CORPORATE FINANCE(FINC521)-ALL IMPORTANT QUESTIONS

1. Factor that is irrelevant in determining the choice of debt equity mix

a. Taxation
b. The nature of asset base
c. Industry norm
d. Variability of cash flow

2. The larger the size of the inventory

a. the greater is the ordering cost
b. the lower is the ordering cost
c. ordering cost remains unaffected
d. carrying cost will the lower

3. What is the term used to describe an annuity with an infinite?

a. Perpetuity
b. Infinity
c. Infinity due
d. There is no special term for an infinite annuity

4. Provision of discount:
a. Raises the average collection period
b. Lessens the average collection period
c. Has no impact on average collection period
d. none of these

5. All else equal, the future value of a lump-sum amount invested today will increase if the
a. Interest rate that is earned is lowered
b. Number of compounding periods is increased
c. Investment time period is shortened
d. Amount initially invested is lowered

6. A group of individuals got together and purchased all of the outstanding shares of common
stock of DL Smith, Ltd. What is the return that these individuals require on this investment
called?
a. Dividend yield
b. Cost of equity
c. Capital gains yield
d. Cost of capital

7. In India, commercial papers are issued as per the guidelines issued by

a. Securities and exchange board of India
b. Reserve bank of India
c. Forward market commission
 d. None of these
8. Theoretically, the optimum capital structure implies a ratio of debt and equity at which____
would be at least and the market value of the firm would be highest.
a. Marginal cost of capital
b. Weighted average cost of capital
c. Cost of debt funds
d. Opportunity cost

9. ABC ltd. Manufactured and sold 20000 unit with a variable cost of Rs. 20 per unit and Rs. 30 as
selling price. The fixed overheads incurred during the period was Rs 1,00,000. The operation
leverage of the firm is – (Guys, this is doubtful, someone has marked A, and someone has
marked C)
a. 2
b. 1.5
c. 1
d. 2.5

10. The value of a firm is maximized when the

a. Cost of equity is maximized
b. Tax rate is 0
c. Levered cost of capital is maximized
d. Weighted average cost of capital is minimized

11. Intrinsic value of a firm depends upon:

a. Present value of its future earnings
b. Cost of its assets minus depreciation
c. None of these
d. All of these

12. The price of a company’s share has been risen from Rs 10 to Rs 400. Small investors are
complaining that this is affecting their ability to buy shares in the company. Which one of the
following might overcome the problem?
a. a share buy-back
b. a share split
c. issuing stock option
d. a share consolidation

13. If the calculated NPV is negative, then which of the following must be true? The discount rate
used is
a. Equal to the internal rate of return
b. Too high
c. Greater than the internal rate of return
 d. Too low

14. The IRR method assumes that the reinvestment rate of cash flow is__
a. The cost of capital
b. The IRR
c. Essentially arbitrary
d. Zero

15. Firm’s cost of capital is the weighted average cost of

a. All sources
b. All borrowings
c. Share capital
d. Share bonds & debentures

16. Your firm has a debt- equity ratio of 0.75. Your pre-tax cost of debt is 8.5% and yours required
return on assets is 15%. What is your cost of equity if you ignore taxes?
a. 0.1125
b. 0.1221
c. 0.1667
d. 0.1988 (Also, if option is in percentage please mark 19.88%)

17. The dividend decisions are concerned with

a. Determination of quantum of profit to be distributed to the owner’s
b. The frequency of such payments
c. The amounts to be retained by the firm
d. All of these

18. You have determined the profitability of a planned project by finding the present value of all the
cash flows from that project. Which of the following would cause the project to look more
appealing in terms of the present value of those cash flows?
a. The discount rate decreases
b. The cash flows are extended over a longer period of time, but the total amount of the
cash flows remains the same
c. The discount rate increases
d. None of these

