Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

APRIL 2018
Section – A (2 Marks) Section – B (5 Marks) Section – C (10 Marks)
1. State the importance of finance
2. What is meant by financial
management?
3. What are the various types of
leverage?
4. What is Net Income Theory in
Capital structure?
5. What does cost of debt mean?
6. What is meant by weighted
average cost of capital? Explain the objectives of
What role should be financial
7. What is dividend policy? finance
manager play in an enterprise?
8. List any two reasons of issuing
stock dividend
9. What is the importance of working
capital?
10. What do you understand by net
working capital?
11. What is profit maximization?
12. Write short note on stable dividend
policy

NOVEMBER 2017
1. What are finance functions?
2. What is the meaning of financial
planning?
3. What is meant by trading on
equity?
4. What is meant by the term
leverage?
5. What do you mean by cost of
capital?
6. Explain the MM approach in the Define the term financial
Explain the major determinants of
capital structure? management. What are its
dividend policy of a firm
7. How cost of capital can be objectives?
classified?
8. What is optimum capital structure?
9. What is stable dividend?
10. What are the sources available for
dividend?
11. List out the factors determining
working capital?
12. What are the various types of
working capital?

1
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

APRIL 2016
Section – A (2 Marks) Section – B (5 Marks) Section – C (10 Marks)
1. Define the term financial management.
2. State any two functions of financial
management.
3. What do you mean by optimum capital
structure?
4. What do you mean by financial
leverage?
5. Why is cost of capital important?
6. What is meant by permanent working
Explain the objectives of Explain the various functions of
capital?
financial management finance manager.
7. What is finance function?
8. What are the features of a sound capital
structure?
9. What do you mean by stock dividend?
10. What is meant by trading on equity?
11. What are the sources available for
dividend?
12. What are the principles of working
capital management?
NOVEMBER - 2016
1. What is financial management?
2. What is investment decision?
3. State the long-term sources of finance?
4. How is cost of equity determined?
5. Define cost of capital
6. What is MM approach of capital
structure?
7. What is operating leverage? Describe about factors affecting
Nil
8. What is stock dividend? divided payment
9. What is MM hypothesis of dividend
irrelevance?
10. What is operating cycle?
11. What are the components of working
capital?
12. How is weighted average cost capital
computed?

2
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

APRIL 2015
Section – A (2 Marks) Section – B (5 Marks) Section – C (10 Marks)
1. Define Financial Management.
2. Mention any two objectives of
financial management.
3. List out the short term sources of
finance.
4. Define the term capital structure.
5. State the different types of leverages.
6. What are the different types of cost of
What is Financial Management?
capital? Explain the functions of a
State the approaches of Financial
7. What do you mean by weighted Finance Manager.
Management.
average cost of capital?
8. What is meant by dividend policy?
9. List out the different types of dividend.
10. What are the assumptions of Gordon’s
dividend model?
11. Define the term working capital.
12. What do you mean by variable
working capital?
NOVEMBER - 2015
1. Define finance.
2. Enumerate any two objectives of
financial management. 1. Explain the
3. Classify the sources of finance importance of
according to ownership. financial
4. State the patterns of capital structure. management.
5. What is Arbitrage process? 2. Explain the factors
6. What is over capitalization? affecting capital
7. Define cost of capital. structure. NIL
8. What is explicit cost of capital? 3. What are the
9. What is stock dividend? external factors
10. State the two basic conditions to be which affect the
complied by a company for issue of dividend policy of a
bonus share. company?
11. What is operating cycle of working
capital?
12. Define 'Net Working Capital'.

