NCERT Solutions for Class 12 Business Studies Chapter 9: Financial Management
These Class 12 Business Studies Chapter 9 solutions cover Financial Management, updated for the NCERT 2026–27 session. The chapter explains the meaning of business finance and financial management, its objective of wealth maximisation, the three financial decisions (investment, financing and dividend), and the concepts of financial planning, capital structure, trading on equity, fixed capital and working capital. Below you get exam-ready answers to every NCERT exercise question — Very Short, Short and Long Answer types — along with the cost-of-debt vs. RoI numerical cases, key terms, formulas, extra practice, MCQs, Assertion–Reason and FAQs.
Class: 12Subject: Business StudiesBook: Business Studies Part 2Chapter: 9Topic: Financial ManagementSession: 2026–27
Chapter 9, Financial Management, deals with the optimal procurement and usage of finance in a business. The money needed to carry out business activities is called business finance, and financial management is concerned with raising funds at the lowest cost and risk and deploying them where returns exceed cost. Its primary objective is wealth maximisation — maximising the market price of equity shares. This is achieved through three financial decisions: the investment decision (capital budgeting and working-capital decisions), the financing decision (the mix of debt and equity, i.e. the capital structure), and the dividend decision (how much profit to distribute vs. retain). The chapter also explains financial planning (a blueprint of future operations), trading on equity (using cheaper debt to raise EPS when RoI exceeds the cost of debt), and the factors affecting the requirement of fixed capital and working capital.
Key Terms, Concepts & Formulas
Business finance: the money required for carrying out business activities — to establish, run, modernise, expand or diversify a business and to buy tangible and intangible assets.
Financial management: concerned with the optimal procurement and usage of finance; it aims to reduce the cost of funds, keep risk under control, ensure availability of funds when required and avoid idle finance.
Wealth maximisation: the primary aim of financial management — maximising the market price of the company’s equity shares, i.e. the wealth of the shareholders.
Investment decision (capital budgeting): deciding how a firm’s funds are invested in different long-term assets; affected by cash flows of the project, the rate of return and the investment criteria.
Financing decision: deciding the proportion of funds to be raised from long-term sources — shareholders’ funds (equity) and borrowed funds (debt); it determines the cost of capital and the financial risk.
Dividend decision: deciding how much of the profit (after tax) is distributed to shareholders and how much is retained in the business.
Financial risk: the chance that a firm fails to meet its fixed financial commitments such as interest payment, preference dividend and repayment of debt.
Capital structure: the mix of owners’ funds (equity) and borrowed funds (debt) used to finance a business; an optimal capital structure maximises the value of the equity share.
Trading on equity: the increase in profit (EPS) earned by equity shareholders due to the presence of fixed financial charges like interest; profitable only when RoI is higher than the cost of debt.
Financial planning: the preparation of a financial blueprint of an organisation’s future operations to ensure enough funds are available at the right time, and that resources are not raised unnecessarily.
Fixed capital: investment in long-term assets (plant, machinery, land, building). Working capital: investment in current assets used for day-to-day operations.
EPS = Earnings after Tax (EAT) ÷ Number of equity shares
Interest Coverage Ratio (ICR) = EBIT ÷ Interest
Return on Investment (RoI) = (EBIT ÷ Total Investment) × 100
Net Working Capital (NWC) = Current Assets − Current Liabilities
NCERT Exercises — Full Solutions
All questions below are reproduced verbatim from the NCERT textbook’s end-of-chapter Exercises. Answers are original and written in CBSE exam-ready style.
Very Short Answer Type
1. What is meant by capital structure?
ANSWERCapital structure refers to the mix between owners’ funds (equity) and borrowed funds (debt) used by a business to finance its assets and operations. It is usually expressed as the debt-equity ratio (Debt ÷ Equity) or as the proportion of debt out of total capital (Debt ÷ (Debt + Equity)).A capital structure is said to be optimal when the proportion of debt and equity is such that it maximises the value of the equity share, balancing profitability and financial risk.
