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Sources of Business Finance — Business Studies STD 11 Commerce — Question

CBSE BoardEnglish MediumSTD 11 CommerceBusiness StudiesSources of Business Finance6 Marks
Question
Daffodils Tech Ltd. is a software engineering company, a technology partner to many dynamic organisations across the globe. The company ability to look beyond technologies and deliver innovative and progressive solutions has been lauded by its clients as well as the tech community worldwide.
The company experiment with the latest technologies, design approaches and development methodologies to build cutting edge software products.
The company has issued equity and preference shares to meet its financial requirements. Other sources of finance have not been considered for fund raising. This has resulted in payment of large amount of taxes to the government. The company wants to seek tax benefits and hence approaches its financial consultant for an advice.
On the basis of the given information about Daffodils Tech Ltd., answer the following questions:
(a) Why does issue of preference shares do not provide tax benefits to the company?
(b) List any two sources which will provide such benefit to the company.
(c) State any two merits and demerits of sources of funds specified in part (b).
✓

Answer

(a) The issue of equity and preference shares do not provide tax benefits to the company because the dividend paid is not deductible from profits as expense. Thus, there is no tax saving as in the case of interest on borrowings.
(b) The sources which provide tax benefit to the company are:
(i) Debentures.
(ii) Loans from commercial banks.
(c) (i) The merits of raising funds through debentures are as follows:
- As debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management.
- Financing through debentures is less costly as compared to cost of preference or equity capital as the interest payment on debentures is tax deductible.
(ii) The demerits of raising funds from a commercial bank are as follows:
- Banks provide timely assistance to business by providing funds as and when needed by it.
- Secrecy of business can be maintained as the information supplied to the bank by the borrowers is kept confidential.

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