Plus One Business Studies Chapter Wise Previous Questions Chapter 8 Sources of Business Finance

Kerala Plus One Business Studies Chapter Wise Previous Questions Chapter 8 Sources of Business Finance

Question 1.
Salim wants to purchase some preference shares. You are to encourage him by convincing him about any three advantages of preference shares. (June – 2008)
Answer:
Advantages of preference shares are:-

• They attract investors who expect the regular return and the safety of their investment.
• The dividend is payable only when there are profits
• It does not affect the management control
• It does not carry any charge on the fixed assets.
• It helps the company to raise long term capital
• It helps to adopt Trading on equity.
• Different types of preference shares can be issued according to the needs of various investors

Question 2.
“Finance is the lifeblood of business”. Comment on this statement by explaining the significance of finance in a modern business. (June – 2008)
Answer:
Nature of Business Finance

1. Fixed capital requirements: In order to start a business fund are needed to purchase fixed assets like land and building, plant and machinery. This is called fixed capital requirement.

2. Working Capital requirements: A business needs funds for its day to day operation. This is known as working capital requirements. Working capital is required for purchase of raw materials, to pay salaries, wages, rent and taxes.

Question 3.
Johnson and Mathew are brothers. Johnson wants to subscribe to equity shares and Methew wants to subscribe to debentures. But they are not aware of the differences between equity shares and debentures. Can you convince them by explaining any six differences between equity shares and debentures? (June – 2008)
Answer:
The differences between shares and debentures :

Question 4.
An arrangement to acquire the right to use an asset without owning is called ……….. (March – 2009)
a) Factoring
b) Leasing
c) Financing
d) Warehousing
Answer:
Leasing

Question 5.
Promoters of Smarts Ltd. approach you to know the various sources of business finance. As a commerce student, explain the different sources of business finance. (March – 2009)
Answer:
Different sources of business finance are

1) Internal sources

a) Equity shares
b) Retained earnings

2) External sources

a) Preference shares
b) Debentures
c) Financial institutions
d) Loan from a bank
e) Public depositors
f) Lease financing
g) Commercial paper
h) Trade credit
i) Factoring

Question 6.
a) Krishnankutty master is a retired primary school teacher. His intention is to invest a part of his terminal benefits in shares or debentures of Companies. But he is not aware of the differences between shares and debentures. Can you help him by convincing any six differences between shares and debentures? If so, what are they? (August – 2009)
Answer:
The difference between shares and debentures are :

Question 7.
Prafulla Kumar is the finance manager of a Company. He is of the opinion that the internal source of financing is better than other sources. Support him by stating any six advantages of ploughing back of funds. (August – 2009)
Answer:
Advantages of Retained earnings (Ploughing back of profit)

• It is more dependable than external sources.
• It does not involve any cost for raising fund
• There is no commitment to pay a dividend
• It increases the financial strength and earning capacity. of the business.
• Control over the management of the company remains unaffected.
• It does not require the security of assets
• There is no need to issue prospectus.

Question 8.
“I am a debenture issued without the name of the owner.” Identify me. (March-2010)
a) Unsecured debenture
b) Mortgage debenture
c) Bearer debenture
d) Registered debenture
Answer:
Bearer debenture

Question 9.
Smt. Saraswathi Amma, a service pensioner, whishes to invest a sum in the shares of a company. She expects a steady return without taking any risk of loss. (March-2010)
i) Name the type of investment she should go for.
ii) Explain its different categories,
Answer:
a) Preference shares
Kinds of preference shares
Issue of shares: The capital of a company is divided into smaller units called a share. Those who subscribe to the shares of a company are known as ‘shareholders’. Two types of shares may be issued by a company to raise capital. They are:-

1. Equity Shares
2. Preference Shares

a) Equity Shares: Equity shares represent the ownership capital of a company. They do not enjoy any preferential right in the matter of a claim of dividend or repayment of capital. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company. They bear the maximum risk. Equity shareholders are the owners of the company. They have the right to vote and participate in the management.