2. Sate the two objectives of financial planning.
ANSWER(a) To ensure availability of funds whenever required: financial planning estimates the funds needed for different purposes (long-term assets and day-to-day expenses), the time at which they are needed, and the possible sources of these funds.(b) To see that the firm does not raise resources unnecessarily: excess funding is almost as bad as inadequate funding, so good planning puts any surplus to the best possible use and ensures resources are not left idle, avoiding wasteful cost.
3. Name the concept of financial management which increases the return to equity shareholders due to the presence of fixed financial charges.
ANSWERThe concept is Trading on Equity (also called financial leverage). It refers to the increase in profit (EPS) earned by equity shareholders because of the presence of fixed financial charges such as interest on debt — provided the firm’s return on investment is higher than the cost of debt.
4. Amrit is running a ‘transport service’ and earning good returns by providing this service to industries. Giving reason, state whether the working capital requirement of the firm will be ‘less’ or ‘more’.
ANSWERThe working capital requirement of the firm will be less.Reason: A transport business is a service industry. Service businesses do not have to maintain any inventory of raw materials, work-in-progress or finished goods, and there is no manufacturing/processing cycle. Since funds are not tied up in stock, such firms need a smaller amount of working capital compared with manufacturing concerns.
5. Ramnath is into the business of assembling and selling of televisions. Recently he has adopted a new policy of purchasing the components on three months credit and selling the complete product in cash. Will it affect the requirement of working capital? Give reason in support of your answer.
ANSWERYes, this policy will reduce (lower) the working capital requirement of the firm.Reason: By purchasing components on three months’ credit, Ramnath avails credit from his suppliers, so payment for materials is postponed and less of his own funds are blocked in them. At the same time, selling the finished product in cash means there are no debtors and funds are realised immediately. Both a higher credit availed and a lower credit allowed reduce the amount tied up in working capital, so the requirement falls.
Short Answer Type
1. What is financial risk? Why does it arise?
ANSWERFinancial risk is the chance that a business will fail to meet its fixed financial commitments — namely the payment of interest on debt, preference dividend and the repayment of the principal amount.Why it arises: It arises because of the use of borrowed funds (debt) in the capital structure. Interest on debt and repayment of principal are obligatory and have to be paid regardless of whether the firm earns a profit, unlike equity which carries no such commitment. The greater the proportion of debt in the total capital, the higher the fixed charges and therefore the higher the financial risk.
2. Define current assets? Give four examples of such assets.
ANSWERCurrent assets are those assets which, in the normal routine of the business, get converted into cash or cash equivalents within a period of one year. They provide liquidity to the business but generally yield a lower return than fixed assets.Four examples: (i) Cash in hand / cash at bank, (ii) Debtors (and bills receivable), (iii) Inventories of finished goods, raw materials and work-in-progress, and (iv) Marketable securities. (Prepaid expenses are also current assets.)
3. What are the main objectives of financial management? Briefly explain.
ANSWERThe primary objective of financial management is the maximisation of shareholders’ wealth, i.e. maximising the current market price of the company’s equity shares. A financial decision adds value when the benefit from it exceeds the cost involved; such value additions raise the share price.To achieve this overall objective, financial management aims at: (i) ensuring availability of enough funds whenever required while avoiding idle finance; (ii) optimal procurement of funds at the lowest possible cost; (iii) effective and efficient deployment of funds so that returns exceed cost; and (iv) keeping the financial risk under control. Every investment, financing and dividend decision is taken so as to ensure efficient, value-adding use of funds.
4. Financial management is based on three broad financial decisions. What are these?
ANSWERThe three broad financial decisions are:(i) Investment Decision: deciding how the firm’s scarce funds are invested in different assets. Long-term investment decisions are called capital budgeting decisions (e.g. buying a new machine, opening a branch); short-term ones are called working capital decisions (levels of cash, inventory and receivables).(ii) Financing Decision: deciding the quantum of finance to be raised from various long-term sources — the proportion of shareholders’ funds (equity) and borrowed funds (debt). It determines the firm’s cost of capital and financial risk.(iii) Dividend Decision: deciding how much of the profit earned (after tax) is to be distributed to shareholders as dividend and how much is to be retained in the business.