19. State which of the following statements is false?

a. The coefficient of variation is a better measure of risk than the standard deviation if the
expected return of the securities being compared significantly
b. Managers cannot act in the best interests of their shareholders unless they know their
shareholder’s average from preference for receiving their money and what risk a special
shareholder is prepared to assume
 c. Companies should deliberately increase their risk relative to the market only if the
actions that increase the risk also increase the expected rate of return on the firm's
assets by enough to completely compensate for the higher risk
d. If the expected rate of return for a particular investment, as seen by the marginal
investor, exceeds its required rate of return ,we should soon observe an increase in
demand for the investment, and the price will likely increase until a price is established
that equates the expected return with the required return

20. Deep discount bonds are issued at

a. Face value
b. Maturity value
c. Premium to face value
d. Discount to face value

21. Which of the following should be the primary goal pursued by the financial manager of a firm?
a. Maximize net income (profits)
b. Maximize dividends paid to common stockholders
c. Minimize variable operating expenses
d. Maximize the market value of the firm’s stock

22. The use of personnel borrowing to change the overall amount of financial to which an individual
is exposed is called:
a. Homemade leverage
b. Restructured leverage
c. The weighted average cost of capital
d. Restructured private debt

23. Computation of future value involves

a. Simple interest rate formula
b. Compound interest rate formula
c. The average of both
d. None of these

24. ABC ltd. has a gearing ratio of 30% the cost of equity at 21% and cost of debt 14% the corporate
tax rate is 40%. The WACC of the company is:
a. 0.1722
b. 0.1
c. 0.0825
d. 0.12

Solution: - WACC = (21% x 0.70) + [14% (1 – 0.40) x 0.30] = 14.70% + 2.52% = 17.22%
25. Walter’s Model suggests for 100% DP ratio when
a. Ke=r
b. Ke< r
c. Ke> r
d. Ke=0

26. A company has an equity rate of return of 12 % and a debt rate of return of 6%. Its gearing ratio
is 40%. The tax rate is 30%. Interest payments on debt are chargeable for tax. The weighted
average cost of capital of the company is:
a. 0.0888
b. 0.1
c. 0.0825
d. 0.12

27. Average size of receivable is equal to

a. Sales * receivable turnover
b. Sales/receivable turnover
c. Sales + receivable turnover
d. Sales – receivable turnover

28. The profitability index is most useful _____________.

a. When the NPV method and the IRR method give conflicting on mutually exclusive
projects
b. In capital rationing situations
c. When the cash flow pattern is unusual
d. When project scales are of concern

29. A firm buys a bond today and sells after 3 months the rate of return related is known as
a. Yield to maturity
b. Current yield
c. Holding period return
d. None of these

30. An aggressive approach to current asset financing leads to

a. Greater profitability
b. Lower profitability
c. No impact on profit
d. None of these

31. Which one of the following statements is correct concerning the relationship between a levered
and an unlevered capital structure? Assume there are no taxes.
 a. When a firm is operating at a point where the actual earnings before interest and taxes
(EBIT) exceed the break-even level, then adding debt to the capital structure will
increase the earning per share (EPS)
b. The earnings per share will equal 0 when EBIT is zero for a levered firm
c. The advantages of leverage are inversely related to the level of debts
d. The use of leverage at any level of EBIT increases the EPS

32. The share of company is selling at Rs 30 per share. The company had paid dividend at Rs 2 per
share last year. If the unregistered growth of the company is approximately 8.7% per year. The
cost of equity capital of the company will be
a. 15.5
b. 0.152
c. 0.16
d. 0.165

33. The optimal capital structures

a. Will the same for all firms in the same industry
b. Will remain constant over time unless the firm does an acquisition
c. Will vary over time as taxes and market conditions change
d. Places more emphasis on operation than on financing

34. Vishnu Steel Ltd. has issued 30,000 irredeemable 14% debenture of Rs 150 each. The cost of
floatation of debentures is 5% of the total issued amount. The company’s taxation rate is 40%.
The cost of debenture is
a. 0.0895
b. 0.0764
c. 0.0986
d. 0.0884

