TYBCOM SEM 5 || Financial management MCQ of Capital structure planning

 TYBCOM SEM 5 || Financial management MCQ of Capital structure planning 

Question 1.

…………. refers to the mix of a firm’s capitalization and includes long term sources of funds.

(A) Leverage

(B) Capital structure

(C) Debt mix

(D) Owner’s equity

Answer:

(B) Capital structure

Question 2.

The term “capital structure” refers to:

(A) Current assets & current liabilities

(B) Long-term debt, preferred stock, and common stock equity

(C) Total assets minus liabilities

(D) Share holders’ equity

Answer:

(B) Long-term debt, preferred stock, and common stock equity

Question 3.

The decisions regarding the forms of financing, their requirements and their relative proportions in total capitalization known as –

(A) Equity decisions

(B) Equilibrium decisions

(C) Outright decisions

(D) Capital structure decisions

Answer:

(D) Capital structure decisions

Question 4.

Which of the following statement is false?

I. In case the firm wants to grow at a faster pace, it would be required to incorporate debt in its capital structure to a greater extent.

II. If the firm has no long term debt in its capital structure, it means that either it is risk averse or it has cost of equity capital or cost of retained earnings less than the cost of debt.

Select the correct answer from the options given below:

(A) Statement I is true while Statement II is false.

(B) Statement I is false while Statement II is true.

(C) Both Statement I and Statement II are false.

(D) Both Statement I and Statement II are true.

Answer:

(D) Both Statement I and Statement II are true.

Question 5.

While designing a capital structure a finance manager should choose a pattern of capital which –

(A) Minimizes cost of capital

(B) Maximizes the owners return.

(C) Maximizes cost of capital and minimizes the owners return.

(D) Both (A) and (B)

Answer:

(D) Both (A) and (B)

Question 6.

Which of the following changes in capital structure would you recommend for growth at faster rate?

(A) Incorporate more retained earnings out of profit and loss account.

(B) Incorporate debt in its capital structure to a greater extent.

(C) Merge with other companies.

(D) Pay more dividend to equity share-holders.

Answer:

(B) Incorporate debt in its capital structure to a greater extent.

Question 7.

The manner in which an organization’s assets are financed is referred to as its –

(A) Capital structure

(B) Financial structure

(C) Asset structure

(D) Owners structure

Answer:

(B) Financial structure

Question 8.

Optimal capital structure consists of -…………..

(A) Appropriate mix of fixed assets and current assets.

(B) Appropriate mix of long term debts and fixed assets.

(C) Appropriate mix of sales and profit.

(D) Appropriate mix of debt and equity.

Answer:

(D) Appropriate mix of debt and equity.

Question 9.

Which of the following is not included in capital structure?

(A) Long term debt

(B) Preferred stock

(C) Current assets

(D) Retained earnings

Answer:

(C) Current assets

Question 10.

Which of the following shows significance of capital structure?

(A) Capital structure reflects the overall strategy of the firm.

(B) One can get a reasonably accurate broad idea about the risk profile of the firm from its capital structure.

(C) The capital structure acts as a tax management tool.

(D) All of the above

Answer:

(D) All of the above

Question 11.

Financial structure involves creation of –

(1) Long term assets

(2) Short term assets

Select the correct answer from the options given below:

(A) (2) only

(B) Neither (1) nor (2)

(C) (1) only

(D) Both (1) and (2)

Answer:

(D) Both (1) and (2)

Question 12.

Which of the following statement is incorrect?

(1) High debt funds in capital structure increases EPS.

(2) High debt funds increases the operating or business risk.

Select the correct answer from the options given below:

(A) Both Statement 1 and Statement 2 are correct.

(B) Statement 1 is correct while Statement 2 is incorrect.

(C) Statement 2 is correct while Statement 1 is incorrect.

(D) Both Statement 1 and Statement 2 are incorrect.

Answer:

(D) Both Statement 1 and Statement 2 are incorrect.

Question 13.

Financial structure is ……………. concept while capital structure is..... concept

(A) inappropriate; appropriate

(B) appropriate; inappropriate

(C) narrow; broader

(D) broader; narrow

Answer:

(D) broader; narrow

Question 14.

