PROJECTS ANALYSIS AND IMPLEMENTATIONCHAPTER 4PROJECT FINANCINGSECTION - ATWO MARKS QUESTIONS AND ANSWERS:Q1. What is venture capital?Venture capital is money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors. Venture capital is an important source of equity for start-up companies.Q2. What is equity capital?Equity Shares also known as ordinary shares, which means, other than preference shares. Equity shareholders are the real owners of the company. They have a control over the management of the company and are eligible to get dividend if the company earns profit. Equity share capital cannot be redeemed during the lifetime of the company. The liability of the equity shareholders is the value of unpaid value of shares.Q3. What is preference capital?The parts of corporate securities are called as preference shares. It is the shares, which have preferential right to get dividend and get back the initial investment at the time of winding up of the company. Preference shareholders are eligible to get fixed rate of dividend and they do not have voting rights.Q4. What is debenture?A Debenture is a document issued by the company. It is a certificate issued by the company under its seal acknowledging a debt.According to the Companies Act 1956, debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge of the assets of the company or not.Q5. What is deferred shares?Deferred shares also called as founder shares because these shares were normally issued to founders. The shareholders have a preferential right to get dividend before the preference shares and equity shares. According to Companies Act 1956 no public limited company or which is a subsidiary of a public company can issue deferred shares. These shares were issued to the founder at small denomination to control over the management by the virtue of their voting rights.Q6. What do you mean by NO PAR SHARES?When the shares are having no face value, it is said to be no par shares. The company issues this kind of shares which is divided into a number of specific shares without any specific denomination. The value of shares can be measured by dividing the real net worth of the company with the total number of shares.Value of no. per share =the real net worth / Total no. of sharesQ7. What is CREDITORSHIP SECURITIES?Creditorship Securities also known as debt finance which means the finance is mobilized from the creditors. Debenture and Bonds are the two major parts of the Creditorship Securities.Q8.What is meant by security financing?If the finance is mobilized through issue of securities such as shares and debenture, it is called as security finance. It is also called as corporate securities. This type of finance plays a major role in the field of deciding the capital structure of the company.Q9. What is term loan?Term loan is a liability accepted by the company for purchasing the fixed assets. These are repayable over a period of 3 10 years. These can be given by banks or other financial institution.Q10. What is capital structure?It is the financial structure of a firm, which consists of different combinations of securities. In other words it represents the relationship between the various long term forms of financing such as debentures, preference shares capital on equity etc.Q11. What is margin money?Margin money is a minimum amount in your bank/brokers account for trading stocks. It is fixed by brokers. If your account balance are not sufficient for trading, the brokers will sell your holding and maintain the amount.Q12. What is sweat equity shares?A sweat equity share refers to those shares which are issued to employees or workers who contribute for the development of a company by providing necessary knowhow using their intellectual property.SECTION BSEVEN & TEN MARKS QUESTIONS AND ANSWERS:Q13. Explain internal finance in detail.A company can mobilize finance through external and internal sources. A new company may not raise internal sources of finance and they can raise finance only external sources such as shares, debentures and loans but an existing company can raise both internal and external sources of finance for their financial requirements. Internal finance is also one of the important sources of finance and it consists of cost of capital while compared to other sources of finance.Internal source of finance may be broadly classified into two categories:A. Depreciation FundsB. Retained earningsDepreciation FundsDepreciation 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 decrease in the value of asset due to wear and tear, lapse of time, obsolescence, exhaustion and accident.Generally depreciation is changed against fixed assets of the company at fixed rate for every year. The purpose of depreciation is replacement of the assets after the expired period. It is one kind of provision of fund, which is needed to reduce the tax burden and overall profitability of the company.Retained EarningsRetained earnings are another method of internal sources of finance. Actually is not a method of raising finance, but it is called as accumulation of profits by a company for its expansion and diversification activities.Retained earnings are called under different names such as; self finance, inter finance, and plugging back of profits. According to the Companies Act 1956 certain percentage, as prescribed by the central government (not exceeding 10%) of the net profits after tax of a financial year have to be compulsorily transferred to reserve by a company before declaring dividends for the year.Under the retained earnings sources of finance, a part of the total profits is transferred to various reserves such as general reserve, replacement fund, reserve for