All questions of Financial Management for Commerce Exam

Fixed assets refer to assets that are expected to provide benefits to a company for more than one year, such as property, plant, and equipment. Financing these assets requires a long-term financing strategy. Let us discuss the reasons why fixed assets should be financed through long-term liability:

1. Matching Principle: The matching principle of accounting requires that expenses should be matched against revenues earned during the same period. A long-term asset should be financed through long-term liabilities to match the repayment of the debt with the revenue generated by the asset.

2. Stability: Fixed assets are expected to provide benefits to a company over a long period of time. Therefore, it is important to have a stable source of financing that matches the life of the asset. Short-term financing sources may not be reliable and may not provide sufficient funds to cover the cost of the asset.

3. Cost of Capital: Long-term financing sources such as bonds and loans generally have a lower cost of capital than short-term sources such as bank overdrafts or trade credit. Therefore, financing through long-term liabilities can reduce the cost of capital and improve the profitability of the company.

4. Debt Capacity: A company's debt capacity is limited by its ability to repay its debts. Financing fixed assets through short-term liabilities can limit a company's ability to borrow in the future as it may exceed its debt capacity. Therefore, financing through long-term liabilities can provide more flexibility and increase the company's debt capacity.

In conclusion, fixed assets should be financed through long-term liabilities as it matches the life of the asset, provides stability and reliability, reduces the cost of capital, and increases the company's debt capacity.

Financial risk is the type of specific risk that encompasses the many different types of risks related to a company's capital structure, financing and the finance industry. These include risks involving financial transactions, such as company loans and exposure to loan default.

This is a factor of the dividend decisions. .....it states that if a firm has a prospect for growth or expansion it tends to pay a lower dividend rate to manage the funds for investment for expansion and globalisation

When there is an increase in the tax on corporate profit, the debt becomes relatively cheaper. This is because interest that is to be paid to the debtors is deducted from the total income before calculating the value of tax. Thus, as the value of tax increases, the debt becomes relatively cheaper.

Financial Leverage refers to the proportion of debt in the overall capital. It is said to be a favourable situation when the return on investment becomes higher than the cost of debt. In other words, as the Return on investment becomes greater, the earning per share also increases and the financial leverage is said to be favourable.

- Long term investment decision is also known as capital budgeting.
- It involves evaluating and selecting investment opportunities that require significant capital expenditure.
- The decision has a long-term impact on the organization's profitability and growth.
- Capital budgeting involves analyzing various investment options and choosing the most suitable projects.
- It helps in determining the allocation of financial resources to different investment projects.

Trading on Equity

Trading on equity refers to the practice of increasing the return on equity by using fixed financial charges like interest. In other words, it is a financial strategy that involves borrowing funds at a fixed rate of interest in order to increase the return on equity. The idea behind trading on equity is to use borrowed funds to invest in assets that generate a higher rate of return than the rate of interest on the borrowed funds. This creates a situation where the return on equity is higher than it would be if the company had not borrowed funds.

This financial strategy is often used by companies that have a high level of fixed assets and a stable cash flow. By using fixed financial charges, these companies are able to increase their earnings per share and provide higher dividends to their shareholders. However, it is important to note that trading on equity also increases the financial risk of the company.

Fixed Financial Charges

Fixed financial charges refer to the expenses that a company incurs on a regular basis, regardless of its level of sales or profitability. These expenses include interest payments on debt, lease payments, and other fixed contractual obligations. Fixed financial charges are a form of financial leverage, which means that they can increase the return on equity when used properly.

Impact on Equity Shareholders

Trading on equity has a positive impact on equity shareholders because it increases the return on equity. When a company uses fixed financial charges to increase its earnings, the equity shareholders are able to earn a higher return on their investment. This can lead to higher dividends and an increase in the value of the company's shares.

Conclusion

Trading on equity is a financial strategy that involves using fixed financial charges to increase the return on equity. This strategy can be effective for companies that have a high level of fixed assets and a stable cash flow. However, it is important to note that trading on equity also increases the financial risk of the company. Overall, trading on equity can have a positive impact on equity shareholders by increasing their return on investment.

Assertion (A): Financial planning ensures that the firm does not raise resources unnecessarily.
Reason (R): Excess funding is almost as bad as inadequate funding.

Explanation:
Financial planning is a crucial process that involves setting goals, evaluating resources, and creating strategies to achieve those goals. It helps businesses to effectively manage their finances and make informed decisions regarding resource allocation.