Assertion (A):

The capital structure should be determined within the debt capacity of the company and this capacity should not be exceeded.

Reason (R):

The debt capacity of a company depends on its ability to generate future cash flows. It should have enough cash to pay creditors’ fixed charges and principal sum.

Select the correct answer from the options given below:

(A) A is true but R is false

(B) A is false but R is true.

(C) Both A and R are true but R is not correct explanation of A.

(D) Both A and Rare true and R is correct explanation of A.

Answer:

(D) Both A and Rare true and R is correct explanation of A.

Question 15.

Which of the following capital structure consist of zero debt components in the structure mix?

(A) Pyramid Shaped Capital Structure

(B) Inverted Pyramid Shaped Capital Structure

(C) Horizontal Capital Structure

(D) Vertical Capital Structure

Answer:

(C) Horizontal Capital Structure

Question 16.

Which of the following statement is false?

(A) The use of excessive debt threatens the solvency of the company.

(B) A firm having operating loss would find it worthwhile to incorporate debt in the capital structure in a greater measure.

(C) The capital structure should be flexible.

(D) None of the above

Answer:

(B) A firm having operating loss would find it worthwhile to incorporate debt in the capital structure in a greater measure.

Question 17.

One can get a reasonably accurate broad idea about the risk profile of the firm from its –

(A) Dividend policy

(B) Capital structure

(C) Debt service ratio

(D) Earning yield

Answer:

(B) Capital structure

Question 18.

A critical assumption of the net operating income (NOI) approach to valuation is that:

(A) Debt and equity levels remain unchanged.

(B) Dividends increase at a constant rate.

(C) Ko remains constant regardless of changes in leverage.

(D) Interest expense and taxes are included in the calculation.

Answer:

(C) Ko remains constant regardless of changes in leverage.

Question 19.

If the debt component in the capital structure is predominant –

(A) The fixed interest cost of the firm will be minimum thereby decreasing its risk.

(B) Earnings per share (EPS) will be very low.

(C) Dividend expectations of equity shareholders are also and P/E Ratio may decrease.

(D) The fixed interest cost of the firm increases thereby increasing its risk.

Answer:

(D) The fixed interest cost of the firm increases thereby increasing its risk.

Question 20.

Capital structure relates to …………. capital deployment for creation of ……… assets.

(A) long term; long term

(B) long term; short term

(C) short term; long term

(D) short term; short term

Answer:

(A) long term; long term

Question 21.

Assertion (A):

The capital structure acts as a tax management tool also.

Reason (R):

Relatively lesser component of equity capital is vulnerable to hostile takeovers.

Select the correct answer from the options given below:

(A) A is true but R is false

(B) A is false but R is true.

(C) Both A and R are true but R is not correct explanation of A.

(D) Both A and Rare true and R is correct explanation of A.

Answer:

(C) Both A and R are true but R is not correct explanation of A.

Question 22.

Select which of the following statement is correct.

Horizontal capital structure -…………

1. is quite stable.

2. is formed by a small amount of equity share capital.

3. there is absence of debt.

4. have increasing component of debt.

Select the correct answer from the options given below:

(A) 1, 2 & 4

(B) 2 & 3

(C) 1 only

(D) 1 & 4 only

Answer:

(C) 1 only

Question 23.

One can design capital structure with proper proportions of equity, preference and debt mix. The choice of the combination of these sources is called –

(A) Structural mix

(B) Policy mix

(C) Capital structure mix

(D) Finance mix

Answer:

(C) Capital structure mix

Question 24.

In horizontal capital structure –

(A) expansion of the firm takes place by issuance of debt securities.

(B) expansion of the firm takes place by issuance of debt securities and preferred stocks.

(C) expansion of the firm takes in a lateral manner, i.e. through equity or retained earning only.

(D) expansion of the firm takes place by issuance of short term and marketable securities.

Answer:

(C) expansion of the firm takes in a lateral manner, i.e. through equity or retained earning only.

Question 25.

According to Cost Principle an ideal pattern or capital structure is one that -…………..

(A) Minimizes cost of capital structure

(B) Maximizes earnings per share (EPS).

(C) Both (A) and (B)

(D) None of the above

Answer:

(C) Both (A) and (B)

Question 26.