Solution: - Total issued amount (30,000 x Rs.150) =Rs. 45,00,000

Less: Floatation cost (Rs. 45,00,000 x 5/100) =Rs. 2,25,000

Net proceeds from issue 42,75,000

Annual interest charge = Rs. 45,00,000 x 14/100 = Rs. 6,30,000

Kd = I (1 – t)/NP = 6,30,000 (1 – 0.40)/ 42,75,000 = 0.0884 or 8.84%

35. Cost of preference share is

a. Treated for taxes
b. Not treated for taxes
c. Only occasionally treated for taxes
 d. Tax treatment is at the discretion of management

36. Share of Moon Ltd. is currently quoted is Rs 55. The retain earnings per share being 40% is Rs 4
per share. If the investor except growth rate of 10%. What would be the cost of equity of moon
ltd.?
a. 0.1722
b. 0.1
c. 0.22
d. 0.12

37. Bigelow, Inc. has a cost of equity of 13.56% and a pre-tax debt of 7%. The required return on the
assets is 11%. What is the firm’s debt-equity ratio based on MM theory with no taxes?
a. 0.60
b. 0.64
c. 0.72
d. 0.75

38. You own 25% of Unique Vacations, Inc. You have decided to retire and want to sell your shares
in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow
Rs. 15,00,000 to purchase your 1,000 shares of stock. What is the total of this firm from today, if
you ignore taxes?
a. Rs 48,00,000
b. Rs 54,00,000
c. Rs 57,00,000
d. Rs 60,00,000

39. A project may have multiple IRRs when___________.

a. The project generates an alternating series of net cash inflows and outflows
b. The project generates an immediate cash inflow followed by cash outflows
c. The project has a negative NPV
d. The project is of considerably large scale

40. Matt invested in Dynamo stock when the firm was unlevered. Since then, Dynamo has become
levered. To unlevered his position, Matt needs to:
a. Borrow some money and purchase additional shares of Dynamo stock
b. Maintain his current position as the debt of the firm did not affect his personal leverage
c. Sell some shares of Dynamo stock and held the proceeds in cash
d. Sell some shares of Dynamo stock and loan out the sale proceeds

41. All of the following are external factors that influence the stock prices of the firm except
a. Regulatory constraints
b. Capital structure
 c. Tax laws
d. General level of economic activity

42. IRR of a project is a rate where NPV leads to

a. 0
b. Less than 1
c. More than 1
d. Equal to 1

43. When a manager develops a cost of capital for a specific project based on the cost of capital for
another firm which has a similar line of business as the project, the manger is utilizing the
____approach.
a. Subjective risk
b. Pure play
c. Divisional cost of capital
d. Capital adjustment

44. The before-tax cost of debt, Rd, is the same as the

a. Average yield to maturity (YTM) associated with the firm’s bonds
b. Dividend yield associated with the firm’s common stock
c. Average coupon rate of the firm’s bonds
d. Re if the firm has no preferred stock

45. Optimum credit exists when

a. Average rate of return is more than the required rate of return
b. Average rate of return is less than the required rate of return
c. Average rate of return is equal to required rate of return
d. None of these

46. JIT involves

a. Larger carrying cost
b. No carrying cost
c. No order cost
d. All of these

47. In perfect capital markets

a. Leasing and borrowing to buy will always be equivalent
b. Borrowing to buy will always be preferable to leasing
c. Leasing will always be preferable to borrowing to buy
d. None of these

48. Terminal cash flow is treated for tax when

 a. Cash salvage value < the book salvage value
b. Cash salvage value = the book salvage value
c. Cash salvage value > the book salvage value
d. None of these

49. Which of the following is not a spontaneous source of short –term funds?
a. Trade credit
b. Accrued expenses
c. Provision for dividend
d. All of these

50. The weighted average cost of capital for a wholesaler:

a. is equivalent to the after-tax cost of the firm’s liabilities
b. Should be used as the required return when analyzing a potential acquisition of a retail
outlet
c. is the return investors requires on the total assets of the firm
d. Remains constant when the debt equity ratio changes