Financial planning and unnecessary resource raising:
Financial planning ensures that the firm does not raise resources unnecessarily. This means that through proper planning, the firm can accurately determine its resource requirements and avoid raising funds that are not needed. Unnecessary resource raising can lead to various issues such as increased debt, higher interest expenses, and inefficient use of resources.

Excess funding and inadequate funding:
The reason states that excess funding is almost as bad as inadequate funding. This means that having too much funding can be detrimental to a firm, just like having inadequate funding. Excess funding can result in complacency, poor financial discipline, and wasteful spending. It can also lead to a lack of motivation to optimize resource utilization and find innovative solutions. On the other hand, inadequate funding can hamper a firm's growth, limit its ability to seize opportunities, and hinder its operations.

Correct interpretation:
Both the assertion and the reason are true, and the reason correctly explains the assertion. Financial planning helps to avoid unnecessary resource raising, and excess funding can be as harmful as inadequate funding. Therefore, option B is the correct answer.

Conclusion:
Financial planning plays a crucial role in ensuring that a firm does not raise resources unnecessarily. It helps in accurately determining resource requirements and avoids excessive funding. Excess funding can be as detrimental as inadequate funding for a firm's growth and overall financial health. Therefore, both the assertion and the reason are true, and the reason correctly explains the assertion.

Profit maximization is the main aim of any business and therefore it is also an objective of financial management. Profit maximization, in financial management, represents the process or the approach by which profits Earning Per Share (EPS) is increased. In simple words, all the decisions whether investment or financing etc. are focused on maximizing the profits to optimum levels.
Profit maximization is the traditional approach and the primary objective of financial management. It implies that every decision relating to business is evaluated in the light of profits. All the decisions with respect to new projects, acquisition of assets, raising capital etc are studied for their impact on profits and profitability. If the result of a decision is perceived to have a positive effect on the profits, the decision is taken further for implementation.

Thank You.

Profits may be the most popular metric of measuring the success of a business venture but it is by no means the only (or the best) method for measuring success. Most start-ups are not profitable at the beginning of operation and many are not profitable for years.

Working capital is a measure of both a company's operational efficiency and its short-term financial health. The working capital ratio (current assets/current liabilities), or current ratio, indicates whether a company has enough short-term assets to cover its short-term debt.

Financial Decisions in Commerce

Financial decisions are essential in commerce to ensure the smooth functioning of a business. The following are some critical financial decisions that every business must make:

a) Financing Decision
The financing decision is concerned with determining the best sources of funds to finance business activities. Businesses need to make sure that they have enough funds to meet their operating costs, invest in new equipment, and pay off debts. Some common sources of funds include equity, debt, and retained earnings.

b) Investment Decision
The investment decision is concerned with determining where to invest the company's funds to generate maximum returns. Businesses need to analyze the potential risks and benefits of different investment opportunities before making a decision.

c) Staffing Decision
The staffing decision is concerned with determining the appropriate number of employees required to operate the business effectively. It also involves recruiting, hiring, and training employees.

d) Dividend Decision
The dividend decision is concerned with determining how much of the company's profits should be distributed to shareholders as dividends. This decision involves balancing the needs of shareholders with the company's need to retain earnings for future growth and development.

Answer
The correct answer is option 'C,' Staffing Decision, which is not a financial decision. Staffing decisions are related to human resource management and do not involve financial aspects. While staffing decisions can impact a company's finances, they are not considered financial decisions.

Investment decision:

Replacing machines with modern machinery of higher production capacity is an investment decision because it involves committing funds for acquiring assets that are expected to generate returns over a long period of time.

- Long-term commitment: This decision involves committing finance on a long-term basis, which makes it an investment decision rather than a short-term working capital decision.
- Impact on earning capacity: The decision to upgrade machinery will affect the company's earning capacity in the long run by increasing production efficiency and potentially leading to higher profits.
- Strategic planning: Expanding business operations to cater to the international market requires strategic planning and investment in resources that can support this expansion.
- Capital investment: The decision to invest in modern machinery involves a significant capital outlay, which is characteristic of investment decisions rather than day-to-day operational decisions.
- Focus on long-term growth: By opting to upgrade machinery for higher production capacity, Sunrises Ltd. is focusing on long-term growth and sustainability, which aligns with the nature of investment decisions.

