CAIIB Paper 3 Module B Quiz 1

Ordinary equity represents ownership and is residual: shareholders are paid after creditors and preference claims. Dividends are generally discretionary rather than a compulsory interest expense, and ordinary shares do not normally have a fixed maturity.

Retained earnings are profits kept in the business. They avoid issue costs and do not create a contractual repayment obligation, although they have an opportunity cost because shareholders could have received the funds as dividends.

Preference shareholders generally have priority over ordinary shareholders for dividends and repayment of capital, according to the issue terms and applicable law. This does not mean dividends are automatically guaranteed in every circumstance.

A term loan is debt provided for a defined period and repaid according to an agreed schedule. It is suited to financing assets whose benefits accrue over several years.

Debentures evidence debt owed by the issuer. Holders are creditors rather than owners and typically receive interest under the instrument’s terms.

The Gordon growth formulation is Ke = D1/P0 + g, where D1 is the expected next dividend, P0 the current share price, and g the constant expected dividend growth rate. The model assumes stable growth and is not appropriate for every company.

Where interest is deductible under applicable tax rules, the after-tax cost of debt is approximately Kd(1−T). The tax shield lowers effective cost, but excessive debt increases financial distress and default risk.

Financing decisions require balancing financing cost with repayment capacity, financial risk, ownership dilution, flexibility, market conditions and legal/regulatory limits. The lowest stated rate alone may not be the best choice.

Factoring involves assignment or sale of receivables to a factor. Depending on the contract, the factor may provide collection, administration and credit protection as well as finance.

A rights issue gives existing shareholders an opportunity to subscribe to new shares, often proportionately, helping them maintain ownership percentage if they take up their rights.

Leasing can reduce the initial cash outlay and match payments with use of the asset. Accounting treatment depends on the applicable standards and lease terms; it is not universally off-balance-sheet.

Commercial paper is a short-term, usually unsecured money-market instrument issued by eligible entities subject to applicable regulatory conditions. It is not a substitute for long-term equity.

Venture capital investors provide risk-bearing equity or equity-linked funding to businesses with high growth potential. They usually accept substantial risk in exchange for potential capital gains and influence or governance rights.

When new shares are issued, the total share count rises. Existing shareholders who do not subscribe may own a smaller percentage and have reduced voting influence.

Financing strategy must operate within the applicable legal and regulatory framework. Capital eligibility, leverage, exposure limits, investor disclosures and instrument terms can materially constrain the available choices.

Annual interest = principal × interest rate = ₹10 crore × 8% = ₹0.8 crore, or ₹80 lakh. Fees, amortisation and tax effects are excluded as specified.

WACC is the weighted average of the costs of equity, debt and other relevant capital components. Market-value weights are generally preferred for valuation because they reflect current economic proportions.

Preference dividends are distributions to shareholders and generally do not receive the same tax deduction as interest on debt. Priority and payment terms depend on the share class and governing law.

Matching long-term assets with appropriately long-term funding reduces the need to refinance short-term liabilities before the asset generates sufficient cash. Exact maturity choices still depend on risk, cost and flexibility.

Available committed facilities can help bridge temporary cash shortfalls, but they remain subject to covenants, drawdown conditions and lender performance. They complement rather than replace liquidity planning.