Financial Management - Test Papers

CBSE Test Paper - 01

Chapter - 9 Financial Management

Fixed assets investment decision is called ________.
1. Financing decision
2. Capital budgeting
3. Management of working capital
4. Dividend decision
A decision to acquire a new and modern plant to upgrade an old one is a:
1. None of the above
2. Investment decision
3. Working capital decision
4. Financing Decision
Which of the following is not a financial Decision?
1. Investment Decision
2. Financing Decision
3. Staffing Decision
4. Dividend Decision
Current assets are those assets which get converted into cash:
1. between three and five years
2. within six months
3. within one year
4. between one and three years
What does a high Debt Service Coverage Ratio indicate?
1. Low ability to issue preference shares
2. Better ability to pay dividends
3. Low ability to raise funds from the public
4. Better ability to meet cash commitments
State whether each of the following statement is True or False:
1. If a company has good growth prospects, it will require more fixed capital but less working capital.
2. Flotation cost includes the cost of discount on issue of shares.
3. An Advertising agency needs to have large fixed capital.
4. If Debt Service Coverage Ratio is high then the company can have more debt in the capital structure.
Fill in the blanks with suitable words:
1. The preparation of a financial blueprint of an organization is known as ________.
2. ________ rate of Interest of Company with more of debt as compared to equity.
3. A company having high fixed operating cost would opt for ________.
4. Current assets get converted into cash within a period of ________.

Match the following:

(i) A fixed asset should be financed through	(a) partly from both types, i.e., long and short term liabilities
(ii) Current assets o a business firm should be financed through	(b) a short term liability
(iii) Current assets are those assets which get converted into cash	(c) Capital budgeting
(iv) Another name for long term investment decision	(d) within one year

Why is the working capital needed? Give any one reason.
In the paint industry, various raw materials are mixed in different proportions with petroleum for manufacturing different kinds of paints. One specific raw material is not readily and regularly available to the paint manufacturing companies. Bonier Paints Company is also facing this problem and because of this, there is a time lag between placing the order and the actual receipt of the material. But, once it receives the raw materials, it takes less time in converting it into finished goods. Identify the factor affecting the working capital requirements of this industry.
Name the financial decision which affects the liquidity as well as the profitability of a business.
What is meant by financial management? State any two financial decisions taken by a financial manager.
Explain how the
1. cost of debt and
2. cost of equity, affect the choice of capital structure.
Give the meaning of ‘investment decision’ and ‘dividend decision’.
Pranav is engaged in the transport business. Identify the working capital requirements of Pranav stating the reason in support of your answer. Pranav wants to expand and diversify his transport business. Explain any two factors that will affect his fixed capital requirements.
What are the main objectives of financial management? Briefly explain.
Explain any six factors which affect the capital structure of a company.
Explain briefly any four factors that affect the working capital requirements of a company.

