Chapter 7: Sources of Finance and Financial Strategies (CAIIB – Paper 3)
1. Which of the following is NOT a characteristic of equity capital?
A. Provides permanent capital to the company
B. Equity shareholders have voting rights
C. Equity holders receive fixed interest irrespective of profits
D. Residual claim on profits after all obligations
Equity capital does not carry fixed interest; returns depend on profits in the form of dividends. Hence option C is NOT a feature.
2. A company has an equity share capital of ₹50 lakh (₹10 per share). It declares a dividend of 20%. What is the dividend per share?
A. ₹2
B. ₹10
C. ₹20
D. ₹200
Dividend per share = 20% of face value (₹10) = ₹2 per share.
3. Which of the following best describes the cost of equity capital?
A. Dividend payout ratio
B. Interest rate on borrowings
C. Corporate tax rate
D. Expected return demanded by equity shareholders
The cost of equity is the expected return required by shareholders to compensate for the risk of investing in the company.
4. Assertion (A): Equity capital reduces financial risk as there is no obligation to pay interest.
Reason (R): Equity dividend is a compulsory payment to shareholders.
A. Both A and R are true, and R is the correct explanation
B. A is true, but R is false
C. A is false, but R is true
D. Both A and R are false
Dividends on equity are not compulsory; they are declared only if the company makes profits. Hence, A is true but R is false.
5. A company’s market price per share is ₹120, and the expected dividend is ₹12 with a growth rate of 5%. What is the cost of equity using the Gordon Growth Model?
6. Internal accruals in a company generally refer to:
A. Retained earnings and depreciation funds
B. Issue of fresh equity shares
C. Raising funds through debentures
D. Bank term loans
Internal accruals represent funds generated within the business, such as retained profits and depreciation provisions, and not from external borrowings or equity issues.
7. Which of the following is an advantage of financing through internal accruals?
A. Increases financial risk
B. Dilutes ownership control
C. Requires interest payments
D. No repayment obligation and preserves independence
Internal accruals do not require repayment or fixed interest payments, hence reduce financial burden and avoid dilution of ownership.
8. Assertion (A): Depreciation provision can be a source of internal accruals.
Reason (R): Although non-cash, depreciation reduces reported profits and creates cash savings within the business.
A. Both A and R are true, and R is the correct explanation
B. A is true, but R is false
C. A is false, but R is true
D. Both A and R are false
Depreciation is a non-cash expense. It lowers accounting profit but does not reduce cash inflows, hence acts as an internal source of funds.
9. A company has net profit after tax of ₹50 lakh. It transfers ₹10 lakh to general reserve and pays dividend of ₹15 lakh. What is the amount of internal accruals retained?
A. ₹15 lakh
B. ₹25 lakh
C. ₹35 lakh
D. ₹40 lakh
Internal accruals = Profit retained in business = Net profit – Dividend = ₹50 lakh – ₹15 lakh = ₹35 lakh (including transfer to reserve).
10. Which of the following is a limitation of internal accruals as a source of finance?
A. No cost of capital
B. Limited availability depending on profitability
C. No dilution of control
D. Increases liquidity strength
Internal accruals depend on the company’s profitability and may not always be sufficient to meet large capital requirements.
11. Which of the following is a key feature of preference share capital?
A. Voting rights in all matters
B. Mandatory redemption within 5 years
C. Priority in dividend payment over equity shareholders
D. Participation in unlimited profits
Preference shareholders receive dividends before equity shareholders but usually have limited or no voting rights.
12. A company issues ₹100 face value preference shares at 10% dividend. If market price is ₹120, what is the cost of preference capital?
A. 8.33%
B. 10%
C. 12%
D. 15%
Cost of preference capital = Dividend / Market Price = 10 / 120 = 8.33%.
13. Assertion (A): Preference dividend is not a legal obligation like interest on debt.
Reason (R): Dividends on preference shares are payable only if the company has distributable profits.
A. Both A and R are true, and R is the correct explanation
B. A is true, but R is false
C. A is false, but R is true
D. Both A and R are false
Preference dividends are paid only from distributable profits, unlike debt interest which is a fixed obligation. Hence both A and R are true and R correctly explains A.
14. Which type of preference shares carry the right to participate further in profits after equity shareholders receive a specified dividend?
A. Redeemable preference shares
B. Convertible preference shares
C. Cumulative preference shares
D. Participating preference shares
Participating preference shares allow holders to claim additional share in profits after equity shareholders receive their specified dividend.
15. A company issues 5,000 preference shares of ₹100 each, carrying 12% dividend. If tax rate is 30%, what is the annual dividend outflow (ignoring taxes on dividends)?
A. ₹40,000
B. ₹60,000
C. ₹6,00,000
D. ₹5,00,000
Dividend = Face value × Rate × No. of shares = 100 × 12% × 5,000 = ₹60,000.
