Consider the following statements about the sources considered in a financing decision:
(A) Shareholders’ funds refer to the equity capital and the retained earnings.
(B) Borrowed funds have to be repaid at a fixed time.
(C) Shareholders’ funds involve a commitment regarding the repayment of capital.
(D) The risk of default on payment of borrowed funds is known as financial risk.
Which of the statements given above are correct?
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A), (B) and (D) only
(A) Shareholders’ funds refer to the equity capital and the retained earnings. — Correct. Shareholders’ funds are the owners’ money. They are made up of equity capital and retained earnings.
(B) Borrowed funds have to be repaid at a fixed time. — Correct. Debentures and loans carry a promise to repay at a fixed time. Interest is also due whether or not the firm earns a profit.
(C) Shareholders’ funds involve a commitment regarding the repayment of capital. — Incorrect. Shareholders’ funds carry no commitment to repay capital or to pay a return. Only borrowed funds carry such a commitment.
(D) The risk of default on payment of borrowed funds is known as financial risk. — Correct. A firm may fail to pay the interest or the principal on time. This risk of default is called financial risk.
NCERT (2026-27 Edition): “Financing Decision This decision is about the quantum of finance to be raised from various long-term sources. Short-term sources are studied under the ‘working capital management’. It involves identification of various available sources. The main sources of funds for a firm are shareholders’ funds and borrowed funds. The shareholders’ funds refer to the equity capital and the retained earnings. Borrowed funds refer to the finance raised through debentures or other forms of debt. A firm has to decide the proportion of funds to be raised from either sources, based on their basic characteristics. Interest on borrowed funds have to be paid regardless of whether or not a firm has earned a profit. Likewise, the borrowed funds have to be repaid at a fixed time. The risk of default on payment is known as financial risk which has to be considered by a firm likely to have insufficient shareholders to make these fixed payments. Shareholders’ funds, on the other hand, involve no commitment regarding the payment of returns or the repayment of capital. A firm, therefore, needs to have a judicious mix of both debt and equity in making financing decisions, which may be debt, equity, preference share capital, and retained earnings. …” |