Questions
6–8 MCQs per paper
Difficulty
Medium
Importance
High yield for CUET and Class 12 Boards
Overview
Business Finance covers the acquisition and management of funds, focusing on the trade-off between debt and equity. It is a high-yield topic for entrance exams like CUET and board exams, requiring a strong conceptual grasp of capital structures, market mechanics, and regulatory oversight by SEBI.
Sources of Finance: Debt vs Equity
Understanding the distinction between ownership capital and borrowed capital is essential for analyzing financial stability. Debt provides tax shields via interest deductibility, while equity offers control and avoids fixed payment obligations.
- Equity: Represents ownership, no fixed repayment, dividend payment is optional.
- Debt: Represents liability, fixed interest obligation, tax-deductible interest.
- Preference Shares: Hybrid instrument with priority in dividend and liquidation.
- Retained Earnings: Internal financing with zero flotation costs.
- Cost of Capital (Ke, Kd): Equity is generally more expensive due to higher risk.
Capital Structure & Leverage
Capital structure is the specific mix of debt and equity used to finance operations, directly impacting the firm's cost of capital and overall valuation. Financial leverage measures the extent to which debt is used to amplify returns to equity shareholders.
- Financial Leverage = EBIT / EBT
- Operating Leverage = Contribution / EBIT
- Combined Leverage = Operating Leverage * Financial Leverage
- Optimal Structure: The mix that minimizes Weighted Average Cost of Capital (WACC).
- Modigliani-Miller Theorem: Under perfect markets, value is independent of capital structure.
Primary vs Secondary Markets
The primary market facilitates capital formation through new security issues, while the secondary market provides liquidity to existing securities. Recognizing the sequence and roles of intermediaries like underwriters and brokers is critical for multi-concept questions.
- Primary Market: Deals in new issues, 'New Issue Market'.
- Secondary Market: Deals in existing securities, 'Stock Exchange'.
- IPO: Initial Public Offering is the first sale of shares to the public.
- Underwriting: Guaranteeing the sale of a minimum number of shares.
- Placement Methods: IPO, FPO, Rights Issue, and Private Placement.
Stock Exchange & SEBI
Regulatory bodies and organized exchanges ensure transparency and protection for investors in the financial ecosystem. SEBI serves as the watchdog, regulating market participants and curbing malpractices to maintain market integrity.
- SEBI Functions: Regulatory, Developmental, and Protective.
- Dematerialization (Demat): Electronic holding of securities.
- T+1/T+2 Settlement Cycle: Time taken for trade finalization.
- Stock Indices: SENSEX (BSE), NIFTY (NSE) as market performance benchmarks.
- Insider Trading: Illegal practice of using non-public information for profit.
Formula Sheet
WACC = (We * Ke) + (Wd * Kd * (1 - t))
EPS = (EBIT - Interest) * (1 - t) / Number of Shares
EBIT = Sales - Variable Costs - Fixed Costs
Exam Tip
Always identify the tax rate in leverage problems, as it is the most common variable used to adjust interest expense impacts on EBT.
Common Mistakes
- Confusing the roles of Primary and Secondary markets in capital formation.
- Neglecting the tax-shield benefit of debt when calculating net income.
- Assuming higher leverage always results in higher net profit without considering the increased risk of bankruptcy.
More Revision Notes
Ready to test yourself?
Play topic-wise Business Finance & Financial Markets questions in Aspirant Arcade — gamified MCQ practice.
Download Free