder control. Ploughing back profits aligns
with the company's situation, where external financing options, like
issuing shares or taking on debt, are not viable. Using retained
earnings is cost-effective and supports financial stability without
affecting shareholder influence. Retained earnings (RE) is the amount
of net income left over for the business after it has paid out dividends
to its shareholders. The decision to retain the earnings or distribute
them among the shareholders is usually left to the company
management.
Case 2: Saksham Ltd.
Saksham Ltd., a firm manufacturing textiles, needs to finance its
day-to-day expenses, like, wages, rent, maintain stock of raw material,
etc. Other than this, the company also decides to set up a new plant at
an estimated cost of ` 5 crores. The finance manager of the company,
Mr. Ramakant was asked by the management to do the financial
planning by identifying most suitable source of raising long-term funds
for financing the investment decision and short-term sources for
working capital decision. As per the suggestions of Mr. Ramakant, the
company approached their raw material supplier to give them credit
for three months, so that the company can get cloth for making
garments without making immediate payment. For long-term
investment, the company had issued equity and preference shares to
meet its requirement. This decision resulted in payment of large
amount of taxes to government as dividend on shares is not deducted
from total income of the company before calculating income tax. But
this situation could be avoided if company had chosen borrowed funds
as a source of finance.
Q5: State the source of finance, suggested by Mr. Ramakant to
finance working capital decision.
(a) Trade credit
(b) Public deposits
(c) Equity and Preference shares
(d) Retained earnings
Correct Answer: Option (a)
The source of finance suggested by Mr. Ramakant to finance the
working capital decision is trade credit. Trade credit is an arrangement
where suppliers allow the company to purchase goods or services and
pay for them later, typically within 30 to 90 days. This method helps
the company manage its cash flow efficiently by deferring payments,
allowing it to use its available funds for other immediate expenses.
Trade credit is a common short-term financing strategy for managing
day-to-day operational costs.
Q6: State the factors which have not been kept in mind for
selecting source of long-term finance.
(a) Risk involved
(b) Financial capacity of the firm
(c) Time period
(d) Tax benefits
Correct Answer: Option (d)
Long-term finance can be defined as any financial instrument with
maturity exceeding one year (such as bank loans, bonds, leasing and
other forms of debt finance), and public and private equity
instruments. Equity, which has no final repayment date of a principal,
can be seen as an instrument with non finite maturity.
Q7: State the source of finance which can give the benefit of tax
saving.
(a) Equity Shares
(b) Debentures
(c) Both (a) and (b)
(d) Neither (a) nor (b)
Correct Answer: Option (b)
Debentures are a debt instrument used by companies and
government to issue the loan. Debentures are also known as a bond
which serves as an IOU between issuers and purchaser. Companies
use debentures when they need to borrow the money at a fixed rate of
interest for its expansion.
Q8: Identify the fund needed for the day-to-day operations of
business.
(a) Working capital
(b) Trading capital
(c) Equity capital
(d) Debt capital
Correct Answer: Option (a)
Working capital is the money used to cover all of a company's
short-term expenses, which are due within one year. Working capital
is the difference between a company's current assets and current
liabilities. Working capital is used to purchase inventory, pay
short-term debt, and day-to-day operating expenses.
Q9: Equity shares are long term sources of Business Finance.
(a) True
(b) False
Correct Answer: Option (a)
Equity shares are one of the most important financial instruments to
raise long-term funds needed for the incorporation, expansion, and
growth of an organization. These shares are treated as the base for
capital formation of the organization. Equity shareholders are
considered as the real owners of the organization.
