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ASSIGNMENT SOLUTIONS GUIDE (2014-2015)

E.C.O.-13
Business Environment
Disclaimer/Special Note: These are just the sample of the Answers/Solutions to some of the Questions given in the
Assignments. These Sample Answers/Solutions are prepared by Private Teacher/Tutors/Auhtors for the help and Guidance
of the student to get an idea of how he/she can answer the Questions of the Assignments. We do not claim 100% Accuracy
of these sample Answers as these are based on the knowledge and cabability of Private Teacher/Tutor. Sample answers
may be seen as the Guide/Help Book for the reference to prepare the answers of the Question given in the assignment. As
these solutions and answers are prepared by the private teacher/tutor so the chances of error or mistake cannot be denied.
Any Omission or Error is highly regretted though every care has been taken while preparing these Sample Answers/
Solutions. Please consult your own Teacher/Tutor before you prepare a Particular Answer & for uptodate and exact
information, data and solution. Student should must read and refer the official study material provided by the university.

Q. 1. What is meant by mixed economy? Why did India adopt mixed economy after achieving
independence?
Ans. A mixed economic system public sector coexist with the private sector, with both private individuals and
government holding a significant portion of production units. In India, mixed economic system was proposed by the
then Prime Minsiter, Shri Jawahar Lal Nehru.
Initially, the leading role was played by public sector in Indian mixed economy. Indian mixed economy is
characterised by predominance of public sector especially in defence, heavy and basic industries, social and economic
infrastructure, banking and insurance. The early phase of economic planning, characterised by predominant role of
state, is called, development of socialistic pattern of society. It was followed by the phrase of democratic socialism,
which aimed at growth with social justice.
However, over the years many reforms have been introduced and economy has been liberalised for increased
participation of foreign and private players to what can be described as mixed capitalistic economic system. In
1991, under the leadership of P.V. Narshimarao, many changes were made in the new economic policy. The year
marks the beginning of era of liberalisation, privatisation and globalisation of the Indian economy. The government
opened up areas otherwise reserved exclusively for public sector participation for private and foreign participation.
This was driven by the fact that several public sector enterprises were either incurring losses year after year and had
very low rate of return.
Mixed Economy in India
After the Indian independence, the country was vested with the challenging task of adopting a system for law
and economy. The National Congress Party stressed on adoption of capitalistic system, while labour leaders emphasised
socialistic system. While in capitalistic model, all means of production are owned by private players and driven by
profit motive, in socialistic system (also called Soviet model), all means of production are state owned.
However, it was realised that both socialistic and capitalistic systems are extreme approaches Soviet model
leads to a totalitarian state in which the citizens are denied of democratic freedom and power is concentrated in
hands of State cabinet, which are against the democratic system of power. On the other lateral, in the capitalistic
system there is exploitation of labour and workers as the system is driven by profit motive. Considering these
aspects, the government adopted a mixed economic system within the parameters laid in the Directive Principles of
the State Policy.
The Directive Principles of State: The State shall, in particular, direct its policy towards securing.
1. That citizens, men and women equally have the right to an adequate means of livelihood.
2. That the ownership and control of resources of the community are so distributed as best to subserve the
common good.

