Corporate Finance

Study the following case/situation and express your opinion

1) The management of ‘Maharashtra State Road Transport Corporation’ wants to determine the size of
working capital
a. Being a public utility service provider, will it need less working or more?
Answer: Maharashtra State Road Transport Corporation, being a public utility service provider
needs less amount of working capital because of continuous flow of cash from their customers.
b. Being a public utility service provider, will it need more fixed capital?
Answer: Maharashtra State Road Transport Corporation being a public utility service provider
needs more amount of fixed capital to acquire fixed assets.
c. Give one example of public utility service that you come across on day-to-day basis?
Answer: Railway Department, Air India, Indian Petroleum, Hindustan Petroleum
2) A company is planning of to enhance its production capacity and is evaluating the possibility of
purchasing new machinery whose cost is 2 crore or has alternative of machinery available on lease
basis.
a. What type of asset is machinery? → Fixed Asset
b. Capital used for purchase of machinery is fixed or working capital? → Fixed Capital
c. Does the size of a business determine the fixed capital requirement? → Yes, determine

Identify the type of corporate decisions

1) Rajan Power looms, a leading company in its industry has decided not to issue equity shares this year as
they want to keep the management control in their own hands. The company’s management already has
only 60% shares in the company. So it would avoid any further dilution of its stake in the company.
Company would prefer taking loan.
Answer: Financing Decision
2) A company has decided to issue debentures as it knows that it will not lead to any additional costs. These
debentures will be carrying a very low rate of return for the debenture holders but will be a surety for
them to get their money back. Investors who want financial safety would like to go for this option as there
will be an assured definite return.
Answer: Financing Decision
3) Shuddhi Steel Manufacturers has been a brand but due to some HR related issues it came into limelight for
bad reasons. The issue was related with non-payment of salaries of the employees but now the company
wants to sort this issue out. The company has decided to pay the salary of all the employees which were
not paid their emoluments since last six months. The company has done so to avoid any image spoiling to
take place.
Answer: Investment Decision – Working Capital Management/Short term investment
4) A soft drink company has decided to run an advertisement campaign. It will hire many famous Bollywood
celebrities for this purpose. The advertisement campaign could involve more than 150 crores. Every
major newspaper is mentioning about it.
Answer: Investment Decision – Capital Budgeting/Long term investment
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5) Tarachand and Sons has decided to open a new branch in the middle of the city in order to increase its
business.
Answer: Investment Decision – Capital Budgeting/Long term investment

Justify the following statements.

1. The firm has multiple choices of sources of financing.
Reasons: Finance is the provision of money at the time it is wanted. It is related with raising capital funds
for satisfaction of various requirement of the company. The firm has multiple choices of sources of
financing as follows.
1) Owned Sources: It consists of the amount contributed by owners as well as the profits reinvested
in the business. It does not create any obligations regarding payment of return as well as
repayment of capital. It is issued in the starting stage of the organizations. Investors enjoy voting
rights as well as management rights. These sources include equity shares, preference shares and
retained earnings.
2) Borrowed Sources: It consists of the amount raised by way of loan or credit. It creates fixed
obligations regarding payment of return and repayment of capital at a particular period. Investor
get fixed rate of interest on their investment. They not bear risk of the organization. It is safe and
temporary capital of the organization. They are creditor of the organization. They not enjoy any
voting and management rights in the organization. It collects by issue debentures, bonds, deposits
and loans.
3) Loan from Financial Institution: Banking and Non-banking organizations provide loan to business
sector. These institutions provide loans by various methods such as term loan, subscription of
securities, underwrite the issue of securities, guarantee letter for foreign loans, etc.
4) Other: Business firms also raise finance by others methods such as commercial papers, trade bills,
discounting of bills, certificate of deposits, bank credit, trade credit, GDR, ADR, loans from money
lenders, etc.
Conclusion: From the above points it is clear that the firms raise the finance as per requirement of
business activities and financing business have multiple choices. The sources of finance determine
upon various factors

2. There are various factors affecting the requirement of fixed capital.

Reasons: Fixed capital is a portion of the total capital invested in the fixed assets (Land and Building, Plant
and Machinery, Furniture and Fixtures, Tools and Equipment, Patents, Copyrights, etc.) which is used for
long term basis. It is required for establishment of business and helps the production. The requirement of
fixed capital affect by following factors.
1) Nature of business: - The nature of business determined the amount of fixed capital requirement as
follows,
Nature Requirement of capital
Manufacturing and Public Utilities More
Trading Company Less
Service – Transport, Electricity Supply, Hotels More