3
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

APRIL 2014
Section – B (5
Section – A (2 Marks) Section – C (10 Marks)
Marks)
1. Distinguish between profit maximization
and wealth maximization.
2. What is financial leverage?
3. Why is cost of capital important in
financial management?
4. What is net income approach theory of
capital structure?
5. What are financial assets?
6. What are the two major issues in
Explain the objectives of financial
formulating working capital policy? NIL
management
7. What are the implications of Gordon’s
dividend model?
8. What is time value of money?
9. How cost of capital can be classified?
10. What is the meaning of financial
planning?
11. What are finance functions?
12. What is meant by permanent working
capital?
NOVEMBER - 2014
1. What is Profit Maximization?
2. What is Trade Credit?
3. What is Dividend Decision?
4. State the meaning of Capital Structure.
5. Explain NI approach.
6. Define Financial Leverage.
What are the factors influencing
7. What is Cost of Debt? NIL
working capital?
8. Explain Walter model of dividend.
9. Define Working Capital.
10. What is Operating Cycle?
11. What is Dividend?
12. What are the components of Working
Capital?

4
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

APRIL 2013
Section – A (2 Marks) Section – B (5 Marks) Section – C (10 Marks)
1. What is financial management?
2. State any three functions of a finance
manager.
3. What is meant by capital structure?
4. What is meant of leverage?
5. What is cost of capital?
6. Differentiate average cost from
marginal cost.
Explain the objectives of financial Discuss the approaches to
7. What do you mean by dividend?
management financial management
8. Write a short note on stable dividend
policy.
9. What is meant by working capital?
10. What is operating cycle?
11. What is meant by weighted average
cost of capital?
12. State any two advantages of stock
dividend.
NOVEMBER - 2013
1. Define financial management.
2. State the basic objectives of financial
management.
3. What is trade credit?
4. What do you mean by capital
1. Distinguish between profit
structure?
maximization and wealth
5. What is meant by the term ‘‘capital
maximization.
gearing’’?
2. Briefly explain the
6. What is under capitalization?
Modigliani-Miller approach NIL
7. State the components of cost of
about cost of capital.
capital.
3. Explain the advantages of
8. What is implicit cost of capital?
issuing bonus share.
9. Define ‘Dividend Policy’.
10. What are Bonus shares?
11. Enumerate four factors which affect
working capital requirements of a
business.
12. What is gross working capital?

5
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

APRIL 2012
Section – A (2 Marks) Section – B (5 Marks) Section – C (10 Marks)
1. What is financial management?
2. What are the short-term sources of
finance?
3. What is meant by capital structure?
4. What do you understand by trading on
equity?
5. Mention the different types of
leverages.
6. What is composite leverage? ‘‘The most important cause of
7. What is cost of capital?
NIL business failure in the faulty
8. What are the components of cost of
financial planning’’ – Discuss
capital?
9. What do you understand by Fixed
Working Capital?
10. What are the different sources of
working capital?
11. Mention the names of different types
of dividend.
12. What do you mean by stable dividend
policy?
NOVEMBER - 2012
1. What is financial management?
2. Define cost of capital.
3. What is a stable dividend policy?
4. Define the term working capital.
5. What do you mean by over
capitalization?
6. State any two functions of financial
management.
7. What are the steps in financial What are the problems in Explain the factors determining
planning? determining cost of capital? the capital structure.
8. State the significance of cost of capital.
9. Define the term capital structure.
10. What do you mean by financial
leverage?
11. What do you mean by retained
earnings?
12. What are the components of working
capital?

6
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

Financial Management Theory Questions Review – Answers

JHA Agarsen College - Jeganraj

State the importance of finance

 Finance is the lifeblood of business organization.
 Some of the importance of the financial management is as follows:
o Financial Planning
o Acquisition of Funds
o Proper Use of Funds
o Financial Decision
o Improve Profitability
o Increase the Value of the Firm
o Promoting Savings
What is meant by financial management?
 Financial management may be defined as planning, organising, directing and controlling
the financial activities of an organisation.
 According to Guthman and Dougal, “the activity concerned with the planning, raising,
controlling and administering of funds used in the business.”

What are the various types of leverage?