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3. That the operations of the economic system, does not result in the concentration of wealth and means of
production to common detriment.
Thus the government adopted a mixed economic system, in which both public and private sectors coexist. Indian
mixed economy is characterised by predominance of public sector especially in the following sectors:
1. Defence, Heavy and Basic Industries
2. Social and Economic Infrastructure
3. Banking and Insurance
The early phase of economic planning, characterised by predominant role of State, is called, development of
socialistic pattern of society. It was followed by the phrase of democratic socialism, which aimed at growth with
social justice. Thus the state was set with the task of maximising production with maximum employment. The State
also initiated programme for reducing income and social inequalities. Thus, the mixed economy framework permits
coexistence of public and private sectors, both of which have to work for attainment of socio-economic goals of
planning.
The State reserved its role and control over key industries including defence, power, railways, waterways,
shipping, heavy industries; to enumerate some. Hence, public sector in Indian economy is commonly referred to as
engine of growth. Though private sector was allowed to operate in other areas of economy, it was necessary that
self-interest was aligned with social interests. In case, the private players exploit the workers and fail to subordinate
the profit-maximisation, the state shall intervene and regulate the working of private sector. Under Directive Principles
of the State Policy, the State has defined regulatory framework for the private sector.
Q. 2. Giving examples, distinguish between direct and indirect roles of the government in business. Explain
the objectives of the Industries (Development and Regulation) Act, 1951.
Ans. Roles of the Government in Business: Government intervention and role in a lassies-free economy is
negligible. Such pure capitalistic system prevailed during seventeenth and eighteenth centuries when the government
role was limited to maintaining law and order.
However such a system lead to exploitation of worker class and unequal distribution of income. Capitalistic
classes reserved most of profits for themselves and kept worker on poor wages. It was realised that state should
intervene the business and economic system and regulate it in the interests of the society. Thus the principle of state
capitalism was born. Under socialistic form, economic power vested in hands of the government and it was the
responsibility to hold and run the business in the interests of the society.
However it was realised that both capitalistic and socialistic system are extreme approaches. Hence a mixed
economic system characterised by co-existence of private and public sectors came to be adopted. Presently, most
countries have a mixed economic system, with some private ownership and some government ownership, as both are
capitalistic and socialistic economic systems are extreme approaches. Over the years, economic reforms have been
introduced to balance economy in the interests of nation. For instance, United State was predominantly a capitalist
system at start. Over the years, it has been realised that state intervention is must and hence the role of government
has increased to stabilise the economy and maintain orderly market conditions. Similarly, Chinese economy was
largely socialistic during formative years, has been transcending into mixed with increased participation of private
players.
In India, mixed economic system was proposed by the then Prime Minsiter, Shri Jawahar Lal Nehru, with
leading role of public sector. Over the years, many reforms have been introduced and economy has been liberalised
for increased participation of foreign and private players.
Regulatory role of government involves regulation of various business and economic activities by directing the
businesses with set of controls. These regulations aim to prevent concentration of power in few hands, localisation
of business in few areas. These also aim at intervening and settling disputes between management and workers.
These controls include general norms and standards as set by the government like ceilings on dividends, public
utility profits, imposition of duties and other taxes.
Objectives of Regulatory Functions of Government
By regulating the business, the government aims at:

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1. Developing small scale industries and promote entrepreneurship.

2. Prevent monopolistic activities.
3. Promote interests of the weaker sections of society.
Thus, regulation aims to align business activities and processes with social justice.
There are two important practical aspects of government regulations:
First regulation should not be excessive
Secondly, regulation should be done efficiently.
Government regulation can be direct or indirect.
Direct Regulations: Direct controls are drastic and discretionary measures taken by the government which
affect the firm/industry at micro-level. Such measures are necessary to control the activities of business which are
at times imperfect in terms. For example, industrial licensing system was introduced by the government based on
the rationale that in free market resources are not fairly allocated and hence must be regulated.
Indirect Regulations: These regulations are made at macro-level and can be in form of monetary incentives,
duties, penalties, rewards, grants, bail; etc. which indirectly affect the interests of industry. For example, to promote
export-oriented units government gives various grants, cheap funds, tax-relief, duty exemptions, duty-cuts ;etc.
Industrial Development and Regulation Act, 1951: The Government of India introduced the process of
registration and licensing to ensure the smooth functioning of industries in India. Within the series of law, it introduced
Industries (Development and Regulation) Act, 1951 aiming for a thorough and planned industrial development that
included regulation, control and development of industries via registration and licensing. It was declared that licensing
comes as a must for establishing a new undertaking and also for manufacturing new article. Licensing was also
required for the substantial expansion; however, small scale industries or ancillary units come to be an exception.
Even the projects situated in backward zones that carried an investment of Rs. 25 crore were kept apart from the
process of licensing.
Q. 3. What do you mean by industrial sickness? Describe its indicators.
Ans. Sick industrial company is identified as an industrial company that has accumulated losses equal to or
exceeding its net worth at the end of any financial year.
Rapid industrialisation and changes in economic policies requires changes in the way companies do business.
Failure to change as per the changes in the external environment, leads to operational inefficiencies, revenue losses,
decline in profitability, failure in debt repayment, all of which are indicators of a sickness of a unit. The unit covers
the nature and causes of industrial sickness.
The government policies with respect to industrial sickness, role of Board for Industrial and Financial
Reconstruction (BIFR), and provisions of Sick Industrial Companies (Special Provisions) Act, 1985 have been also
discussed.
Nature of Industrial Sickness: The term sickness with reference to industrial units indicates malfunctioning.
The survival of a sick unit is doubtful, unless appropriate remedial and recovery measure are taken.
Industrial sickness is not an unnatural phenomenon.
Sick Industrial Companies (Special Provision) Act, 1985, (amended 1993), defines a sick industrial unit as,
one which has been in existence for at least than five years, and has the accumulated losses equal to or exceeding
its entire net worth at end of any financial year.
Weak units or potentially sick units, as these are alternatively called, are defined as industrial units which had
at the end of any accounting year, accumulated losses equal to more than 50 per cent of peak net worth during
preceding four years. It is used as an indicator for revival and recovery of the sick unit.
Incipient and Actual Sickness: Sickness of an industrial unit which can be identified during early stages is
called incipient sickness.
For small scale units, if the capacity utilisation achieved during preceding five years is less than 50 per cent of
the highest capacity achieved during preceding five years, it is taken as an indicator of incipient sickness. Incipient
sickness is also identified on basis of events like liquidity crunch, decline in revenue, decline in market price of the
companys shares, skipping of dividend payout; etc. Default in repayment is considered as an early indicator of

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sickness by all financial institutions.