In a …………. the base of the structure is formed by a small amount of equity share capital. This base serves as the foundation on which the super structure of preference share capital and debt is built.

(A) horizontal capital structure

(B) vertical capital structure

(C) diagonal capital structure

(D) matrix capital structure

Answer:

(B) vertical capital structure

Question 27.

According to Risk Principle……..

(A) Reliance is placed on excessive use of debt financing for capital requirements than common equity.

(B) Reliance is placed on ability of finance manager than external analyst.

(C) Reliance is placed more on common equity for financing capital requirements than excessive use of debt.

(D) Reliance is placed more on short term finance for financing capital requirements than excessive use of working capital.

Answer:

(C) Reliance is placed more on common equity for financing capital requirements than excessive use of debt.

Question 28.

Match List I with List II:

 

Select the correct answer from the options given below

 

Answer:

(D)

Question 29.

Use of more and more debt and preference capital –

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

(B) increases value of debt and preference capital and equity share.

(C) Increases the profit after tax (PAT) even though sales pattern shows decreasing trends.

(D) All of the above

Answer:

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

Question 30.

Match List – I with List – II:

 

Select the correct answer from the options given below

 

Answer:

(D)

Question 29.

Use of more and more debt and preference capital –

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

(B) increases value of debt and preference capital and equity share.

(C) Increases the profit after tax (PAT) even though sales pattern shows decreasing trends.

(D) All of the above

Answer:

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

Question 30.

Match List – I with List – II:

 

Select the correct answer from the options given below

 

Answer:

(D)

Question 29.

Use of more and more debt and preference capital –

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

(B) increases value of debt and preference capital and equity share.

(C) Increases the profit after tax (PAT) even though sales pattern shows decreasing trends.

(D) All of the above

Answer:

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

Question 30.

Match List – I with List – II:

 

Select the correct answer from the options given below

 

Answer:

(D)

Question 29.

Use of more and more debt and preference capital –

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

(B) increases value of debt and preference capital and equity share.

(C) Increases the profit after tax (PAT) even though sales pattern shows decreasing trends.

(D) All of the above

Answer:

(A) affects equity share values and in unfavourable situation equity share prices may consequently drop.

Question 30.

Match List – I with List – II:

 1.Horizontal capital Structure- low EPs

 

2. Credit management- incriminate investment detort

3. Vertical capital Structure- higher EPS

4.

Capital budgeting decision-IRR

Question 31.

Business Risk is –

(A) Avoidable risk

(B) Unavoidable risk

(C) Not relevant

(D) Less important than financial risk

Answer:

(B) Unavoidable risk

Question 32.

Which of the following statement is true in relation to vertical capital structure?

(A) The incremental addition in the capital structure is almost entirely in the form of debt.

(B) The absence of debt it results in the lack of financial leverage and hence low financial risk.

(C) Since there is more equity shares EPS is likely to be high.

(D) For this capital structure combined leverage is very low as compared to other firms in industry which have more equity finance.

Answer:

(A) The incremental addition in the capital structure is almost entirely in the form of debt.

Question 33.

The rate of tax affects the –

(A) Cost of retained earning

(B) Cost of debt

(C) Cost of equity

(D) All of the above

Answer:

(D) All of the above

Question 34.

A pyramid shaped capital structure has –

(A) Retained earnings of the firm which are usually lower than the cost of debt.

(B) A large proportion consisting of equity capital and retained earnings which have been ploughed back into the firm over a considerably large period of time.

(C) Incremental addition in the capital structure is almost entirely in the form of debt.

(D) Both (A) and (B)

Answer:

(D) Both (A) and (B)

Question 35.

Assertion A:

While making a choice of the capital structure the future cash flow position should be kept in mind.

Reason R:

Debt capital should be used only if the cash flow position is really good because a lot of cash is needed in order to make payment of interest and refund of capital.

Select the correct answer from the options given below:

(A) A is true and R is false

(B) A is false and R is true

(C) Both A and R are true and R is not correct explanation of A.

(D) Both A and Rare true and R is correct explanation of A.

Answer:

(D) Both A and Rare true and R is correct explanation of A.

Question 36.

