Sources of Finance – Long Answer Questions (Part 2)
Medium Level (Application & Explanation)
Q1. Explain why equity shares are called ownership capital. How are they important for a company?
Answer:
- Equity shares represent ownership in the company.
- Money raised is called share capital or owner’s funds.
- Equity shareholders get voting rights in key decisions.
- They may get dividends, but only if the company makes profit.
- Equity capital is permanent. It is not refunded till the company closes.
- Example: Buying shares of Tata Motors makes you a part-owner.
Q2. What are preference shares? Explain their key features and importance.
Answer:
- Preference shares have preferential rights over equity shares.
- They get a fixed rate of dividend before equity shareholders.
- On winding up, they are repaid before equity shareholders.
- Money raised is called preference share capital.
- They usually do not carry voting rights on company matters.
- They offer stable income to investors and help the company raise funds.
Q3. What are debentures? Why are they useful for both the company and investors?
Answer:
- Debentures are used by a company to borrow money.
- Buyers of debentures are lenders, not owners.
- Debenture holders get a fixed interest regularly.
- Interest is paid even if there is no profit.
- For the company, debentures give quick funds without sharing ownership.
- For investors, debentures offer regular income and lower risk than shares.
Q4. How do commercial banks help businesses meet immediate fund needs? Explain with methods.
Answer:
- Commercial banks give loans and advances to all types of businesses.
- They offer cash credit to buy raw materials and run daily operations.
- Overdraft lets firms withdraw more than their bank balance.
- Banks also give term loans for a fixed period.
- They purchase or discount bills for quick cash from sales.
- Letters of credit help in trade by assuring payment to suppliers.
Q5. What role do financial institutions play in business financing?
Answer:
- The government set up financial institutions to support industry.
- They provide owned capital and loan capital to firms.
- They focus on long-term and medium-term finance needs.
- They help industrial growth and build infrastructure.
- They often give lower interest rates and special schemes.
- Examples: IDBI, SIDBI, and National Housing Bank provide targeted support.
High Complexity (Analysis & Scenario-Based)
Q6. A company must choose between issuing equity shares and preference shares. Analyze which is better in different situations.
Answer:
- Choose equity shares if the company wants permanent capital.
- Equity gives investors voting rights, so control may be shared.
- Equity dividends are not guaranteed, so cash outflow is flexible.
- Choose preference shares for fixed dividends and investor confidence.
- Preference shareholders get priority in dividends and repayment.
- They generally have no voting rights, so control stays with existing owners.
Q7. Your firm expects losses for the next two years but needs funds now. Compare equity, preference shares, and debentures. What should you choose and why?
Answer:
- Equity has no fixed dividend, so it does not strain cash in loss years.
- But equity dilutes control because it gives voting rights to new owners.
- Preference shares need fixed dividends before equity, adding pressure.
- Debentures require fixed interest even in loss, which is a burden.
- If control is key and cash is tight, equity may be safer for cash flow.
- If you can handle fixed payments, debentures avoid sharing ownership. Choose based on cash capacity.
Q8. A trading firm can get a large discount on bulk raw materials if it pays quickly. Evaluate bank options and select the best mix.
Answer:
- Cash credit is good for buying inventory as and when needed.
- Overdraft helps to cover a short cash gap in the current account.
- Bill discounting turns sales bills into immediate cash.
- A letter of credit assures the supplier of payment in trade deals.
- A smart plan: use overdraft for immediate payment, then discount bills to reduce interest.
- If purchase is ongoing, use a cash credit limit to finance repeated buys.
Q9. An infrastructure company plans a long project. Should it go to financial institutions or rely on banks, equity, or debentures? Analyze.
Answer:
- Financial institutions focus on long-term and medium-term funds.
- They offer lower interest rates and special schemes for such sectors.
- They support industry and infrastructure growth as a policy goal.
- Commercial banks are faster, but often suit short-term needs better.
- Equity is permanent but dilutes control and depends on market response.
- Debentures add fixed interest load. For long projects, institutions fit best.
Q10. You want funds but also want to keep control over decisions. Compare equity, preference shares, debentures, and bank loans. What approach works best?
Answer:
- Equity shares give voting rights to buyers; control may reduce.
- Your own equity keeps control, but selling equity shares power.
- Preference shares usually have no voting rights, so control stays.
- Debentures are borrowed money; you do not sell ownership.
- Bank loans also keep ownership intact and are faster to get.
- To keep control, prefer preference shares, debentures, or bank finance over new public equity.