5. Sunrises Ltd. dealing in readymade garments, is planning to expand its business operations in order to cater to international market. For this purpose the company needs additional ₹80,00,000 for replacing machines with modern machinery of higher production capacity. 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 ₹8,00,000 and total capital investment was ₹1,00,00,000. Suggest whether issue of debenture would be considered a rational decision by the company. Give reason to justify your answer.
ANSWERNo, issuing debentures would not be a rational decision for the company.Reason — comparing RoI with the cost of debt: A firm should use trading on equity (raise debt) only when its Return on Investment (RoI) is higher than the cost of debt. Here:
Particulars
Amount / Working
EBIT (previous year)
₹8,00,000
Total capital investment
₹1,00,00,000
Return on Investment (RoI)
(8,00,000 ÷ 1,00,00,000) × 100 = 8%
Estimated cost of debt
10%
Since the cost of debt (10%) is more than the RoI (8%), the use of debt would be a case of unfavourable financial leverage — the interest payable would exceed the return earned on the borrowed funds, reducing the EPS and the wealth of equity shareholders. Therefore, the issue of debentures is not advisable.
6. How does working capital affect both the liquidity as well as profitability of a business?
ANSWERWorking capital is the investment in current assets, and there is a trade-off between liquidity and profitability.Effect on liquidity: Current assets such as cash, debtors and inventory are highly liquid and enable a firm to meet its day-to-day payment obligations on time. A higher level of working capital therefore increases liquidity — the firm can pay its bills and short-term dues comfortably; a very low level makes it difficult to honour obligations.Effect on profitability: However, current assets generally provide little or no return (idle cash and stock earn nothing). So holding a large amount of working capital reduces profitability, because funds locked in low-return current assets could have earned more if invested in fixed assets. Conversely, a low level of working capital raises profitability but lowers liquidity and increases the risk of insolvency. A business must therefore strike a balance — enough working capital to stay liquid, but not so much that profitability suffers.
7. Aval Ltd. is engaged in the business of export of canvas goods and bags. In the past, the performance of the company had been upto the expectations. In line with the latest demand in the market, the company decided to venture into leather goods for which it required specialised machinery. For this, the Finance Manager Prabhu prepared a financial blueprint of the organisation’s future operations to estimate the amount of funds required and the timings with the objective to ensure that enough funds are available at right time. He also collected the relevant data about the profit estimates in the coming years. By doing this, he wanted to be sure about the availability of funds from the internal sources of the business. For the remaining funds, he is trying to find out alternative sources from outside.
a. Identify the financial concept discussed in the above paragraph. Also, state the objectives to be achieved by the use of financial concept so identified.
b. ‘There is no restriction on payment of dividend by a company’. Comment.
ANSWER(a) Financial concept: The concept discussed is Financial Planning — the preparation of a financial blueprint of an organisation’s future operations to estimate the quantum and timing of funds required.Objectives of financial planning: (i) To ensure availability of funds whenever required — estimating the funds needed, the time they are needed and the possible sources (internal and external); and (ii) To see that the firm does not raise resources unnecessarily, so that surplus funds are put to good use and resources are not left idle, avoiding extra cost.(b) Comment: The statement is incorrect. There are restrictions on the payment of dividend in the form of Legal Constraints and Contractual Constraints. Under legal constraints, certain provisions of the Companies Act place restrictions on payouts as dividend, which must be adhered to while declaring a dividend. Under contractual constraints, while granting a loan the lender may impose conditions restricting the payment of dividend, and the company must ensure the dividend does not violate the terms of the loan agreement.
