PREVIOUS YEAR SOLVED PAPERS - January 2017
- Option : B
- Explanation : Financial Leverage and the Shareholders’ Return : The primary motive of a company in using financial leverage is to magnify the shareholders’ return under favourable economic conditions. The role of financial leverage in magnifying the return of the shareholders is based on the assumptions that the fixed-charges funds (such as the loan from financial institutions and banks or debentures) can be obtained at a cost lower than the firm’s rate of return on net assets (RONA or ROI). Thus, when the difference between the earnings generated by assets financed by the fixedcharges funds and costs of these funds is distributed to the shareholders, the earnings per share (EPS) or return on equity (ROE) increases. However, EPS or ROE will fall if the company obtains the fixed-charges funds at a cost higher than the rate of return on the firm’s assets. It should, therefore, be clear that EPS, ROE and ROI are the important figures for analyzing the impact of financial leverage.
32. Debt financing is a cheaper source of finance because of
- Option : C
- Explanation : Cost of capital means interest on debts or dividend on shares. Debt is a cheaper source of finance in comparison to equity capital because rate of interest is lower than the return expected by equity shareholders and the tax deductibility of interest further reduces the cost of debt. The preference share capital is also cheaper than equity capital, but not as cheap as debt. Thus, optimum capital structure should include sufficient amount of debt since it is the cheapest source of finance.
34. Which of the following statements is not correct?
- Option : C
- Explanation : The cost of capital is the minimum required
rate of return which firm must earn on its
funds in order to satisfy the expectation of its
supplier of funds. If the return from capital
budgeting proposals is more than cost of
capital then difference will be added to wealth
of shareholders.
The concept of cost of capital has a role to play in capital budgeting as well as in finalizing the capital structure for the firm. The cost of capital depends upon the risk free interest rate and risk premium, which depends upon the risk of investment and risk of firm.
The cost of capital may be defined in terms of (1) explicit cost, which the firm pays to supplier, and (2) implicit cost. i.e., opportunity cost of funds to firm. The cost of capital is calculated in after tax terms.
Different sources of funds available to firm may be grouped into Debt, Preference share capital, Equity share capital and retained earning and these sources have their specific cost of capital. However the overall cost of capital of the firm may be ascertained as the weighted average of these specific costs of capital.
35. Which of the following is not the quality of human resources in any organization?
- Option : B
- Explanation : An organisation is made up of four resources, i.e., men, money, material and machines. Of them the first one is the living resource and the other three are non-living i.e., non-human resource. It is the human resource, formerly termed as ‘manpower’ that make use of nonhuman resources. Hence, people are the most significant resources for any organisation. Human resource are heterogeneous in the sense that they differ in personality, perception, devotions, values, attitudes, motives , mode of thoughts and social background also. Their behaviour to stimuli is often inconsistent and unpredictable. Therefore, motivational tools also vary accordingly. For example, while increase in salary may satisfy one psychological needs, recognition may satisfy the esteem needs. While other resources depreciate, human resource appreciate with the passage of time. Given the highly competitive and complex business environment, attracting and retaining the qualified and competent employees have become a real challenge of the day for the managers. The ‘rule of thmb’ has become obsolete and redundant. The need of the new perspective is to have right people for right jobs that offers “competitive advantage” for “core competency” to the organisation to survive and thrive in the competitive business environment.
