PAST UNIVERSITY PAPERS CONCEPT TESTINGS (1 marks each)
Q. 1. What is Trading on Equity? (Oct 12)
Trading on Equity means using borrowed funds (loaned funds) having a fixed charge (fixed rate) in the expectation of obtaining a higher a higher return to the equity shareholders.
This generates favourable financial leverage and higher rate of returns.
Trading on Equity leads to increase in funds available to the equity shareholders, thus results into higher EPS (Earnings per Share).
Q.2. What is Gross Working Capital? (Oct 12)
Gross Working Capital is equal to the total current assets only.
It is basically liquid assets available with the company and are anticipated to be converted into cash within one year.
Items of current assets include stock of raw materials, work in progress, finished goods, sundry debtors, cash and bank balance, etc.
Q. What is Net Working Capital? (Oct 12)
Net Working Capital is the excess of current assets over current liabilities.
Net Working Capital = Current Assets – Current Liabilities.
In other words, value of gross working capital is reduced by current liabilities such as sundry creditors, bills payable, bank overdraft, etc.
Q.4 What is Operating Cycle? (April 11, Nov 11)
It refers to length of time between payment of cash for purchase of raw materials, production , stocking and collection of money from debtors.
OC = RM + WIP + FG + D
Where, OC- Operating Cycle
RM – Raw Materials, WIP – Work in Progress , FG – Finished Goods , D- Debtors.
c. This number is calculated by adding the age of inventory ( the number of days that inventory is held prior to sale) with the collection period ( the number of days required to collect receivables).
Q.5 What is Default Cost?
The firm may not be able to recover the due money because of inability of the customers.
Such debts are treated as bad debts and have to be written off as they cannot be recovered. Such costs are known as Default Cost.
It is mainly associated with credit sales and accounts receivable.
Q.6 What is Delinquency Cost?
Delinquency cost refers to failure to repay an obligation as due or when agreed.
This cost arises out of the failure of the customers to meet their obligations when payment on credit sales become due after the expiry of the credit period.
It is basically the opportunity costs on the amount that is blocked due to inability of the customer to pay on time.
Q. 7. What is Cost of Capital?
Cost of Capital is the rate of return which the company must earn to satisfy the investors who have provided long term finance.
Cost of Capital helps in the goal of maximisation of shareholders’ wealth by designing a capital structure which minimises the overall cost of capital.
Components of Cost of Capital :
Cost of Debt
Cost of Equity Share Capital
Cost of Retained Earnings
Cost of Preference Share Capital.
Q.8 What is Weighted Average Cost of Capital (WACC)?
Weighted average cost of capital also known as the overall cost of capital is the rate of return that must be earned by the firm in order to satisfy the requirements of the different investors.
The overall cost of capital takes into account the relative proportion of different sources in the capital structure of the firm.
Calculate cost of each source
Assign weights to specific cost
Multiply cost of each source
Add the weighted component cost to get WACC.
Q.9. What is Operating Leverage? (April 11)
Operating leverage is concerned with ability of the firm to discharge its fixed cost.
Operating leverage is determined by the relationship between sales revenue and earnings before interest and tax.
Degree of Operating Leverage = Contribution
Q. 10. What is Financial Leverage?
Financial leverage indicates the effect on earnings due to rise of fixed cost funds.
Financial leverage represents the relationship between the firms earnings before interest and taxes and the earnings available for equity shareholders.
Degree of Financial Leverage = EBIT
Q.11 What is Combined Leverage?
The degree of combined leverage is a combination of the presence of degree of operating leverage as well as degree of financial leverage.
b. It measures the rate of change in Earnings Per Share due to change in sales.