If companies are preferring collaborations, then companies will need less fixed capital as they can share plant and machinery with their collaborators but if company prefers to operate as independent unit then there is more requirement of fixed capital.

Assertion (A): Financial management provides the base for the success of promotion.
Reason (R): A sound financial plan is very necessary for the success of a business enterprise.

The correct answer is option 'A', which means both the assertion and the reason are true, and the reason is the correct explanation of the assertion.

Explanation:
Financial management is a crucial aspect of any business organization. It involves planning, organizing, controlling, and monitoring the financial resources of a company. It plays a significant role in the success and growth of a business, including its promotional activities.

Financial management provides the base for the success of promotion:
1. Financial resources: Promotion requires financial resources to implement various marketing and advertising strategies. Financial management ensures that adequate funds are available for promotional activities such as advertising campaigns, sales promotions, public relations, etc. Without proper financial management, a company may not have sufficient funds to effectively promote its products or services.

2. Budgeting: Financial management involves budgeting, which helps in allocating funds to different promotional activities. It ensures that the available resources are distributed wisely and effectively for maximum impact. A well-planned budget allows the company to allocate funds based on the objectives of the promotion and the target audience.

3. Cost control: Financial management helps in controlling the costs associated with promotion. It ensures that the promotional expenses are within the allocated budget and are generating the desired results. Effective cost control measures, such as negotiating better deals with suppliers or optimizing advertising expenses, can be implemented through financial management.

4. Return on investment (ROI): Financial management evaluates the return on investment of promotional activities. It helps in analyzing the effectiveness of different promotional strategies and identifying the ones that generate the highest ROI. This analysis enables the company to make informed decisions regarding future promotions and allocate resources accordingly.

A sound financial plan is very necessary for the success of a business enterprise:
1. Capital requirements: A business enterprise requires adequate capital to finance its operations, including production, marketing, and promotion. A sound financial plan ensures that the company has sufficient capital to meet its promotional needs and support its overall growth.

2. Risk management: Financial management helps in identifying and managing financial risks. It involves forecasting and analyzing potential risks, such as market fluctuations or changes in consumer behavior, that can impact the success of the business enterprise. By having a sound financial plan, the company can mitigate these risks and ensure the success of its promotional efforts.

3. Growth opportunities: A sound financial plan enables a business enterprise to identify and seize growth opportunities. It provides the necessary resources to expand into new markets, launch new products, or invest in innovative promotional strategies. Without a solid financial plan, the business may miss out on these opportunities and struggle to grow.

In conclusion, financial management plays a crucial role in the success of promotion and the overall success of a business enterprise. It provides the necessary foundation, resources, and strategies to effectively implement promotional activities and achieve the desired results. Therefore, both the assertion and the reason are true, and the reason correctly explains the assertion.

As the financial leverage increases, the cost of funds declines because of increased use of cheaper debt but the financial risk increases. The impact of financial leverage on the profitability of a business can be seen through EBIT-EPS (Earning before Interest and Taxes-Earning per Share) analysis.

An optimum capital structure is one which maximises earning per equity share and minimizes cost of financing. In a sound capital structure, content of debt will be a reasonable proportion of the total capital employed in the business. As a result, it has minimum risk of becoming insolvent.

Capital Budgeting

Capital budgeting is the process of making long-term decisions regarding investments in projects or assets that will affect a company's future earning capacity.

Explanation:

Importance of Long-term Decisions:
- Long-term decisions, such as investing in new machinery, can have a significant impact on a company's profitability and growth. Therefore, it is crucial for companies to carefully evaluate and plan for such investments.

Role of Financial Manager:
- The financial manager plays a key role in making decisions related to raising funds for long-term investments. They must consider factors such as cost of capital, risk, and return on investment.

Choosing the Cheapest Source:
- In the case of Sunrises Ltd., the financial manager is considering whether to issue debentures or equity shares to raise funds for replacing machinery. The decision will be based on the cost of capital associated with each option.

Capital Budgeting vs. Working Capital:
- Capital budgeting focuses on long-term investments, while working capital management deals with the day-to-day operational needs of a company. Both are essential for the overall financial health of a business.

Conclusion:
- Making informed decisions about long-term investments is crucial for the success of a company. By carefully evaluating the cost and benefits of different funding sources, companies can ensure sustainable growth and profitability in the long run.