repairs and renewals, reserve funds and secrete reserves, etc.Advantages of Retained Earnings:Retained earnings consist of the following important advantages:1. Useful for expansion and diversification: Retained earnings are most useful to expansion and diversification of the business activities.2. Economical sources of finance: 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 of funds by issuing different types of securities.3. No fixed obligation: If the companies use equity finance they have to pay dividend and if the companies use debt finance, they have to pay interest. But if the company uses retained earnings as sources of finance, they need not pay any fixed obligation regarding the payment of dividend or interest.4. Flexible sources: Retained earnings allow the financial structure to remain completely flexible. The company need not raise loans for further requirements, if it has retained earnings.5. Increase the share value: 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.6. Avoid excessive tax: Retained earnings provide opportunities for evasion of excessive tax in a company when it has small number of shareholders.7. Increase earning capacity: Retained earnings consist of least cost of capital and also it is most suitable to those companies which go for diversification and expansion.Disadvantages of Retained EarningsRetained earnings also have certain disadvantages:1. Misuses: The management by manipulating the value of the shares in the stock market can misuse the retained earnings.2. Leads to monopolies: Excessive use of retained earnings leads to monopolistic attitude of the company.3. Over capitalization: Retained earnings lead to over capitalization, because if the company uses more and more retained earnings, it leads to insufficient source of finance.4. Tax evasion: Retained earnings lead to tax evasion. Since, the company reduces tax burden through the retained earnings.5. Dissatisfaction: If the company uses retained earnings as sources of finance, the shareholder cant get more dividends. So, the shareholder does not like to use the retained earnings as source of finance in all situations.Q14. Critically examine the advantages and disadvantages of equity shares.Advantages of Equity SharesEquity shares are the most common and universally used shares to mobilize finance for the company. It consists of the following advantages.1. Permanent sources of finance: Equity share capital is belonging to long-term permanent nature of sources of finance, hence, it can be used for long-term or fixed capital requirement of the business concern.2. Voting rights: Equity shareholders are the real owners of the company who have voting rights. This type of advantage is available only to the equity shareholders.3. No fixed dividend: Equity shares do not create any obligation to pay a fixed rate of dividend. If the company earns profit, equity shareholders are eligible for profit, they are eligible to get dividend otherwise, and they cannot claim any dividend from the company.4. Less cost of capital: Cost of capital is the major factor, which affects the value of the company. If the company wants to increase the value of the company, they have to use more share capital because, it consists of less cost of capital (Ke) while compared to other sources of finance.5. Retained earnings: When the company have more share capital, it will be suitable for retained earnings which is the less cost sources of finance while compared to other sources of finance.Disadvantages of Equity Shares1. Irredeemable: Equity shares cannot be redeemed during the lifetime of the business concern. It is the most dangerous thing of over capitalization.2. Obstacles in management: Equity shareholder can put obstacles in management by manipulation and organizing themselves. Because, they have power to contrast any decision which are against the wealth of the shareholders.3. Leads to speculation: Equity shares dealings in share market lead to secularism during prosperous periods.4. Limited income to investor: The Investors who desire to invest in safe securities with a fixed income have no attraction for equity shares.5. No trading on equity:When the company raises capital only with the help of equity, the company cannot take the advantage of trading on equity.Q15.Explain the merits and demerits of preference shares?Advantages of Preference SharesPreference shares have the following important advantages.1. Fixed dividend: The dividend rate is fixed in the case of preference shares. It is called as fixed income security because it provides a constant rate of income to the investors.2. Cumulative dividends: Preference shares have another advantage which is called cumulative dividends. If the company does not earn any profit in any previous years, it can be cumulative with future period dividend.3. Redemption: Preference Shares can be redeemable after a specific period except in the case of irredeemable preference shares. There is a fixed maturity period for repayment of the initial investment.4. Participation: Participative preference shareholders can participate in the surplus profit after distribution to the equity shareholders.5. Convertibility: Convertibility preference shares can be converted into equity shares when the articles of association provide such conversion.Disadvantages of Preference Shares1. Expensive sources of finance: Preference shares have high expensive source of finance while compared to equity shares.2. No voting right: Generally preference shareholders do not have any voting rights. Hence they cannot have the control over the management of the company.3. Fixed dividend only: Preference shares can get only