Merits

• Equity shares are suitable for investors who are willing to assume the risk for higher returns
• Payment of equity dividend is not compulsory.
• Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company.
• Equity shares do not carry any charge on the assets of the company.
• They have the right to vote and participate in the management.
• Equity capital provides creditworthiness to the company

Limitations

• Investors who want steady income may not prefer equity shares.
• The cost of equity shares is generally more as compared to the cost of raising funds through other sources.
• Issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders.
• Issue of Equity shares is time-consuming.

b. Preference Share: The capital raised by the issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential right over equity shareholders in two ways:

a) The right to get a fixed rate of dividend.
b) The right to claim repayment of capital in the event of winding up of the company.

Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.
Types of Preference Shares

a. Cumulative and Non-cumulative Preference Share:- in cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in a non-cumulative preference share, the dividend is not accumulated if it is not paid out of the current year’s profit.

b. Participating and Non-participating Preference Share:- Participating preference shares have a right to share the profit after making payment to the equity shares. The non-participating preference shares do not enjoy such a right.

c. Convertible and Non-convertible Preference Share:- The preference shares which can be converted into equity shares after a specified period of time are known as convertible preference share. Non-convertible shares cannot be converted into equity shares.

d. Redeemable and Irredeemable Preference Share:- Redeemable preference shares are those where the company undertakes to repay it after a specified period. Where the amount of the preference shares is refunded only at the time of liquidation, are known as irredeemable preference shares.

Merits

• Preference shares provide a reasonably steady income in the form of a fixed rate of return and safety of the investment.
• Preference shares are useful for those investors who want a fixed rate of return with comparatively low risk
• It does not affect the control of equity shareholders because they have no voting right.
• Preference shares do not create an arty charge on the assets of the company.
• They have a preferential right of repayment of capital over equity shareholders in the event of liquidation of a company.

Limitations

• Preference shareholders have no voting right.
• The dividend paid is not deductible from profit for income tax.
• These shares may not attract investors who are expecting higher returns.
• The rate of dividend on preference shares is generally higher than the rate of interest on debentures.

Question 10.
There are debentures which are secured by a charge or mortgage on the assets of the company. Identify this type of debentures. (March-2011)
Answer:
Secured debentures

Question 11.
Stanley and Roy are brothers. Stanley wants to subscribe to equity shares while Roy wants to subscribe to debentures. But they are not aware of the differences between equity shares and debentures. Can you convince them by explaining any eight differences between equity shares and debentures? (March-2011)
Answer:
Differences between Equity shares and Debentures are

Question 12.
Successful companies re-invest a part of their profits in their business. This source of finance is considered to be better than other sources. Establish the gravity of the statements by indicating the merits of ‘ploughing back of profits’.(Answer may be limited to six important merits.) (March-2011)
Answer:
When the whole or part of the profit of the company is set aside from time to time and is used for further expansion of the business, it is called Ploughing back of profits.
Advantages of Retained earnings (Ploughing back of profit)

• It is more dependable than external sources.
• It does not involve any cost for raising fund
• There is no commitment to pay a dividend
• It increases the financial strength and earning capacity. of the business.
• Control over the management of the company remains unaffected.
• It does not require the security of assets
• There is no need to issue prospectus.

Question 13.
Name the financial services provided by the following firms: (March-2012)
a) Sudha Solutions engaged in credit management and debt servicing for their clients.
b) Bull Enterprises Ltd. collects savings of individuals and organizations to invest in a portfolio of stocks.
c) Falcon Associates provide services for issue management, underwriting and similar financial services to the corporate sector.
Answer:
a) Factoring
b) Mutual Fund
c) Merchant Banking

Question 14.
A company with a good track record of profitability proposes to borrow additional funds from the public for the expansion of their business. The management of the company is not interested in dilution of control over the business. (March-2012)
a) Suggest a suitable type of securities for raising the funds.
b) Explain its main features as a source of finance.
Answer:
a) Debentures
b) Features of Debentures
1) Debenture holders get a fixed rate of dividend.
2) Control of the management is not diluted
3) They have no voting rights
4) Company can take the benefits of trading on equity.