Leverage: The use of fixed costs in an attempt to increase (or lever up) profitability.
1. Financial Leverage: The use of fixed financing costs by the firm. It is the ability of a
firm to use fixed financial charges to expand the effects of changes in EBIT on the
earnings per share
2. Operating Leverage: The use of fixed operating costs by the firm. It is associated with
investment activities
3. Combined Leverage: When the company uses both financial and operating leverage to
magnification of any change in sales into a larger relative changes in earning per share.
Combined leverage is also called as composite leverage or total leverage.
What is Net Income Theory in Capital structure?
 Net income approach suggested by the Durand.
 According to this approach, the capital structure decision is relevant to the valuation of
the firm. In other words, a change in the capital structure leads to a corresponding change
in the overall cost of capital as well as the total value of the firm.
 According to this approach, use more debt finance to reduce the overall cost of capital
and increase the value of firm.

What does cost of debt mean?

 Cost of debt is the interest a company pays on its borrowings.
 It is the effective interest rate a company pays on its debt obligations, including bonds,
mortgages, and any other forms of debt
 It is expressed as a percentage rate.
 In addition, cost of debt can be calculated as a before-tax rate or an after-tax rate.

7
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What is meant by weighted average cost of capital?

 WACC is the average rate of return a company expects to compensate all its different
investors
 The weighted average cost of capital is the percentage rate of return that must be
achieved to add shareholder value taking into account all the various sources of finance
used by the firm.
WACC = (E/V x Re) + ((D/V x Rd) x (1 – T))
 E = market value of the firm’s equity (market cap)
 D = market value of the firm’s debt
 V = total value of capital (equity plus debt)
 E/V = percentage of capital that is equity
 D/V = percentage of capital that is debt
 Re = cost of equity (required rate of return)
 Rd = cost of debt (yield to maturity on existing debt)
 T = tax rate

What is dividend policy?

 A dividend policy is the parameters used by a board of directors as the basis for its
decisions to issue dividends to investors
 A dividend policy is a company's approach to distributing profits back to its owners or
stockholders.
 The Dividend Policy is a financial decision that refers to the proportion of the firm's
earnings to be paid out to the shareholders.

List any two reasons of issuing stock dividend

Stock Dividend: It is a dividend payment made in the form of additional shares rather than a
cash payout.
1. Increase the number of shares of stock outstanding
2. Move some of its retained earnings to paid-in capital
3. Minimize distributing the corporation's cash to its stockholders.

What is the importance of working capital?

Working Capital means Current Assets. The importance are:
1. Smooth Flow of Production
2. Increase in Liquidity and Solvency Position
3. Goodwill
4. Advantages of Cash Discount
5. Easy Loan
6. Regular Payment of Wages and Salaries
7. Security and Confidence
8. Meeting of Contingencies

8
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What do you understand by net working capital?

 Net working capital is the difference between your current assets and current liabilities.
 Net Working Capital is the excess of current assets over the current liability.
Net Working Capital = Current Assets - Current Liabilities

What is profit maximization?

 It means cashing per share maximization
 Profit maximization happens when marginal cost is equal to marginal revenue.
 Under this objective, the business enterprises to earn at least satisfactory returns on the
funds invested

Write short note on ‘Stable Dividend Policy’ (Nov-2017)

 Stable Dividend means payment of certain minimum amount of dividend regularly.
 There is no change in the amount of dividend if there are temporary changes in the
earnings This dividend policy consists of the following three important forms:
o Constant dividend per share
o Constant payout ratio
o Stable rupee dividend plus extra dividend.

Explain the objectives of finance

Definition of finance
 According to Khan and Jain, “Finance is the art and science of managing money”.
 According to the Wheeler, “Business finance is that business activity which concerns
with the acquisition and conversation of capital funds in meeting financial needs and
overall objectives of a business enterprise”.
Objectives of Finance