fixed rate of dividend. They may not enjoy more profits of the company.4. Permanent burden: Cumulative preference shares become a permanent burden so far as the payment of dividend is concerned. Because the company must pay the dividend for the unprofitable periods also.5. Taxation: In the taxation point of view, preference shares dividend is not a deductible expense while calculating tax. But, interest is a deductible expense.Hence, it has disadvantage on the tax deduction point of view.Q16. List out the types of debentures.Types of DebenturesDebentures may be divided into the following major types:1. Unsecured debentures: Unsecured debentures are not given any security on assets of the company. It is also called simple or naked debentures. This type of debentures are treaded as unsecured creditors at the time of winding up of the company.2. Secured debentures: Secured debentures are given security on assets of the company. It is also called as mortgaged debentures because these debentures are given against any mortgage of the assets of the company.3. Redeemable debentures: These debentures are to be redeemed on the expiry of a certain period. The interest is paid periodically and the initial investment is returned after the fixed maturity period.4. Irredeemable debentures: These kind of debentures cannot be redeemable during the life time of the business concern.5. Convertible debentures: Convertible debentures are the debentures whose holders have the option to get them converted wholly or partly into shares. These debentures are usually converted into equity shares. Conversion of the debentures may be:Non-convertible debenturesFully convertible debenturesPartly convertible debentures6. Other types: Debentures can also be classified into the following types. Some of the common types of the debentures are as follows:1. Collateral Debenture2. Guaranteed Debenture3. First Debenture4. Zero Coupon Bond5. Zero Interest Bond/DebentureQ17. Discuss the features of equity shares.Features of Equity SharesEquity shares consist of the following important features:1. Maturity of the shares: Equity shares have permanent nature of capital, which has no maturity period. It cannot be redeemed during the lifetime of the company.2. Residual claim on income: Equity shareholders have the right to get income left after paying fixed rate of dividend to preference shareholder. The earnings or the income available to the shareholders is equal to the profit after tax minus preference dividend.3. Residual claims on assets: If the company 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.4. Right to control: Equity shareholders are the real owners of the company. Hence, they have power to control the management of the company and they have power to take any decision regarding the business operation.5. Voting rights: Equity shareholders have voting rights in the meeting of the company with the help of voting right power; they can change or remove any decision of the business concern. Equity shareholders only have voting rights in the company meeting and also they can nominate proxy to participate and vote in the meeting instead of the shareholder.6. Pre-emptive right: Equity shareholder 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.7. Limited liability: Equity shareholders are having only limited liability to the value of shares they have purchased. If the shareholders are having fully paid up shares, they have no liability. For example: If the shareholder purchased 100 shares with the face value of Rs. 10 each. He paid only Rs. 900. His liability is only Rs. 100.Total number of shares 100Face value of shares Rs. 10Total value of shares 100 10 = 1,000Paid up value of shares 900Unpaid value/liability 100Liability of the shareholders is only unpaid value of the share (that is Rs. 100).Q18. Mention the types of preference shares.Preference shares may be classified into the following major types: Cumulative preference shares Non-cumulative preference shares Redeemable preference shares Irredeemable Preference Shares Participating Preference Shares Non-Participating Preference Shares Convertible Preference Shares Non-convertible Preference Shares.Q19. Explain the features of preference shares.1. Maturity period: Normally preference shares have no fixed maturity period except in the case of redeemable preference shares. Preference shares can be redeemable only at the time of the company liquidation.2. Residual claims on income: Preferential shareholders have a residual claim on income. Fixed rate of dividend is payable to the preference shareholders.3. Residual claims on assets: The first preference is given to the preference shareholders at the time of liquidation. If any extra Assets are available that should be distributed to equity shareholder.4. Control of Management: Preference shareholder does not have any voting rights. Hence, they cannot have control over the management of the company.Q20. Discuss the term loan in detail.Term loan is a liability accepted by the company for purchasing the fixed assets. These are repayable over a period of 3 10 years. These can be given by banks or other financial institution.Features: Banks or financial institution granting term loans are creditors and not the owners of the company. They are required to be repaid during the life time of the company at a pre-decided interval The term loans are either secured or unsecured Return of term loans is paid in the form of interest.Term loan agreement is a written contract between the borrowing company and lending bank or financial institution. This agreement stipulates various terms and conditions on which the relationship between the lending