Long-term planning relates to long term growth and investment. It focuses on capital expenditure programmes. Short Term planning covers short-term financial plan called budget.

Companies using capital intensive techniques require more fixed capital whereas companies using labour-intensive techniques require less capital because capital intensive techniques make use of plant and machinery and company needs more fixed capital to buy plants and machinery.

Current assets are those assets that can be converted into cash within one year or the normal operating cycle of a business, whichever is longer. These assets are essential for the day-to-day operations of a business and are expected to be used up, sold, or converted into cash within a relatively short period of time.

The correct answer is option 'C' - within one year.

Below is a detailed explanation of why current assets are considered to be those that can be converted into cash within one year:

1. Definition of current assets:
- Current assets are a category of assets listed on a company's balance sheet, representing resources that are expected to be used up or converted into cash within the next operating cycle or one year, whichever is longer.
- These assets are important for a company's liquidity and short-term financial stability.

2. Examples of current assets:
- Cash and cash equivalents: This includes cash on hand, bank deposits, and highly liquid investments that can be easily converted into cash.
- Accounts receivable: Amounts owed to the company by customers for goods or services provided on credit.
- Inventory: Goods held for sale or raw materials used in the production process.
- Prepaid expenses: Payments made in advance for goods or services that will be utilized within the next year.
- Short-term investments: Investments that are expected to be converted into cash within a year, such as marketable securities or certificates of deposit.

3. Importance of current assets:
- Current assets are crucial for a company's day-to-day operations, as they provide the necessary resources to fund ongoing expenses, such as salaries, rent, and utilities.
- These assets also play a significant role in assessing a company's liquidity and financial health, as they indicate the ability to meet short-term obligations and cover immediate expenses.

4. Classification of assets:
- Assets are typically classified into current and non-current categories on a company's balance sheet.
- Non-current assets are those that are expected to be held for more than one year, such as long-term investments, property, plant, and equipment.
- Current assets, on the other hand, are those that are expected to be converted into cash or used up within a shorter timeframe.

In conclusion, current assets are those assets that can be converted into cash within one year or the normal operating cycle of a business. These assets are necessary for the day-to-day operations of a business and provide the necessary resources to meet short-term obligations and cover immediate expenses.

The finance manager begins by reviewing corporate objectives to determine the funds the company needs. The finance manager plans a strategy based on whether the ending cash is positive or negative. If cash inflows exceed cash outflows the company will have cash to invest.

Understanding Debt-Equity Ratio
When Mr. Ghosh advised Mr. Bose to utilize more debt in financing the expansion of R.K. Cement Ltd., he was referring to the debt-equity ratio, which is a measure of the relative proportion of debt and equity used to finance a company's assets.
Higher Financial Risk
- A higher debt-equity ratio indicates that a company is relying more on borrowed funds (debt) than on its own funds (equity).
- This increased reliance on debt raises the financial risk associated with the business.
Implications of Higher Financial Risk
- Repayment Obligations: Companies with higher debt must consistently meet interest and principal repayment obligations, which can strain cash flow, especially during downturns.
- Increased Volatility: Higher debt levels can lead to greater volatility in earnings per share (EPS) since profits must cover fixed interest expenses.
- Risk of Bankruptcy: Excessive debt increases the likelihood of financial distress or bankruptcy if the company cannot generate sufficient revenue.
Trade-offs in Financial Strategy
- While higher financial risk can lead to higher returns for equity shareholders due to leveraged profits when times are good, it also poses significant risks during economic downturns.
- Companies must strike a balance between using debt to enhance returns and maintaining a manageable level of financial risk.
In conclusion, Mr. Ghosh's recommendation to raise more funds from debt means that Mr. Bose will face a higher degree of financial risk, which is the correct answer to the question. By understanding these dynamics, Mr. Bose can make informed decisions for his business expansion.

Explanation:
This question is testing the candidate's understanding of the relationship between capital structure and profitability. Let's break down the given Assertion and Reason statements:

Assertion (A): Capital structure of a company affects only the profitability.

Reason (R): A capital structure will be said to be optimal when the proportion of debt and equity is such that it results in an increase in the value of the equity share.
Now, let's analyze these statements:
1. Assertion (A): Capital structure affects more than just profitability. It also influences the riskiness of the company, cost of capital, financial flexibility, and the overall value of the firm. Therefore, this statement is false.
2. Reason (R): The Reason statement is correct. An optimal capital structure is one that maximizes the value of the equity share by balancing the benefits of debt (tax shield, leverage) with the costs (financial distress, bankruptcy risk). Achieving this balance helps in increasing the overall value of the firm.
Therefore, the correct answer is:

• A is false, but R is true.

