Altros Ltd. dealing in ready made garments, is planning to expand its business operations in order to cater to international market. For this purpose, the company needs additional Rs. 80,00,000 for replacing machines with modern machinery of higher production capacity. It involves committing the finance on a long-term basis. These decisions are very crucial for any business since they affect its earning capacity in the long run. The company wishes to raise the required funds by issuing Debentures. The debt can be issued at an estimated cost of 10%. The EBIT for the previous year of the company was Rs. 8,00,000 and total capital investment was Rs. 1,00,00,000. Instead of issuing 10% Debenture the company can issue Equity shares for raising the funds. The financial manager of the company would normally opt for a source which is the cheapest.
The decision involving the choice between the right mix of equity financing and debt financing is:
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Capital Structure decision
Option (1) Operating decision — Incorrect. There is no such financial decision. The three are investment, financing and dividend.
Option (2) Dividend decision — Incorrect. The dividend decision fixes how much profit is paid out and how much is kept. It does not choose between debt and equity.
Option (3) Investing decision — Incorrect. Investment is about which assets to buy with the funds, not how the funds are raised.
Option (4) Capital Structure decision — Correct. Capital structure is the mix of owners’ funds (equity) and borrowed funds (debt) in a business. Choosing the right mix is the heart of the financing decision. More debt can raise the return to shareholders, but it also raises risk, because interest must be paid whether or not there is profit.
Note: The passage is built on the NCERT exercise case study of Sunrises Ltd. in the chapter ‘Financial Management’, which has been reproduced in the exam. NCERT (2026-27 Edition): “Capital Structure … On the basis of ownership, the sources of business finance can be broadly classified into two categories viz., ‘owners’ funds’ and ‘borrowed funds’. Owners’ funds consist of equity share capital, preference share capital and reserves and surpluses or retained earnings. Borrowed funds can be in the form of loans, debentures, public deposits etc. …” “Capital structure refers to the mix between owners and borrowed funds. These shall be referred as equity and debt in the subsequent text. …” |