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 Manufacturing and Public utilities require huge amount of investment in land & building, plant
& machinery, tools & equipment, patents, copyrights, etc. Hence they require more fixed capital
compare to other.
2) Size of Business: - Size of business also affect amount of fixed capital. Size may be measured in terms
of scale of operations.
Size Requirement of capital
Large Scale Manufacturing Company More
Small Scale Manufacturing Company Less
Large Scale Trading Company More
(Departmental Stores, shopping mall)
Small Scale Trading Company (Retailers) Less
3) Type of Product Manufactured: - Product is anything offers by seller or manufacturer to the market.
Product is sellable outcome of series of production sources. Every product has different utility in that
aims satisfy the end-users needs. The amounts of fixed capital also depend upon type of product
manufactured.
Type of Product Requirement of capital
Industrial Goods(Machineries, Tools, Equipment) More
Consumer Goods Less
4) Method of Production: - Company use different types of methods for manufacturing product. This
method also affect requirement of fixed capital.
Method of Production Requirement of capital
Large and Complex (Involves many processes) More
Small and Simple (Very few processes) Less
5) Other factors: Methods of Acquiring Assets, Technology, Arrangement of sub-contract, Government
subsidy, International conditions, Trend in economy, Population trend, Consumer preference,
Competitive factors, etc.
Conclusions: from the above points it clear that fixed capital affect by various factors. These factors
determine the more or less requirement of finance.
3. Fixed capital stays in the business almost permanently.
Reasons: Fixed capital is a portion of the total capital invested in the fixed assets (Land and Building, Plant
and Machinery, Furniture and Fixtures, Tools and Equipment, Patents, Copyrights, etc.) which is used for
long term basis. It is required for establishment of business and helps the production. It is a permanent
capital explain by following points
1) Initial Capital: Fixed capital is required for acquiring fixed (tangible and intangible) assets, which is
the preliminary requirement for starting a company. There are certain enterprises (manufacturing
and public utilities) which cannot think of running in the absence of sufficient amount of fixed
capital. Right from the very beginning, when the idea to set up an industrial unit generates in the
mind of the entrepreneur/promoters, the initial investment is made in fixed assets, only then,
enterprise will be in a position to work smoothly. So fixed capital investment is permanent.
2) Promotional Capital: Once a company is established, its promotion takes place. The promoters of a
company execute the promotional activities. Generally, the promotional expenses included
Preparation of project reports, Payment of preliminary (establishment) expenses, Legal and other
professional fees, Issuance of a company's prospectus to the investors. The promoters need fixed
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 capital to pay their promotion expenses. These expenses are long term basis and never do again. It
is also consider fixed assets of company. So it is almost permanent capital.
3) Expansion & Diversification: Expansion means growth of business activities in the same sector of
an economy. Diversification implies growth of business activities in more than one sector of
economy. Generally, most companies undergo expansion and diversification. Fixed capital is
needed for making improvements and expanding the existing set up of a business enterprise. So it
is permanent capital of organization.
4) Reusable Capital: Fixed capital consists of assets that are not consumed or destroyed in the
production of a good or service and can be used multiple times. It is help for production activities.
The life fixed assets is very long compare to working assets. Fixed capital assets are usually illiquid
items and are depreciated over time. So it is permanent capital of organization.
Conclusion: From the above points it clear that fixed capital used by company for initial stage, promotion,
modernization, expansion, diversification, replacement of absolute assets, automation, multiple use, etc.
Fixed capital is the portion of total capital outlay of a business invested in physical assets such as factories,
vehicles, and machinery that stay in the business almost permanently.
4. Capital structure is composed of owned funds and borrowed funds.
Reasons: Capital Structure refers to the combination /composition of long term funds comprising mainly
shares holder funds, long term loans and debentures. It is used by a company to finance its overall
operations and growth. It is collection pattern or ratio of owned capital and borrowed capital. Explain by
following points
1. Owned Capital: - Owned Capital consists of the amount contributed by owners as well as the profits
reinvested in the business. It does not create any obligations regarding payment of return as well as
repayment of capital. It is issued in the initial stage of the company. Company provide dividend as a
return on owned capital. The dividend rate always fluctuates. It is repayable at the time of winding up
of the company. The owned capital providers are known as Shareholder/Owners/Members of the
company. The owner enjoys voting rights as well as management rights. It is collected by issue of