16. Which of the following is a key feature of term loans provided by banks and financial institutions?
A. They are payable on demand
B. They are repayable in installments over a fixed period
C. They do not carry any interest obligation
D. They do not require collateral security
Term loans are generally repayable over a fixed schedule in installments and carry interest charges. They are not payable on demand.
17. A company borrows ₹1 crore as a term loan at 12% interest per annum. If the company pays simple interest annually, what will be the interest outflow in 3 years?
A. ₹12 lakh
B. ₹18 lakh
C. ₹36 lakh
D. ₹30 lakh
Interest = Principal × Rate × Time = 1,00,00,000 × 12% × 3 = ₹36 lakh.
18. Debentures differ from equity shares primarily because:
A. Debenture holders are creditors, while equity holders are owners
B. Both provide ownership rights in management
C. Equity holders get fixed returns, debenture holders do not
D. Equity is repayable after fixed tenure, debentures are not
Debenture holders are creditors of the company entitled to fixed interest, while equity holders are owners entitled to residual profits and control.
19. Assertion (A): Convertible debentures can be converted into equity shares after a specified period.
Reason (R): This feature allows investors to participate in the company’s ownership and potential growth.
A. Both A and R are true, and R is the correct explanation
B. A is true, but R is false
C. A is false, but R is true
D. Both A and R are false
Convertible debentures carry an option to be converted into equity, enabling investors to share in ownership benefits. Hence both A and R are true and R explains A.
20. A company issues 10,000 debentures of ₹1,000 each at 10% interest. What is the annual interest liability of the company?
A. ₹1,00,000
B. ₹5,00,000
C. ₹50,00,000
D. ₹1,00,00,000
Annual interest = Face value × Rate × No. of debentures = 1,000 × 10% × 10,000 = ₹1,00,00,000.
21. Which of the following is an example of alternative financing strategy for businesses?
A. Issuing equity shares
B. Taking a traditional term loan
C. Crowdfunding through online platforms
D. Issuing debentures to the public
Crowdfunding, venture capital, and private equity are considered alternative financing strategies, unlike traditional debt or equity issuance.
22. Under SEBI regulations, Alternative Investment Funds (AIFs) in India are classified into how many categories?
A. Two
B. Three
C. Four
D. Five
SEBI has classified AIFs into three categories: Category I (start-ups, SME funds, infrastructure funds), Category II (private equity, debt funds), and Category III (hedge funds).
23. Assertion (A): Venture capital is considered a high-risk financing option.
Reason (R): It generally invests in early-stage businesses with high growth potential but uncertain future.
A. Both A and R are true, and R is the correct explanation
B. A is true, but R is false
C. A is false, but R is true
D. Both A and R are false
Venture capital funds high-risk start-ups and new ventures. Returns are uncertain, but potential gains are high, making both A and R true.
24. Which of the following regulatory requirements is applicable to External Commercial Borrowings (ECBs) in India?
A. Governed by Companies Act, 2013
B. Controlled entirely by SEBI
C. Monitored by Ministry of Finance only
D. Regulated by RBI under FEMA guidelines
External Commercial Borrowings (ECBs) are regulated by RBI under the Foreign Exchange Management Act (FEMA) framework.
25. A start-up raises ₹50 lakh through angel investors who receive equity in exchange. This is an example of:
A. Debt financing
B. Equity-based alternative financing
C. Crowdfunding
D. Lease financing
Angel investing is an equity-based alternative financing method where investors provide funds to start-ups in exchange for ownership stakes.
26. A company raises ₹10 lakh through internal accruals. If no interest or dividend is payable on this amount, what will be its cost of capital?
A. Zero explicit cost
B. Equal to average cost of debt
C. Equal to cost of preference capital
D. Equal to weighted average cost of capital
Internal accruals carry no explicit cost, though there may be an opportunity cost. Hence, explicit cost of capital is zero.
27. A company issues ₹5,00,000 preference shares with 10% dividend at par. If flotation cost is 5%, calculate the cost of preference capital.
A. 10%
B. 9.8%
C. 10.53%
D. 12%
Cost of preference capital = (Dividend / Net Proceeds) × 100 = (50,000 ÷ 4,75,000) × 100 = 10.53%.
28. A company issues debentures worth ₹10,00,000 at 12% interest. The corporate tax rate is 30%. What is the after-tax cost of debt?
29. A firm has Equity of ₹20 lakh (cost of equity 15%) and Debt of ₹10 lakh (cost of debt 10%, tax rate 30%). Calculate Weighted Average Cost of Capital (WACC).
30. A firm is considering lease financing instead of borrowing. Lease rental is ₹2,00,000 per year for 5 years. If cost of debt is 10% and tax rate is 30%, the present value factor of annuity at 10% for 5 years is 3.79. Calculate the Net Advantage of Leasing (NAL) in terms of tax shield.