Question 15.
These shares also form part of ownership securities with a preferential claim over dividends and repayment of capital. The investors who except a fixed higher-income prefer to invest in these securities. (March-2012)
a) Explain the different varieties of such securities.
b) How do they differ from other ownership securities issued to the public?
Answer:

Issue of shares: The capital of a company is divided into smaller units called a share. Those who subscribe to the shares of a company are known as ‘shareholders’. Two types of shares may be issued by a company to raise capital. They are:-

1. Equity Shares
2. Preference Shares

a) Equity Shares: Equity shares represent the ownership capital of a company. They do not enjoy any preferential right in the matter of the claim of dividend or repayment of capital. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company. They bear the maximum risk. Equity shareholders are the owners of the company. They have the right to vote and participate in the management.

Merits

• Equity shares are suitable for investors who are willing to assume the risk for higher returns
• Payment of equity dividend is not compulsory.
• Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company.
• Equity shares do not carry any charge on the assets of the company.
• They have the right to vote and participate in the management.
• Equity capital provides creditworthiness to the company

Limitations

• Investors who want steady income may not prefer equity shares.
• The cost of equity shares is generally more as compared to the cost of raising funds through other sources.
• Issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders.
• Issue of Equity shares is time-consuming.

b. Preference Share: The capital raised by the issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential right over equity shareholders in two ways:

a) The right to get a fixed rate of dividend.
b) The right to claim repayment of capital in the event of winding up of the company.

Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.
Types of Preference Shares

a. Cumulative and Non-cumulative Preference Share:- in cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in a non-cumulative preference share, the dividend is not accumulated if it is not paid out of the current year’s profit.

b. Participating and Non-participating Preference Share:- Participating preference shares have a right to share the profit after making payment to the equity shares. The non-participating preference shares do not enjoy such a right.

c. Convertible and Non-convertible Preference Share:- The preference shares which can be converted into equity shares after a specified period of time are known as convertible preference share. Non-convertible shares cannot be converted into equity shares.

d. Redeemable and Irredeemable Preference Share:- Redeemable preference shares are those where the company undertakes to repay it after a specified period. Where the amount of the preference shares is refunded only at the time of liquidation, are known as irredeemable preference shares.

Merits

• Preference shares provide a reasonably steady income in the form of a fixed rate of return and safety of the investment.
• Preference shares are useful for those investors who want a fixed rate of return with comparatively low risk
• It does not affect the control of equity shareholders because they have no voting right.
• Preference shares do not create an arty charge on the assets of the company.
• They have a preferential right of repayment of capital over equity shareholders in the event of liquidation of a company.

Limitations

• Preference shareholders have no voting right.
• The dividend paid is not deductible from profit for income tax.
• These shares may not attract investors who are expecting higher returns.
• The rate of dividend on preference shares is generally higher than the rate of interest on debentures.

Question 16.
As a source of finance, retained profits are better than other sources of company finance. Do you agree with this view? Give reasons for your answer. (March-2012)
Answer:
Yes. The cheapest source of company finance is retained earnings because it does not involve any cost for raising funds. Also, there is no commitment to pay a dividend.

