FIN622 Corporate Finance
MidTerm Paper 2009 Solved
1. Which of the following firms would have the highest financial leverage?
A. A firm having debt-to-equity ratio of 30:70
B. A firm having debt-to-equity ratio of 40:60
C. A firm having debt-to-equity ratio of 50:50
D. A firm having debt-to-equity ratio of 60:40
Greater the amount of debt higher will be debt to equity ratio and higher will be financial leverage.
2. Which of the following is the principal advantage of high debt financing?
A. Tax savings
B. Low Bankruptcy costs
C. Minimum financial risk
D. Low financial leverage
As interest expesnes provide tax shield.
3. Which of the following is a proposition of Miller and Modigliani theory of Capital structure?
A. Value of a firm is independent of its capital structure
B. Value of a firm is independent of its level of debt
C. Value of a firm is dependent of its cost of capital
D. Value of a firm is independent on its level of equity finances
According to this theory WACC remain same regardless of its capital structure.
4. Which of the following is a disadvantage of Capital Asset Pricing Model?
A. It considers market risk
B. It can be used for listed companies
C. It can be used for non-listed companies
D. It is based on past data
5. Which of the following shows the reward to risk ratio of a Security A?
A. Expected return of A (rA) – risk free return / beta of A
B. Expected return of A (rA) – risk free return / required return of A
C. Expected return of A (rA) – beta of A / risk free return
D. Risk free return - expected return of A (rA)/ beta of A
Expected return of A (rA) – risk free return / beta of A.
6. In Capital Assets Pricing Model, which of the following shows time value of money?
A. Beta of the security
B. Risk free rate of return
C. Risk premium
D. Market rate of return
The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time..
7. Which of the following statements is TRUE regarding Balance Sheet of a firm?
A. It reports how much of the firm’s earnings were retained in the business rather than paid out in dividends.
B. It reports the impact of a firm’s operating, investing, and financing activities on cash flows over an accounting period.
C. It shows the firm’s financial position at a specific point in time.
D. It summarizes the firm’s revenues and expenses over an accounting period.
8. Suppose that a corporation of which you are a shareholder has just gone bankrupt. Its liabilities are far in excess of its assets. How much of your investment would you get back?
A. A proportionate share of bondholder claims based on the number of common shares that you own
B. A proportional share of all creditor claims based on the number of common shares that you own
C. An amount that could, at most, equal what you originally paid for the shares of common stock in the corporation
D. Nothing at all
On going bankcurrupt, shareholders of the company are paid after paying debt or liabilities.As in this case, liabilities are in excess of its assets.So, shareholder will get nothing at all. .
9. The gross profit margin is unchanged, but the net profit margin declined over same period. This could have happened due to which one of the following reasons?
A. Cost of goods sold increased relative to sales
B. Sales increased relative to expenses
C. The tax rate has been increased
D. Dividends were decreased
Taxes are paid out of operating profit. If net income is decreased without decreasing gross profit then there should be some thing wrong with financial expenses like tax or interedsts.
10. Palo Alto Industries has a debt-to-equity ratio of 1.6 compared with the industry average of 1.4. What do these ratios tell about this company?
A. The company will be viewed as having high creditworthiness
B. The company has greater than average financial risk when compared to other firms in its industry
C. The company will not experience any difficulty with its creditors
D. The company has less liquidity than other firms in the industry
11. If a creditor wants to know about the bill payment status of a potential customer, the creditor could look at which one of the following ratios?
A. Current ratio
B. Acid ratio
C. Average age of accounts payable
D. Average age of accounts receivable
.
12. Suppose you invested Rs. 8,000 in a savings account paying 5 percent interest a year, compounded annually. How much amount your account will have at the end the end of four years?
A. Rs.9,624
B. Rs.10,208
C. Rs.9,728
D. Rs.10,880
FV = PV * (1+i)^n
FV =8000 * (1.05)^4
FV = PV * (1+i)^n
FV = 9728.
13. The present value of Rs.100 per year received for 10 years discounted at 8 percent is closest to which of the following amounts?
A. Rs.177
B. Rs.362
C. Rs.425
D. Rs.671
Using Financial Calculator or excel, Put I = 8%, Nper =10, PMT =100, FV = 0 and solve for PV = 671.