Degree of Combined leverage = Contribution
Q.12 Distinguish between operating leverage and financial leverage. (Oct 12)
|Operating Leverage||Financial Leverage|
|The objective of operating leverage is to magnify||The objective of financial leverage is to|
|the effect of changes in sales on EBIT.||magnify the effect of changes in EBIT on|
|It relates with investment decisions.||It relates with financing decisions.|
|It relates to the ASSETS side of the Balance Sheet.||It relates to the LIABILITIES side of Balance|
Q.13. What is meant by financial breakeven point? (Oct 10)
Financial breakeven point is a point at which firm’s earning per share is equal to zero.
b. It is that level of earnings before interest and tax (EBIT) at which firm’s earning per share is equal to zero.
It is the minimum level of EBIT required to satisfy all fixed financial charges i.e. to pay interest on borrowed funds and also to pay preference dividends.
If EBIT is more than financial breakeven point then EPS will be positive and if EBIT is less than financial breakeven point than EPS will be negative.
Q. 14. What is P/E ratio?
P/E ratio is a valuation ratio of a company’s current share price to its earnings per share.
b. Calculated as :
P/E Ratio = Market Price Per Share (MPS)
Earnings Per Share (EPS)
C. In general, a high P/E suggests that investors are expecting higher earnings growth in future compared to companies with a lower P/E.
Q. 15. What is meant by Net Present Value of a project? (April 12)
Net present value is the present value of net cash inflows generated by a project including salvage value, if any, less the initial investment on the project.
It is one of the most reliable measures used in capital budgeting because it accounts for time value of money by using discounted cash inflows.
c. Basically, it is present value of cash inflows minus present value of cash outflows.
d. NPV = PVCI – PVCO.
e. Acceptance Rule – accept if NPV › 0. reject if NPV ‹ 0.
Q. 16. What is meant by Accounting Rate of Return of a project?
Accounting rate of return (also known as simple rate of return, average rate of return) is the ratio of estimated accounting profit of a project to the average investment made in the project.
b. It is found by dividing the average profit by the average investment.
c. ARR is used in investment appraisal.
ARR (Based on Avg Investment) = Average Annual Profit After Tax × 100
ARR (Based on Original Cost) = Average Annual Profit After Tax × 100
Q.17 What is Capital Rationing? (Nov 11, April 13)
Capital Rationing refers to a situation where a firm is constrained to obtain necessary funds to invest in all profitable projects.
Such constraints which lead to a decision to keep capital expenditures within a ceiling during a specified period of time may arise due to self-imposed restrictions or market conditions.
In capital rationing the projects will be ranked using the PI method in descending order of profitability.
Q.18.What is meant by profitability index of a project?
a. It is the relation between present value of cash inflows and the initial cash outlays.
In case of mutually exclusive investment proposals , the acceptance criterion is , higher the index, the more profitable is the proposal and vice versa.
PI = Present value of cash inflows
Present value of cash outflows
Q.19. What is Letter of Credit? (Nov 2007)
a. Letter of Credit is the most important mode of payment for trade in International Business throughout the world.
As the buyers (importers) and sellers (exporters) are often not known to each other and the bankers are well known for their credit standing, banks credit worthiness is substituted for the importers credit worthiness.
C. The Letter of Credit is an undertaking given by the importers bank to pay the exporter on behalf of the importer if importer fails to pay on due date.
Q.20 . What is ICRA? (Nov 2006)
Investment Information and Credit Rating Agency of India Ltd. (ICRA) was promoted by IFCI in 1991 with its headquarters at New Delhi.
Its main function is Credit Rating. Credit Rating is an expression through the use of alpha- numeric symbols of opinion about credit quality of the issuer of securities with reference to a particular instrument.
C .Besides Credit rating, it also performs other functions such as Risk recognition, Policy advisory, etc.
d. ICRA is a Public Limited Company with its shares listed on BSE and NSE.
Q.21. What is Inter- Corporate Deposits? (Nov 2008)
a. Inter- corporate Deposits are the deposits made by one company with another company, normally for a period within six months.
b. The interest rates on Inter Corporate deposits are around 14%.