Question 17.
A public limited company decided to borrow additional funds. The management of the company is not interested in dilution of control. (March-2013)
a) Suggest a suitable type of securities for raising the funds.
b) Explain the various types of that security.
Answer:
Debentures: A debenture is a document issued by a company under its seal to acknowledge its debt. Debenture holders are, therefore, termed as creditors of the company. Debenture holders are paid a fixed rate of interest.
Types of Debentures

a. Secured and Unsecured Debentures:- Secured (Mortgaged) debentures are debentures which are secured by a charge on the assets of the company. Unsecured (Simple or naked) debentures do not carry any charge or security on the assets of the company.

b. Registered and Bearer Debentures:- In the case registered debentures, the name, address and other details of the debenture holders are entitled in the books of the company. The debentures which are transferable by mere delivery are called bearer (Unsecured) debentures.

c. Convertible and Non-convertible Debentures: Convertible debentures are those debentures that can be converted into equity shares after the expiry of a specified period. On the other hand, nonconvertible debentures are those which cannot be converted into equity shares.

d. First and Second: Debentures that are repaid before other debentures are repaid are known as first debentures. The second debentures are those which are paid after the first debentures have been paid back.

Merits

• It. is preferred by investors who want fixed income at lesser risk
• Debenture holder do not have voting right
• Interest on Debentures is a tax-deductible expense
• It does not dilute control of equity shareholders on management
• Debentures are less costly as compared to the cost of preference shares.
• They guarantee a fixed rate of interest
• It enables the company to take the advantage of trading on equity.
• The issue of debentures is suitable when the sales and earnings are relatively stable

Limitations

• It is not suitable for companies with unstable future earnings.
• The company has to mortgage its assets to issue debentures.
• Debenture holders do not enjoy any voting rights.
• In the case of redeemable debentures, the company has to make provisions for repayment on the specified date, even during periods of financial difficulty.
• With the new issue of debentures, the company’s capability to further borrow funds reduces.

Question 18.
“These type of shares do not enjoy any preferential rights. The owners, of such type of shares, are the real masters.” Identify these type of shares and explain their merits and demerits. (March-2013)
Answer:

Issue of shares: The capital of a company is divided into smaller units called a share. Those who subscribe to the shares of a company are known as ‘shareholders’. Two types of shares may be issued by a company to raise capital. They are:-

1. Equity Shares
2. Preference Shares

a) Equity Shares: Equity shares represent the ownership capital of a company. They do not enjoy any preferential right in the matter of the claim of dividend or repayment of capital. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company. They bear the maximum risk. Equity shareholders are the owners of the company. They have the right to vote and participate in the management.

Merits

• Equity shares are suitable for investors who are willing to assume the risk for higher returns
• Payment of equity dividend is not compulsory.
• Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company.
• Equity shares do not carry any charge on the assets of the company.
• They have the right to vote and participate in the management.
• Equity capital provides creditworthiness to the company

Limitations

• Investors who want steady income may not prefer equity shares.
• The cost of equity shares is generally more as compared to the cost of raising funds through other sources.
• Issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders.
• Issue of Equity shares is time-consuming.

b. Preference Share: The capital raised by the issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential right over equity shareholders in two ways:

a) The right to get a fixed rate of dividend.
b) The right to claim repayment of capital in the event of winding up of the company.

Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.
Types of Preference Shares

a. Cumulative and Non-cumulative Preference Share:- in cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in a non-cumulative preference share, the dividend is not accumulated if it is not paid out of the current year’s profit.

b. Participating and Non-participating Preference Share:- Participating preference shares have a right to share the profit after making payment to the equity shares. The non-participating preference shares do not enjoy such a right.

c. Convertible and Non-convertible Preference Share:- The preference shares which can be converted into equity shares after a specified period of time are known as convertible preference share. Non-convertible shares cannot be converted into equity shares.

d. Redeemable and Irredeemable Preference Share:- Redeemable preference shares are those where the company undertakes to repay it after a specified period. Where the amount of the preference shares is refunded only at the time of liquidation, are known as irredeemable preference shares.

Merits

• Preference shares provide a reasonably steady income in the form of a fixed rate of return and safety of the investment.
• Preference shares are useful for those investors who want a fixed rate of return with comparatively low risk
• It does not affect the control of equity shareholders because they have no voting right.
• Preference shares do not create an arty charge on the assets of the company.
• They have a preferential right of repayment of capital over equity shareholders in the event of liquidation of a company.