14. How many years will it take for Rs.152,000 to grow to be Rs. 405,000 if it is invested in an account with an annual interest rate of 10%?
A. 13.68
B. 8.23
C. 10.28
D. Cannot be calculated from the given data
Using Financial Calculator or excel, Put I = 10% ,PV =152000, FV = 405000 and solve for Nper = 10.28
15. Which of the following types of bonds pays no annual interest to the holder, but is sold at discount below the par value?
A. An original maturity bond
B. A floating rate bond
C. A fixed maturity date bond
D. A zero coupon bond
16. Which of the following is a financial asset?
A. A building
B. Bonds
C. Inventories
D. Equipments
17. An investor buys a bond that will pay the interest amount of Rs.60 annually, forever. Which of the following would be the present value of the bond if there is exactly one year remaining until the next interest payment and the investor's required annual return is 5 percent?
A. Rs. 1,200
B. Rs. 800
C. Rs. 600
D. Rs. 1,000
It is perpetuity.
P = D/i
= 60 /0.05
= 1200
18. How much should you pay for a bond with Rs.1,000 face value, a 10 percent coupon rate, and seven years to maturity if your appropriate discount rate is 8 percent and interest is paid annually? (Answers are rounded to the nearest dollar)
A. Rs.560
B. Rs.1,000
C. Rs.903
D. Rs.1104
=100*{1-[1/(1+0.08)7]}/0.08+1000/(1+0.08)7
= 100* 5.2063 + 583.50
= 1,104
19. Following are amongst the three main areas of Finance EXCEPT:
A. Financial institutions
B. Investments
C. Accounting
D. Financial management
20. Which one of the following is an offering in which the shares of a company are offered to a limited number of investors?
A. Initial Public Offering
B. Private Placement
C. Direct Public Offering
D. Primary Offering
b. The sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds.
21. If you want to earn 8 percent, approximately how much should you pay for a security which matures in one year at Rs. 1,000?
A. Rs. 1,080
B. Rs. 940
C. Rs. 920
D. Rs. 926
Using Financial Calculator or excel, Put I = 8%, Nper =1, FV = 1000 and solve for PV.
22. When the market's nominal annual required rate of return for a particular bond is less than its coupon rate, the bond will be selling at which of the following?
A. At discount
B. At premium
C. At par value
D. At indeterminate price
A bond trading
below its face value is trading at a discount; a bond trading above its face value is at a premium.
23. Which of the following terms refers to the process of systematic investigation of the effects on estimates or outcomes of changes in data or parameter inputs or assumptions to evaluate a capital project?
A. Sensitivity Analysis
B. Fundamental Analysis
C. Technical Analysis
D. Trend Analysis
24. For a firm with a Degree of Operating Leverage of 3.5, an increase in sales of 6% will:
A. Increase pre-tax profits by 3.5%
B. Decrease pre-tax profits by 3.5%.
C. Increase pre-tax profits by 21.0%.
D. Increase pre-tax profits by 1.71%.
for every percentage increase in sales, the company's EBIT will increase 3.50 times; a 6% increase in sales will lead to a 21.0 increase in EBIT.
25. The percentage change in a firm's operating profit (EBIT) resulting from a 1% change in output (sales) is known as the ________.
A. Degree of operating leverage
B. Degree of profit leverage
C. Degree of total leverage
D. Degree of financial leverage
26. Suppose a stock is selling today for Rs.60 per share. At the end of the year, it pays a dividend of Rs.2.00 per share and sells for Rs.66.00. what is the capital gain yield on the stock?
A. 7%
B. 8%
C. 9%
D. 10%
Capital Gain Yiled = P1 - P0 / Po
= 66 -60 /60
=6/60
=0.1 or 10%
27. Which of the following is considered as a risk free financial asset?
A. Government T-bills
B. Junk bonds
C. Preferred stock
D. Secured bonds
28. If the common stocks of a company have beta value less than 1, then such stocks refer to which of the following?
A. Normal stocks
B. Aggressive stocks
C. Defensive stocks
D. Income stocks
Betas of defensive stocks are less than one.