51. All else being equal, risk averse investors generally require _____ returns to purchase
investments with _____risks.
a. Higher; lower
b. Lower; higher
c. Higher; higher
d. None of these

52. Assigning discount rates to individual projects based on the risk level of each project:
a. May cause the firm’s overall weighted average cost of capital to either increases or
decrease over time
b. Will prevent the firm’s overall cost of capital from changing over time
c. Will cause the firm’s overall cost of capital to decrease over time
d. Decreases the value of the firm over time

53. Which of the following is not considered a capital component for the purpose of calculating the
weighted average cost of capital as it applies to capital budgeting?
a. Long-term debt
b. Common stock
c. Short-term debt
d. Preferred stock

54. It is coupon bond is selling at discount, then which of the following is true?
a. Po< par and YTM < coupon
b. Po < par and YTM > coupon
 c. Po > par and YTM < coupon
d. Po > par and YTM > coupon

55. Thompson & Thomson is an all equity firm that has 5,00,000 shares of stock outstanding. The
company is in process of borrowing Rs 80,00,000 at 9% interest to repurchase 2,00,000 shares of
the outstanding stock. What is the value of this firm if you ignore taxes?
a. Rs 2,00,00,000
b. Rs 2,05,00,000
c. Rs 2,10,00,000
d. Rs 2,12,00,000

56. Collection of account receivables result in

a. Increase in total assets
b. Decrease in total assets
c. No change in total asset
d. None of these

57. Matching the current assets as much as is possible with long term capital and stressing more on
liquidity than on probability
a. Hedging approach of financing
b. Matching approach of financing
c. Conservative approach of financing
d. Aggressive approach of financing

58. The rate of interest payable on a bond is also called

a. Effective rate of interest
b. Yield to maturity
c. Coupon rate
d. Internal rate of return

59. Perpetual bonds have

a. Shorter maturity
b. Longer maturity
c. Mid-term maturity
d. No maturity

60. The unlevered cost of capital is

a. The cost of capital for a firm with no equity in its capital structure
b. The cost of capital for a firm with no debt in its capital structure
c. Equal to the interest tax shield multiplied by the pretax net income
d. Equal to the cost of preferred stock for a firm with no debt
61. An annuity consists of
a. Uniform cash flow during different periods
b. Different size of cash flows during different periods
c. Both above
d. None of these

62. Stock of semi-finished goods is a

a. Fixed capital
b. Working capital
c. Liquid capital
d. Watered capital

63. Increasing the credit period from 30 to 60 days, in response to a similar action taken by all our
competitors, would likely should is
a. An increase in average collection period
b. A decrease in bad debt losses
c. An increase in sales
d. Higher profits

64. A problem with payback method is:

a. It assigns a 0 percent discount rate to cash flows that occur before the cutoff point
b. It assigns a 10 percent discount rate to cash flows that occur before the cutoff point
c. It assigns a 20 percent discount rate to cash flows that occur before the cutoff point
d. It assigns a 30 percent discount rate to cash flows that occur before the cutoff point

65. The weighted average cost of capital of the firm is the:

a. Discount rate which the firm should apply to all of the projects it undertakes
b. Rate of return a firm must earn on its existing assets to maintain the current value of its
stock
c. Coupon rate the firm should expect to pay on its next bond issue
d. Minimum discount rates the firm should require on any new project

66. IRR of a project is a rate where NPV tends to

a. Zero
b. Less than 1
c. More than 1
d. Equal to one

67. A long-term debt issued with collateral is called

a. Junk bond
b. Treasury bills
c. Debenture
 d. Preference shares

68. The optimal capital structure has been achieved when the
a. Debt equity ratio is equal to 1
b. Weight of equity is equal to the weight of debt
c. Cost of equity is maximized given a pretax cost of debt
d. Debt-equity ratio selected results in the lowest possible weighted average cost of capital