Limitations

• Preference shareholders have no voting right.
• The dividend paid is not deductible from profit for income tax.
• These shares may not attract investors who are expecting higher returns.
• The rate of dividend on preference shares is generally higher than the rate of interest on debentures.

Question 19.
Green Co. Limited wants to start a new project at Cochin. The Finance Manager is in a confusion to decide whether to make use of their own source or to borrow from outside. Give advice to the finance manager by analysing the merits and demerits of both these sources. (October – 2013)
OR
Anil Holds 500 equity shares in Stars Ltd. and his friend Akhil invested? 10,000 in the debentures of the same company.
a) Do you think both these investments are the same?
b) Substantiate your answer.
Answer:
Advantages of Ownership Capital

• Outsiders will be more confident to deal with the enterprises.
• As it is permanent capital, it can be used in an emergency.
• It protects the interest of the owners.
• It increases the efficiency of the management.
• No security is needed for raising owners capital.
• Companies can raise huge capital by issue of shares.

Disadvantages of Ownership Capital

• Management may lose control of the company.
• As it is a permanent source it lacks flexibility. Advantages of Borrowed Capital
• It does not dilute the control of management.
• Interest paid is a tax-deductible expense.
• It is a flexible source of financing.
• It enables the company to take the advantage of trading on equity

Disadvantages of Borrowed Capital

• Even if there is no profit, interest is to be paid.
• Security is needed for raising such funds,
• No Differences between shares and debentures.

Question 20.
Equity shareholders are called……………….. (March – 2014)
a) owners of the company
b) partners of the company
Sources of Business Finance
c) executives of the company
d) guardians of the company
Answer:
Owners of the company

Question 21.
Mr Ganesh, a sole trader, acquired machinery on a monthly rental basis from an outside agency. Identify the type of financial services in which he entered. Explain it. (March – 2014)
Answer:
Leasing.
Lease Financing: A lease is a contractual agreement whereby the owner of an asset (lessor) grants the right to use the asset to the other party (lessee). The lessor charges a periodic payment for renting of an asset for some specified period called lease rent.

Question 22.
These are shares which carry preferential rights over equity shares. Being a commerce student, identify these type of shares and state their rights discussed as above. (March – 2014)
Answer:
Preference Share :
a) The right to get a fixed rate of dividend.
b) The right to claim repayment of capital in the event of winding up of the company.

Question 23.
Explain the meaning of ploughing back of profit. Explain any five merits. (March – 2014)
Answer:
Merits of Ploughing back of profit:

• It is a permanent source of funds available to an organization
• No costs in the form of interest, dividend or flotation cost.
• It is more dependable than external sources.
• There is no commitment to pay a dividend.
• It increases the financial strength and earning capacity of the business.
• Control over the management of the company remains unaffected.
• It does not require the security of assets.
• It may lead to an increase in the market price of the equity shares of a company.

Question 24.
Write two limitations of using borrowed funds as a source of business finance. (August – 2014)
Answer:
1) Payment of interest and principal is the responsibility of the owner.
2) Adequate security must be provided for obtaining borrowed fund.

Question 25.
As a source of finance, explain the features of preference shares. (August – 2014)
Answer:
Features of preference shares :
1) The right to get a fixed rate of dividend.
2) The right to claim repayment of capital in the event of winding up of the company.
3) They have no voting rights.
4) A Company can issue different types of Preference Shares.

Question 26.
In a classroom debate, Sanju argued that retained profit is the best source of company finance. Substantiate his views. (August – 2014)
Answer:
Merits of Ploughing back of profit:

• It is a permanent source of funds available to an organization
• No costs in the form of interest, dividend or flotation cost.
• It is more dependable than external sources.
• There is no commitment to pay a dividend.
• It increases the financial strength and earning capacity of the business.
• Control over the management of the company remains unaffected.
• It does not require the security of assets.
• It may lead to an increase in the market price of the equity shares of a company.