Long Answer Type
1. What is working capital? Discuss five important determinants of working capital requirement?
ANSWERWorking capital is the investment a business makes in current assets (cash, debtors, inventory, etc.) to finance its smooth day-to-day operations. Net working capital = Current Assets − Current Liabilities, i.e. the excess of current assets over current liabilities financed through long-term sources.Five important determinants of working capital requirement:(i) Nature of business: A trading or service business needs little working capital (no processing, hence no raw material/finished-goods distinction), whereas a manufacturing concern needs more because raw material must be converted into finished goods before sale.(ii) Scale of operations: Organisations operating on a larger scale need larger inventories and debtors, and therefore require more working capital than small-scale firms.(iii) Production cycle: The longer the time span between receipt of raw material and conversion into finished goods, the more funds are blocked in materials and expenses, so a longer production cycle means higher working capital.(iv) Credit allowed and credit availed: A liberal credit policy to customers raises debtors and hence working capital; getting more credit from suppliers reduces the working capital required.(v) Business/seasonal cycle: During a boom or peak season, higher sales and production need more working capital; during depression or the lean season the requirement falls. (Other determinants include operating efficiency, availability of raw material, growth prospects, level of competition and inflation.)
2. “Capital structure decision is essentially optimisation of risk-return relationship.” Comment.
ANSWERThe statement is correct. Capital structure is the mix of debt and equity, and the choice between them is essentially a balancing of risk and return.Debt and return: Debt is the cheaper source of finance — the lender’s risk is lower and so is the required return, and interest is a tax-deductible expense. When the firm’s RoI is higher than the cost of debt, using more debt (trading on equity) raises the EPS and hence the return to equity shareholders.Debt and risk: However, interest and repayment of principal are obligatory; any default may force the business into liquidation. So increasing debt increases the fixed financial charges and therefore the financial risk of the company. Higher debt also pushes up the shareholders’ desired rate of return and may depress the share price.Optimisation: Thus a company cannot keep increasing debt merely to raise EPS; it must choose the risk-return combination that maximises shareholders’ wealth. The debt-equity mix that achieves the highest value of the equity share is the optimum capital structure — which is precisely an optimisation of the risk-return relationship.
3. “A capital budgeting decision is capable of changing the financial fortunes of a business.” Do you agree? Give reasons for your answer?
ANSWERYes, I agree. Capital budgeting (long-term investment) decisions can change the financial fortunes of a business, for the following reasons:(i) Long-term growth: Funds invested in long-term assets yield returns over future years, so these decisions directly affect the long-term growth and future prospects of the firm.(ii) Large amount of funds involved: A substantial portion of capital gets blocked in long-term projects, so a wrong decision can lock up huge funds unproductively.(iii) High risk: Such decisions involve investment of huge amounts and affect the returns and overall business-risk complexion of the firm in the long run.(iv) Irreversibility: Capital budgeting decisions are normally irreversible except at a huge cost; abandoning a project after heavy investment causes a great waste of funds. A wrong capital budgeting decision can therefore severely damage a firm’s financial fortunes, while a sound one can enhance its earning capacity, profitability and competitiveness. Hence these decisions must be taken with utmost care after detailed analysis.
4. Explain the factors affecting dividend decision?
ANSWERThe dividend decision — how much profit to distribute and how much to retain — is affected by the following factors:(i) Amount of earnings: Dividends are paid out of current and past earnings, so earnings are a major determinant.(ii) Stability of earnings: A company with stable earnings can declare higher dividends than one with fluctuating earnings.(iii) Stability of dividends: Companies generally follow a policy of stable dividend per share, raising it only when higher earnings are expected to be sustained.(iv) Growth opportunities: Companies with good growth opportunities retain more and pay smaller dividends to finance investment.(v) Cash flow position: Dividend involves an outflow of cash; a profitable firm short of cash may not be able to declare a dividend.(vi) Shareholders’ preference: Managements consider the preference of shareholders who may want a regular income.(vii) Taxation policy: The difference in tax treatment of dividends and capital gains influences the choice between paying and retaining.(viii) Stock market reaction: An increase in dividend is viewed positively and raises share prices, while a cut may lower them.(ix) Access to capital market: Large, reputed firms with easy market access depend less on retained earnings and may pay higher dividends.(x) Legal and (xi) contractual constraints: Provisions of the Companies Act and conditions imposed by lenders restrict dividend payouts.