C. Such deposits are made by some prosperous companies to invest their substantial liquid funds primarily kept aside to exploit investment opportunities until such opportunities arised.
Q.22. What is Margin of Safety? (Nov 2004)
Margin of Safety sales is the excess sales over the break-even sales. It is the difference between actual sales and break-even sales.
b. The more the margin of safety sales it is better because :
It indicates a higher profit.
It acts as a cushion even if the sales drops drastically.
It indicates recovery of the full costs and profit earned above that.
Higher the Margin of Safety sales the more safer is the firms position. c. Formulae-
MOS = Profit
P/V Ratio MOS = Actual Sales – Break Even Sales
Q.23. Explain Five ‘C’s of Credit.
Character (Good Citizen) – Credit Character is a relative term which tells the reputation of the applicant in meeting the obligations upon maturity. High income, good business and profits need not necessarily always be taken for granted as creditworthy applicant.
Capacity (Cash Flow) – the ability to repay depends upon the earning capacity. Therefore this point measures the ability of the borrower to utilise the credit effectively and profitably.
Capital (Wealth) – the financial position of the potential customers firm is to be analysed with special reference to the tangible net worth and profitability.
d. Collateral (Security) – the type of assets the potential customer pledges against the credit as security is assessed.
Conditions (Economic Conditions, Especially Downside vulnerability) – the general position of the business, economic conditions in the country and the competitive factors which will affect the potential customers ability to earn income and repay credit.
Q.24. What is Business Risk? (Nov 2001)
a. Business risk refers to the risk of failure of a particular business resulting in decline in the firm’s earnings.
b. It may be caused due to decline in the sales of a particular product line.
c. Business Risks may be caused due to external or internal factors.
External business risks is due to conditions beyond its control whereas Internal business risks is due to operational inefficiency.
Q.25. What is Systematic Risk/ Undiversifiable Risk? (Nov 2007)
Systematic risk is the fluctuation in an investment returns attributable to changes in the broad social, economic or political factors which influence the return on investment.
Systematic risk is undiversifiable risk and investors cannot avoid such a risk arising from the factors like inflation, money supply, level of Government spending, level of rainfall, etc. which are economy wide factors.
Q.26. What is Amalgamation? (April 2013)
a. The term ‘Amalgamation’ is a situation where two or more companies come together and form a new company.
b. The old ceases and its shareholders are paid by the new companies in cash or in its shares or debentures.
In case of merger the existing company takes over other company whereas in the amalgamation new company takes over the business of two or more companies into existing companies.
Q.27. What is Vertical Merger?(April 2012)
Vertical mergers occur when two firms, each working at different stages in the production get involved in the same product.
Vertical integrations are usually mergers of non – competing companies where one’s product is a necessary component or complement of the other(s).
In backward integration the company moves towards the source of raw materials by eliminating the suppliers and in case of forward integration the company moves towards the consumers by eliminating the distributors.
Q.28. What is Optimum Capital Mix?(April 2011)
a. Optimum capital mix is the best debt-to-equity ratio for a firm that maximizes its value.
The optimal capital structure for a company is one which offers a balance between the ideal debt-to-equity range and minimizes the firm’s cost of capital.
In theory, debt financing generally offers the lowest cost of capital due to its tax deductibility. However, it is rarely the optimal structure since a company’s risk generally increases as debt increases.
Q.29. What is EPS?(April 2013)
The portion of a company’s profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company’s profitability.
b. Earnings per share represents a portion o f a company’s profit that is allocated to one share of stock.
c. EPS = EAT – Preference Dividend .
No. Of Equity shares
Q.30. What is Angel Funding?(April 2011)
An angel investor or angel (also known as a business angel or informal investor) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity.
b. He is an investor who provides financial backing for small start ups or entrepreneurs.
c. Angel investors are usually found among an entrepreneur’s family and friends.
The capital they provide can be a one-time injection of seed money or ongoing support to carry the company through difficult times.
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