To have optimal capital structure the firm must fulfil the following conditions:

I. Return on investment should be greater than cost of investment.

II. There should be minimum financial risk.

III. There is absence of equity finance.

IV. The capital structure should be flexible

V. Cost of investment should be greater than ROI.

Select correct answer from the options given below:

(A) III, I

(B) IV,II & V

(C) II, I & IV

(D) II & IV

Answer:

(C) II, I & IV

Question 37.

Business risk is influenced by –

(A) Revenue

(B) Variable cost

(C) Fixed assets

(D) All of the above

Answer:

(D) All of the above

Question 38.

Capital Structure of a firm –

(A) Is a reflection of the overall investment and financing strategy of the firm.

(B) Shows how much reliance is being placed by the firm on external sources of finance and how much internal accrual is being used to finance expansions

(C) Means the structure or constitution or break-up of the capital employed by a firm.

(D) All of the above

Answer:

(D) All of the above

Question 39.

With the help of Interest Coverage Ratio (ICR) ratio an effort is made to find out –

(A) How many times the profit after tax (PAT) is available to the payment of interest.

(B) How many times the net operating profit after tax (NOPAT) is available to the payment of interest.

(C) How many times the EBIT is available to the payment of interest.

(D) Most suitable bank for negotiation.

Answer:

(C) How many times the EBIT is available to the payment of interest.

Question 40.

Pyramid Shaped Capital Structure –

(A) Have a high proportion of fixed assets and considerably a very low proportion of current assets.

(B) Have a high proportion of debts and considerably a very low proportion of equity.

(C) Have a high proportion of equity and considerably a very low proportion of debt.

(D) Have a high proportion of current assets and considerably a very’ low proportion of liquid assets.

Answer:

(C) Have a high proportion of equity and considerably a very low proportion of debt.

Question 41.

Financial Risk is –

(A) Affected by demand of firm products, variations in prices and proportion of fixed cost in total cost.

(B) Represented by the variability of earnings before interest and tax (EBIT)

(C) Is unavoidable if firm does not use debt in its capital structure.

(D) All of the above

Answer:

(C) Is unavoidable if firm does not use debt in its capital structure.

Question 42.

Inverted Pyramid Shaped Capital Structure –

(A) Has a large component of equity capital.

(B) Is highly stable and permanent.

(C) Is opposite as that of pyramid shaped capital structure.

(D) Has reasonable level of debt but an ever increasing component of retained earnings.

Answer:

(C) Is opposite as that of pyramid shaped capital structure.

Question 43.

Which of the following statement is true?

(0 Flexibility principle states that the management chooses such a combination of sources of financing which it finds easier to adjust according to changes in need of funds in future too.

(ii) Penalty for not meeting financial obligations is bankruptcy.

(iii) Firms with high business risk therefore tend toward less highly leveraged capital structures, and firm with low business risk tend toward more highly leveraged capital structures.

Select correct answer from the options given below:

(A) (i) only

(B) (i) and (iii)

(C) (i) only

(D) All of the above

Answer:

(D) All of the above

Question 44.

Which of the following is vulnerable to hostile takeovers?

(A) Horizontal Capital Structure

(B) Vertical Capital Structure

(C) Pyramid Shaped Capital Structure

(D) All of the above

Answer:

(B) Vertical Capital Structure

Question 45.

Floatation costs are those expenses which are incurred while –

(A) Issuing securities

(B) Repayment of debts

(C) Negotiations for business deal

(D) Repayment of equity and debts

Answer:

(A) Issuing securities

Question 46.

Operating/Business Risk refers to the risk of –

(A) Inability to pay fixed financial payments (e.g., payment of interest, preference dividend, return of the debt capital, etc.)

(B) Inability to discharge permanent operating costs (e.g., rent of the building, payment of salary, insurance instalment, etc.)

(C) Both (A) and (B)

(D) None of the above

Answer:

(B) Inability to discharge permanent operating costs (e.g., rent of the building, payment of salary, insurance instalment, etc.)

Question 47.

Which of the following is floatation cost?

(A) Commission of underwriters

(B) Brokerage paid on issue of securities

(C) Stationery expenses on issue of securities

(D) All of the above

Answer:

(D) All of the above

Question 48.

……….. denotes the level of EBIT for which the firm’s EPS equals zero.