69. If a firm has ke>r the Walter’s model suggests for

a. 0% payout
b. 100% payout
c. 50% payout
d. 25% payout

70. Which of the following is the current asset?

a. Bank loan for three years
b. Account receivables
c. Long term investments
d. All of these

71. The main virtue of the payback method is its

a. Simplicity
b. Complexity
c. Completeness
d. Thoroughness

72. Which present value tables can be used only when cash flows are uniform to determine NPV?
a. Annuity
b. Simple
c. Compound
d. None of These

73. In order to calculate Weighted average cost of weights may be based on:
a. Market values
b. Target values
c. Book values
d. All the above

74. The basic lesson of M& M theory (without taxes) for capital structure is that the value of the
firm is dependent upon the
a. Capital structure of the firm
b. Total cash flows of the firm
 c. Percentage of firm to which the bondholders have a claim
d. Tax claim placed on the firm by the government

75. Cost of carrying inventory applies to

a. The acquisition cost of the items as per invoice
b. Cost of economic lot size
c. Risk of obsolescence & interest
d. Moving average of the cost of the items

76. Which of the following is not true for MM model?

a. Share price goes if dividend is paid
b. Share price goes down if dividend is not paid
c. Market value is unaffected by dividend policy
d. All of these

77. Which of the following increases the working capital?

a. Cash received from debtors
b. Conversion of debentures into shares
c. Bill receivables received
d. Issue of debentures

78. The equity risk derived from the nature of a firm’s operating activities is called _____ risk.
a. Market
b. Systematic
c. Extrinsic
d. Business

79. Residuals theory argues that dividend is a

a. Relevant decision
b. Active decision
c. Passive decision
d. Irrelevant decision

80. EOQ is the order quantity that _______ over our planning horizon.
a. Minimizes total ordering cost
b. Minimizes total carrying cost
c. Minimizes total inventory cost
d. The required safety stocks

81. Holding cost

a. Increases with the growing inventory
b. Decrease with the growing inventory
 c. Remains unchanged with the level of inventory
d. None of these

82. The primary goal of a publicly owned firm interested in serving its stockholders to be to:
a. Minimize the debt issued by the firm
b. Maximize expected eps
c. Minimize the chances of losses
d. Maximize the stock price per share

83. You have computed the break-even point between a levered and unlevered capitals structure.
Assume there are no taxes, at break-even level, the:
a. Firm is just earning enough to pay for the cost of debt
b. Firm’s earnings before interest and taxes are equal to zero
c. Earnings per share for the levered option are exactly double those of the unlevered
option.
d. Advantages of leverage exceed the disadvantages of leverage

84. Where the firm has sufficient profits from its existing operations, the loss on the new project
will:
a. Cause overall loss
b. Reduce the overall taxation liability
c. Increase WACC
d. Increase cost of debt

85. The cost of equity for a firm:

a. Tends to remain static with increasing levels of risk
b. Increases as the unsystematic risk of the firm increases
c. Ignores the firm’s risk when that cost is based on the dividend growth model
d. Equals the risk-free rate plus the market rate premium

86. Which of the following is not a benefit of carrying inventories?

a. Reduction in ordering cost
b. Avoiding lost sales
c. Reducing carrying cost
d. Avoiding production shortages

87. Commercial paper is a type of

a. Fixed coupon bond
b. Unsecured short- term debt
c. Equity share capital
d. Government bond
88. _____ is a measure of total risk, whereas ______ is a measure of systematic risk.
a. Standard deviation, Beta
b. Beta, Standard deviation
c. Standard deviation, Variance
d. Coefficient of Variation, Standard deviation

89. The cost of preferred stock:

a. is equal to the dividend yield
b. is equal to the YTM
c. is highly dependent on dividend growth rate
d. is independent of the stock’s price

90. The most preferred technique for evaluating most capital investments is
a. Payback period
b. Disc payback period
c. IRR
d. Net present value

91. YTM is bond’s

a. IRR
b. Coupon rate
c. Market value
d. Intrinsic value bonds

92. Bonds will be selling at par if

a. Discount rate=Coupon rate
b. Discount Rate<Coupon rate
c. Discount rate>coupon rate
d. None of these