CBSE Test Paper - 01
Chapter - 9 Financial Management

Solution

(b) Capital budgeting
Explanation: The decision to invest in fixed assets must be taken very carefully as the investment is usually quite large. Such decisions once taken are irrevocable except at a huge loss. Such decisions are called capital budgeting decisions.
(b) Investment decision
Explanation: A decision to acquire a new and modern plant to upgrade an old one is an investment decision.
(c) Staffing Decision
Explanation: Financial decisions include investment decision, financing decision, dividend decision.
(c) within one year
Explanation: These are the assets which can be converted into cash and cash equivalents within one year in the normal routine of business.
(d) Better ability to meet cash commitments
Explanation: A higher Debt Service Coverage Ratio indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure.
1. False
2. False
  Explanation: False, flotation cost doesn't include the cost of discount on issue of shares.
3. False
  Explanation: False, because it is a service Co. & need not maintain any inventory.
4. True
1. Financial planning
2. Low
3. Debt
4. 1 year
(i) - (b), (iv) - (a), (iii) - (d), (iv) - (c).
Working capital is needed in order to meet day by day expenses.
Availability of Raw Material is the factor affecting the working capital requirements of this industry. Raw materials can include commodities such as metal or oil.
A short-term investment decision (working capital management).
Financial Management is that branch of Management which is related to the effective and efficient procurement and utilization of funds. Main decisions involved in financial management are as follows:
1. Investment decision: The investment decision relates to how the firm's funds are invested in different assets. Investment decision may be long-term or short-term. The long-term investment decision is called capital budgeting decision and short-term investment decision is called a working capital decision. This decision is related to the utilization of available funds in an optimum manner.
2. Financing decision: It deals with the quantum of finance to be raised from long-term sources, viz debt-equity. In other words, it refers to the determination as to how the total funds required by the business will be obtained from various long-term sources.
3. Dividend decision: This decision involves how much of the 'after-tax profits' is to be distributed as dividends to shareholders and how much to retain in the business to meet future investment requirements.
1. Cost of debt: A firm's ability to borrow at a lower rate of interest increases its capacity to employ higher debt Thus, more debt can be used if the debt can be raised at a lower rate. In case the cost of debt, i.e.interest rate which is a fixed cost is higher, then the company prefers more equity in the capital structure.
2. Cost of equity: The higher cost of equity makes the overall Weighted Average cost of capital higher which forces the company to include less equity in the capital structure and vice -versa.
1. Investment decision: It relates to how the funds of a firm are to be invested in different assets so that the firm is able to earn the highest possible return for the investors. An investment decision can be -long-term, also known as capital budgeting where the funds are committed on a long-term basis. Long-term Investment decisions are concerned with the utilization of funds for the purchase of fixed assets as required by the organization. Short-term investment decision also is known as working capital decision and it is concerned with the levels of cash, inventories, and debtors. They are related to the utilization of funds to meet the day to day expenditure requirements.
2. Dividend decision: It relates to the decision regarding the distribution of dividend. The decision taken is as to how much dividend is to be retained in the business and how much should be distributed to shareholders, after taking into account various factors affecting it. The Finance Manager has a mammoth task in hand related to the bifurcation of profits between the distribution of dividend and retained earnings.
In a business like Transport business, it requires less working capital owing to the fact that it comes under the Service Industry It is so because :
Factors affecting the fixed capital requirement are:
1. Day-to-day operations are very limited.
2. Less Inventory needs to be maintained.
3. It sells more on a cash basis.
4. Growth prospects: Pranav wants to expand his business, in such a situation, a company requires higher investment to meet the anticipated demand in the future. Thus, the requirement of fixed capital will be higher. With the increasing demand, he will need to invest more in long-term assets for which he will require more fixed capital.
5. Diversification: If the businessman diversifies his business, this means a larger amount of fixed capital is required. Diversification demands opening up of new divisions in various places for which investment needs to be made in building and other long-term assets.
Main objectives of financial management:
1. To maximize the shareholders' wealth by utilizing funds in an optimum manner and investing in the right project yielding higher returns.
2. To increase the market price of shares by following investment avenues with a higher ROI.
3. To take important financial decisions which will ultimately be gainful from the point of view of shareholders.
4. To choose the best alternative form the various available alternatives in order to make a wise investment.
Factors affecting the capital structure of a company:
1. Cash Flow Position: A stronger and regular cash flow position of the business makes debt as the primary choice for capital structure.
2. Interest Coverage Ratio: In case the Interest Coverage Ratio is higher, the Finance Manager prefers debt over equity and vice-versa.
3. Tax Consideration: The inclusion of more debt in the capital structure makes it easier for the company to lessen the burden of the tax.
4. Control Consideration: If the company has no hesitation in diluting the control of ownership, then it may opt for higher equity, else, it prefers debt.
5. Market Consideration: In case of the boom period, the flow of cash is stronger and thus debt becomes an automatic choice in the capital structure, while in case of Depression, the company incorporates more of equity in the capital structure.
6. Debt-Service Coverage Ratio: Higher Debt-Service Coverage ratio ensures more of debt in the capital structure.
Working Capital is the excess of current assets over current liabilities. The four factors that affect the working capital requirements are:
1. Nature of business- The amount of working capital requirement depends upon the nature of business. A trading business needs less amount of working capital because there is no processing of goods so no amount of cash is to be held as inventory. On the other hand, the working capital requirement would be more in case of a manufacturing business where raw materials are converted into finished goods more amount of current assets needs to be held as inventory.
2. The scale of operation- The amount of working capital requirement depends upon the scale of operations. A large-scale organisation requires a large amount of working capital as compared to the small-scale organisation because the quantum of inventory, debtors and cash required is generally high.
3. Seasonal factors- Business operations are affected by seasonal changes. As during peak season, higher is the demand for the product and higher is the requirements of working capital. On the other hand, during the lean season requirements of working capital will be lower as the demand for the product is less.
4. Production cycle- It is the time span between the receipt of raw materials and their conversion into finished goods. Length of production cycle affects the working capital requirement. If the duration of the production cycle is longer, the working capital requirements to meet day-to-day expenses would be higher. An organisation with a short production cycle require less working capital.