Answer in brief.
1. Define capital structure and state it’s components.
Definition: “A firm’s capital structure is the relation between the debt and equity securities that makes up the firm’s financing of its assets”.
Components of Capital Structure:
There are four basic components of capital structure, They are as follows :
1) Equity share capital: It is the basic source of financing activities of the business. Equity shares are shares which get dividend and repayment of capital after it is paid to preference shares. They own the company. They bear the ultimate risk associated with ownership. They carry dividends at a fluctuating rate depending upon the profits.
2) Preference share capital: Preference shares carry preferential right as to payment of dividends and have priority over equity shares for return of capital when the company is liquidated. These shares carry dividends at a fixed rate.
3) Retained earnings: It is an internal source of financing. It is nothing but a ploughing back of profit.
4) Borrowed capital: It comprises the following:
a) Debenture: It is an acknowledgement of loans raised by the company. Company has to pay interest at an agreed rate.
b) Term loan: Term loans are provided by the bank and other financial institutions. They carry a fixed rate of interest.
2. State any four factors affecting fixed capital requirement.
Ans: Factors affecting fixed capital requirement:
1) Nature of business: Manufacturing industries and public utilities have to invest a huge amount of funds to acquire fixed assets. While the Trading business may not need huge investments in fixed assets.
2) Size of business: Where a business firm is set up to carry on large scale operations, its fixed capital requirements are likely to be high. It is because most of their production processes are based on automatic machines and equipment.
3) Scope of business: There are business firms which are formed to carry on production or distribution on a large scale. Such businesses would require more amount of fixed capital.
4) Extent of lease or rent: If an entrepreneur decides to acquire assets on a lease or on a rental basis, less amount of funds for fixed assets will be needed for the business.
3. What is corporate finance and state two decisions which are basis of corporate finance.
Definition: ‘‘corporate finance deals primarily with the acquisition and use of capital by business corporation.’’
Meaning: The term corporate finance also includes financial planning, study of the capital market, money market and share market. It also covers capital formation and Two decisions that are the basis of corporate finance.
1) Financing Decision: The business firm has access to the capital market to fulfill its financial needs. The firm has multiple choices of sources of financing. The firm can choose whether it wants to raise equity capital or debt capital. Firms can even opt for a bank loan, public deposits, debentures, etc. to raise funds. The finance manager ensures that the firm is well capitalised i.e. they have the right amount of capital and that the firm has the right combination of debt and equity.
2) Investment Decision: Once the business firm has gained access to capital, the finance manager has to take a decision regarding the use of the funds in a systematic manner so that it will bring a maximum return for its owners. For this, the firm has to take into consideration the cost of capital. Once they know the cost of capital, the firm can deploy or use the funds in such a way that returns are more than the cost of capital.