Question 27.
The cheapest source of finance is …………………. (March-2015)
a) equity shares
b) preference shares
c) debentures
d) retained earnings
Answer:
Retained earnings

Question 28.
What are the rights of preference shares over equity shares? (March-2015)
Answer:
a) Right to receive a dividend of the company
b) Right to receive the return of capital, in the case of winding up.

Question 29.
After returning from Dubai, Mr Rajan and his friends decided to form a private company in Kerala. What are the stages they have to undergo the formation of this company?  (March-2015)
Answer:
a) Promotion
b) Incorporation

Question 30.
Shares and debentures are equally important sources of finance for a joint-stock company. But there are some significant differences between these two sources of finance. Explain these differences. (March-2015)
Answer:

Question 31.
NHAI requires 100 trucks for 2 years for their project of developing the National Highway from Walayar to Thrissur and does not want to own it. (Say-2015)
a) Suggest the most suitable form of financial service.
b) Write any two merits of it.
Answer:
a) Leasing
b) 1. It enables the lessee to acquire the asset with
a lower investment;
2. Lease rentals paid by the lessee are
deductible for computing taxable profits;

Question 32.
Management of RKS Ltd. decided to distribute only 30% of the profit among the shareholders as a dividend. They planned to invest the remaining profit in business for expansion purposes. (Say-2015)
a) Identify the name of this internal source of finance for the business.
b) Explain its advantages.
Answer:
a) Retained earnings
b) Merits of Ploughing back of profit:

1. It is a permanent source of funds available to an organization
2. No costs in the form of interest, dividend or flotation cost.
3. It is more dependable than external sources.
4. There is no commitment to pay a dividend.
5. It increases the financial strength and earning capacity of the business.
6. Control over the management of the company remains unaffected.
7. It does not require the security of assets.
8. It may lead to an increase in the market price of the equity shares of a company.

Question 33.
The limit of minimum subscription is % of the size of the issue. (March-2016)
Answer:
90%

Question 34.
Gangothri Ltd., planning to raise the required funds from both owned and borrowed sources. (March-2016)
a) Identify one source from each group.
b) Explain its merits.
Answer:

Issue of shares: The capital of a company is divided into smaller units called a share. Those who subscribe to the shares of a company are known as ‘shareholders’. Two types of shares may be issued by a company to raise capital. They are:-

1. Equity Shares
2. Preference Shares

a) Equity Shares: Equity shares represent the ownership capital of a company. They do not enjoy any preferential right in the matter of the claim of dividend or repayment of capital. Equity shareholders do not get a fixed dividend but are paid on the basis of earnings by the company. They bear the maximum risk. Equity shareholders are the owners of the company. They have the right to vote and participate in the management.

Merits

• Equity shares are suitable for investors who are willing to assume the risk for higher returns
• Payment of equity dividend is not compulsory.
• Equity capital serves as permanent capital as it is to be repaid only at the time of liquidation of a company.
• Equity shares do not carry any charge on the assets of the company.
• They have the right to vote and participate in the management.
• Equity capital provides creditworthiness to the company

Limitations

• Investors who want steady income may not prefer equity shares.
• The cost of equity shares is generally more as compared to the cost of raising funds through other sources.
• Issue of additional equity shares dilutes the voting power and earnings of existing equity shareholders.
• Issue of Equity shares is time-consuming.

b. Preference Share: The capital raised by the issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential right over equity shareholders in two ways:

a) The right to get a fixed rate of dividend.
b) The right to claim repayment of capital in the event of winding up of the company.

Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.
Types of Preference Shares

a. Cumulative and Non-cumulative Preference Share:- in cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in a non-cumulative preference share, the dividend is not accumulated if it is not paid out of the current year’s profit.

b. Participating and Non-participating Preference Share:- Participating preference shares have a right to share the profit after making payment to the equity shares. The non-participating preference shares do not enjoy such a right.

c. Convertible and Non-convertible Preference Share:- The preference shares which can be converted into equity shares after a specified period of time are known as convertible preference share. Non-convertible shares cannot be converted into equity shares.

d. Redeemable and Irredeemable Preference Share:- Redeemable preference shares are those where the company undertakes to repay it after a specified period. Where the amount of the preference shares is refunded only at the time of liquidation, are known as irredeemable preference shares.

Merits

• Preference shares provide a reasonably steady income in the form of a fixed rate of return and safety of the investment.
• Preference shares are useful for those investors who want a fixed rate of return with comparatively low risk
• It does not affect the control of equity shareholders because they have no voting right.
• Preference shares do not create an arty charge on the assets of the company.
• They have a preferential right of repayment of capital over equity shareholders in the event of liquidation of a company.

Limitations

• Preference shareholders have no voting right.
• The dividend paid is not deductible from profit for income tax.
• These shares may not attract investors who are expecting higher returns.
• The rate of dividend on preference shares is generally higher than the rate of interest on debentures.

b) Debentures: A debenture is a document issued by a company under its seal to acknowledge its debt. Debenture holders are, therefore, termed as creditors of the company. Debenture holders are paid a fixed rate of interest.

Types of Debentures

a. Secured and Unsecured Debentures:-
Secured (Mortgaged) debentures are debentures which are secured by a charge on the assets of the company. Unsecured (Simple or naked) debentures do not carry any charge or security on the assets of the company.

b. Registered and Bearer Debentures:- In the case registered debentures, the name, address and other details of the debenture holders are entitled in the books of the company. The debentures which are transferable by mere delivery are called bearer (Unsecured) debentures.

c. Convertible and Non-convertible Debentures:- Convertible debentures are those debentures that can be converted into equity shares after the expiry of a specified period. On the other hand, nonconvertible debentures are those which cannot be converted into equity shares.

d. First and Second: Debentures that are repaid before other debentures are repaid are known as first debentures. The second debentures are those which are paid after the first debentures have been paid back.

Merits

• It. is preferred by investors who want fixed income at lesser risk
• Debenture holder do not have voting right
• Interest on Debentures is a tax-deductible expense
• It does not dilute control of equity shareholders on management
• Debentures are less costly as compared to the cost of preference shares.
• They guarantee a fixed rate of interest
• It enables the company to take the advantage of trading on equity.
• The issue of debentures is suitable when the sales and earnings are relatively stable

Limitations

• It is not suitable for companies with unstable future earnings.
• The company has to mortgage its assets to issue debentures.
• Debenture holders do not enjoy any voting rights.
• In the case of redeemable debentures, the company has to make provisions for repayment on the specified date, even during periods of financial difficulty.
• With the new issue of debentures, the company’s capability to further borrow funds reduces.

Question 35.
The newly established Eastern Valley Ltd. requires a huge volume of finance for establishing their business. A wide variety of sources of funds are available for them. Advice the finance department about the factors to be considered before selecting the suitable sources. (March-2016)
Answer:
b) Factors to be considered before selecting a suitable source of finance.
Factors affecting the choice of the source of funds
The factors that affect the choice of source of finance are:-

1. Cost: The cost of procurement of funds and cost of utilising the funds should be taken into account while deciding about the source of funds that will be used by an organization.

2. Financial strength and stability of operations: In the choice of source of funds, the business should be in a sound financial position so
as to be able to repay the principal amount and interest on the borrowed amount. When the earnings of the organisation are not stable, it can issue equity shares to collect the fund.

3. Form of organisation and legal status: The form of business organisation and status influences the choice of a source for raising money.

4. Purpose and time period: Business should plan according to the time period for which the funds are required. A short-term need can be met through borrowing funds at a low rate of interest through trade credit, commercial paper, etc. For long term finance, sources such as the issue of shares and debentures are more appropriate.