93. The value of shares depends upon

a. Dividend only
b. Par value
c. Earnings only
d. Both dividend & earnings

94. Variable current assets/permanent current asset ratio is normally:

a. Very high
b. Very low
c. Constant throughout the year
d. Differs business to business
 95. Operating cycle includes-
a. Inventory conversion period+ Debtor conversion Period
b. Inventory conversion period-Debtor Conversion Period
c. Inventory conversion period only
d. Debtor conversion period only

96. The longer the operating cycle:

a. The larger the size of current asset
b. The smaller the size of current asset
c. The size of current assets remains unchanged
d. Equal to the size of current liabilities

97. Cash flow should exclude depreciation because

a. Depreciation is a non-cash expense
b. Depreciation extends over a no. of years
c. Depreciation reduces the tax liability
d. Depreciation is not required

98. PR company equity share is expected to provide a dividend of Rs 3 and fetch a price of Rs.40a
year, hence what price would it sell for now, if investors IRR is 15%
a. Rs.35.5
b. Rs 37.39
c. Rs.38.27
d. Rs.40

Solution: - Po = 3.0/1.15+40/1.15 = Rs 37.39

99. For the analysis of prospective investments, for capital investment decisions, the only relevant
measure to be considered is
a. Sunk cost
b. Operating profits
c. Cash flows from operations
d. Incremental cash flows

100. With the increase in frequency of compounding

a. Annual percentage yield=Annual percentage rate of interest
b. Annual percentage yield>Annual percentage rate of interest
c. Annual percentage yield< Annual percentage rate of interest
d. None of these

CASE STUDY
101. Find the projects operating value cash flows per year over its 5-year life.
a. 68600
b. 68000
c. 50000
d. 3000

102. Find the projects initial cash outlay.

a. 250000
b. 200000
c. 50000
d. 300000

103. Find the projects net present value.

a. (2697)
b. 2697
c. 5000
d. 3000

104. Calculate the Profitability index of the project.

a. .989
b. 1.989
c. 2.989
d. .50

105. As the discount rate increases, without limit, the present values of the future cash
inflows
a. Gets larger without limit
b. Stays unchanged
c. Approaches zero
d. Gets smaller without limit i.e. approaches minus infinity

106. Mutually exclusive proposals are:

a. Complementary in nature
b. Supplementary in nature
c. Those where accepting one means rejecting the other
d. None of these

107. The term current assets does not include:

a. Stock
b. Cash
 c. Advance payment
d. Furniture

108. Principal value of a bond is called the

a. Maturity value
b. Issue price
c. Par value
d. Market price

109. High degree of financial leverage means:

a. High debt proportion
b. Lower debt proportion
c. Equal debt and equity
d. No debt

110. Profitability index show benefits from the proposal in:

a. Absolute terms
b. Relative terms
c. All of these
d. None of these

111. The tax savings derived from the deductibility of interest expense is called:
a. Interest tax shield
b. Depreciable basis
c. Financing umbrella
d. Current yield

112. A sum deposited at a private bank fetches Rs. 16,000 after 4 years at 15% simple rate of
interest. The principle amount is:
a. Rs. 10,000
b. Rs. 80,000
c. Rs. 12,000
d. Rs. 1,40,000

113. The dividend policy of the firm and its market price of the share is determined by:
a. Earnings per share
b. Dividend yield
c. Price earnings ratio
d. Book value

114. Economic order quantity represents a point where:

a. Ordering cost = holding cost
 b. Ordering cost = total cost
c. Total cost = holding cost
d. None of these

115. The interest tax shield has no value for a firm when the: i. Tax rate is equal to zero. ii.
Debt-equity ratio is exactly equal to 1. iii. Firm is unlevered. iv. Firm has no taxable income.
a. i and iii only
b. ii and iv only
c. i, iii, and iv only
d. ii, iii, and iv only

116. ABC technique of inventory control is

a. Always better control
b. Always best control
c. Selective control
d. None of these