The utility industry is an example of defensive stocks because during all phases of the business cycle, people need gas and electricity. Many active investors will invest in defensive stocks if a market downturn is expected.
29. Which of the following is known as market portfolio?
A. A portfolio consists of all risk free securities available in the market
B. A portfolio consists of securities of the same industry
C. A portfolio consists of all aggressive securities available in the market
D. A portfolio consists of all securities available in the market
The market portfolio consists of all assets in all markets, where each asset is weighted by its market capitalization.
30. What will be the risk premium if the market portfolio has an expected return of 10% and the risk free rate is 4%?
A. 4%
B. 5%
C. 6%
D. 7%
31. Which of the following statements is true regarding Weighted Average Cost of Capital (WACC)?
A. WACC of a levered firm is greater than that of an un-levered firm
B. WACC of a levered firm is lesser than that of an un-levered firm
C. WACC of a levered firm is equal to that of an un-levered firm
D. An Un-levered firm has zero WACC.
The after tax cash flow of two identical firms in terms of EBIT but having different capital structure – debt – equity weight age will effect the value of firm. This is because debt in capital structure provides tax shield as interest on debt is tax deductible expense. Thus tax shield increases the value of firm: a levered firm’s value is greater than the un-levered firm.
32. XYZ Airlines will pay a Rs.4.00 dividend next year on its common stock, which is currently selling at Rs.100 per share. What is the market’s required return on this investment if the dividend is expected to grow at 5% forever?
A. 9%
B. 4%
C. 5%
D. 7%
Po = D1 / r-g
r= D/ P +g
r = 4 / 100 + 0.05
r = 0.04 + 0.05
r =0.09 or 9%.
33. A Pure Play method of selecting a discount rate is most suitable in which of the following situations?
A. When the intended investment project has a Non-conventional stream of cash flows
B. When the intended investment project is a replacement project
C. When the intended investment project belongs to industry other than the firms operating in
D. When the intended investment project has a conventional stream of cash flows
34. A Levered firm has a lower weighted average cost of capital as compare to an Un-levered firm because of which of the following?
A. Interest tax shield
B. Low level of financial risk
C. Low level of business risk
D. Low level of systematic risk
A levered firm deducted the interest expenses paid on debt from net income while calculating taxable income. As interest on debt is exempt from tax.
35. ABC Corporation declared 10% dividend on its shares. A person purchased some shares of this corporation after the dividend was announced. If he is entitled to receive the declared dividend, his shares would be categorized as which of the following?
A. Ex-Dividend
B. Cum-Dividend
C. Stock- Dividend
D. Cash Dividend
Cum dividend means "with dividend." A stock trades cum-dividend up until the ex-dividend date. On or after this point, the stock trades without its dividend rights.
A. Financial institutions
B. Investments
C. Accounting
D. Financial management
20. Which one of the following is an offering in which the shares of a company are offered to a limited number of investors?
A. Initial Public Offering
B. Private Placement
C. Direct Public Offering
D. Primary Offering
b. The sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds.
21. If you want to earn 8 percent, approximately how much should you pay for a security which matures in one year at Rs. 1,000?
A. Rs. 1,080
B. Rs. 940
C. Rs. 920
D. Rs. 926
Using Financial Calculator or excel, Put I = 8%, Nper =1, FV = 1000 and solve for PV.
22. When the market's nominal annual required rate of return for a particular bond is less than its coupon rate, the bond will be selling at which of the following?
A. At discount
B. At premium
C. At par value
D. At indeterminate price
A bond trading
below its face value is trading at a discount; a bond trading above its face value is at a premium.
23. Which of the following terms refers to the process of systematic investigation of the effects on estimates or outcomes of changes in data or parameter inputs or assumptions to evaluate a capital project?
A. Sensitivity Analysis
B. Fundamental Analysis
C. Technical Analysis
D. Trend Analysis
24. For a firm with a Degree of Operating Leverage of 3.5, an increase in sales of 6% will:
A. Increase pre-tax profits by 3.5%
B. Decrease pre-tax profits by 3.5%.
C. Increase pre-tax profits by 21.0%.
D. Increase pre-tax profits by 1.71%.
for every percentage increase in sales, the company's EBIT will increase 3.50 times; a 6% increase in sales will lead to a 21.0 increase in EBIT.
