Chapter financial-management: Financial Management Case Study Questions | business studies Class 12 CBSE

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Chapter financial-management: Financial Management Case Study Questions | business studies Class 12 CBSE | ByteNotes.in

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Case Set 1

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Priya runs a medium-sized garment manufacturing unit in Jaipur. She recently decided to expand operations by purchasing new stitching machines worth ₹50 lakhs. To finance this, she approached her bank for a term loan and also considered issuing preference shares. Her finance manager advised her to carefully analyse the cash flows expected from the new machines over the next five years before committing to the investment. The finance manager also reminded her that once such a large investment in fixed assets is made, it is very difficult to reverse without incurring heavy losses. After detailed analysis comparing the rate of return of the new machine (15%) with the cost of debt (11%), Priya decided to go ahead with a combination of debt and equity financing.

Question 1: What type of financial decision did Priya take when she decided to invest ₹50 lakhs in new stitching machines?

Priya took a Capital Budgeting Decision (long-term investment decision).
It involves committing finance on a long-term basis in fixed assets such as machinery.

Question 2: Why did the finance manager advise analysing cash flows before making the investment decision?

Cash flows help evaluate whether the investment will generate sufficient returns over its life to justify the cost.
Capital budgeting decisions involve huge, often irreversible investments, so cash flow analysis is critical before committing.

Question 3: Since the rate of return (15%) is higher than the cost of debt (11%), explain how this situation illustrates Trading on Equity and what it means for Priya's shareholders.

Trading on Equity refers to the increase in profit (EPS) earned by equity shareholders due to the presence of fixed financial charges like interest.
When RoI (15%) > cost of debt (11%), using more debt increases the EPS for equity shareholders.
This is a situation of favourable financial leverage, where the difference between RoI and cost of debt benefits equity holders, making it rational for Priya to use debt financing.

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Case Set 2

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Raghav Ltd. is a listed company that reported strong profits this year. The Board of Directors is deliberating on what portion of profits to distribute as dividends and what to retain for expansion. The company has been growing rapidly and needs funds for a new production line. Several shareholders, especially retired investors, have written to the Board requesting a stable and regular dividend. The company's lender, a nationalized bank, has imposed a covenant that dividend payments cannot exceed 40% of net profits. The company's stock price has been rising, and market analysts believe a dividend cut may negatively impact investor sentiment.

Question 1: Identify the type of financial decision being made by the Board of Directors of Raghav Ltd.

The Board is making a Dividend Decision.
It involves deciding how much profit to distribute to shareholders as dividends and how much to retain in the business.

Question 2: Explain any two factors visible in the case that will affect the dividend decision of Raghav Ltd.

Growth Opportunities: Raghav Ltd. needs funds for a new production line, so it may retain more earnings rather than paying high dividends.
Contractual Constraints: The bank's covenant limiting dividend to 40% of net profit restricts the company's dividend payout decision.

Question 3: Retired shareholders prefer regular dividends while the company needs funds for expansion. How should the Board of Directors balance these competing interests? Explain with reference to any three relevant factors.

Shareholders' Preference: Retired shareholders depend on dividend income, so the Board should not drastically cut dividends to avoid causing financial hardship to such investors.
Stock Market Reaction: A dividend cut may negatively impact the share price. Since wealth maximisation is the objective, the Board must maintain a reasonable payout to protect market value.
Growth Opportunities: The company can retain a portion of earnings to finance the new production line, balancing stability of dividends with the need for internal financing for growth.

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Case Set 3

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Sunita is the CFO of Bright Future Ltd., a company planning to set up a new manufacturing plant. She prepares a detailed financial blueprint estimating fund requirements for the next five years. She starts with a sales forecast and then estimates the funds needed for fixed capital and working capital. She calculates expected profits to determine how much can be financed internally through retained earnings. For the remaining funds, she identifies external sources including term loans and public issue of debentures. Her plan also identifies the timing at which funds will be required at each stage of the project so that there is neither a shortage nor an idle surplus of funds.

Question 1: Identify the financial concept described in the case and state one objective it seeks to achieve.

The concept described is Financial Planning.
One objective: To ensure availability of funds whenever required so that the company can honour its commitments and carry out its plans.

Question 2: Why does Sunita start her financial plan with a sales forecast? Explain the significance.

Sales forecast is the starting point because all fund requirements—for fixed capital, working capital, and operating expenses—are derived from the expected level of sales.
It helps estimate future revenues and profits, which in turn determines how much can be financed internally and how much needs to be raised externally.

Question 3: Explain any three points of importance of financial planning as illustrated or implied by the activities of Sunita in the above case.

Helps avoid shortage and surplus: By forecasting fund requirements and their timing, Sunita ensures funds are available when needed and idle funds are minimised, avoiding unnecessary cost.
Links investment and financing decisions: Sunita's plan connects the capital expenditure decision (new plant) with the financing sources (loans, debentures, retained earnings) on a continuous basis.
Prepares the firm for the future: By preparing alternative blueprints based on varying business situations, financial planning enables management to respond to uncertainties in a planned manner.