(A) Financial break-even point

(B) Margin of safety

(C) Equilibrium point

(D) Min-max point

Answer:

(A) Financial break-even point

Question 49.

Which of the following is correct formula to calculate EPS?

(A) [(EBIT + I) (1 – T) – Dp]/N0

(B) [EBIT -1 + T – Dp]/N0

(C) [(EBIT -1) (1 – T) – Dp]/N0

(D) [(EBIT -1) (1 – T) + Dp]/N0

Answer:

(C) [(EBIT -1) (1 – T) – Dp]/N0

Question 50.

If the EBIT is less than the financial 5 breakeven point, then the EPS will be –

(A) Positive

(B) Negative

(C) Zero

(D) Maximum

Answer:

(B) Negative

Question 51.

According to Net Income Approach, capital structure decision –

(A) Is relevant to the value of the firm.

(B) Of the firm are irrelevant.

(C) Will not lead to any change in the total value of the firm and the market price of shares.

(D) Division between debt and equity is irrelevant.

Answer:

(A) Is relevant to the value of the firm.

Question 52.

According to Net Operating Income Approach –

(A) Capital structure decisions of the firm are irrelevant.

(B) Any change in the leverage will not lead to any change in the total value of the firm and the market price of shares, as the overall cost of capital is independent of the degree of leverage.

(C) The division between debt and equity is irrelevant.

(D) All of the above

Answer:

(D) All of the above

Question 53.

According to ……………, the firm can increase its total value by decreasing its overall cost of capital through increasing the degree of leverage.

(A) Net Operating Income Approach

(B) Net Income Approach

(C) Both (A) and (B)

(D) Neither (A) nor (B)

Answer:

(B) Net Income Approach

Question 54.

As per Net Income Approach the value of the firm will be maximum at a point where –

(A) Average cost of equity is minimum.

(B) Average cost of debt is minimum.

(C) Weighted average cost of equity is maximum.

(D) Weighted average cost of capital is minimum.

Answer:

(D) Weighted average cost of capital is minimum.

Question 55.

Any change in the leverage will not lead to any change in the total value of the firm and the market price of shares, as the overall cost of capital is independent of the degree of leverage. This is as per

(A) Net Operating Income Approach

(B) Net Income Approach

(C) Both (A) and (B)

(D) Neither (A) nor (B)

Answer:

(A) Net Operating Income Approach

Question 56.

Inability to pay fixed financial payments e.g. payment of interest, preference dividend, return of the debt capital, etc. is called as –

(A) Business risk

(B) Financial risk

(C) Operating risk

(D) (A) and (C)

Answer:

(B) Financial risk

Question 57.

If expected level of EBIT is more than the breakeven point, then the EPS will be –

(A) Minimum

(B) Negative

(C) Positive

(D) Infinite

Answer:

(C) Positive

Question 58.

The overall cost of capital under Net Income Approach is –

(A) EBIT 4 ÷ Value of firm

(B) Net Income 4÷ Ke

(C) Value of firm 4 ÷ EBIT

(D) EBIT4 ÷ Ko

Answer:

(A) EBIT 4 ÷ Value of firm

Question 59.

Which formula would you use to calculate market value of equity?

(A) Net Income 4÷Ke

(B) Ke ÷ Net Income

(C) Sales 4÷Ke

(D) Gross Profit 4÷ Ke

Answer:

(A) Net Income 4÷Ke

Question 60.

Which of the following proposition is made by Modigliani and Miller?

(A) The total market value of a firm and its cost of capital are independent of its capital structure.

(B) The cost of equity (Ke) is equal to capitalization rate of pure equity stream plus a premium for financial risk.

(C) The cut-off rate for investment decision making for a firm in a given risk class is not affected by the manner in which the investment is financed.

(D) All of the above

Answer:

(D) All of the above

Question 61.

Which of the following assumption is valid as per MM Approach?

1. There is imperfect competition in the market.

2. There is no transaction cost.

3. All investors are rational.

4. All information is not freely available. Select the correct answer from the options given below:

(A) 1 & 2

(B) 4 & 1

(C) 1 & 3

(D) 3 & 2

Answer:

(D) 3 & 2

Question 62.

According Modigliani & Miller Approach

(A) Individuals (arbitragers) through the use of personal leverage can alter corporate leverage.