bank and borrowing company is regulated.Term lending institutions may be categorized on the basis of their area of operations as under: IDBI, IFCI,NABARD, COMMERCIAL BANKS, LIC, etcQ22. Explain the term Consortium Lending.Like the other infrastructure projects, power projects are also highly capital intensive and have long gestation periods and a sizeable part of the investment is required to be made by the private sector. However, in the absence of uniformly acceptable approach, private sector projects are bound to face numerous hazards in obtaining finance like multiplicity of appraisal by participating institution, stipulation of different types of terms and conditions, different procedures/methodologies for disbursement and monitoring leading to delays in achieving financial closure and expeditious project implementation. Realizing the above, PFC, in association with LIC and other Indian Banks had established a Power Lenders Club (PLC) in August 2005 to provide single window financing solutions for clients in the private power sector and to achieve expeditious financial closure. Q23. Discuss Local syndication by banks.Syndication is an arrangement wherein several banks participate in a single loan. The corporate seeking a syndicated loan chooses a lead bank to manage the same. The lead bank prepares an information memorandum which is sent to other banks potentially interested in participating in the syndicated loan. Based on the interest evinced by the participating banks, the lead bank works out the sharing arrangement. In India, in the year 2005, the IDBI managed an Rs.6000 crores syndicated loan. There were thirty other banks participated with IDBI as lead bank. Normally such huge finance cannot be granted by any single bank. Syndication is the only solution.Q24. Explain the ways in which a company may raise capital in the primary market.A number of securities are issue by the companies in the primary market to raise capital. They include:Equity shares: Equity Shares also known as ordinary shares, which means, other than preference shares. Equity shareholders are the real owners of the company. They have a control over the management of the company and are eligible to get dividend if the company earns profit. Equity share capital cannot be redeemed during the lifetime of the company. The liability of the equity shareholders is the value of unpaid value of shares.Preference shares: have a preference over the equity shares in the event of liquidation of company. The preference dividend rate is fixed and known. A company may issue preference with a maturity period. A preference share may also provide for the accumulation of dividend. It is called cumulative preference share.Debentures: represent long term loan given by the holders of debentures to the company. The rate of interest is specified and interest charged are treated as deductible expenses in the hands of the company. Debentures may be issued without an interest rate. They are called zero interest debentures. Such debentures are issued at a price much lower than their face value. Therefore, they are also called deep-discount debentures/bonds.Convertible securities: a debenture or a preference share may be issues with the feature of being convertible into equity shares after a period of time at a given price. Thus a convertible debenture will have features of a debentures as well as equity.Warrants: a company may issue equity shares or debentures attached with warrants. Warrants entitle an investor to buy equity shares after a specified time period at a given price.Cumulative convertible preference shares (CCPs): is an instrument giving regular returns @ 10% during the gestation period from three years to five years and equity benefit thereafter. Introduces by government in 1984 CCPs has, however, failed to catch the investors interest mainly because the rate of return was considered to be too low in the initial years and the provision for conversion into equity was also unattractive if the company failed to perform well.Zero coupon bonds and convertible warrants: zero coupon bonds do not carry an explicit rate of interest. The difference between the face value of the bond and its purchase price is the return of the investor.Q25. Explain the different theories of capital structure.The following are the theories on Capital Structure / approach.Net Income Approach (NI),Net Operating Income Approach (NOI),Traditional approachModigliani Miller Approach,NI APPROACH: Net Income theory was introduced by David Durand. According to this approach, the capital structure decision is relevant to the valuation of the firm. This means that a change in the financial leverage will automatically lead to a corresponding change in the overall cost of capital as well as the total value of the firm. According to NI approach, if the financial leverage increases, the weighted average cost of capital decreases and the value of the firm and the market price of the equity shares increases. Similarly, if the financial leverage decreases, the weighted average cost of capital increases and the value of the firm and the market price of the equity shares decreases.

ASSUMPTIONS OF NET INCOME APPROACH:Net Income Approach makes certain assumptions which are as follows.Increase in debt will not affect the confidence levels of the investors.The cost of debt is less than cost of equity.There are no taxes levied.ARGUMENTS AGAINST NI APPROACH:No change in risk perception on changing debt equity components not true,No corporate taxes - incorrect,In reality it is not possible to have a firm with 100% debt funded. In case if it were so, who are the shareholders to share the wealth.

