Financial management 2-chapter 1 HEEE practice questions with answers
1. ………………..is mix of different long term sources of finance of a company.
a) Financial structure
b) Capital structure
2. Which one is not under capital structure?
a) Debentures
b) Current liabilities
c) Preferred shares
d) Common stock
e) Retained earning
3. Financing structure= capital structure + current liabilities. T/F
4. Optimum capital structure:
a) Maximizes value and minimizes weighted average cost of capital
b) Minimizes value and minimizes weighted average cost of capital
c) Maximizes both value and cost of capital
d) Minimizes both value and cost of capital
5. A business expecting to have long period of operation:
a) Will use equity financing
b) Will use debt financing
6. If the firm is of large size,
a) It will rely on internal source of finance
b) It will rely on external source of finance
7. According to this approach, mix of debt and equity capital can maximize value and minimize
weighted average cost of capital up to some level of debt.
a) Traditional approach
b) Modern approach
8. ………………approach is mix of NI and NOI approach.
a) Traditional approach
b) Modern approach
9. According to this approach capital structure is relevant to change in cost of capital and value.
a) NI (net income) approach
b) NOI (net operating income) approach
10. According to this approach capital structure is irrelevant to change in cost of capital and value.
a) NI (net income) approach
b) NOI (net operating income) approach
Based on the following information attempt the 11th, 12th, 13th, 14th and 15th questions
NOI= 100,000
Debenture= 250,000
Interest rate= 6%
Equity capitalization rate= 11%
11. What is the amount of interest in the above example?
a) 250,000
b) 15,000
c) 150,000
12. What is the value of debt?
a) 250,000
b) 15,000
c) 150,000
13. Value of equity equals
a) 250,000
b) 85,000
c) 772,727
14. Value of the firm would be
a) 1,000,000
b) 1,022,727
c) 772,727
15. Weighted average cost of capital would be
a) 10.48%
b) 9.78%
c) 10%
16. ………………..states that financing decision of a firm doesn’t affect market value of a firm and WACC in
a perfect capital market.
a) NI approach
b) NOI approach
c) Modiglani and Miller approach
17. Why is cost of debt less than cost of equity?
a) Because dividends are tax deductible but interests are not
b) Because interests are tax deductible but dividends are not
18. ………………..is the use of fixed cost assets or funds to increase return to sharholders.
a) Capital structure
b) Financing structure
c) Leverage
19. Which type of leverage is concerned with investment activities?
a) Financial leverage
b) Operating leverage
20. Which type of leverage is concerned with financing activities?
a) Financial leverage
b) Operating leverage
21. Company’s ability to use fixed costs to magnify the effects of sales on EBIT (OPERATING PROFIT)
a) Financial leverage
b) Operating leverage
22. Company’s ability to use fixed costs to magnify the effects of EBIT (OPERATING PROFIT) on EPS or
earning before tax.
a) Financial leverage
b) Operating leverage
23. Sales=2,500,000
VC=1,250,000
FC=750,000
What would be the operating leverage?
a) 500,000
b) 2
c) 5
d) 2.5
24. Operating leverage:
a) Has direct relation with variable cost and inverse relationship with FC
b) Has inverse relation with variable cost and direct relationship with FC
25. 8% debentures= 125,000
EBIT=50,000
What is the financial leverage?
a) 2.5
b) 1.25
c) 50,000
d) 10,000
26. The level of EBIT which covers all fixed financing costs of the company or the level of EBIT at which
EPS is 0:
a) Indifference point
b) Combined leverage
c) Financial BEP
27. Combined leverage equals
a) EPS/EBIT
b) Contribution margin/Profit before tax
c) Sales/EBIT
ANSWERS
1. B
2. B
3. True
4. A
5. A
6. A
7. A
8. A
9. A
10. B
11. B
Interest= 6% * 250,000= 15,000
12. A
Value of debt= 250,000
13. C
Value of equity= 100,000-15,000/11%= 772,727
14. B
Value of firm= value of debt + value of equity
772,727 + 250,000= 1,022,727
15. B
WACC= EBIT/VALUE OF FIRM= 100,000/1,022,727= 9.78%
16. C
17. B
18. C
19. B
20. A
21. B
22. A
23. D
Operating leverage= sales – vc/EBIT(OPERATING PROFIT)
2,500,000-1,250,000/2,500,000-1,250,000-750,000= 2.5
24. B
25. B
Financial leverage= EBIT/EPS(EBT)
EARNING BEFORE TAX= EARNING-INTEREST (50,000-(125,000*8%))= 40,000
50,000/40,000= 1.25
