Business Studies

Business Finance

Easy

Aval Ltd. is engaged in the business of the export of canvas goods and bags. In the past, the performance of the company was above expectations. In line with the latest demand in the market, the company decided to venture into leather goods for which it required specialized machinery. For this, the Finance Manager Prabhu prepared a financial blueprint for the organization's future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at the right time. He also collected the relevant data about the profit estimates for the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds, he is trying to find alternative sources from outside. The company is willing to go for a public issue of shares and debentures to be made under SEBI guidelines. Public issue of shares and debentures requires considerable outlay of funds too. Due to extensive operations, the manager is of the viewpoint that a company may have to ensure that earnings before interest and taxes of a company should cover the interest obligation. The manager also felt that the cash profits generated by the operations need to be compared with the total cash required for the service of the debentures and the preference share capital.

"Public issue of shares and debentures requires considerable outlay of funds at the time of issue too". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Risk Consideration

Cost of Equity

Floatation Costs

Cost of debt

✅ Correct Option: 3

Option 1 -> Risk Consideration refers to the financial and business risks associated with debt levels in capital structure, not the costs incurred during issuance.

Option 2 -> Cost of Equity represents the return required by equity shareholders, calculated through models like dividend growth or CAPM, not the upfront expenses of issuing securities.

Option 3 -> Floatation Costs are the expenses incurred when issuing new securities, including underwriting fees, legal charges, registration fees, and printing costs—directly matching the "considerable outlay of funds at the time of issue."

Option 4 -> Cost of Debt refers to the interest expense paid on borrowed funds over time, not the initial costs of issuing securities.

Hence, Option 3: Floatation Costs -> The statement specifically mentions the "considerable outlay of funds at the time of issue" for public issuance of shares and debentures. These upfront expenses—such as underwriting commissions, brokerage, legal fees, printing, and registration costs—are known as floatation costs and represent a significant factor in capital structure decisions -> correct

Question 46

"The company is willing to go for a public issue of shares and debentures to be made under SEBI guidelines". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Question 47

"Finance Manager Prabhu prepared a financial blueprint for the organization's future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at the right time". Identify the concept of financial management highlighted in the aforesaid statement.

Question 49

"Due to extensive operations, the manager is of the viewpoint that a company may have to ensure that earnings before interest and taxes of a company should cover the interest obligation". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Question 50

Which financial ratio will establish the relation between the cash profits generated by the operations and the total cash required for the service of the debentures and the preference share capital?

"Public issue of shares and debentures requires considerable outlay of funds at the time of issue too". Identify the factor affecting capital structure highlighted in the aforesaid statement.

Solution

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