Question

“G. Motors” is the Manufacturer of Sophisticated Cranes. The Production Manager of the company, Reported to the Chief Executive Officer, Ashish Jain that one of the Machines used in Manufacturing Sophisticated Cranes had to be replaced to compete in the market, as other Competitors were using automatic machines for manufacturing cranes. After a detailed analysis, it was decided to Purchase a New Automatic Machine having the latest technology . It was also decided to Finance this machine through Long Term Sources of Finance. Ashish Jain compared various Machines and decided to Invest in the Machine, which would yield the Maximum Returns to its Investors. 

(a) Identify the Financial Decision taken by Ashish Jain. 

(b) Explain any THREE Factors Affecting the Decision identified in (a) above .

Answer 1

(a) Financing Decision. Financing Decision is concerned with the Decisions about, How much Funds are to be Raised from which Long Term Sources i.e. Owner’s Funds (Consisting of Equity Share Capital and Retained Earnings) or Borrowed Funds (Consisting of Debenture Loans , Bonds etc.) 

(b) Factors Affecting the Finance Decision are :

Cost : A Prudent Financial Manager would normally Opt for a source which is the Cheapest . The Cost of each type of Finance is estimated. Some sources may be Cheaper than Others . E.g. Debt is considered the Cheapest of all sources because Interest on Debt is a Tax Deductible Expense. 

Risk : Associated Risk is also different for each source. E.g. it is necessary to pay Interest on Debt and Redeem the Principal Amount on Maturity. There is no such compulsion to Pay Dividend on Equity Shares. Thus, there is some amount of Financial Risk in Debt Financing . The Overall Financial Risk depends upon the Proportion of Debt in the Total Capital . 

Control Consideration : If Existing Shareholders want to Retain the Complete Control of Business, then they prefer Borrowed Fund Securities to raise further fund. On the other hand, if they do not mind to loose the control, then they may go for Owner’s Fund Securities .