5. Explain the term ‘Trading on Equity’? Why, when and how it can be used by company.
ANSWERMeaning:Trading on Equity refers to the increase in profit (EPS) earned by the equity shareholders due to the presence of fixed financial charges like interest on debt. The proportion of debt in the total capital is called financial leverage; using cheaper debt to magnify the return to equity is trading on equity.Why it is used: Debt is the cheapest source of finance because the lender’s risk and required return are lower and interest is tax-deductible. So if a company earns more on its funds than the cost of debt, the surplus accrues to the equity shareholders, raising their EPS. This is done to maximise the return to equity shareholders and thereby their wealth.When it can be used: It is beneficial only when the firm’s Return on Investment (RoI) is higher than the cost of debt (favourable financial leverage). If RoI is less than the cost of debt, the use of debt actually reduces EPS (unfavourable financial leverage) and trading on equity is inadvisable.How it works (example): Suppose a firm uses funds of ₹30 lakh, EBIT is ₹4 lakh (RoI = 13.33%), interest rate is 10% and tax is 30%. With no debt, EPS comes to about ₹0.93; with ₹10 lakh debt, EPS rises to ₹1.05; and with ₹20 lakh debt, EPS rises to ₹1.40. EPS rises because RoI (13.33%) exceeds the cost of debt (10%). However, debt must be used only up to a level, because higher debt also raises the financial risk and the desired return of equity holders.
6. ‘S’ Limited is manufacturing steel at its plant in India. It is enjoying a buoyant demand for its products as economic growth is about 7–8 per cent and the demand for steel is growing. It is planning to set up a new steel plant to cash on the increased demand. It is estimated that it will require about ₹5000 crores to set up and about ₹500 crores of working capital to start the new plant.
a. Describe the role and objectives of financial management for this company.
b. Explain the importance of having a financial plan for this company. Give an imaginary plan to support your answer.
c. What are the factors which will affect the capital structure of this company?
d. Keeping in mind that it is a highly capital-intensive sector, what factors will affect the fixed and working capital. Give reasons in support of your answer.
ANSWER(a) Role and objectives of financial management: For S Ltd., financial management will decide the optimal procurement of the ₹5,000 crore (the right mix of debt and equity at the lowest cost and risk) and the optimal usage of these funds in the new plant so that returns exceed cost. Its objective is the maximisation of shareholders’ wealth — ensuring the investment, financing and dividend decisions add value and raise the market price of S Ltd.’s equity shares. It must also ensure availability of funds when required and avoid idle finance.(b) Importance of a financial plan (with an imaginary plan): A financial plan is a blueprint of S Ltd.’s future operations. It is important because it helps the company forecast the funds needed and their timing, avoid shocks and surprises, coordinate different functions, reduce waste and link investment with financing decisions. Imaginary plan: of the ₹5,500 crore total requirement, S Ltd. could finance, say, ₹2,000 crore through equity shares and retained earnings, ₹3,000 crore through long-term debt/debentures and bank loans (for the fixed plant), and arrange the ₹500 crore working capital partly from short-term bank credit and supplier credit. It would prepare a sales forecast for the next 3–5 years, estimate profits, and time the inflow of funds to match construction and start-up.(c) Factors affecting capital structure: Cash flow position, Interest Coverage Ratio (ICR), Debt Service Coverage Ratio (DSCR), Return on Investment, cost of debt, tax rate, cost of equity, floatation costs, risk consideration, flexibility, control, regulatory framework (SEBI guidelines), stock market conditions, and the capital structure of other steel companies in the industry. Because steel is a capital-intensive sector with high fixed costs, S Ltd. should keep its financial risk moderate and not over-rely on debt.(d) Factors affecting fixed and working capital: Being highly capital-intensive, the steel plant requires very large investment in plant and machinery, so its fixed capital requirement is high — influenced by the nature of business (manufacturing/capital-intensive), scale of operations (a large new plant), choice of technique (capital-intensive technology), growth prospects (buoyant 7–8% demand needing extra capacity) and diversification. Its working capital requirement is also high because, as a manufacturing concern with a long production cycle and large scale, big inventories of raw material and finished goods and high debtors must be maintained; a boom phase further raises it. Hence both fixed and working capital needs are large.