117. The shares of company are selling at Rs.30 per share. The company had dividend @ Rs.2
per share last year. If the estimated growth of the company is approximately 8% of the year, the
cost of equity capital of the company will be:
a. 15.5
b. 0.152
c. 0.16
d. 0.165

118. Given some amount to be received several years in the future, if the interest rate
increases, the present value of the future amount will
a. Be higher
b. Be lower
c. Be variable
d. Cannot tell

119. MM model of dividend irrelevance uses arbitrage between

a. Dividend and business
b. Dividend and capital gain
c. Profit and investment
d. None of these

120. Standard deviation can be used to measure

a. Risk of an investment
b. Return on an investment
c. Both of these
 d. None of these

121. Annual demand for a commodity is 1000 tones and the carrying cost is Rs.20 per ton.
Ordering cost per order is Rs.2, find out the economic order quantity.
a. 14.142 tons
b. 15.142 tons
c. 25 tons
d. 12.243 tons

122. What is the effective annual return (ear) for an investment that pays 10 percent
compounded annually?
a. Equal to 10 percent
b. Greater than 10 percent
c. Less than 10 percent
d. None of these

123. Which one of the following makes the capital structure of a firm irrelevant?
a. Homemade leverage
b. Interest tax paid
c. Relationship between dividends and earnings per share
d. Effects of leverage on the cost of equity

124. Net working capital means

a. Current assets + current liabilities
b. Current assets - current liabilities
c. Current assets only
d. Current liabilities

125. Cost of new debt incorporates

a. Floatation cost
b. No floatation cost
c. Only a part of floatation cost
d. Part of floatation cost and part on interest cost

126. Taxation effects of a project will have impact on:

a. Project profit and losses
b. Investment incentives
c. Weighted average cost of capital
d. All of these

127. The Modigliani miller approach to capital structure theory is based on certain simplified
assumptions. One of the following is not included in such assumptions:
 a. Capital markets are imperfect
b. Investors are rational
c. No corporate income-tax
d. Investors have homogenous expectations

128. Assume that you are comparing the two mutually exclusive projects. Which of the
following statements is most correct?
a. The NPV and IRR rules will always lead to the same decision unless one or both of the
projects are non-conventional in the sense of having only one change of sign in the cash
flow stream, i.e., one or more initial cash outflows (the investment) followed
b. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by
dropping the IRR and replacing it with the pay-back period
c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects NPV
profiles cross, and even then, only if the required rate of return is to the left of (or lower
than) the discount rate at which the crossover occurs
d. None of these

129. A shareholder has received bonus shares in the proportion of 1:1. What is his stake
holding in the company (Indicate the most appropriate alternative)?
a. Stake holding remains the same
b. Stake holding has gone up with more shares available for trading
c. Stake holding has gone up
d. Stake holding remains the same with more shares available for trading

130. The Winter wear company has expected earnings before interest and taxes of Rs. 2,100,
an unlevered cost of capital of 14% and a tax rate of 34%. The company also has Rs. 2,800 of
debt that carries a 7% coupon. The debt is selling at par value. What is the value of this firm?
a. Rs 9,900
b. Rs 10,852
c. Rs 11,748
d. Rs 12,054

Solution: - VU= [Rs. 2,100 × (1 - .34)] ÷ .14 = Rs. 9,900; VL= Rs. 9,900 + (.34 × Rs. 2,800) = Rs. 10,852

131. Which of the following statements concerning financial risk are correct? i. Financial risk
is the risk associated with the use of debt financing. ii. As financial risk increases so too does the
cost of equity. iii. Financial risk is wholly dependent upon the financial policy of a firm. iv.
Financial risk is the risk that is inherent in a firm's operations.
a. i and iii only
b. ii and iv only
c. ii and iii only
d. i, ii and iii only
132. What is the reason that the present value of an amount to be received (paid) in the
future less than future amount?
a. Deflation causes investors to lose Purchasing power when their dollars are invested for
greater than one year
b. Investors have the opportunity to earn positive rates of return, so any amount invested
today should grow to a larger amount in the future
c. Investments generally are not as good as those who sell them suggest, so investors
usually are not willing to pay full face value for such investments, thus the price is
discounted
d. Because investors are taxed on the income received from investments, they never will
buy an investment for the amount expected to be received in the future

