CUET UG Business Studies Booster Test 3 Capital Requirements and Management

�� According to the fundamental principles of financial management, fixed capital requirements should be met through long-term sources of finance. → Fixed assets are held in the business for more than one year and yield returns over a long duration. If a firm uses Short-term sources (C) (like 3-month bank loans) to buy a factory, the loan will become due long before the factory has generated enough profit to pay it back. This leads to insolvency. Long-term assets should always be matched with long-term liabilities like Equity, Preference shares, or Retained earnings.

�� Statement I is incorrect: Capital budgeting refers specifically to long-term investment decisions (fixed assets). Decisions that affect "day-to-day" working are known as Working Capital decisions. → Statement II is correct: The management of fixed capital is synonymous with capital budgeting. It involves the allocation of a firm's scarce capital to different projects or assets (like plant, machinery, or land) which have long-term implications for growth and risk.

�� Assertion (A) is true: Because the amounts involved (e.g., 100 crores for a plant) are so large, even a minor percentage error can result in massive financial waste. → Reason (R) is true: These decisions are often irreversible. Once a plant is built, it cannot be easily converted back into cash or used for another purpose without a substantial loss in value. → Explanation: Since the potential for damage and irreversibility (R) is exactly why extreme care (A) is needed, R is the correct explanation of A.

�� This case illustrates the Irreversible nature (B) of fixed capital decisions. Fixed assets are often specialized to a specific product or process. → When the product fails, the machinery has little value to others (except as scrap). Therefore, the firm is "stuck" with the investment. While technically they can sell it, the "heavy loss" mentioned in the question proves that the decision is economically irreversible.

�� The passage explicitly states that these decisions are important because the funds invested are likely to yield returns in the future (B). → These assets (like a new factory) do not produce profit immediately but expand the firm's capacity to earn over the next 5, 10, or 20 years. This long-term horizon is what determines the growth trajectory and future competitive standing of the company.

�� The passage concludes by stating that investment decisions involving fixed capital influence the overall business risk complexion of the firm (B). → This is because fixed capital involves massive amounts of money and sets the level of fixed costs (like depreciation and interest) that the firm must pay regardless of sales volume. This determines how sensitive the firm's profits are to changes in the market, thereby defining its risk profile.

�� A trading concern buys finished goods and sells them immediately. It skips the "processing" stage. → Fixed Capital: Since there is no production, it doesn't need to buy expensive plants or machinery. → Working Capital: Since it doesn't manufacture, it doesn't have to keep "Raw Materials" or "Work-in-Progress." The inventory is simply the finished product. This shorter "Operating Cycle" and lack of machinery lead to lower capital needs.

�� Statement I is incorrect: An organisation operating at a larger scale actually requires more working capital, because it must maintain higher levels of inventory and likely has a higher volume of debtors to manage. → Statement II is correct: As a firm grows (scale of operations), its physical requirements grow. It needs more floor space, larger warehouses, and higher-capacity machines. This necessitates a larger investment in fixed assets.

�� This shift represents a change in the Choice of Technique. → Switching from humans (Manual) to robots (Automated) means the firm is becoming Capital-intensive (A). Robots are expensive fixed assets that must be purchased upfront and depreciated over time. Consequently, the firm's fixed capital requirement will spike significantly.

�� 1-C: Leasing allows a firm to use an asset by paying rent, acting as an alternative to buying (Financing). → 2-D: Banks sharing ATMs is the definition of Collaboration—sharing assets to reduce individual fixed capital needs. → 3-B: Moving to IT systems that become obsolete quickly relates to Technology Upgradation. → 4-A: Using manual workers instead of machines is a choice of a Labour-intensive technique.

Growth prospects are an important determinant of fixed capital requirements. When management expects higher growth and future demand (2), it plans for higher production capacity (1). To create this capacity, the business must make larger investments in fixed assets (4) such as plant, machinery, and buildings. As a result, the firm experiences a larger fixed capital requirement (3). Thus, the logical sequence is: 2 → 1 → 4 → 3 Option A correctly represents this chain of events.

A firm can reduce fixed capital requirements through labour-intensive production, leasing, and sharing facilities through collaborations. However, entering a completely new capital-heavy industry generally requires substantial investments in plant, machinery, infrastructure, and technology. Therefore, diversification into a capital-heavy industry increases rather than reduces fixed capital requirements. Hence, Option C is correct.

Current assets include cash, debtors, inventory, and short-term investments. They are expected to be converted into cash within one year and primarily support day-to-day operations and liquidity rather than generating high profits. The asset described matches the characteristics of a current asset. Therefore, Option B is correct.

Statement I is correct because current assets such as cash, inventory, and debtors are essential for smooth day-to-day operations. Statement II is incorrect because during a business boom, sales and production generally rise, requiring more inventory, receivables, and operational funds. Therefore, working capital requirements increase rather than decrease. Hence, Option A is correct.

Liquidity refers to the ease with which an asset can be converted into cash. Cash in hand and cash at bank are already cash and therefore require no conversion, no waiting period, and no reduction in value. Thus, cash possesses maximum liquidity. Hence, Option C is correct.

The assertion is true because the production cycle influences the amount of working capital needed. The reason is also true because a longer production cycle keeps funds tied up in raw materials and work-in-progress inventory for longer durations. This directly explains why more working capital is required. Therefore, the reason correctly explains the assertion. Hence, Option A is correct.

The correct matching is: Liquidity → B (ability to meet payment obligations smoothly) Profitability → D (return generated by an asset) Current Liabilities → C (obligations due within one year) Net Working Capital → A (current assets minus current liabilities) This exactly matches Option B.

Financial management requires balancing liquidity and profitability. Current assets provide liquidity but generally generate lower returns than fixed assets. Excessive investment in current assets improves liquidity but may reduce profitability because funds remain idle or earn lower returns. Therefore, Option C incorrectly defines the relationship.

Net Working Capital is calculated as: Net\ Working\ Capital = Current\ Assets - Current\ Liabilities = 500,000 − 300,000 = 200,000 The excess of current assets over current liabilities is called Net Working Capital. Hence, Option B is correct.

When a better sales effort is applied (2), products are sold faster. This reduces the average time for which finished goods inventory is held (4). As inventory remains unsold for shorter periods, the level of finished goods inventory falls (1). Consequently, less money is tied up in inventory, which lowers the overall requirement of working capital (3). Thus, the correct sequence is: 2 → 4 → 1 → 3 Hence, Option B is correct.