In conclusion, while the Reason statement provides a correct explanation of the concept of an optimal capital structure, the Assertion statement oversimplifies the impact of capital structure by only focusing on profitability.

This process of estimating the fund requirement of a business and specifying the sources of funds is called financial planning. Financial planning takes into consideration the growth, performance, investments and requirement of funds for a given period. ... Long-term planning relates to long term growth and investment.

Financing Decision:

Explanation:
The decision to raise funds of ₹ 80,00,000 either from 10% debenture or equity shares is a financing decision.
- Financing decisions involve determining the best capital structure for the company by choosing between different sources of funds.
- In this case, the company needs to decide whether to issue debentures or equity shares to raise the required funds.
- The financial manager will evaluate the cost of each option and choose the one that is the cheapest.
- Issuing debentures at 10% cost or equity shares will impact the company's capital structure and financial performance in the long run.
- This decision is crucial as it will affect the company's earning capacity and financial stability.

Therefore, the decision to raise funds through debentures or equity shares falls under the category of financing decision as it involves determining the optimal mix of debt and equity to fund the company's expansion plans.

Assertion (A): Finance is the life blood of business.
Reason (R): Finance is very essential for the smooth running of the business.

The correct answer is option 'A', which means both the Assertion (A) and the Reason (R) are true, and the Reason (R) is the correct explanation of the Assertion (A).

Explanation:
Finance is the life blood of business:
Finance is often referred to as the life blood of business because it is essential for the functioning and survival of any business. Just like how blood is crucial for the sustenance of the human body, finance is necessary for the smooth functioning and growth of a business. Finance is required to fund various activities such as purchasing assets, paying salaries, investing in research and development, marketing, and expansion. Without adequate finance, a business cannot operate efficiently and may struggle to survive.

Finance is very essential for the smooth running of the business:
The Reason states that finance is very essential for the smooth running of the business. This is true because finance plays a crucial role in various aspects of a business, including:

1. Working Capital: Finance is required to manage the day-to-day operations of a business by providing funds for inventory, raw materials, and other working capital needs. Adequate working capital ensures that the business can meet its short-term obligations and continue its operations smoothly.

2. Investment: Finance is needed to make investments in new projects, equipment, technology, and infrastructure. These investments help businesses improve their productivity, efficiency, and competitiveness, leading to growth and profitability.

3. Risk Management: Finance enables businesses to manage risks by having adequate insurance coverage, maintaining emergency funds, and implementing risk mitigation strategies. This helps businesses navigate unforeseen challenges and disruptions effectively.

4. Expansion and Growth: Finance is crucial for business expansion, whether it is entering new markets, launching new products, or setting up additional production facilities. Expansion and growth require significant financial resources, and finance enables businesses to pursue these opportunities.

5. Financial Decision Making: Finance provides businesses with the necessary information and tools to make informed financial decisions. It helps in analyzing the profitability, viability, and financial health of the business, enabling management to make strategic decisions and allocate resources wisely.

In conclusion, finance is indeed the life blood of business, and it is essential for the smooth running, growth, and sustainability of any business.

A higher ICR ratio indicates a better financial health. It means company is more capable to meet its interest obligations from operating earnings.

Alternative finance is any type of business finance that doesn't come from a mainstream provider like a high street bank. Mainstream finance is great for many businesses but the banks often have criteria which smaller businesses can't fulfil, and they need other options.

A firm may choose to diversify its operations for various reasons. With diversification, fixed capital requirements increase e.g., a textile company is diversifying and starting a cement manufacturing plant.

Shareholders Funds

Shareholders funds refer to the amount of money that belongs to the shareholders of a company. It includes the following:

Share Capital
This refers to the money raised by a company by issuing shares to the public. It is the portion of the company's capital that has been raised by the sale of equity. Share capital is the amount of money that shareholders have invested in the company.

Surpluses and Retained Earnings
Surpluses refer to the excess of revenues over expenses. Retained earnings, on the other hand, refer to the portion of a company's profits that it has not distributed as dividends but has kept for reinvestment in the business. These funds are used to finance the growth and expansion of the company.

