Question

Krishna Ltd. Is manufacturing steel at its plant at Noida. Due to economic growth, the demand for steel is also growing. The company is planning to set up a new steel plant at Gurgaon. It needs Rs. 800 crore to start the new plant. It decides to raise Rs. 300 crore through debentures, Rs. 200 crore through long-term loan from banks and Rs. 200 crore by issue of equity share to the public. It is decided to finance the remaining amount by utilizing its reserves and surplus.

1. State the importance of financial planning for this company.

2. What is the capital structure of this company? Explain.

3. Identify the financial decision involved when the company decides to raise Rs. 800 crore from different sources of funds.

4. How will the dividend decision of Krishna Ltd. Be affected? Explain.

Answer 1

1. Financial planning will help the company in avoiding business shocks and surprises. It will reduce waste and duplication of efforts.

 2. Capital structure refers to the mix between owner’s funds and borrowed funds. It is calculated as debt equity ratio

i.e., Debt/Equity.

For Krishna Ltd. Debt = Debentures + Long term loans from banks = 300 + 200 = Rs. 500 crore.

Equity = Share capital + Reserves and surplus (or retained earnings) = 200 + 100 = Rs. 300 crores.

Therefore, debt equity ratio = 500 = 1.67 : 1

3.Financing decision : The financial decision involved is about how Krishna Ltd. will fund its new steel plant in Gurgaon. It's essentially a decision on the mix of debt, equity, and internal funds the company will use to raise the required Rs. 800 crore. This is known as the capital structure decision.

4. Since the company have growth opportunities of setting up a new steel plant at Gurgaon, it retains Rs. 100 crore out of profits to finance the required investment. So, it is likely to pay less dividend. However, since the company makes more debt financing than funding through equity, it implies that cash flow position of the company is strong. Therefore, it can pay higher dividend.