question_answer

Dev Ltd is a company engaged in the production and distribution of films. The company is an established name in Bollywood. Now the company wants to enter in the regional cinemas also and for this, they are now targeting the South Indian Films Industry. They have launched three films in South with leading actors and actresses and even managed to sign Rajnikanth. To fund its projects, the management takes a decision to raise money for long-term capital needs of business from certain sources.

(i) State the different sources of long term capital.

(ii) Decision to raise money for long term capital needs is affected by several factors. Discuss any five such factors.

Answer:

(i) Sources of long-term capital are as follows: [a] Equity shares [b] Preference shares [c] Debentures [d] Long-term loans and advances [e] Retained earnings (ii) The following factors affect the financing decision: [a] Cost The cost of all the sources of finance is different. The rate of interest on debt, fixed rate of dividend to be paid on preference share capital and the expectations of the shareholders on the equity share capital are in the form of costs. If the situations happen to be favourable, the benefit of cheap finance can be availed of by choosing debt capital. [b] Risk Debt capital is most risky and from the point of view of risk, it should not be used. [c] Flotation Cost From the point of view of floating costs, retained profit is the most appropriate source. Therefore, its use should be made. [d] Cash Flow Position If the cash flow position of the company is good, the payment of interest on the debt and the refund of capital can be easily made. Therefore, in order to take advantage of cheap finance, debt can be given priority. [e] Level of Fixed Operating Costs In business, there are mainly two types of costs which are as follows: Fixed Operating Cost e.g. Rent of the building, payment of salary, insurance premium, etc. Fixed Financial Cost e.g. Interest on debt, etc. If the level of fixed operating costs is in excess, it is better to keep the fixed financial costs at the minimum. Therefore, debt capital should not be used. On the contrary, if the level of fixed operating cost is low, the use of debt capital is more profitable.