Equity shares, Preference Shares and Retained Earnings.
a. Equity share Capital: -Those shares do not enjoy any preference in the payment of dividend
and repayment of capital at the time of winding up of a company is known as Equity shares. It is
a basic source of finance. Every company must raise capital by issue of equity shares. Equity
shareholders are real owners of the company. They enjoy all membership rights such as voting
and management. They get dividend at fluctuating rate depending upon the profits.
b. Preference share Capital: -preference shares enjoy preference in the payment of dividend and
repayment of capital at the time of winding up of the company. They do not carry normal
voting rights. They get dividend at fixed rate.
c. Retained Earnings: - An existing company can generate finance through its internal sources. It is
cheapest and simplest source of finance. A company earns profit by the transactions. The whole
profit is not distributed into owners as a dividend; retain some part of profit as a saving for
provision of future. This saving is known as retained earnings. The policy of using such retained
profit in the business is known as ‘Self-financing’ or ‘Ploughing back of Profit’. The management
can convert this retained profit into permanent capital which is known as ‘Capitalization of
Profit’. By issuing bonus shares to the existing equity shareholders at free of cost.
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 2. Borrowed Capital: - Borrowed capital consists of the amount raised by way of loan or credit. It creates
fixed obligations regarding payment of return and repayment of capital at a particular period. This
capital cannot use up to dissolution of business; it was repaid after specific period. They get fixed rate
of interest on their investment. They not bear risk of the organization. It is safe and temporary capital
of the organization. They are creditor of the organization. They not enjoy any voting and management
rights in the organization. It collects by issue debentures, bonds and obtains loans from financial
institutions.
a. Debentures: - Debenture is a document issued by a company as an evidence of a debt due from
the company with or without a charge on the assets of the company. It is one of the capital
market instruments which are used to raise medium or long term funds from public. Debenture
holder gets interest as return on investment. They are considered creditors of the company.
b. Bonds: - A bond is an interest bearing certificate issued by a government or business firm,
promising to pay the holder a specific sum at a specified date. It is a formal contract or written
promise to repay borrowed money with interest on particular date. The bond holders are
creditors of the company.
c. Long Term Loans: - After independence Indian government establish various banks and
financial institution for long term finance as well as short term finance to business such as IFCI,
IRBI, ICICI, IDBI, LIC, GIC, UTI, SIDBI, EXIM Bank, TDCI and others.
Conclusion: From above points it is clear that capital structure is collection pattern or ratio of owned
capital and borrowed capital. It affects the profitability and financial risk of the organization. While
deciding the capital structure the company considers the profitability, flexibility, capacity, solvency,
and control factors of the business.
5. There are various factors affecting the requirement of working capital.
Reasons: Working capital means which capital required for company for day to day activities of business. It
is used for purchase raw material, conversion of raw material into finished goods and these finished goods
sell in market. The requirement of working capital affect by following factors.
1) Nature of Business: - Firm’s working capital requirements are basically related to type of business it
conducts.
Nature of Business Requirement of Capital
Manufacturing Company & Public Utilities
Long period of operating cycle More
Small period of operating cycle Less
Trading Company / Merchandising Firm More
Service Company
Financial (Bank, insurance) More
Other (Transport) Less
Generally trading/ merchandising and financial firms require relatively large amount of working
capital as compared to manufacturing units, because they maintain huge stock-in-trade, account
receivables and liquid cash.
2) Size of Business: - There is direct link between working capital and size of business. Large scale
organizations require more working capital compare to small scale organizations.

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3) Volume of Sale: - The volume of sale also affect requirement of working capital. The volume of sales
and size of working capital are directly related with each other. If the volume of sale increases, increase
the amount of working capital and vice versa.
4) Production Cycle: - Production cycle is the time span between the receipt of raw material and their
conversion into finished goods. It is a process of converting raw material into finished goods.
Production Cycle Requirement of Capital
Longer Period (Textiles) More
Smaller Period (Automobiles) Less

5) Others: Business cycle, Seasonal factors, Terms of purchase and sales/ credit policy, Credit control,
Availability of raw material, Requirement of cash, Management ability, Growth and expansion, external
factors, etc.
Conclusion: from the above points it clear that working capital affect by various factors. These factors
determine the more or less requirement of finance.