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Financial Management

Question
CBSEENBS12004237
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Are the shareholders of a company likely to gain with a debt component in the capital employed? Explain with the help of an example.

Solution

Yes, the shareholders of a company likely to gain with a debt component in the capital employed. It is clarified in the following example:

EBIT - EPS Analysis

Liabilities

‘X’ Co. (र)

‘Y’ Co. (र)

Equity Share Capital (Face Value Per Equity Share र 10)

10,00,000

4,00,000

10% Debentures

  

6,00,000

Total Capital

10,00,000

10,00,000

It is clear from the above table that both the companies have raised र 10,00,000 as total capital. But X-Co. has raised it by issuing equity capital. On the other hand, Y-Co. has raised र 4,00,000 by issuing equity capital and र 6,00,000 by issuing debentures bearing 10% fixed interest rate. Suppose, both the companies have earned EBIT र 2 lakh each and Tax Rate is 30%.

EBIT - EPS Analysis

In the above example, shareholders of X-Co. are getting र 1.40 return on their investment as against र 2.45 return to shareholders of Y-Co. Both companies raised equal total capital 10 lakh each) and earned equal total profit 2 lakh each), yet the earning of Y-Co.’s shareholders is more. The reason being that Y-Co. has taken advantage of the process of “trading on equity.” In other words, Y-Co. has raised fixed cost capital (borrowed capital) along with equity share capital. On fixed cost capital (borrowed capital), it paid fixed interest at the rate of 10 per cent (10% debentures) and the remainder is distributed as dividend to equity shareholders. Obviously, return on equity shares of Y-Co. is greater than that of X-Co.

Some More Questions From Financial Management Chapter

What is meant by Dividend decision? State any four factors affecting the Dividend decision.

What is meant by Financing decision? State any four factors affecting the financing decision.

 

Explain briefly the factors affecting the investment decision.

Explain, in brief, any five factors that should be taken into consideration while determining the long-term dividend policy.

Or

Explain factors affecting the dividend policy of a company.

“Determining the relative proportion of various types of funds depends upon various factors”. Explain any five such factors.

Or

“Determining the overall cost of capital and the financial risk of the enterprise depends upon various factors”. Explain any five such factors.

Investment decision can be long-term or short-term. Explain long-term investment decision and state any two factors affecting this decision.

Identify the financial decision which determines the amount of profit earned to be distributed and to be retained in the business. Explain any four factors affecting this decision.

Explain, in brief, any three decisions involved in financial management.

What is meant by investment decision?

From the point of view of ‘Floatation costs’ which source of finance is most appropriate?

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