THE NET OPERATING INCOME APPROACH: Net Operating Income Approach to capital structure believes that the value of a firm is not affected by the change of debt component in the capital structure. It assumes that the benefit that a firm derives by infusion of debt is invalid by the simultaneous increase in the required rate of return by the equity shareholders. With increase in debt, the risk associated with the firm, mainly insolvency risk, also increases and such a risk perception increases the expectations of the equity shareholders. ASSUMPTIONS:The critical assumptions of NOI approach are as below;1: At all degrees of leverage (debt), the overall capitalization rate would remain constant. For a given level of EBIT, the value of a firm would be equal to EBIT/overall capitalization rate.2: The Value of Equity = Total value of the firm - Value of debt3: Cost of equity increases with every increase in debt and the weighted average cost of capital (WACC) remains constant.TRADITIONAL APPROACH:The Net Income theory and Net Operating Income theory stand in extreme forms. Traditional approach stands in the midway between these two theories. According to this theory a proper and right combination of debt and equity will always lead to market value enhancement of the firm. This approach accepts that the equity shareholders perceive financial risk and expect premiums for the risks undertaken. This theory also states that after a level of debt in the capital structure, the cost of equity capital increases.

MODIGLIANI MILLAR APPROACH:Modigliani Millar approach, popularly known as the MM approach is similar to the Net operating income approach. The MM approach favors the Net operating income approach and agrees with the fact that the cost of capital is independent of the degree of leverage and at any mix of debt-equity proportions.The significance of this MM approach is that it provides operational or behavioral justification for constant cost of capital at any degree of leverage. Whereas, the net operating income approach does not provide operational justification for independence of the company's cost of capital.

ASSUMPTION OF MM THEORY:1:Capital markets are perfect.2: All investors have the same expectation of the company's net operating income for the purpose of evaluating the value of the firm.3: Within similar operating environments, the business risk is equal among all firms.4: 100% dividend payout ratio.5: An assumption of "no taxes" was there earlier, which has been removed.CRITICISMS OF MM THEORYCan lend & borrow at same rate is incorrect,Transaction costs are nil - is invalid,Corporate taxes cannot be assumed to be nil,The concept of perfect capital market does not appear in reality.Q26. Explain the factors determining capital structure.Factors Determining Capital Structure1. Trading on Equity- The word equity denotes the ownership of the company. Trading on equity means taking advantage of equity share capital to borrowed funds on reasonable basis. It refers to additional profits that equity shareholders earn because of issuance of debentures and preference shares. It is based on the thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower than the general rate of companys earnings, equity shareholders are at advantage which means a company should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity becomes more important when expectations of shareholders are high.2. Degree of control- In a company, it is the directors who are so called elected representatives of equity shareholders. These members have got maximum voting rights in a concern as compared to the preference shareholders and debenture holders. Preference shareholders have reasonably less voting rights while debenture holders have no voting rights. If the companys management policies are such that they want to retain their voting rights in their hands, the capital structure consists of debenture holders and loans rather than equity shares.3. Flexibility of financial plan- In an enterprise, the capital structure should be such that there is both contractions as well as relaxation in plans. Debentures and loans can be refunded back as the time requires. While equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in order to make the capital structure possible, the company should go for issue of debentures and other loans.4. Choice of investors- The companys policy generally is to have different categories of investors for securities. Therefore, a capital structure should give enough choice to all kind of investors to invest. Bold and adventurous investors generally go for equity shares and loans and debentures are generally raised keeping into mind conscious investors.5.Capital market condition- In the lifetime of the company, the market price of the shares has got an important influence. During the depression period, the companys capital structure generally consists of debentures and loans. While in period of boons and inflation, the companys capital should consist of share capital generally equity shares.6.Period of financing- When company wants to raise finance for short period, it goes for loans from banks and other institutions; while for long period it goes for issue of shares and debentures.7. Cost of financing- In a capital structure, the company has to look to the factor of cost when securities are raised. It is seen that debentures at the time of profit earning of company prove to be a cheaper source of finance as compared to equity shares where equity shareholders demand an extra share in profits.8. Stability of sales- An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet such fixed commitments like interest on debentures and dividends on preference shares. If company is having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital proves to be safe in such cases.9. Sizes of a company- Small size business firms capital structure generally consists of loans from banks and retained profits. While on the other hand, big companies having goodwill, stability and an established profit can easily go for issuance of shares and debentures as well as loans and borrowings from financial institutions. The bigger the size, the wider is total capitalization.

12Prof. Ramya.H.P. Asst.Professor, KRUPANIDHI SCHOOL OF MANAGEMENT