9
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What role should be financial manager play in an enterprise? / Functions of finance

manager
1. Forecasting Financial Requirements: It is the primary function of the Finance Manager.
He is responsible to estimate the financial requirement of the business concern.
2. Acquiring Necessary Capital: After deciding the financial requirement, the finance
manager should concentrate how the finance is mobilized and where it will be available.
3. Investment Decision: The finance manager must carefully select best investment
alternatives and consider the reasonable and stable return from the investment.
4. Interrelation with Other Departments: Finance manager deals with various functional
departments such as marketing, production, personnel, system, research, development, etc.
5. Provision of Capital: To establish and execute programmes for the provision of capital
required by the business.
6. Investor Relations: to establish and maintain an adequate market for the company securities
and to maintain adequate liaison with investment bankers, financial analysis and share
holders.
7. Short Term Financing: To maintain adequate sources for company’s current borrowing
from commercial banks and other lending institutions.
8. Banking and Custody: To maintain banking arrangement, to receive, has custody of
accounts.
9. Credit and Collections: to direct the granting of credit and the collection of accounts due to
the company including the supervision of required arrangements for financing sales such as
time payment and leasing plans.
10. Investments: to achieve the company’s funds as required and to establish and co-ordinate
policies for investment in pension and other similar trusts.
11. Insurance: to provide insurance coverage as required.
12. Planning for Control: To establish, co-ordinate and administer an adequate plan for the
control of operations.
13. Reporting and Interpreting: To compare information with operating plans and standards
and to report and interpret the results of operations to all levels of management and to the
owners of the business.
14. Evaluating and Consulting: To consult with all the segments of management responsible
for policy or action concerning any phase of the operation of the business as it relates to the
attainment of objectives and the effectiveness of policies, organization structure and
procedures.
15. Tax Administration: to establish and administer tax policies and procedures.
16. Government Reporting: To supervise or co-ordinate the preparation of reports to
government agencies.
17. Protection of Assets: To ensure protection of assets for the business through internal control,
internal auditing and proper insurance coverage.

10
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What are finance functions?

What is the meaning of financial planning?

 Financial Planning is the process of estimating the capital required and determining its
competition.
 It is the process of framing financial policies in relation to procurement, investment and
administration of funds of an enterprise. It includes:
o Determining capital requirements
o Determining capital structure
o Framing financial policies
What is meant by trading on equity?
 Trading on Equity, also known as financial leverage
 It is the financial process of using debt to produce gain for the residual owners
 Trading on equity occurs when a corporation uses bonds, other debt, and preferred stock
to increase its earnings on common stock.
 The earnings in excess of the interest expense on the new debt will increase the earnings
of the corporation's common stockholders.
What is meant by the term leverage?
 James Horne has defined leverage as, “the employment of an asset or fund for which the
firm pays a fixed cost or fixed return.
 It refers to debt or to the borrowing of funds to finance the purchase of inventory,
equipment and other company assets.
 Leverage reflects both the business risk and the financial risk of the company

What do you mean by cost of capital?

 Cost of capital is the required rate of return on its investments which belongs to equity,
debt and retained earnings.
 Cost of capital is the rate of return that a firm must earn on its project investments to
maintain its market value and attract funds.
 According to Solomon Ezra, “Cost of capital is the minimum required rate of earning or
the cut-off rate of capital expenditures”.

11
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

Explain the MM approach in the capital structure?

 This approach was developed by Modigliani and Miller during 1950s.
 The fundamentals of Modigliani and Miller approach look like Net operating income
approach.
 Modigliani and Miller advocate capital structure irrelevancy theory.
 Modigliani and Miller approach states that the financing decision of a firm does not affect
the market value of a firm
 The cost of capital does not change with change in the debt weighted equity mix or
capital structures capital market.
 In other words MM approach maintains that the average of the firm.

How cost of capital can be classified?

Cost of capital may be classified into the following types on the basis of nature and usage:
1. Explicit Cost - the rate that the firm pays to procure financing
2. Implicit Cost - the rate of return associated with the best investment opportunity for the firm
3. Average Cost - the weighted average cost of each component of capital employed by the
company
4. Marginal Cost - the weighted average cost of new finance raised by the company
5. Historical Cost - the cost which has already been incurred for financing
6. Future Cost - the expected cost of financing in the proposed project
7. Specific Cost - The cost of each sources of capital
8. Combined Cost - the combination of all sources of capital

What is optimum capital structure?

• Optimum capital structure is the capital structure at which the weighted average cost of
capital is minimum and thereby the value of the firm is maximum.
• The capital structure or combination of debt and equity that leads to the maximum value
of the firm.

