Q1What is meant by capital structure?
Answer: Capital structure refers to the mix between owners and borrowed funds. It represents the proportion of equity and debt.
Q2 When is financial leverage favourable?
Answer: Financial leverage affects the profitability of a business and it is said to be favourable when return on investment ( ROI) is higher than cost of Debt.
Q3 Radhika and Vani who are young fashion designers, left their job vyith a famous fashion designer chain to set-up a company ‘Fashionate Pvt. Ltd.’ They decided to run a boutique during the day and coaching classes for the entrance examination of National Institute of Fashion Designing in the evening. For the coaching centre, they hired the first floor of a nearby building. Their major expense was the money spent on photocopying of notes for their students. They thought of buying a photocopier knowing fully that their scale of operations was not sufficient to make full use of photocopier.
In the basement of the building of Fashionate Pvt. Ltd, Praveen and Ramesh were carrying on a printing and stationery business in the name of ‘Neo Prints Pvt. Ltd.’ Radhika approached Praveen with the proposal to buy a photocopier jointly which could be used by both of them without making separate investment. Praveen agreed to this.
Identify the factor affecting the fixed capital requirements of Fashionate Pvt. Ltd.
Answer: The factor affecting the fixed capital requirement of Fashionable Pvt. Ltd. is the level of collaboration. This kind of arrangement of using the resources jointly helps to reduce the fixed capital requirements of the business firms.
Q4 Rizul Bhattacharya, after leaving his job, wanted to start a Private Limited Company with his son. His son was keen that the company may start manufacturing mobile-phones with some unique features. Rizul Bhattacharya felt that mobile phones are prone to quick obsolescence and a heavy fixed capital investment would be required regularly in this business. Therefore, he convinced his son to start a furniture business.
Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya choose the furniture business over mobile phones.
Answer: The factor affecting the fixed capital requirements which made Rizul Bhattacharya choose the furniture business over mobile phones is technological upgradation.
Q5 Define a ‘current assets’ and give four examples.
Answer: Current assets are those assets of the business which can be converted into cash within a period of one year. Cash in hand or at bank, bills receivables, debtors, finished goods inventory are some of the examples of current assets.
Q6 What is meant by working capital? How is it calculated? Discuss five important determinants of working capital requirements.
Answer: Working capital IS that part of total capital which is required to meet day-to-day expenses. to buy raw materials, to pay wages and other expenses of routine nature in the production process or we can say it refers to excess of current assets over current liabilities.
Working Capital = Current Assets – Current Liabilities
Factors affecting working capital requirement are:
(i) Nature of Business The basic nature of a business influences the amount of working capital required. A trading organisation usually needs a lower amount of working capital compared to a manufacturing organisation. This IS because in trading. there is no processing required. In a manufacturing business, however. raw materials need to be converted into finished goods. which increases the expenditure on raw material, labour and other expenses.
(ii) Scale of Operation The firms which are operating on a higher scale of operations, the quantum of inventory. debtors required is generally high. Such organisations. therefore, require large amount of working capital as compared to the organisations which operate on a lower scale.
(iii) Production Cycle Production cycle is the time span between the receipts of raw materials and their conversion into finished goods. Some businesses have a longer production cycle while some have a shorter one. Working capital requirement is higher in ferms with longer processing cycle and lower in firms with shorter processing cycle.
(iv) Credit Allowed Different firms allow different credit terms to their customers. A liberal credit policy results in higher amount of debtors, increasing the requirements of working capital.
(v) Credit Availed Just as a firm allows credit to its customers it also may get credit from its suppliers. The more credit a firm avails on its purchases, the working capital requirement is reduced.