Professional Documents
Culture Documents
LEVERAGES
1. Give the meaning of the term leverage.
It refers to the employment of an asset or funds for which the firm pays a fixed cost
or fixed return.
2. Define composite Leverage.
It is combination of both operating and financial leverages. It expresses the effect of
change in sales over change in taxable profit.
3. Define Financial Leverage.
The tendency of the residual net income to vary disproportionately with operating
profit.
4. What is the significance of financial leverage?
Financial leverage is having the following significances:
Profit planning.
5. Define Leverage.
James Horne has defined leverage as the employment of an asset or funds for which
the firm pays a fixed cost or fixed return. The fixed cost indicates fixed operating
cost, and fixed return indicates financial cost it should remain constant irrespective
of changes in the volume of output or sales.
Capital structure
1. Define capital structure.
According to Gerestenbeg, Capital structure of a company refers to the
composition or make up of its capitalization and it includes all long term
resources viz., loans, reserves, shares and bonds.
2. Write a note on importance of capital structure.
The term capital structure refers to the relationship between various long
term forms of financing such as debenture, preference share capital, and
equity share capital.
Financing the firms asset is a very crucial problem in every business and
as a general rule there should be a proper mix of debt and equity capital
in financing firms asset.
The use of long term fixed interest bearing debt and preference share
capital along with equity shares is called financial leverage or trading on
equity.
3. What is optimal capital structure?
The optimum capital structure may be defined as that capital structure or
combination of debt equity that leads to the maximum value of the firm optimal
structure maximizes the value of the company and hence wealth of its owners
and minimizes the companys cost of capital. Thus, every firm should aim at
achieving the optimal capital structure and then to maintain it.
4. Name various theories of capital structure.
Different kinds of theories have been propounded by different authors to explain
the relationship between capital structure, cost of capital and value of the firm.
The main contributors to the theories are Durand, Ezra, Solomon, Modigliani and
Miller. The important theories are discussed below:
Net Income Approach
Net Operating Income Approach
The Traditional Approach
Modigliani and Miller Approach
5. What are the essentials of sound capital mix?
A sound or an appropriate capital structure should have the following essential
features:
The expected earnings of all the firms have identical risk characteristics
(X-I2) (I-T) PD SF
---------------------------S2
Where:
X = Equivalency point or point of indifference or break even EBIT level
I1 = Interest rate under alternative financial plan 1
I2 = Interest rate under alternative financial plan 2
T = Tax rate
PD = preference dividend
SF = sinking fund obligations
S1 = No. of equity shares or amount of share capital under plan 1
S2 = No. of equity shares or amount of share capital under plan 2
Dividend policy
1. Name the two main theories of dividend.
The two main theories of dividend:
Residual approach
ii.
Walters Approach
ii.
Gordons Approach
Inflation
j.
Control objectives
Stability of dividends
m. Liquid resources.
A company can finance its buy back of (i) its free reserves or (ii)
the securities premium account or (iii) proceeds of an earlier issue
other than fresh issue of shares made specifically for buy back
purposes.
No dividend policy.
Profit dividend
Liquidation dividend
Interim dividend
Final dividend
Cash dividend
Property dividend
Stock dividend