Financial Decisions, Capital Structure

1 Mark Questions

1. Define capital structure. (Delhi 2014)

Ans. Capital structure can be defined as the mix between the owners' funds and borrowed funds. Capital Structure = Debt/Equity

1. How does cost of debt affect the capital structure of a company? State.(Foreign 2014, Delhi 2009)

Ans. When a firm is able to borrow at a lower rate, ft increases the capacity to employ higher debt and can increase the debt component in the capital structure.

1. What is meant by financial risk? (All India 2014)

Ans. Financial risk refers to a position when a company is not able to meet its fixed financial charges namely interest, preference dividend payment and repayment obligations.

1. Name the major determinant of dividend decision. (All India 2011)

Ans. Dividends are paid out of current and past earnings. Therefore, earning is the most important determinant of dividend decision.

1. Which type of companies can declare higher dividend? (Delhi 2011 c)

Ans. A company having stable earnings is in a position to declare higher dividends.

1. Name the financial decision which will help a businessman in opening a new branch of its business. (Hots; Delhi 2010)

Ans. Investment decision helps a businessman in opening a new branch of its business.

1. Cost of debt is lower than the cost of equity share capital. Give reason why

even then a company cannot work only with the debt? (Hots, - All India 2010; Delhi 2010)

Ans. A company cannot work only with debt because a company cannot be formed or be in existence without equity.

8. What is meant by floatation cost? (Delhi 2009 c)

Ans. Floatation costs are those expenses which are incurred while issuing securities like equity shares, preference shares, debentures, etc, e.g. underwriting commission, brokerage, stamp duty, listing charges, etc.

9. Which component of capital structure determines the overall financial risk in an organisation? (Hots; Delhi 2009 c)

Ans. Proportion of debt in the total capital determines the overall financial risk.

10. What does higher business risk indicate? (All India 2009; Delhi 2009)

Ans. Higher business risk indicates high fixed operating cost.

11. What is meant by cost of equity? (All India 2009)

Ans. Equity shareholders expect a return on their investment, i.e. Earnings per Share (EPS). When a company increases debt, the financial risk faced by the equity shareholders increases and then EPS starts decreasing with inclusion of debt beyond a certain point. Thus, cost of equity may go up sharply and share price may decrease.

12. What does a firm's lower business risk indicate? (All India 2009)

Ans. A firm's lower business risk indicates that a firm has lowered operating cost and can raise more capital by issue of debt securities. Whereas, at the time of high business risk, it should depend upon equity.

13.'A company wants to establish a new unit in which a machinery of worth? 10 lakh is involved'. Identify the type of decision involved here in financial management. (HOTS; Delhi 2008)

Ans. The given situation pertains to investment in fixed assets of the business. Hence, it is capital budgeting decision or fixed investment decision.

1. Name the concept which increases the return on equity shares with a change

in the capital structure of a company. (Delhi 2008) Ans. Trading on equity increases the return on equity shares with a change in the capital structure of a company.