Fundamentals of Corporate Finance Exam Question Solution BITM 6th Sem 2025
Group “A”: Brief Answer Questions [10 × 2 = 20 Marks]
1. Write the meaning of corporate finance.
Corporate Finance is the area of finance that deals with how corporations manage their funding sources, capital structuring, and investment decisions.
Thank you for reading this post, don't forget to subscribe!- It focuses on maximizing shareholder value through long-term and short-term financial planning and strategy implementation.
2. What is meant by capital market?
Capital Market refers to a financial market where long-term financial instruments such as shares, debentures, bonds, and other securities are bought and sold.
- It provides a platform for companies, governments, and other institutions to raise long-term funds, usually for investment and development purposes.
3. Define the term financial structure.
Financial structure refers to the way a company arranges and uses different sources of funds to finance its total assets.
- It includes both long-term sources (like equity, preference shares, debentures, long-term loans) and short-term sources (like trade credit, bank overdrafts, short-term loans).
4. What do you mean by financial risk?
Financial Risk refers to the possibility that a company may fail to meet its financial obligations, particularly interest payments and repayment of principal on borrowed funds.
- In simple terms, financial risk measures the uncertainty in a company’s earnings due to the use of debt financing. The higher the proportion of debt in the capital structure, the higher the financial risk.
5. Why preferred stock is called hybrid security?
Preferred stock is known as a hybrid security because it combines the characteristics of equity and debt; it is similar to equity since it represents ownership in the company, but it also behaves like debt because it pays a fixed dividend and has priority over common stock during dividend distribution and liquidation.
6. What are the merits of payback technique of project evaluation?
- It is simple and easy to calculate, because it only requires estimating the time needed to recover the initial investment.
- It helps in measuring the liquidity of a project, as it shows how quickly the invested money will be returned.
- It is useful for evaluating projects in uncertain environments, because it emphasizes quick recovery of funds and reduces the risk of long-term uncertainty.
- It assists management in selecting projects with faster returns, which is helpful when a firm faces capital shortages.
- It enables quick comparison between different investment alternatives, making it suitable for preliminary screening of projects.
7. Delta Company has cash and bank balance Rs 50,000; inventory Rs 350,000 and accounts receivable Rs 400,000. Its current liabilities is Rs 480,000. What is the current ratio?
Current Ratio = Current Assets ÷ Current Liabilities
Current Assets = Cash and Bank Balance (50,000) + Inventory (350,000) + Accounts Receivable (400,000)
Current Assets = Rs 800,000
Current Ratio = 800,000 ÷ 480,000 = 1.67 : 1
So, the company’s current ratio is 1.67:1.
8. How does net working capital differ from gross working capital?
- Gross working capital refers to the total investment in current assets, such as cash, inventory, and receivables.
- Net working capital refers to the difference between current assets and current liabilities, showing the firm’s short-term financial strength.
Therefore, gross working capital measures the size of current assets, while net working capital measures the liquidity position of the firm.
9. If you deposit Rs 10,000 now, how much shall it grow at the end of the 3rd year? Bank offers 10 percent interest per year.
We use the compound interest formula:
FV = PV × (1 + r)ⁿ
FV = 10,000 × (1.10)³
FV = 10,000 × 1.331
FV = Rs 13,310
So, the amount will grow to Rs 13,310 at the end of the 3rd year.
10. The Healthy Noodles converts raw materials in 30 days, allows customers 40 days credit, and pays suppliers in 20 days. What is the length of the company’s cash conversion cycle?
Cash Conversion Cycle (CCC) = Inventory Conversion Period + Receivables Collection Period – Payables Deferral Period
CCC = 30 + 40 – 20
CCC = 50 days
So, the cash conversion cycle is 50 days.
Group “B”: Short Answer Questions [6 × 5 = 30 Marks]
11. Explain the financial manager’s responsibilities in a business firm.
A financial manager plays a critical role in the planning, directing, and controlling of a company’s financial activities. Their core responsibility is to ensure that financial decisions align with the firm’s strategic goals and contribute to its overall financial health and value.
Financial Manager’s Responsibilities are:
1.) Analysis of the Financial Aspects of All Decisions:
- A financial manager must evaluate the financial impact of all major decisions taken by the company. This includes assessing how each decision affects costs, revenues, cash flows, profitability, and overall financial performance. The goal is to ensure that every decision contributes positively to the firm’s financial goals.
2.) Analysis of Investment Decisions:
- The financial manager is responsible for analyzing investment opportunities to determine which projects or assets the firm should invest in. This involves capital budgeting techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period. The aim is to allocate resources to projects that offer the highest returns and align with the firm’s long-term strategy.
