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The Board of… (Class 12 Business Studies SQP 2023-24, Q1)

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Business StudiesCBSE Class 12 · Sample paper, session 2023-24 · 1 mark · MCQ

CBSE Class 12 Business Studies sample paper 2023-24: question 1

From the official CBSE sample question paper for 2023-24, section A, question 1, for 1 mark. Try it first; the hints and our step-by-step solution are below.

Q1 · 1 mark · MCQCompetency-basedFinancial Management

The Board of directors of Medex Pharma Ltd. decided to issue debentures worth ₹40 lakhs in order to finance a major Research and Development project. This would increase the Debt Equity ratio from 1:1 to 2:1. However, at the same time it would increase the Earnings per share.
The reason that will justify the above situation is:

  1. (A)Unfavourable financial leverage, as the financial risk will be higher.
  2. (B)Unfavourable financial leverage, as return on investment is lower than the cost of debt.
  3. (C)Favourable financial leverage as debt is easily available
  4. (D)Favourable financial leverage, as return on investment is higher than cost of debt

Source: official sample paper from cbseacademic.nic.in (PDF). See it in the full Sample paper 2023-24.

Hints

Open one hint at a time and try again before the next.

Hint 1

Did EPS go up or down with more debt?

Hint 2

When does borrowing increase the owners' earnings?

Step-by-step solution

Each step shows the marks it earns, as an examiner would award them. Checked by an independent re-solve from the question paper.

  1. Raising debt (debt-equity from 1:1 to 2:1) increases fixed interest, yet EPS rises.

  2. EPS rises with more debt only when the return on investment is higher than the cost of debt: favourable financial leverage (trading on equity). Option (D).

    1 mark

Answer: (D) Favourable financial leverage, as return on investment is higher than cost of debt

Where the marks are

  • ROI > cost of debt (1 mark)

Revise the chapter

Practise this chapterBoard-style questions from Financial Management, one at a time, marked against the answer key and marking points.Back to the full paperSample paper 2023-24: every question, by section.

The question is transcribed from the official paper; figures are described in words. The solution, hints and chapter tag are ours. Spotted an error? Write tosupport@questionbuddy.in.