Financial Planning and Management — Important Questions

It must be flexible

Step 1: The chapter lists several essentials of a sound financial plan. Step 2: These include: simplicity, long-term view, flexibility, optimal use of funds, low cost of funds, and adequate liquidity. Step 3: Flexibility means the plan should be capable of being adjusted and revised without difficulty to meet future requirements. Step 4: 'Abundant availability of funds' is NOT an essential — the plan should ensure optimal, not excess, use of funds. 'Short-term focus only' is wrong; a long-term view is required. 'Highly complex' is also wrong — the plan must be simple. Step 5: Therefore, 'It mu

Capital Structure

Step 1: Understand the basic terms. Working capital is for day-to-day operations; Fixed capital is invested in long-term assets. Step 2: Capital Structure refers to the choice of combination of debt and equity used to finance business operations, aiming to maximize the market value of shares. Step 3: Financial Structure is broader — it includes capital structure PLUS current liabilities. Step 4: Capital Structure specifically refers to long-term sources (equity shares, preference shares, debentures, long-term loans, retained earnings). Step 5: Therefore, 'Capital Structure' is the correct answ

Debt involves less cost as interest is tax-deductible

Step 1: Compare the features of debt and equity as described in the chapter. Step 2: Debt involves LESS cost because the interest paid on debt is treated as a revenue expense and is subject to tax-shield (tax deduction), reducing the effective cost. Step 3: Equity is expensive because dividend payment is NOT tax-deductible, and shareholders expect high returns. Step 4: Debt holders (debenture holders) do NOT have voting rights — that belongs to equity shareholders. Step 5: Debt is actually RISKY for the company because interest payment is a legal obligation. Therefore, 'Debt involves less cost

EBIT / EBT

Step 1: Recall the three leverage formulas from the chapter. Step 2: Financial Leverage = EBIT / EBT (Earnings Before Interest and Tax divided by Earnings Before Tax). Step 3: Operating Leverage = Contribution / EBIT. Step 4: Combined Leverage = Contribution / EBT (or Financial Leverage × Operating Leverage). Step 5: Financial leverage measures the effect of fixed financial charges (interest) on EPS. It compares EBIT (before interest) to EBT (after interest), so EBIT / EBT is the correct formula. Option 'EBT / EBIT' is the inverted formula and is incorrect.