İŞLETME FİNANSI II

The financial management of a company requires the management of funds’ uses as well as optimizing the funding of those uses.  The uses of cash flows are for net working capital and others and also for capital expenditures. In order to fund those uses, there exist two types of cash sources. Internal cash flow is generated from retained earnings and depreciation. External cash flow is generated from short-term borrowings and long-term debt and equity finance. The correct answer is C.

Pre-emptive right: Equity shareholders have pre-emptive rights. The pre-emptive right is the legal right of the existing shareholders. It is attested by the company in the first opportunity to purchase additional equity shares in proportion to their current holding capacity. The correct answer is A.

With revolving credits, a limit of credit is set on the credit account of the borrower and both limits of credit and the due date are determined in a loan agreement. From concluding a loan contract till maturity date the borrower can draw the credit repeatedly within the limit. The bank overdraft is based on the same principle as the revolving loans, but the limit of the credit is set as a debit of a company’s current account. The correct answer is D.

Project finance is the process of financing a specific economic unit that the sponsors create, in which creditors share much of the venture’s business risk and funding is obtained strictly for the project itself. Project finance creates value by reducing the costs of funding, maintaining the sponsor’s financial flexibility, increasing the leverage ratios, avoiding contamination risk, reducing corporate taxes, improving risk management, and reducing the costs associated with market imperfections. The correct answer is A.

The main differences between debt and equity are the following:

• Debt is not an ownership interest in the firm. Creditors do not generally have voting power.

• The corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible.

• Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization, two of the possible consequences of bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial failure. This possibility does not arise when equity is issued.

The correct answer is C.

Depreciation funds are the major part of internal sources of finance, which is used to meet the working capital requirements of the business concern. Depreciation means a decrease in the value of an asset due to wear and tear, lapse of time, obsolescence, exhaustion and accident. Generally, depreciation is changed against fixed assets of the company at a fixed rate for every year. The correct answer is A.

The advantages of retained earnings are stated below:

• Retained earnings are most useful to expansion and diversification of the business activities.

• Retained earnings are one of the least costly sources of finance since it does not involve any floatation cost as in the case of raising funds by issuing different types of securities.

• If the companies use equity finance they have to pay a dividend. Instead, if the companies use debt finance, they have to pay interest. However, if the company uses retained earnings as sources of finance, they need not pay any fixed obligation regarding the payment of dividend or interest.

• Retained earnings allow the financial structure to remain completely flexible. The company need not raise loans for further requirements if it has retained earnings.

• When the company uses the retained earnings as the sources of finance for their financial requirements, the cost of capital is very cheaper than the other sources of finance. Hence the value of the share will increase.

• Retained earnings provide opportunities for evasion of excessive tax in a company when it has a small number of shareholders.

The correct answer is D.

Financial leases are basically a medium-term financing alternative referring to its basic characteristics indicated below:

• Financial leases do not provide for maintenance or service by the lessor.

• Financial leases are fully amortized.

• The lessee usually has a right to renew the lease on expiration.

• Generally, financial leases cannot be canceled. The lessee has the sole responsibility to make all payments.

The correct answer is B.

Advantages of Common Stock Common stock is the most common security to provide finance for the corporate. This way of financing has the following advantages:

Permanent sources of finance: Common stock is a long-term permanent nature of sources of finance; hence, it can be used for long-term or fixed capital requirement of the business.

No fixed dividend payment obligation: The issuance of common stock does not create any obligation to pay a fixed rate of dividend. If the company earns a profit, owners are eligible for profit, they are eligible to get dividend otherwise, and they cannot claim any dividend from the company.

Lower cost of capital: Cost of capital is the major factor, which affects the value of the company. A company with a strong capital base can secure funding less costly as the capital base is considered as a buffer for risks buy the debtors.

Retained earnings: When the company have more share capital, it will be suitable for retained earning which is the fewer cost sources of finance while compared to other sources of finance. 

The correct answer is C.

Residual claims on assets: If the company is wound up, the ordinary or equity shareholders have the right to get the claims on assets. These rights are only available to the equity shareholders. The correct answer is D.

For funding investments and/or other cash uses by medium and long-term sources, the companies have four different alternatives. These are generally in the forms of bank borrowing, borrowing from special institutions, debt issuance and equity finance, securitization. Therefore, the correct option is D.

For funding investments and/or other cash uses by medium and long-term sources, the companies have four different alternatives. These are generally in the forms of bank borrowing, borrowing from special institutions, debt issuance and equity finance, securitization. Furthermore, depending on the peculiarities of the funding needs leasing can be another source of medium and long-term financing. Additionally, the internal sources such as Retained Earning and Depreciation provide financing to the corporate. Therefore, the correct option is B.

Some of the important factors affecting the decision amongst those alternatives are: • Peculiarities of the fund use (whether machinery or equipment purchase financing or construction, etc.)Some of the important factors affecting the decision amongst those alternatives are:

• Peculiarities of the fund use (whether machinery or equipment purchase financing or construction, etc.) 

• Bank lending capacity and relation with banks,

• Availability of security,

• Existing capital structure of the company,

• Capital market depth,

• Financial climate (Boom or boost financial market conditions),

• Legal and tax issues,

• The approach of top management with regards to equity sharing. 

Therefore, the correct option is C.

In order to fund those uses, there exist two types of cash sources. Internal cash flow is generated from retained earnings and depreciation. External cash flow is generated from short-term borrowings and long-term debt and equity finance. As a general principle, short-term uses are proposed to be financed by short-term sources and vice versa. Long-term uses of cash are basically for funding the future of the company by new investments. Therefore, the correct option is E.

The funding provided by the banks are classified into short-term loans (payback period up to 1 year), medium-term loans (payback period 1 to 5 years) and long-term loans (payback period over 5 years, up to about 30 years such as for mortgage credits. Therefore, the correct option is A.

Loans are granted by financial institutions after a client presents an application form. Before deciding about providing the loan, financial institutions consider all details of the client’s financial position, the feasibility of their business plans, and they require securing the loan with real estate (pledge), backing it by a third person (surety for a person), by a bank guarantee etc. Therefore, the correct option is A.

The main medium and long term funding provided by banks are in the form of Project Finance. Project finance is the process of financing a specific economic unit that the sponsors create, in which creditors share much of the venture’s business risk and funding is obtained strictly for the project itself. Therefore, the correct option is B.

Project finance transactions are complex undertakings, they have higher costs of borrowing when compared to conventional financing and the negotiation of the financing and operating agreements is time-consuming. The costs applicable loans can be in the forms of:

• interest

• arrangement fees

• covenant compliance costs

• professional advice.

Therefore, the correct option is C.

Syndication loans are credits granted by a group of banks to a borrower. In a syndication loan, two or more banks agree jointly to make a loan to a borrower. Every syndicate member has a separate claim on the debtor, although there is a single loan agreement contract. Therefore, the correct option is B.

The main differences between debt and equity are the following:

• Debt is not an ownership interest in the firm. Creditors do not generally have voting power.

• The corporation’s payment of interest on debt is considered a cost of doing business and is fully tax deductible. Dividends paid to stockholders are not tax deductible.

• Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm. This action can result in liquidation or reorganization, two of the possible consequences of bankruptcy. Thus, one of the costs of issuing debt is the possibility of financial failure. This possibility does not arise when equity is issued. 

Therefore, the correct option is A.