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Ans g) capital budgeting is a process in which a firm determines whether a project is worth pursuing or not.

so to determine this most of the time the firm assesses the expected inflow and outflow of cash over the lifetime of a project.Any project giving agood returnto the firm or in other words increasing the value of the firm should be pursued.But, due to limited availability of capital at one point of time, management uses capital budgeting techniques to determine which project will yield most returns over an applicable period of time. In short it is a project selection uses the concept of present value to select the projects.Further,it uses the tools such as pay back period, net present value, internal rate of return and profitability index. IMPORTANCE: 1)Long term implicationsCapital budgeting decisions affect a companys long term cost structure and growth. Wrong decisions can be disastrous for the firm.on the other hand a lack of investment would influence competitive position of the firm. 2)Large Funds: A firm needs substantial amount of capital outlay for capital budgeting, which involves huge risk. 3)Risk and uncertainty: Estimates may not come true due to uncertain future. 4)Difficult to decide

Ans (h) The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise money from a number of sources e.g. equity, preference shares, convertible debt, warrants, options, governmental subsidies, and so on. Different securities, which represent different sources of finance, are expected to generate different returns. The WACC is calculated taking into account the relative weights of each component of the capital structure.

Companies can use WACC to see if the investment projects available to them are worthwhile to undertake
The cost of capital is affected by a number of factors. Some are beyond the firms control, but others are influenced by its financing and investment policies. Factors Firm Can Control: Capital Structure Policy: Capital structure largely affects the WACC of a firm. For example,after tax cost of debt is lower than cost of equity, so if a firm decides to have more debt and less equity then this increase in debt will lower the WACC.However, an increased use of debt will increase the risk. Capital structure should be such that minimizes WACC and simultaneously maximizes the intrinsic value of the stock. Dividend Policy: Percentage of earnings paid out as dividend will effect a stocks required rate of return.Also if payout ratio is high then a firm will have to issue new stocks to fund its capital budget, then the resulting floatation cost will also effect WACC. Investment Policy: While estimating cost of capital, we use the starting point as the required rate of return a firms assets are giving. So implicitly it is assumed that new capital will be invested in assets with more or less same degree of risk and return. But this will only hold true if investment is done in same kinds of assets. If a firm changes its investment policy then WACC will also change.

Factors the Firm Cannot Control Financial markets: Sometimes markets may get disrupted, making it virtually impossible for a firm to raise capital at reasonable rates. During such times firms tend to cut back on growth plans, if they still continue rates will be high. If interest rates become higher cost of debt and equity will be higher. Higher inflation also leads to higher interest rates. Market Risk Premium: Investors aversion to risk determine premium which effects cost of equity and thus WACC. Tax Rates: Only while calculating after tax WACC. lower tax rate on dividends and capital gains than on interest income favours financing with stock than debt. Tax rates are used in the calculation of the cost of debt as used in the WACC, and there are other less

obvious ways in which tax policy affects the cost of capital. For example, lowering the capital gains tax relative to the rate on ordinary income would make stocks more attractive, which would reduce the cost of equity relative to that of debt.

Weighted Average Cost of Capital (WACC) is therefore an overall return that a corporation MUST earn on its existing assets and business operations in order to increase or maintain the current value of the current stock. Ans (i):

Capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% debt-financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage. In reality, capital structure may be highly complex and include dozens of sources. Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e.g. by taking a short term loan etc.

i. ii.

Highly geared companies- Those companies whose proportion of equity capitalization is small. Low geared companies- Those companies whose equity capital dominates total capitalization.

For instance - There are two companies A and B. Total capitalization amounts to be Rs. 20 lakh in each case. The ratio of equity capital to total capitalization in company A is Rs. 5 lakh, while in company B, ratio of equity capital is Rs. 15 lakh to total capitalization, i.e, in Company A, proportion is 25% and in company B, proportion is 75%. In such cases, company A is considered to be a highly geared company and company B is low geared company.

b) When initiating a business, the best form of business is said to be that of sole proprietorship. It is one of the simplest forms of business entity as it is owned by a single entity. Also, the profits from the business go to ones own account which the proprietor might use for his own personal expenses or reinvested into business. This form of ownership has its own disadvantages as well such as limited availability of capital due to which expansion of the business is not possible as such. Also, the entity has a limited lifespan as it exists only as long as the owner or proprietor is alive as upon the owners death, the assets of the business go to his estate.

To tackle the disadvantages of sole proprietorship, partnership is an option. A partnership can start between 2 or more people with the capital of both the parties involved; hence more capital gives them the benefit of reaping more profits and expansion as well. Also, in a partnership it is not required to register with the state and pay a hefty amount for the same. Partnership but does have its own disadvantages as well such as all partners are personally liable for business debts and liabilities. A joint stock company is the form of business wherein the company collects a large number of capitals from the general public by floating shares. The companies can also accept deposits from the public and issue debentures to raise the funds. One of the major advantages of such a form of business is that the liability of the members is limited only to the value or amount of shares held by them; it means that in case the company occurs losses, the private property of any member is not liable to be confiscated or mortgaged. Also, with such large capital the companies can afford to have large production, invest in research and development, hire qualified people etc. Like any other business, this form of business suffers from certain disadvantages like having to go through several legal procedures which involve a lot of money, effort and time. Also, this form of business are governed by a lot of government regulations, these regulations sometimes create hindrance for the members in taking certain decisions which might help them increase and expand their business. J) Financial assets can be defined as assets or economic resources in an intangible form which derive value for the organization due to a contractual claim. These assets would generally be more liquid than other assets such as land and machinery because of their form and also because of the large available market. Such assets are usually traded through financial markets. Financial instrument are defined under IAS 32-39 as any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity . The financial instruments can be divided into cash instruments where the value is decided by the market forces such as securities, and derivative instruments whose value is decided by factors such as interest rates. Some financial instruments are listed below: Commercial paper- it is an unsecured promissory note with a fixed maturity of 1-270 days. It is issued by large banks and corporations to meet short term requirement of liquidity. A longer maturity period would usually mean higher interest rate. Bond is usually a type of loan where the holder is the creditor and the issuing authority is the debtor who is obliged to pay the interest and also the principal at a later stage. Bond holders usually have a creditors stake in the company unlike shareholders who have an owners stake. K) Financial markets can be defined as a place where trade of financial securities such as bonds and equities and commodities such as precious metals and agricultural products takes place. The prices are determined by market forces which mean its decided by demand and supply as in case of any other market. They play a pivotal role in the economy as they facilitate raising of capital,

transfer of risk, transfer of liquidity, and also is a source of international trade and hence boosts foreign exchange. Capital market is where securities are traded by both organizations and governments with a view to raise capital or long term funding. In this kind of market money is provided for a period of longer than one year and it includes both primary and secondary markets. Primary is where a security is introduced for the first time and in secondary market already existing securities exchange hands, resulting in transfer of liquidity. Capital market includes stock markets and bond markets. Money market is where short term borrowing and lending takes place, the maturity for securities is usually less than an year. It includes treasury bills, commercial paper and short lived asset backed securities. It includes dealers or organizations interested in lending or borrowing for a short period. This market is very necessary for liquidity in the global financial system.