Extra Practice Questions
Short Answer Type Questions
Q1. What is meant by financial leverage?
ANSWERFinancial leverage is the proportion of debt in the overall capital of a firm, computed as Debt ÷ Equity (or Debt ÷ (Debt + Equity)). When RoI exceeds the cost of debt, higher leverage raises EPS (favourable leverage); when RoI is lower than the cost of debt, it reduces EPS (unfavourable leverage).
Q2. Why is debt considered a cheaper source of finance than equity?
ANSWERDebt is cheaper because the lender’s risk is lower than that of an equity shareholder — the lender earns an assured return and gets back the principal — so the required rate of return is lower. In addition, interest paid on debt is a tax-deductible expense, whereas dividends are paid out of after-tax profit, making debt cheaper still.
Q3. Distinguish between fixed capital and working capital.
ANSWERFixed capital is the investment in long-term assets such as plant, machinery, land and building, financed through long-term sources, and it stays in the business for more than one year. Working capital is the investment in current assets such as cash, inventory and debtors, used for day-to-day operations, and it is converted into cash within one year.
Q4. State any two factors affecting the requirement of fixed capital.
ANSWER(i) Nature of business: a manufacturing concern needs more fixed capital than a trading concern, which does not need plant and machinery. (ii) Scale of operations: a firm operating at a larger scale needs bigger plant and more space, requiring higher fixed capital. (Other factors: choice of technique, technology upgradation, growth prospects, diversification, financing alternatives, level of collaboration.)
Q5. What is meant by financial planning?
ANSWERFinancial planning is the preparation of a financial blueprint of an organisation’s future operations. It estimates the quantum and timing of funds required, specifies the sources of these funds, and ensures that enough funds are available at the right time while resources are not raised unnecessarily. It usually covers a period of three to five years; plans of one year or less are called budgets.
Long Answer Type Questions
Q1. Explain any five factors affecting the financing decision of a firm.
ANSWER(i) Cost: the cost of raising funds through different sources differs; a prudent manager prefers the cheapest source (usually debt). (ii) Risk: debt carries higher risk because interest and repayment are obligatory, so the firm must judge how much risk it can bear. (iii) Floatation costs: the higher the floatation cost of a source, the less attractive it is. (iv) Cash flow position: a strong cash flow makes debt financing more viable as the firm can meet fixed payments. (v) Fixed operating costs: a firm with high fixed operating costs should use less debt to avoid excessive total fixed charges. (Other factors: control considerations and the state of the capital market.) These factors together decide how much to raise from which source, determining the cost of capital and the financial risk.
Q2. Explain the importance of financial planning for a business enterprise.
ANSWERFinancial planning is an important part of overall business planning and helps a firm tackle uncertainty about the availability and timing of funds. Its importance lies in that: (i) it helps forecast what may happen in future under different situations and prepares the firm to face them; (ii) it helps in avoiding business shocks and surprises by preparing the firm for the future; (iii) it helps coordinate various business functions such as sales and production through clear policies; (iv) detailed plans reduce waste, duplication of efforts and gaps in planning; (v) it links the present with the future; (vi) it provides a continuous link between investment and financing decisions; and (vii) by spelling out detailed objectives for various segments, it makes evaluation of performance easier. Thus financial planning ensures smooth functioning of the enterprise.