(B) Financial risk increases with more debt content in the capital structure.

(C) The total value of a firm is not affected by its capital structure

(D) All of the above

Answer:

(D) All of the above

Question 63.

A situation where a firm has more capital than it needs is called as –

(A) Over Finance

(B) Over Capitalization

(C) Over Trading

(D) Over Realization

Answer:

(B) Over Capitalization

Question 64.

Which of the following is one of the causes of over capitalization?

(A) Reduction in the market price of shares.

(B) Borrowing huge amount at higher rate than rate at which company can earn.

(C) Reduction in the rate of dividend and interest payments.

(D) Buying of shares in the unleveraged firm.

Answer:

(B) Borrowing huge amount at higher rate than rate at which company can earn.

Question 65.

Which of the following is one of the causes of over capitalization?

(A) Raising more money through issue of shares or debentures than company can employ profitably.

(B) Excessive payment for the acquisition of fictitious assets such as goodwill etc.

(C) Improper provision for depreciation, replacement of assets and distribution of dividends at a higher rate.

(D) All of the above

Answer:

(D) All of the above

Question 66.

The pecking order theory is popularized by-

(A) Franco and Merton

(B) Modigliani and Miller

(C) Myers and Majluf

(D) Myers and Merton

Answer:

(C) Myers and Majluf

Question 67.

Financing comes from three sources, internal funds, debt and new equity. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a “last resort”. Hence, internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This is as per

(A) Order pecking theory

(B) Sequential theory

(C) Sequential pecking theory

(D) Pecking order theory

Answer:

(D) Pecking order theory

Question 68.

Finance function comprises –

(A) Safe custody of funds only

(B) Expenditure of funds only

(C) Procurement of finance only

(D) Procurement & effective use of funds

Answer:

(D) Procurement & effective use of funds

Question 69.

Finance functions includes –

(A) Planning for funds

(B) Raising of funds

(C) Allocation of resources

(D) All of the above

Answer:

(D) All of the above

Question 70.

Earning Yield computed by

(A) EPS/Current Market Price Per Share

(B) Paid up value of Share/100

(C) EPS/Profit × 100

(D) EPS/Market Price

Answer:

(A) EPS/Current Market Price Per Share

Question 71.

Assertion (A):

High capital gearing leads to greater speculation.

Reason (R):

Proportion of equity share capital in relation to the total capital comprising the other securities is small leading to capitalization being highly geared.

(A) Both A and R are true and R is the correct explanation of A.

(B) Both A and R are true but R is not a correct explanation of A.

(C) A is true but R is false

(D) A is false but R is true

Answer:

(D) A is false but R is true

Question 72.

Which is external source of finance?

(A) Letters of Credit

(B) Advance from customers

(C) Finance from Companies

(D) All of the above

Answer:

(D) All of the above

Question 73.

The traditional approach towards the valuation of a company assumes that –

(A) The cost of capital is independent of the capital structure of the firm.

(B) The firm maintains constant risk regardless of the type of financing employed.

(C) There exists no optimal capital structure.

(D) That management can increase the total value of the firm through the judicious use of financial leverage.

Answer:

(D) That management can increase the total value of the firm through the judicious use of financial leverage.

Question 74.

Which of the following statements regarding the net operating income approach is incorrect?

(A) The overall capitalization rate, Ko is constant.

(B) The cost of debt funds, K is constant.

(C) The required return on equity, Kc, is constant.

(D) The total value of the firm is unaffected by changes in financial leverage.

Answer:

(C) The required return on equity, Kc, is constant.

Question 75.

Two identical companies exist except that Company A uses no debt and Company B uses some debt. The total value of Company A is less than the total value of Company B, but you own 2% of Company B. Based on the arguments by Modigliani and Miller regarding the total value principle, what should you do?

(A) Buy 2% of Company A with funds from “shorting” your shares in Company B. Submit a press release that

the two companies should be worth identical values. This will cause Company A to rise in value and leave you extra funds for investment.

(B) You should borrow enough funds to equal the difference in company value, purchase shares of Company A with these funds, and sell your shares in Company B. This will leave extra funds for an investment of your choice.

(C) Sell your shares, personally borrow 2% of the quantity of company debt, and purchase 2% of Company A. This will leave extra funds for an investment of your choice.

