CORPORATE

FINANCE
TEST – 3
7th June 2020
Total Marks: 30 (20 X 1.5)
This test contains 30 questions of 1.5 marks each (0.75 mark is for selecting the correct option and 0.75
mark is for the working notes supporting the answer). Answer any 20 questions.

1. The stock of Excellent Housing Ltd.. a housing finance company, sells for Rs. 50/- per share. The dividend is likely to
be paid after one year is Rs. 2.50/- per share and the price of the share after one year is expected to be Rs. 55/-. The
return at the end of one year on the basis of the likely dividend and the price per share will be:
a) 5%
b) 10%
c) 15%
d) 20%
e) 25%

2. Beta Ltd. Has recently paid a dividend of Rs. 1.50/- per share. If the required rate of return is 12% and the growth
rate is 7%, the intrinsic value of the shares of Beta Ltd. Is approximately:
a) Rs. 28
b) Rs. 30
c) Rs. 32
d) Rs. 34
e) Rs. 36

3. Given the following information of Nile Ltd.
Cost of Equity 14%
Earnings per share 18
Dividend pay-out ratio 40%
Retention Ratio 60%
Return on Investment 15%
According to Gordon’s dividend capitalization model, the stock value of Nile Ltd. Is:

a) Rs. 54
b) Rs. 100
c) Rs. 121
d) Rs. 144
e) Rs. 168

4. Mr. Kumar has invested in three securities: X, Y, and Z. The following table shows the beta of each security and the
amount of money invested in each security.
Security Beta Amount invested (in Rs.)
X 1.70 1,00,000
Y 2.00 2,00,000
Z 0.50 3,00,000
The beta of his portfolio will be approximately:
a) 0.85
b) 0.97
c) 1.20
d) 1.25
e) 1.40

5. Consider the following information pertaining to expected returns arising from investment in risky equities and risk
free Treasury Bills and their associated probabilities:
Instrument Probability Expected Return
Equities 0.7 50%
0.3 -30%
Treasury Bill 1.0 6%

For an investment of Rs. 1,00,000/-, the risk premium expected to be offered by equities over Treasury Bills is:
a) Rs. 10,000
b) Rs. 12,500

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 c) Rs. 15,000
d) Rs. 17,500
e) Rs. 20,000

6. Mr. Sunder wants to invest in two stocks A and B in the proportion of 1:3. The variance of the returns on his portfolio
is 144(%)2. The variances of the returns on the stocks A and B are 169(%)2 respectively. The correlation coefficient
between the return of these two stocks is approximately:
a) -0.36
b) -0.25
c) 0.27
d) 0.34
e) 0.56

7. Which of the following is not an assumption of Capital Asset Pricing Model (CAPM)?
a) Investors are risk-averse
b) Investors make their investment decisions based on holding the security infinitely
c) Transaction costs are negligible
d) Taxes do not affect the choice of buying assets
e) All individuals assume that they can buy assets at the going market price and they all agree on the nature of the
return and risk associated with each investment.

8. Which of the following advantages make standard deviation preferable to range?
I. Standard deviation considers every possible event and assigns each event a weight equal to its probability
II. Standard deviation is a measure of dispersion around the expected value
III. Standard deviation is obtained as the square root of the sum of squared differences multiplied by their
probabilities.
IV. Standard deviation offers a high uniformity of the observations.

a) Both (I) and (III)
b) Both (I) and (IV)
c) (I), (II) and (III)
d) (II), (III) and (IV)
e) All of the above

9. The risk associated with the secondary market in which the particular security is traded is known as:

a) Market Risk
b) Inflation Risk
c) Business Risk
d) Liquidity Risk
e) Interest rate Risk

10. Ace Technology Ltd. Has paid a latest dividend of Rs. 5/- per share. The groeth of the dividend per share is estimated
to be 4% p.a. If the estimated growth rate of the dividends rises to 8% and assume that the required rate of return of
the equity investors is 18.5%, then increase in the estimated market price of the equity share is:
a) Rs. 12.03
b) Rs. 15.56
c) Rs. 17.33
d) Rs. 18.19
e) Rs. 20.03