Q3. Explain any five factors that affect the choice of capital structure of a company.
ANSWER(i) Cash flow position: only a firm with strong, sufficient cash flows to cover fixed obligations and keep a buffer should raise more debt. (ii) Interest Coverage Ratio (ICR = EBIT ÷ Interest): a higher ratio means lower risk of failing to pay interest, allowing more debt. (iii) Return on Investment (RoI): when RoI is higher than the cost of debt, the firm can use trading on equity and employ more debt to raise EPS. (iv) Cost of debt: a firm able to borrow at a lower rate can employ more debt. (v) Tax rate: since interest is deductible, a higher tax rate lowers the after-tax cost of debt and makes debt more attractive. (Other factors: cost of equity, floatation costs, risk consideration, flexibility, control, regulatory framework, stock market conditions, and industry norms.) The firm chooses the mix that maximises shareholders’ wealth.
MCQs & Assertion–Reason
1. The primary objective of financial management is:
For each Assertion–Reason question, choose: (A) Both true and the Reason correctly explains the Assertion; (B) Both true but the Reason is not the correct explanation; (C) Assertion true, Reason false; (D) Assertion false, Reason true.
A-R 1. Assertion: The use of debt increases the financial risk of a business.
Reason: Interest payment and repayment of principal are obligatory regardless of whether the firm earns a profit.
A-R 2. Assertion: A renewable, cheaper source of debt should always be increased to the maximum.
Reason: Beyond a point, higher debt raises the cost of equity and financial risk, which can lower the share price despite a higher EPS.
A-R 3. Assertion: A service industry such as transport needs less working capital.
Reason: Service businesses do not maintain inventory and have no manufacturing cycle that blocks funds.
A-R 4. Assertion: Financial planning is the same as financial management.
Reason: Financial management aims at choosing the best investment and financing alternatives by focusing on their costs and benefits.
A-R 5. Assertion: A higher tax rate makes debt relatively more attractive.
Reason: Interest on debt is a tax-deductible expense, so a higher tax rate lowers the after-tax cost of debt.
Answer key: 1-(A), 2-(D), 3-(A), 4-(B), 5-(A).
Exam Tips & Common Mistakes
How to score full marks in this chapter
Memorise the three financial decisions (investment, financing, dividend) and the factors affecting each — these are frequent 3 to 6-mark questions. For trading on equity / capital structure case studies, always compare RoI with the cost of debt and show the working (e.g. RoI = EBIT ÷ Total Investment × 100). Remember the rule: use debt only when RoI > cost of debt. For fixed vs. working capital questions, present the factors as a numbered list with a one-line reason each, and quote the textbook examples (steel plant, transport service, manufacturing vs. trading). Learn all six formulas in the Key Terms box.
Common mistakes to avoid
Confusing profit maximisation with the correct objective, wealth (shareholders’) maximisation.
Saying trading on equity is always good — it benefits only when RoI > cost of debt.
Mixing up fixed capital (long-term assets) with working capital (current assets).
Treating financial planning as the same as financial management — they are different.
Forgetting that interest is tax-deductible, which makes debt cheaper than equity.
In case studies, giving an answer without showing the RoI vs. cost-of-debt working.
Frequently Asked Questions
What is Chapter 9 of Class 12 Business Studies about?
Chapter 9, Financial Management, explains business finance and financial management, the objective of wealth maximisation, the three financial decisions (investment, financing and dividend), financial planning, capital structure, trading on equity, and the factors affecting fixed capital and working capital.
What is trading on equity in Class 12 Business Studies?
Trading on equity is the increase in EPS earned by equity shareholders due to the presence of fixed financial charges like interest on debt. It is beneficial only when the firm’s Return on Investment is higher than the cost of debt; otherwise it reduces EPS.
How many questions are there in the NCERT exercise of this chapter?
The end-of-chapter Exercises contain 5 Very Short Answer Type questions, 7 Short Answer Type questions and 6 Long Answer Type questions — all answered step by step on this page.