25. The percentage change in a firm's operating profit (EBIT) resulting from a 1% change in output (sales) is known as the ________.
A. Degree of operating leverage
B. Degree of profit leverage
C. Degree of total leverage
D. Degree of financial leverage
26. Suppose a stock is selling today for Rs.60 per share. At the end of the year, it pays a dividend of Rs.2.00 per share and sells for Rs.66.00. what is the capital gain yield on the stock?
A. 7%
B. 8%
C. 9%
D. 10%
Capital Gain Yiled = P1 - P0 / Po
= 66 -60 /60
=6/60
=0.1 or 10%
27. Which of the following is considered as a risk free financial asset?
A. Government T-bills
B. Junk bonds
C. Preferred stock
D. Secured bonds
28. If the common stocks of a company have beta value less than 1, then such stocks refer to which of the following?
A. Normal stocks
B. Aggressive stocks
C. Defensive stocks
D. Income stocks
Betas of defensive stocks are less than one.
The utility industry is an example of defensive stocks because during all phases of the business cycle, people need gas and electricity. Many active investors will invest in defensive stocks if a market downturn is expected.
29. Which of the following is known as market portfolio?
A. A portfolio consists of all risk free securities available in the market
B. A portfolio consists of securities of the same industry
C. A portfolio consists of all aggressive securities available in the market
D. A portfolio consists of all securities available in the market
The market portfolio consists of all assets in all markets, where each asset is weighted by its market capitalization.
30. What will be the risk premium if the market portfolio has an expected return of 10% and the risk free rate is 4%?
A. 4%
B. 5%
C. 6%
D. 7%
31. Which of the following statements is true regarding Weighted Average Cost of Capital (WACC)?
A. WACC of a levered firm is greater than that of an un-levered firm
B. WACC of a levered firm is lesser than that of an un-levered firm
C. WACC of a levered firm is equal to that of an un-levered firm
D. An Un-levered firm has zero WACC.
The after tax cash flow of two identical firms in terms of EBIT but having different capital structure – debt – equity weight age will effect the value of firm. This is because debt in capital structure provides tax shield as interest on debt is tax deductible expense. Thus tax shield increases the value of firm: a levered firm’s value is greater than the un-levered firm.
32. XYZ Airlines will pay a Rs.4.00 dividend next year on its common stock, which is currently selling at Rs.100 per share. What is the market’s required return on this investment if the dividend is expected to grow at 5% forever?
A. 9%
B. 4%
C. 5%
D. 7%
Po = D1 / r-g
r= D/ P +g
r = 4 / 100 + 0.05
r = 0.04 + 0.05
r =0.09 or 9%.
33. A Pure Play method of selecting a discount rate is most suitable in which of the following situations?
A. When the intended investment project has a Non-conventional stream of cash flows
B. When the intended investment project is a replacement project
C. When the intended investment project belongs to industry other than the firms operating in
D. When the intended investment project has a conventional stream of cash flows
34. A Levered firm has a lower weighted average cost of capital as compare to an Un-levered firm because of which of the following?
A. Interest tax shield
B. Low level of financial risk
C. Low level of business risk
D. Low level of systematic risk
A levered firm deducted the interest expenses paid on debt from net income while calculating taxable income. As interest on debt is exempt from tax.
35. ABC Corporation declared 10% dividend on its shares. A person purchased some shares of this corporation after the dividend was announced. If he is entitled to receive the declared dividend, his shares would be categorized as which of the following?
A. Ex-Dividend
B. Cum-Dividend
C. Stock- Dividend
D. Cash Dividend
Cum dividend means "with dividend." A stock trades cum-dividend up until the ex-dividend date. On or after this point, the stock trades without its dividend rights.
36. Which of the following is a dividend that is paid in the form of additional shares, rather than a cash payout?
A. Stock Dividend
B. Cum Dividend
C. Ex Dividend
D. Extra Dividend
Share holders are offered to get additional shares of the company instead of cash dividend.
A. Stock Dividend
B. Cum Dividend
C. Ex Dividend
D. Extra Dividend
Share holders are offered to get additional shares of the company instead of cash dividend.