5. Risk profile: Business should evaluate each of the source of finance in terms of the risk involved.

6. Control: the business firm should choose a source keeping in mind the extent to which they are willing to share their control over the business.

7. Effect on creditworthiness: The dependence of business on certain sources may affect its creditworthiness in the market.

8. Flexibility and ease:: Another aspect affecting the choice of a source of finance is the flexibility and ease of obtaining funds.

9. Tax benefits: Various sources may also be weighed in terms of their tax benefits. For example, while the dividend on preference shares is not tax-deductible, interest paid on debentures and loans is tax-deductible.

Question 36.
A certain portion of the profit of the companies is kept for future purposes, without distributing as dividends. (September – 2016)
a) Name the source of finance mentioned above.
b) State any three merits.
Answer:
a) Retained earnings/Reserves/Ploughing back of profit.
b)Merits of Ploughing back of profit:

• It is a permanent source of funds available to an organization
• No costs in the form of interest, dividend, or flotation cost.
• It is more dependable than external sources.
• There is no commitment to pay dividends.
• It increases the financial strength and earning capacity of the business.
• Control over the management of the company remains unaffected.
• It does not require the security of assets.
• It may lead to an increase in the market price of the equity shares of a company.

The preference shareholders enjoy a preferential right over equity shareholders in two ways:
a) The right to get a fixed rate of dividend.
b) The right to claim repayment of capital in the event of winding up of the company.

Participating and Non-participating Preference Share:- Participating preference shares have a right to share the profit after making payment to the equity shares. The non-participating preference shares do not enjoy such a right.

Question 38.
Explain the factors affecting the choice of business finance. (March – 2017)
Answer:
Factors affecting the choice of the source of funds
The factors that affect the choice of source of finance are:-

1. Cost: The cost of procurement of funds and cost of utilising the funds should be taken into account while deciding about the source of funds that will be used by an organization.

2. Financial strength and stability of operations: In the choice of source of funds, a business should be in a sound financial position so
as to be able to repay the principal amount and interest on the borrowed amount. When the earnings of the organisation are not stable, it can issue equity shares to collect the fund.

3. Form of organisation and legal status: The form of business organisation and status influences the choice of a source for raising money.

4. Purpose and time period: Business should plan according to the time period for which the funds are required. A short-term need can be met through borrowing funds at a low rate of interest through trade credit, commercial paper, etc. For long term finance, sources such as the issue of shares and debentures are more appropriate.

5. Risk profile: Business should evaluate each of the source of finance in terms of the risk involved.

6. Control: the business firm should choose a source keeping in mind the extent to which they are willing to share their control over the business.

7. Effect on creditworthiness: The dependence of business on certain sources may affect its creditworthiness in the market.

8. Flexibility and ease:: Another aspect affecting the choice of a source of finance is the flexibility and ease of obtaining funds.

9. Tax benefits: Various sources may also be weighed in terms of their tax benefits. For example, while the dividend on preference shares is not tax-deductible, interest paid on debentures and loans is tax-deductible.

Question 39.
What is meant by public deposits? Explain its merits and limitations as a source of finance. (March – 2017)
Answer:
Public Deposits:- The deposits that are raised by organisations directly from the public are known as public deposits. Rates of interest offered on public deposits are usually higher than those allowed by commercial banks.. Companies generally invite public deposits for a period of up to three years. This is regulated by the R.B.I. and can not exceed 25% of its paid-up share capital and reserves.

Merits

• The procedure for obtaining public deposits is simpler than share and Debenture.
• The cost of public deposits is generally lower than the cost of borrowings from banks
• Public deposits do not usually create any charge on the assets of the company
• They do not have voting right therefore the control of the company is not diluted
• Interest paid on public deposits is tax deductible.

Limitations

• New companies generally find it difficult to raise funds through public deposits
• They are not secured.
• They are costly as most Of the companies have to offer high interest.
• It is an unreliable source of finance as the public may not respond when the company needs money

Plus One Business Studies Chapter Wise Previous Questions