(D) Sell enough of your shares (Company B) to pin-chase 2% of Company A. This will leave extra funds for an investment of your choice.

Answer:

(C) Sell your shares, personally borrow 2% of the quantity of company debt, and purchase 2% of Company A. This will leave extra funds for an investment of your choice.

Question 76.

Which term would most likely be associated with the phrase “actions speak louder than words”?

(A) Incentive signalling

(B) Shareholder wealth maximization

(C) Financial signalling

(D) Optimal capital structure

Answer:

(C) Financial signalling

Question 77.

External sources of finance do not include:

(A) Overdrafts

(B) Leasing

(C) Retained earnings

(D) Debentures

Answer:

(C) Retained earnings

Question 78.

Internal sources of finance do not include:

(A) Retained earnings

(B) Ordinary shares

(C) Better management of working capital

(D) Trade credit

Answer:

(B) Ordinary shares

Question 79.

A firm’s optimal capital structure:

(A) Is the debt-equity ratio that exists at the point where the firm’s weighted after-tax cost of debt is minimized.

(B) Is generally a mix of 40% debt and 60% equity

(C) Is the debt-equity ratio that results in the lowest possible weighted average cost of capital.

(D) Is found by locating the mix of debt and equity which causes the earnings per share to equal exactly ?

Answer:

(C) Is the debt-equity ratio that results in the lowest possible weighted average cost of capital.

Question 80.

M&M Proposition I, without taxes, states that:

(A) Firms should borrow to the point where the tax benefit from debt is equal to the cost of the increased probability of financial distress.

(B) Financial risk is determined by the debt-equity ratio.

(C) The cost of equity rises when financial leverage rises.

(D) It is completely irrelevant how a firm arranges its finances.

Answer:

(D) It is completely irrelevant how a firm arranges its finances.

Question 81.

Which of the following step would you recommend to avoid the negative consequences of over capitalization?

(A) Company should go for thorough reorganization.

(B) Buyback of shares.

(C) Reduction in claims of debenture-holders and creditors.

(D) All of the above

Answer:

(D) All of the above

Question 82.

Which one of the following statements concerning financial leverage is correct?

(A) If a firm employs financial leverage, the shareholders will be exposed to greater risk.

(B) A firm employing leverage will always have higher earnings per share than a firm which does not employ leverage.

(C) The benefits of leverage are unaffected by changes in a firm’s earnings before interest and taxes.

(D) The earnings per share remain constant even when an all-equity firm switches to a debt-equity ratio of 4.

Answer:

(A) If a firm employs financial leverage, the shareholders will be exposed to greater risk.

Question 83.

Market values are often used in computing the weighted average cost of capital because

(A) This is the simplest way to do the calculation.

(B) This is consistent with the goal of maximizing shareholder value.

(C) This is required in India by the Securities and Exchange Board of India.

(D) This is a very common mistake

Answer:

(B) This is consistent with the goal of maximizing shareholder value.

Question 84.

Two firms that are virtually identical except for their capital structure are selling in the market at different values. According to M & M:

(A) One will be at greater risk of bankruptcy.

(B) The firm with greater financial leverage will have the higher value.

(C) This proves that markets cannot be efficient.

(D) This will not continue because arbitrage will eventually cause the firms to sell at the same value.

Answer:

(D) This will not continue because arbitrage will eventually cause the firms to sell at the same value.

Question 85.

An EBIT-EPS indifference analysis chart is used for –

(A) Evaluating the effects of business risk on EPS.

(B) Examining EPS results for alternative financing plans at varying EBIT levels.

(C) Determining the impact of a change in sales on EBIT.

(D) Showing the changes in EPS quality over time

Answer:

(B) Examining EPS results for alternative financing plans at varying EBIT levels.

Question 86.

EBIT of NS Ltd. is ₹ 4,50,000.

Debt in capital structure – ₹ 9,00,000

Cost of debt (Kd) =12%

Cost of equity (Ke) =15%

Ignore taxation.

Total market value of X Ltd. = ?

(A) ₹ 22,80,000

(B) ₹ 31,80,000

(C) ₹ 21,80,000

(D) ₹ 30,80,000

Answer:

(B) ₹ 31,80,000