11. From the given formula, which of the following statements is/are true for αj?
Kj = αj + βjKm + ej

I. Intercept of fitted line
II. Indicates return of security/portfolio when the market return is zero.
III. It has only positive values.

a) Only (I)
b) Only (II)
c) Only (III)
d) Both (I) and (II)
e) Both (II) and (III)
2

12. Given below is the distribution of returns and explicit probability distribution of stocks of Daiwik Ltd. And Tushar
Ltd. :
Probability Return
Daiwik Ltd. Tushar Ltd.
20% 90% 11%
10% 75% 29%
30% 60% 33%
25% 20% 60%
15% 30% 55%
The standard deviations of returns for the stocks of Daiwik Ltd., and Tushar Ltd. are mentioned above.
a) 20.45% and 17.58%
b) 23.87% and 17.83%
c) 26.24% and 18.65%
d) 28.64% and 19.25%
e) 20.71% and 20.14%

13. The stock of Mamta Ltd., is currently quoting at Rs. 60 per share in the market and it is expected to pay a dividend of
Rs. 2 per share in the current year. The stock price is expected one year hence has the following probability
distribution:
Probability 0.30 0.50 0.20
Price (Rs.) 70 80 90
The expected return from investing in the stock is approximately:
a) 15%
b) 25%
c) 35%
d) 45%
e) 55%

14. If a portfolio is constructed by investing 40% of funds in the shares of Arha Ltd., and 60% of funds in the shares of
Chintan Ltd., the portfolio risk will be approximately:
Probability Return
Arha Ltd. Chintan Ltd.
20% -7% -3%
50% 12% 11%
30% 18% 20%

a) 5.92%
b) 8.29%
c) 11.68%
d) 26.71%
e) 51.71
15. A zero-coupon bond that matures 5 years from today has a par value of Rs. 2,500 and yield to maturity of 11.5% per
annum, what is the current value of the issue?
a) Rs. 1,450
b) Rs. 1,827
c) Rs. 2,500
d) Rs. 2,742
e) Rs. 3,200

16. The capitalization rate of BI Ltd. Is 12%. This company has outstanding shares to the extent of 25,000 shares selling
at a rate of Rs. 100 each. They anticipate a net income of Rs. 3,50,000 for the current financial year in which will be
fully retained in the business. The company also has a new project, the investment requirement for which is Rs.
5,00,000. According to Miller and Modigilani model, the value of the firm is:
a) Rs. 10,00,000
b) Rs. 15,00,000
c) Rs. 20,00,000
d) Rs. 25,00,000
e) Rs. 30,00,000

17. According to the Walter Model, if ‘r’ is the internal rate of return, ‘g’ is the growth rate and ‘ke’ is the cost of the
capital, under which of the following conditions the optimal payout ratio is zero?

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 a) r = ke
b) r < ke
c) r > ke
d) g > ke
e) g = ke

18. If the beta of the stock is 1.2 and the standard deviation of the return on the market is 11.25%, the covariance of
returns of the stock and market will be:
a) 322.125%2
b) 250.026%2
c) 162.003%2
d) 151.875%2
e) 99.397%2

19. According to which approach to dividend policy, the stock price increases as dividends increase and the stock price
decreases as dividends decrease?
a) Walter’s Model
b) Gordon’s Model
c) Traditional Approach
d) Rational expectations Model
e) Miller and Modigilani approach

20. The stock of Silver Technologies Ltd. Is currently quoting at Rs. 60 per share in the market and is expected to pay a
dividend of Rs. 2 per share in the current year. The stock price expected one year, hence has the following probability
distribution:
Probability 0.30 0.50 0.20
Price (Rs.) 70 80 90
The expected return from investing in the stock is approximately
a) 15%
b) 25%
c) 35%
d) 45%
e) 55%