What are the sources available for dividend?

There are three sources from which dividends may be declared, namely:
1. Current year's profits
2. Past profits remaining undistributed
3. Moneys provided by government.

List out the factors determining working capital?

Nature of business, Production cycle, Business cycle, Production policy, Credit policy, Growth
and expansion, Availability of raw materials, Earning capacity

12
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What are the various types of working capital?

1. Permanent Working Capital: It is also known as Fixed Working Capital. It is the

capital; the business concern must maintain certain amount of capital at minimum level at
all times.
2. Temporary Working Capital: It is also known as variable working capital. It is the
amount of capital which is required to meet the Seasonal demands and some special
purposes.
3. Semi Variable Working Capital: Certain amount of Working Capital is in the field
level up to a certain stage and after that it will increase depending upon the change of
sales or time.

Define the term financial management. What are its objectives?

Definition of Financial Management
• Financial management is an integral part of overall management. It is concerned with the
duties of the financial managers in the business firm.
• The term financial management has been defined by Solomon, “It is concerned with the
efficient use of an important economic resource namely, capital funds”.
• The most popular and acceptable definition of financial management as given by S.C.
Kuchal is that “Financial Management deals with procurement of funds and their
effective utilization in the business”.

Objectives of Financial Management

Objectives of Financial Management may be broadly divided into two parts such as:
1. Profit maximization
2. Wealth Maximization

Profit Maximization
• Main aim of any kind of economic activity is earning profit. A business concern is also
functioning mainly for the purpose of earning profit. Profit is the measuring techniques to

13
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

understand the business efficiency of the concern. Profit maximization is also the
traditional and narrow approach, which aims at, maximizes the profit of the concern.
Profit maximization consists of the following important features.
1. Profit maximization is also called as cashing per share maximization. It leads to maximize
the business operation for profit maximization.
2. Ultimate aim of the business concern is earning profit; hence, it considers all the possible
ways to increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So it shows the
entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
Wealth Maximization
• Wealth maximization is one of the modern approaches, which involves latest innovations
and improvements in the field of the business concern. The term wealth means
shareholder wealth or the wealth of the persons those who are involved in the business
concern. Wealth maximization is also known as value maximization or net present worth
maximization. This objective is a universally accepted concept in the field of business.
Explain the major determinants of dividend policy of a firm

Why is cost of capital important?

1. Designing the capital structure
2. Capital budgeting decisions
3. Comparative study of sources of financing
4. Evaluations of financial performance
5. Knowledge of firms expected income and inherent risks

What is meant by permanent working capital?

 It is also called fixed working capital
 Permanent working capital is the minimum level of current assets required by a firm to
carry-on its business operations.
What are the features of a sound capital structure?
(i) Maximum Return (ii) Less Risky (iii) Safety (iv) Flexibility (v) Economy (vi) Capacity (vii)
Control.

14
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What do you mean by stock dividend?

 A dividend in the form of more shares of stock.
 A stock dividend is a dividend payment made in the form of additional shares rather than
a cash payout.
 It's a payment of additional shares, instead of cash, to shareholders as a form of return on
their investment in the company

What are the sources available for dividend?

a. Out of current profits – Dividend can be declared by a company out of profits for the current
year arrived at after providing depreciation.
b. Out of past profits – Dividend can be declared out of the undistributed profits of the company
for any previous financial year in accordance with the provisions.
c. Declaration of dividend out of profits If a company wants to declare dividend out of the
accumulated profits:

What are the principles of working capital management?

1) Principle of equity position: as per this principle every investment in the current assets
should contribute to the net worth of the firm. The position of current assets can be well
judged by the two ratios; current assets to total asset and current asset to total sales.
2) Principle of cost of capital: different sources of working capital finance have different
cost of capital. Generally there is –ve relationship between the risk and cost of capital,
which means more the risk less will be the cost and less the risk more will be the cost. So
there should be balance between the two.
3) Principle of maturity of payment: as per this principle the firm should make an every
effort regarding the maturity of payment. In case the period to pay back the liabilities is
short than it becomes difficult for the firm to meet it obligations in time.
4) Principle of risk variation: there is direct relationship between risk and profitability. • If
the firm makes large investment in current asset→ increase liquidity→ reduce risk→
decrease the opportunity for gain for the firm

What is investment decision?

