Business Finance Very Short Answer Type Questions

Business Finance Very Short Answer Type Questions

Question 1.
What, are sources of long term financing?
Answer:
The sources of long term financing include ordinary share capital, preference share capital, debentures, long term borrowings form financial institutions and retained earnings.

Question 2.
What are equity Shares?
Answer:
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.

Question 3.
What are Preference Shares?
Answer:
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.

Question 4.
What is trading on equity?
Answer:
Trading on equity means to raise fixed cost capital such as borrowed capita! and preference share capital on the basis of equity share capital so as to increasing the income of equity shareholders.

Question 5.
Define a debenture.
Answer:
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.”

Question 6.
What is retained earning?
Answer:
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.

Question 7.
What do you mean by term loan?
Answer:
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.

Question 8.
What is cost of capital?
Answer:
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.

Question 9.
What do you mean by cost of equity capital?
Answer:
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.

Question 10.
What is cost of preferred capital?
Answer:
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.

Question 11.
What is cost of debt capital?
Answer:
Cost of debt refers to the minimum rate of return expected by the suppliers of debt capital. It is instrument that yields to protect the shareholdeer’s interest.

Question 12.
What is weighted average cost of capital?
Answer:
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.

Question 13.
What is capital structure?
Answer:
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.

Question 14.
What is optimal capital structure?
Answer:
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.

Question 15.
What do you mean by flexible capital structure?
Answer:
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.

Question 16.
What is capital expenditure?
Answer:
Capital expenditure refers to investment that involves huge amount, associated with high risk and the benefits from such investment are derived over a longer period of time.

Question 17.
What is leverage?
Answer:
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.

Question 18.
What are the different types of leverages?
Answer:
There are three types of leverages.

• Operating leverage
• Financial leverage
• Combined leverage

Question 19.
What do you mean by personal leverage?
Answer:
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.

Question 20.
What is a financial leverage?
Answer:
The use of long term fixed interest and dividend bearing securities like debentures a«d preference shares along with equity is called financial leverage or trading on equity.

Question 21.
What is Operating Leverage?
Answer:
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.

Question 22.
Expand EAT,EBIT and PAT?
Answer:
EAT = Earnings after Tax
FBIT = Earnings Before Interest and Tax
PAT – Profit after tax

Question 23.
What is EPS?
Answer:
EPS = Earnings per share.
The formula for computing EPS: \(\frac{\text { Earnings available for equity Shareholders }}{\text { number of equity shares }}\)

Question 24.
What is Net Income Approach?
Answer:
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.

Question 25.
Give the meaning of Net Operating Income Approach.
Answer:
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.

Question 26.
What is capital budgeting?
Answer:
Capital budgeting is the planning process used to determine whether an organization’s long term investments such as new machinery, replacement of machinery, new plants, new products and research development projects are worth the funding of cash through the firm’s capitalization structure.

Question 27.
What is traditional approach of capital structure?
Answer:
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.

Question 28.
State the MM approach of capital structure.
Answer:
The Modigliani – Miller (MM) hypothesis is identical to the net operating income approach. MM argue, that in the absence of taxes, a firm’s market value and the cost of capital remain invariant to the capital structure changes.