3.) Analysis of Financing Decisions:
- A financial manager must determine the most appropriate sources of finance—such as equity, debt, or retained earnings—and evaluate their cost and impact on the firm’s capital structure. The goal is to raise necessary funds at the lowest possible cost while maintaining financial stability and flexibility.
4.) Analysis of Dividend Policy Decisions
- The financial manager is responsible for analyzing how much profit should be distributed to shareholders as dividends and how much should be retained for reinvestment. This involves evaluating the firm’s current financial position, future investment needs, and shareholder expectations to design an appropriate dividend policy.
5.) Analysis of the Financial Condition of the Firm:
- A financial manager must continuously monitor the financial health of the company by analyzing financial statements, liquidity ratios, solvency ratios, profitability, and cash flow. This helps in identifying strengths and weaknesses and making informed strategic decisions.
6.) Analysis of Financial Markets:
- Understanding and analyzing financial markets is essential for a financial manager. This includes staying updated on market trends, interest rates, exchange rates, stock prices, and regulatory changes. Such analysis helps in timing financial decisions, such as issuing shares or bonds, to take advantage of favorable market conditions.
7.) Analysis of Risk:
- A financial manager must assess and manage various financial risks that the firm may face, including credit risk, market risk, interest rate risk, and operational risk. Risk analysis helps in implementing hedging strategies, insurance, and other risk management tools to protect the firm’s assets and ensure financial stability.
12. What do you mean by financial markets? Discuss the major types of financial markets.
A financial market is a marketplace where buyers and sellers engage in the trading of financial assets such as stocks, bonds, currencies, and derivatives.
- Also, the markets for buying and selling of financial assets are called financial market.
Types of Financial Markets
- Primary Markets and Secondary Markets
- Money Markets and Capital Markets
- Spot Markets and Futures Markets
- National and International Markets
- Organized Stock Exchanges and Over-the-Counter (OTC) Market
1. Primary Market
The primary market is the market where new financial securities are issued and sold for the very first time.
- In this market, companies, governments, or other entities raise fresh capital by offering shares, bonds, or debentures to investors.
The main function of the primary market is to facilitate capital formation. For example, when a company launches an Initial Public Offering (IPO), it is done in the primary market.
2. Secondary Market
The secondary market is the market where previously issued securities are bought and sold among investors.
- Unlike the primary market, no new capital is raised here; instead, it provides liquidity and marketability to existing securities.
Stock exchanges such as the New York Stock Exchange (NYSE), NASDAQ, or Nepal Stock Exchange (NEPSE) are examples of secondary markets.
3. Money Market
The money market deals with short-term financial instruments and securities that typically mature in less than one year.
- It is mainly used for managing short-term liquidity needs of businesses, governments, and financial institutions.
Instruments traded in the money market include Treasury Bills, Commercial Papers, Certificates of Deposit, and Repurchase Agreements (Repos). It is considered low risk and highly liquid.
4. Capital Market
The capital market is the market for long-term financial securities with maturities greater than one year.
- It helps companies and governments raise long-term funds for expansion, infrastructure, or development projects.
The capital market includes both the equity market (shares and stocks) and the debt market (bonds and debentures). It plays a vital role in economic growth by channeling savings into long-term investments.
5. Spot Market
The spot market is the market where financial assets are traded for immediate delivery and payment.
- Transactions in the spot market are settled “on the spot,” meaning buyers pay cash and take ownership of the asset right away.
For example, buying shares at the current market price in a stock exchange is a spot market transaction.
6. Futures Market
The futures market is the market where financial assets or commodities are traded based on contracts for future delivery at a predetermined price and date.
- These contracts help investors and businesses hedge against future price fluctuations or speculate on expected price changes.
For example, a farmer may sell a wheat futures contract to lock in a price for his harvest in advance.
13. Describe the factors affecting the size of working capital of a firm.
The size or amount of working capital a company needs depends on various internal and external factors. These determine how much money a business should invest in current assets to maintain liquidity and profitability.
- Nature of Business
- Size and Scale of Business
- Production Cycle (Operating Cycle)
- Business Cycle and Economic Conditions
- Seasonality of Operations
- Credit Policy and Terms
- Availability of Raw Materials
- Growth and Expansion Plans
1. Nature of Business
The nature of a business plays a major role in determining its working capital requirement.
- Manufacturing businesses need a larger amount of working capital because they have to maintain inventories of raw materials, work-in-progress, and finished goods.