Decline in net worth by 50 per cent or more, default in loan repayment, or halt in business for a period of 6
months or more is an indicator of actual sickness.
An industrial unit is considered as sick by financial company if the company sustains losses for period of two
years or more, and if the latest balance sheet shows accumulated losses more than 50 per cent of the paid-up capital
and reserves.
Financial indicators reflect operational inefficiencies in a company. Some of the important financial indicators
are:
1. Profitability Ratios: These are best indicators of industrial sickness in Indian context. Profitability ratios
include earnings before depreciation, interest and taxes to sales ratio and operating cash flows to sales units. Revenue
loss/ decreased earnings/ decline in profitability are an important indicator of sickness.
2. Cash losses, incicated by increased Working capital to total Asset Ratio.
3. Loan Defaults.
4. Falling Current Ratio (Current Ratio = Current Assets/Current Liabilities).
5. Declining Debt-Equity Ratio (Debt Equity ratio = Long Term Debt /Owner's Equity).
6. Decreased dividend rate and fall in dividend payment.
7. Decline in Net Worth (Net Worth = Owner's Capital + Free Reserves).
8. Retained Earnings to Total Asset Ratio.
9. Earnings before Interest and Tax (EBIT) to Total Asset Ratio.
10. Ratio of Earnings before Depreciation, Interest and Taxes (EBDIT) to total assets plus depreciation.
11.Market Value (Equity) to book Value (of Total Debt Ratio.
12. Sales to Total Asset Ratio.
13. Operating Cash Flows to Total Assets plus accumulated Depreciation Ratio.
14. Solvency ratios ( Net worth to total Debt Ratios, Total External Liability to Tangible Assets Ratios)
There are two main limitations of use of financial indicators:
Financial information available in annual reports is not completely reliable.
Financial indicators give clue about sickness which has already set in, and hence these cannot be used as early
signs of sickness (incipient sickness).
Due to the above stated limitations of financial indicators, the need of identifying management deficiencies and
other non-financial factors as indicators of early industrial sickness has been emphasised.
Q. 4. Distinguish between the following:
(a) Heavy industries and small scale industries
Ans. Small Scale Industry
Heavy Scale Industry
(i) These industries employ less number of persons (i) These industries employ a larger number
and capital.
of persons and capital.
(ii) Most of the work is done by manpower, small
(ii) The work is done mostly by larger machines and
machines and tools.
laborers.
(iii) Raw materials used are less and the production (iii) Raw materials and used is large and there is mass
is consequently less.
production.
(iv) They are scattered in rural and urban areas and (iv) They are located in urban cen-tres and are in the
are in the pri-vate sector, e.g., cycle, T.V., radio.
public sec-tor or run by big industrialists, e.g.,
Cotton textiles, Jute textiles.
Automobile, mining, petroleum, and steel industries which require very large capital investment in weighty
machinery and huge plants. A section of an economys secondary industry characterized by capital-intensive and
less labour-intensive operations. One way of characterizing heavy industry is that one unit of currency will buy
more heavy industry-produced products than it would buy light industry-produced products (for example, more
steel can be purchased for $1 than pharmaceuticals). Products made by an economys heavy industry tend are less

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likely to be targeted toward end consumers. Steel manufacturing and chemical manufacturing are two types of
heavy industries.
A section of an economys secondary industry characterized by less capital-intensive and more labour-intensive
operations. Products made by an economys light industry tend to be targeted toward end consumers rather than
other businesses. Consumer electronics and clothing manufacturing are examples of light industry.
(b) Foreign direct investment and foreign portfolio investment
Ans. Foreign Direct Investment (FDI): The country in which investment is made is called home/destination
country. The country which makes the investment is called foreign country. Foreign affiliate is a subsidiary company
or an associate company in which the investor has at least 10 per cent stake and not more than half voting power/
rights.
The IMF Manual on 'Balance of Payment' defines FDI as-"an investment involving long-term relationship and
reflecting a lasting interest and control of a residual entity in one country in an enterprise resident in an economy
other than that of the direct investor. Such investment involves both initial transactions between them and among
foreign affiliates."
Some of the important characteristics of Foreign Direct Investments (FDI) are outlined below:
The prime motive behind FDI is profit. Profit can be in form of royalty (in case of intellectual property) or in
form of dividend payout.
FDI is a capital investment made by a foreign company in 'home country'.
On decease of firm, the invested foreign capital and assets in the holding company can be repatriated to source
country or country of origin.
FDI investors control management and investments in different ways such as:
Management contracts and memorandums
Turnkey arrangements
Product pricing
Franchising and contracting
Licensing
Patents, trade marks and controlling other intellectual property
Product sharing
Subcontracting
Foreign investors can enter home country by making investments in different ways such as:
Opening branch(es)
Setting up subsidiary (wholly owned or joint venture )
Foreign controlled company
Acquire stake in exiting businesses
FDI is harmful if the economy is highly protected and foreign investments are made behind high tariffs.
A foreign company has been under Section 591 of Indian Companies Act, 1956, as 'a company incorporated
outside India, which has business established in India after or before 1.4.1956.
Foreign companies in India are governed by following acts:
Indian Companies Act, 1956
Foreign Exchange Regulation Act (FERA), 1973, replaced by FEMA
Customs Act, 1962
Quality Control and Inspection Act, 1963
MRTP Act 1969
Indian Income Tax, 1961
Industrial Development and Regulation Act, 1951
The apex bank, RBI has classified foreign companies into three types:

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1. Foreign Subsidiaries: Companies in which a foreign company holds more than 50% of equity share capital.
2. Minority Companies: In these companies foreign companies hold 50% or less equity share capital.
3. Technical Collaborations: These companies have no foreign equity participation and are pure technical
collaborations.
Some of the important aspects of FDI are:
FDI is a long-term investment made and cannot be easily liquidated.
A foreign investor who makes investment decision is convinced that comparative advantage are more than
comparative disadvantages.
Factors influencing FDI decisions are:
Political climate (stability)
Government policies
Industrial and economic prospects
Law and taxation
Repatriation of profits and disinvestments
Bureaucracy and legislation
Portfolio Investment: Portfolio investment refers to an investment in foreign country in which the investor(s)
do not seek control over the investment. There are different forms of portfolio investment like equity investments,
credit or capital investments in foreign companies.
Some of the important features of portfolio investment are:
1. Investors buy equity in foreign stock market.
2. Equity bought is that of a joint stick company.
3. Equity includes - shares (stock) of the company, and creditors capital (bonds/debentures/other securities).
4. The creditor capital can be made by private investors or institutions.
5. Investors are non-resident individuals.
6. Portfolio investments can be liquidated easily.
7. Portfolio investments are more sensitive than FDI, and are guided by short-term gains.
8. Investors cannot control investments, unless they are involved in the management of the company.
In India, there are two main forms of portfolio investment:
1. Foreign Institutional Investors (FIIs).
2. Global Depository Receipts and Foreign Currency Convertible Bonds.
Indian stock market opened for foreign participation in 1992-93.
In November 1995 the Reserve Bank of India issued regulations for FIIs. The notification contained eligibility
criteria for FIIs, investment ceilings, registration procedure, general responsibilities and obligations of FIIs. According
to regulations, FII could invest in securities of listed companies. These securities could be in form of shares, debentures
or warrants of companies which are listed on a recognised stock exchange. Mutual fund schemes launched by asset
management companies (listed or not).
Subsequently, in 1996-97, government liberalised foreign investment policy taking off the restrictions on
investment sums and time (lock-in). Thus, FIIs could invest in unlisted companies, but disinvestment in equity was
allowed only through Indian stock exchanges. FIIs were liable to pay tax on capital gains. Besides, capital holding of
single FII was revised to a ceiling of 10% of total equity capital.
Balance of Payments (BOP): Balance of payment is a statement showing all economic transactions (visible
and invisible) done by a country during a given time period, usually a year. It is primary tool for analyzing international
trade and economics of a country. The BOP statement has all the recorded transactions in a given period between
residents of a given country with those of another country.
Mathematically, BOP is aggregate of current and capital accounts. The current and capital account work in
opposite directions, in such a way that surplus in one finances deficit in other. These accounts balance each other,
though practically it is rarely achieved. Thus it is merely an accounting equality.

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If current accounts of a country incur ongoing deficit, which are financed/balanced by capital account surpluses,
it means that while the country is repaying its old debts, it is at the same time postponing its current liabilities to
future. In this case the external debt keeps mounting, as new loans/borrowings are contracted.
BOP account reflects the relation between gross external debt (borrowings), imports and spending of economy.
In developing economy, a small deficit in current account is necessary to maintain country's reserves and take
advantage of foreign savings.
Mathematically, Balance of Payment is aggregate of current and capital account.
Gross External Debt (Increase ) = Current Account deficit direct and long term capital inflows
+ official reserve increase + private capital outflows
It is important to note that a small deficit in current account is essential for economic development. In other
words, foreign savings and capital investment though give negative impact to current account, these are must for the
development of the economy.

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