 The investment decision means capital budgeting.
 Capital budgeting is the process in which a business determines and evaluates potential
large expenses or investments.

State the long-term sources of finance?

1) Share Capital or Equity Shares.
2) Preference Capital or Preference Shares.
3) Retained Earnings or Internal accumulation.
4) Debenture / Bonds.
5) Term Loans from Financial Institutes, Government, and Commercial Banks.
6) Venture Funding.
7) Asset Securitization.

15
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What is MM approach of capital structure?

 Modigliani and Miller approach to capital theory, developed in the 1950s
 This suggests that the valuation of a firm is not important to the capital structure of a
company. Whether a firm is highly leveraged or has lower debt component, it has no
bearing on its market value. Rather, the market value of a firm is dependent on the
operating profits of the company.

What is MM hypothesis of dividend irrelevance?

 According to Miller and Modigliani Hypothesis or MM Approach, dividend policy has
no effect on the price of the shares of the firm and believes that it is the investment policy
that increases the firm's share value.

What is operating cycle?

 The operating cycle is the average period of time required for a business to make an
initial outlay of cash to produce goods, sell the goods, and receive cash from customers in
exchange for the goods.
 An operating cycle is the amount of time a company spends between spending money
operating activities and collecting money from the same

What are the components of working capital?

1) Cash Management
2) Receivables Management
3) Inventory Management
4) Accounts Payable Management:

Describe about factors affecting divided payment

1. Legal requirements: There is no legal compulsion on the part of a company to distribute dividend.
However, there certain conditions imposed by law regarding the way dividend are distributed. Basically there are
three rules relating to dividend payments. They are the net profit rule, the capital impairment rule and insolvency
rule.
2. Firm's liquidity position: Dividend payout is also affected by firm's liquidity position. In spite of sufficient
retained earnings, the firm may not be able to pay cash dividend if the earnings are not held in cash.
3. Repayment need: A firm uses several forms of debt financing to meet its investment needs. These debt must
be repaid at the maturity. If the firm has to retain its profits for the purpose of repaying debt, the dividend payment
capacity reduces.
4. Expected rate of return: If a firm has relatively higher expected rate of return on the new investment, the
firm prefers to retain the earnings for reinvestment rather than distributing cash dividend.
5. Stability of earning
If a firm has relatively stable earnings, it is more likely to pay relatively larger dividend than a
firm with relatively fluctuating earnings.
6. Desire of control: When the needs for additional financing arise, the management of the firm may not prefer
to issue additional common stock because of the fear of dilution in control on management. Therefore, a firm prefers
to retain more earnings to satisfy additional financing need which reduces dividend payment capacity.
7. Access to the capital market: If a firm has easy access to capital markets in raising additional financing, it
does not require more retained earnings. So a firm's dividend payment capacity becomes high.
8. Shareholder's individual tax situation: For a closely held company, stockholders prefer relatively
lower cash dividend because of higher tax to be paid on dividend income. The stockholders in higher personal tax
bracket prefer capital gain rather than dividend gains.

16
 Financial Management Theory Questions Review – JHA Agarsen College - Jeganraj

What are the various types of working capital?

1) Cash Credit/Bank Overdraft
2) Trade Credit
3) Purchase/Discount of Bills
4) Working Capital Loans
5) Bank Guarantee
6) Invoice Factoring
7) Letter of Credit

NET INCOME (NI) APPROACH

Net income approach is based on the following three important assumptions:
1. There are no corporate taxes.
2. The cost debt is less than the cost of equity.
3. The use of debt does not change the risk perception of the investor.
Where V = S+B
V = Value of firm S = Market value of equity B = Market value of debt Market value of the equity
can be ascertained by the following formula:
S = NI/K e
NI = Earnings available to equity shareholder Ke = Cost of equity/equity capitalization rate

17