- Trading businesses, on the other hand, need moderate working capital since they buy and sell goods directly without much processing.
- Service-based organizations usually require less working capital as they deal mostly with intangible outputs.
Example:
A car manufacturing company needs significant funds for inventory and raw materials, while a consulting firm requires very little.
2. Size and Scale of Business
The overall size and scale of business operations significantly affect the size of working capital.
- Large-scale businesses require more working capital because they operate in larger markets, maintain extensive inventories, employ more workers, and often provide longer credit terms to customers.
- Smaller firms, on the other hand, have limited production, fewer customers, and smaller inventories, which reduce their need for working capital.
3. Production Cycle (Operating Cycle)
The length of a company’s production or operating cycle has a direct impact on its working capital needs.
- A longer production cycle means that raw materials are converted into finished goods more slowly, resulting in a longer delay in generating cash from sales. This requires the firm to maintain higher working capital to finance the materials, labor, and overhead costs during production.
- Businesses with shorter production cycles require less working capital because their investment in inventory and receivables is recovered more quickly.
4. Business Cycle and Economic Conditions
Economic conditions and business cycles influence the working capital needs of a company.
- During periods of economic growth or boom, demand for goods increases, leading firms to boost production and maintain higher inventories, thus requiring more working capital.
- In contrast, during recessions or economic slowdowns, market demand decreases, production is reduced, and firms need less working capital.
5. Seasonality of Operations
Seasonal industries experience fluctuations in production and sales, leading to varying working capital needs throughout the year.
- For example, businesses like ice cream, woolen garments, sugar production, and agriculture-related industries require higher working capital during peak seasons to build up inventory and meet increased demand.
- During off-peak seasons, working capital requirements drop as production decreases and sales slow down.
6. Credit Policy and Terms
A company’s credit policy towards customers and suppliers greatly affects its working capital.
- If a firm offers longer credit periods to customers, its money remains tied up in receivables for a longer time, increasing the need for working capital.
- Conversely, if the company receives favorable credit terms from its suppliers—such as delayed payments—its working capital requirement decreases because it can use supplier credit to finance part of its current operations.
7. Availability of Raw Materials
When raw materials are easily available and can be purchased quickly, companies don’t need to maintain large inventories—resulting in lower working capital requirements.
However, if raw materials are scarce or supplied irregularly, businesses must stock more, thus needing higher working capital.
8. Growth and Expansion Plans
A firm with plans for growth or expansion typically requires more working capital to support increased production, larger inventories, additional employees, and enhanced marketing activities.
- Rapidly growing companies must invest more in current assets to keep up with expansion, whereas stable or slow-growing firms have relatively lower working capital requirements.
9. Market and Demand Conditions
Stable and predictable market conditions require less working capital since cash flows remain steady. Unstable or fluctuating demand creates uncertainty, forcing companies to maintain extra liquidity as a safeguard.
14. Explain the methods of selling / issuing securities.
Securities are tradable financial instruments that represent ownership (equity) or creditorship (debt) in a company. Common types of securities include:
- Equity Securities: Common stocks and preferred stocks
- Debt Securities: Bonds, debentures, and notes
Companies sell securities to raise funds from investors in order to finance projects, working capital, and growth initiatives in three ways:
- Public Offering
- Rights Offering
- Private Placement
1. Public Offering
A public offering is a method where a company issues securities to the general public through a stock exchange or over-the-counter market. It is the most common way for companies to raise large amounts of capital.
- Securities are available to the general public.
- Usually requires regulatory approval (e.g., SEBI in India, SEC in the USA).
- Companies often issue a prospectus detailing the financial status, objectives, and risks.
- Can involve both initial public offerings (IPO) and follow-on public offerings (FPO).
2. Rights Offering
A rights offering allows existing shareholders to purchase additional shares of the company at a discounted price, usually in proportion to their current holdings. It is a way to raise capital while preserving ownership among existing investors.
- Only current shareholders are eligible.
- Shares are offered at a fixed price, often below market value.
- Shareholders can exercise their rights, sell them, or let them expire.
3. Private Placement
A private placement is the sale of securities to a select group of investors, such as institutional investors, banks, or high-net-worth individuals. This method avoids public markets and is often used by emerging companies or startups.
- Limited to a specific number of investors.
- Does not require public disclosure, reducing compliance costs.
- Usually involves negotiated terms between the company and investors.
15. You opened an account in City Bank.
(a) If you deposit Rs 10,000 per year for 5 years, how much shall it grow at the end of 5th year at 10% interest?
(b) What rate will you earn if Rs 50,000 doubles in 6 years?