Reserves
Reserves refer to the portion of the company's profits that have been set aside for a specific purpose. It can be used for contingencies, such as future expansion, or for meeting unexpected expenses. Reserves can also be created to comply with legal and regulatory requirements.

All of these
Shareholders funds include all of the above-mentioned components, i.e., share capital, surpluses and retained earnings, and reserves. Shareholders funds are an important source of financing for a company and indicate the amount of money that the company's owners have invested in the business. It is important for investors to understand the composition of shareholders funds to make informed investment decisions.

Financial planning is a crucial aspect of any business organization as it involves managing the financial resources effectively and efficiently. The main objective of financial planning is to ensure that enough funds are available at the right time to meet the organization's financial obligations. This involves forecasting future cash flows, setting financial goals, and developing strategies to achieve these goals.

The following are the key points that explain the objective of financial planning:

1. Forecasting future cash flows: Financial planning involves estimating future cash inflows and outflows to determine the organization's financial position. This helps in identifying the funds required for various activities and ensures that enough funds are available at the right time.

2. Setting financial goals: Financial planning helps in setting realistic financial goals for the organization. These goals can be short-term or long-term and can include increasing profitability, reducing costs, or expanding the business.

3. Developing strategies: Financial planning involves developing strategies to achieve the financial goals set by the organization. This can include investing in new projects, reducing costs, or increasing sales.

4. Managing financial resources: Financial planning helps in managing the organization's financial resources effectively. This involves allocating funds to various activities based on their priority and ensuring that the funds are utilized in the most efficient manner.

In conclusion, financial planning is essential for any business organization as it helps in managing the financial resources effectively and achieving the organization's financial goals. The main objective of financial planning is to ensure that enough funds are available at the right time to meet the organization's financial obligations.

A higher DSCR indicates better ability to meet cash commitments and consequently, the company’s potential to increase debt component in its capital structure. If a firm uses its debt potential to the full, it loses flexibility to issue further debt. To maintain flexibility, it must maintain some borrowing power to take care of unforeseen circumstances.

The cost of raising funds through different sources are different. A prudent financial manager would normally opt for a source which is the cheapest.

Financial planning means deciding in advance how much to spend and on what to spend according to the funds at your disposal. It enables the management to foresee the funds requirements both the quantum as well as the timing.

Assertion (A): Higher the flotation cost, less attractive the source.
Reason (R): The choice between the payment of dividend and retaining the earnings is, to some extent, affected by the difference in the tax treatment of dividends and capital gains.

Explanation:
Flotation costs refer to the expenses incurred by a company when it raises funds through the issuance of securities such as equity shares or bonds. These costs include underwriting fees, legal fees, registration fees, and other expenses associated with the issuance process. The assertion states that higher the flotation cost, less attractive the source.

The reason given for this assertion is that the choice between the payment of dividend and retaining the earnings is affected by the difference in the tax treatment of dividends and capital gains. Let's analyze both the assertion and the reason.

Flotation Costs and Source Attractiveness:
Flotation costs represent a significant burden for a company when raising funds. These costs reduce the net proceeds received by the company and increase the cost of capital. Therefore, a higher flotation cost makes the source of funds less attractive for the company. This is because the company will have to bear additional expenses, resulting in a lower amount of funds available for investment or other purposes.

Choice between Dividend Payment and Retaining Earnings:
The reason given in the statement suggests that the choice between dividend payment and retaining earnings is influenced by the tax treatment of dividends and capital gains. Dividends are generally subject to taxation, either at the corporate level or at the individual level. On the other hand, capital gains may have different tax implications, depending on the jurisdiction and holding period.

The difference in tax treatment can impact the decision-making process of a company. If the tax rate on dividends is higher than the tax rate on capital gains, the company may choose to retain earnings instead of paying dividends. This is because retaining earnings allows the company to reinvest the funds internally and potentially generate higher returns for shareholders.

Conclusion:
Both the assertion and the reason are true in this case. Higher flotation costs make the source of funds less attractive, as they increase the cost of capital for the company. The tax treatment of dividends and capital gains can influence the choice between dividend payment and retaining earnings. If the tax rate on dividends is higher, the company may prefer to retain earnings to avoid higher tax liabilities. Therefore, both the assertion and the reason are true, and the reason correctly explains the assertion.

Trading on Equity refers to the increase in profit earned by the equity shareholders due to the presence of fixed financial charges like interest.