133. Which of the following stresses on investor’s preference on dividend than higher future
capital gains?
a. Walter’s Model
b. Gordon’s Model
c. MM Model
d. Residuals Theory

134. “Bird in hand” argument is given by:

a. Walter’s Model
b. Gordon’s Model
c. MM Model
d. Residuals Theory

135. A firm’s overall cost of equity is:

a. Is generally less that the firm’s WACC given a leveraged firm
b. Highly dependent upon the growth rate and risk level of the firm
c. Unaffected by changes in the market risk premium
d. Generally, less that the firm’s after-tax cost of debt

136. Volatility means- (book, page no.-32)

a. Variation from the mean in a negative way
b. Variation from the mean in a negative and positive way
c. Variation from the square of means
d. None of these

137. Depreciation must be considered while evaluating the incremental operating cash flows
associated with a capital budgeting project because:
a. It represents a tax-deductable cash expense
b. The firm has a cash outflow equal to the depreciation expense each year
 c. Although it is a non-cash expense, depreciation has an impact on the taxes paid by the
firm, which is a cash flow.
d. Depreciation is a sunk cost.

138. One of the following is an assumption of capital structures theories

a. There are only two sources of funds of the firm: Perpetual risk-less debt and ordinary
shares
b. There are non-corporate tax
c. The dividend pay-out ratio varies between 0% to 100%
d. The firm business risk is constant overtime

139. A firm should select the capital structure that:

a. Produces the highest cost of capital
b. Maximizes the value of the firm
c. Minimizes taxes
d. Is fully unlevered

140. The interest tax shield is a key reason why:

a. The required rate of return on assets rises when debt is added to the capital structure
b. The value of an unlevered firm is equal to the value of a levered firm
c. The net cost of debt to a firm is generally less than the cost of equity
d. The cost of debt is equal to the cost of equity for a levered firm

141. If a firm is operating with the optimal amount of debt, then the:
a. Financial distress cost must equal the present value of the tax shield on debt
b. Value of the levered firm will exceed the value of the firm if it were unlevered
c. Value of the firm is equal to Vu-TD
d. Value of the firm is equal to VI+TD

142. An annuity due is a case in which:

a. Uniform cash flows at beginning of regular interval
b. Different size of cash flow during different periods
c. Uniform cash flow during different periods
d. None of the above

143. In which of the following methods of capital budgeting annual returns of the future
years are discounted to their present value.
a. Pay-back period
b. IRR
c. NPV
d. Both IRR and NPV
144. By definition, what type of annuity best describes payments such as rent and magazine
subscriptions (assuming the costs do not change over time)?
a. Ordinary annuity
b. Annuity due
c. Non constant annuity
d. Annuity in arrears

145. MM model argues that dividend is irrelevant as

a. The value of the firm depends upon earning power
b. The investors buy shares for capital gain
c. Dividend is payable after deciding the retained earnings
d. Dividend is a small amount

146. The accounting rate of return is calculated as:

a. Sale/stock price
b. Net income/stock price
c. Sales/book value of assets
d. Net income/book value of assets

147. Dividend irrelevance argument of MM Model is based on:

a. Issue of Debentures
b. Issue of Bonus Share
c. Arbitrage
d. Hedging

148. In case of conflict in ranking which methods provides better results.

a. Net present value
b. Internal rate of return
c. Pay-back period
d. Profitability index

149. A new machinery in place of old machinery due to technological changes is termed as
a. Balancing
b. Modernization
c. Replacement
d. Expansion

150. The equity risk derived from a firm’s capital structure policy is called_______ risk.
a. Market
b. Systematic
c. Extrinsic
d. Financial