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Case Set 4

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Omega Pharma Ltd. is a pharmaceutical company with a high business risk due to fluctuating demand and strict regulatory requirements. Its finance committee is meeting to decide the proportion of debt and equity for a new project worth ₹200 crores. One director argues for maximum debt utilisation as it is cheaper and tax-deductible. Another director cautions that the company's Interest Coverage Ratio (ICR) is already low at 1.5 and further debt will increase financial risk. The company has strong retained earnings but its stock price is currently depressed due to a bearish stock market, making a fresh equity issue unattractive.

Question 1: What is meant by capital structure? What two broad categories of funds are used to determine it?

Capital structure refers to the mix between owners' funds and borrowed funds used by a company to finance its assets.
The two broad categories are: Owners' Funds (equity share capital, preference share capital, retained earnings) and Borrowed Funds (debentures, loans, public deposits).

Question 2: Using the case, explain how ICR and Stock Market Conditions affect the capital structure decision of Omega Pharma Ltd.

Interest Coverage Ratio (ICR): A low ICR of 1.5 means the company barely covers its interest obligation from earnings, making further debt risky. Hence the company should avoid more debt.
Stock Market Conditions: A bearish stock market makes fresh equity issues difficult and expensive; however, given the company's high business risk, it may have to rely on retained earnings rather than high-risk debt.

Question 3: Do you agree with the director who favours maximum debt? Justify your answer with reference to at least three factors from the chapter.

No, maximum debt is not advisable for Omega Pharma Ltd. given the following reasons:
Risk Consideration: The company already has high business risk. Increasing financial risk through more debt would raise total risk to an unacceptable level, threatening solvency.
ICR: A low ICR of 1.5 means the company is already strained in meeting interest payments. Further debt could lead to default on interest obligations.
Flexibility: If the company uses its full debt potential now, it loses the ability to borrow further in case of unforeseen emergencies, reducing financial flexibility.

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Case Set 5

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Nandini Traders is a wholesale distribution company. Its business involves buying goods on credit from manufacturers (30-day credit) and selling to retailers on cash basis. The company has invested heavily in automated warehousing. The Finance Director is preparing a working capital estimate for the upcoming festive season when sales volumes are expected to triple. He notes that suppliers have offered an extended credit of 60 days for bulk orders. However, a rival firm has started offering 45-day credit to retailers, creating pressure on Nandini Traders to match these terms or lose market share.

Question 1: What is working capital? State the formula for Net Working Capital.

Working capital refers to the funds invested in current assets that are used in day-to-day operations of the business.
Net Working Capital (NWC) = Current Assets – Current Liabilities.

Question 2: Identify any two factors from the case that will increase the working capital requirement of Nandini Traders during the festive season.

Seasonal Factor: During the festive season, sales volumes triple, leading to a higher level of activity and thus a larger working capital requirement.
Credit Allowed: If Nandini Traders offers 45-day credit to retailers (to match rivals), it will increase debtors, thus increasing the working capital requirement.

Question 3: Analyse how 'Credit Availed' and 'Nature of Business' affect the working capital needs of Nandini Traders, and suggest how the company can optimise its working capital.

Credit Availed: Nandini Traders gets 60-day credit from suppliers (extended from 30 days). This means more of its purchases are financed by suppliers, reducing the working capital required from its own funds.
Nature of Business: As a trading/distribution firm, Nandini Traders does not manufacture goods. There is no production cycle, so raw material and WIP inventories are absent. Generally, trading firms need less working capital than manufacturers.
Optimisation: The company should leverage the 60-day supplier credit, manage receivables carefully if it extends credit to retailers, and use efficient warehousing to minimise inventory holding costs, thereby keeping working capital needs manageable.

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Chapter financial-management: Financial Management | Case Study Questions

Passage

Question 1: What type of financial decision did Priya take when she decided to invest ₹50 lakhs in new stitching machines?

Question 2: Why did the finance manager advise analysing cash flows before making the investment decision?

Question 3: Since the rate of return (15%) is higher than the cost of debt (11%), explain how this situation illustrates Trading on Equity and what it means for Priya's shareholders.

Passage

Question 1: Identify the type of financial decision being made by the Board of Directors of Raghav Ltd.

Question 2: Explain any two factors visible in the case that will affect the dividend decision of Raghav Ltd.

Question 3: Retired shareholders prefer regular dividends while the company needs funds for expansion. How should the Board of Directors balance these competing interests? Explain with reference to any three relevant factors.

Passage

Question 1: Identify the financial concept described in the case and state one objective it seeks to achieve.

Question 2: Why does Sunita start her financial plan with a sales forecast? Explain the significance.

Question 3: Explain any three points of importance of financial planning as illustrated or implied by the activities of Sunita in the above case.

Passage

Question 1: What is meant by capital structure? What two broad categories of funds are used to determine it?

Question 2: Using the case, explain how ICR and Stock Market Conditions affect the capital structure decision of Omega Pharma Ltd.

Question 3: Do you agree with the director who favours maximum debt? Justify your answer with reference to at least three factors from the chapter.

Passage

Question 1: What is working capital? State the formula for Net Working Capital.

Question 2: Identify any two factors from the case that will increase the working capital requirement of Nandini Traders during the festive season.

Question 3: Analyse how 'Credit Availed' and 'Nature of Business' affect the working capital needs of Nandini Traders, and suggest how the company can optimise its working capital.

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