21. The standard deviation of Greaves Ltd. Stock is 24% and its correlation coefficient with the market portfolio is 0.5.
The expected return on the market is 16% with a standard deviation of 20%. If the risk-free return is 6%, the
required rate of return on Greaves Ltd. Stock is:
a) 11.0%
b) 11.5%
c) 12.0%
d) 12.5%
e) 13.0%

22. The expected return on the market portfolio and the risk-free rate of return are estimated to be 15% and 11%
respectively. Malavika Ltd. has just paid a dividend of Rs. 3 per share with annual growth rate of 9%. The sensitivity
index beta of Malavika Ltd., has been found to be 1.2. The equilibrium price for the shares of Malavika Ltd. is
approximately:
a) Rs. 26
b) Rs. 31
c) Rs. 35
d) Rs. 40
e) Rs. 48

23. The following information of Ram and Co. Ltd. is available in respect of the return from security X under different
economic conditions:
Economic Conditions Returns (%) Probability
Good 18 0.1
Average 15 0.4
Bad 12 0.3
Poor 5 0.2
The risk associated with the security is:
a) 8.5%

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 b) 7.4%
c) 6.3%
d) 5.2%
e) 4.1%


24. India Investment Fund holds the following portfolio:
Stock Investment (Rs. Crore) Beta
A 200 0.5
B 200 2
C 100 4
The required rate of return on the market is 14% and that of the above portfolio according to CAPM is 20.4%. The
fund manager has proposed to sell C for Rs. 100 Crores and use the proceeds to purchase stock D which has a beta of
3. The required rate of return of the new portfolio according to CAPM is:
a) 12.8%
b) 16.1%
c) 18.8%
d) 20.2%
e) 22.3%

25. The following information is given by the Forum Capital Services Ltd.
Current dividend Rs. 2.00 per share
Constant rate of growth is dividends 5 percent
Expected return from the market index 12 percent
Beta of the stock 1.50
Risk free rate of return 6 percent
The present market price per share will be approximately:
a) Rs. 7
b) Rs. 14
c) Rs. 21
d) Rs. 28
e) Rs. 35

26. A firm expects to pay dividends of Rs. 1.00, Rs. 1.40, Rs. 2.00 and Rs. 3.00 at the end of each of the next four years
respectively. If growth is then expected to level off at 9 percent, and if you require a 13 percent rate of return, how
much should you be willing to pay for this stock?
a) Rs. 55.35
b) Rs. 62.86
c) Rs. 81.75
d) Rs. 24.83
e) Rs. 50.22

27. If the dividend for the year is Rs. 2/- growth rate of dividends is 12% and the present market price of the stock is Rs.
52.50 , the required rate of return on the stock will be:
a) 15.00%
b) 15.81%
c) 16.27%
d) 16.49%
e) 17.53%

28. Which of the following statements is/are true regarding the value of a bond when the required rate of return is
greater than coupon rate?
I. The value of the bond will decrease with the passage of time.
II. The value of the bond is less than the par value.
III. The discount on the bond declines as maturity approaches.

a) Only (I)
b) Only (II)
c) Only (III)
d) Both (I) and (III)
e) Both (II) and (III)

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 29. Which of the following is not an assumption of Capital Asset Pricing Model (CAPM) ?
a) Investors are risk-averse
b) Investors make their investment decisions based on holding the security infinitely
c) Transaction costs are negligible
d) Taxes do not affect the choice of buying assets
e) All individuals assume that they can buy assets at the going market price and they all agree on.

30. The expected return on the market portfolio and the risk-free rate of return are estimated to be 15% and 8.5%
respectively. Mahi Ltd., has just paid a dividend of Rs. 3 per share with annual growth rate of 9% . The sensitivity
index beta of Mahi Ltd., has been found to be 1.2. The equilibrium price for the shares of Mahi Ltd., is approximately:
a) Rs. 26.55
b) Rs. 31.63
c) Rs. 35.75
d) Rs. 40.50
e) Rs. 44.80