Multiple Choice Questions

1. The only contradicting goal of financial management is

a. Profit Maximisation
b. Wealth Maximisation
c. Sales Maximisation
d. Asset Maximisation
Answer: b. Wealth Maximisation

2. The basic objective of financial management is

a. Maximise profits
b. Maximise shareholders wealth
c. Creating finance discipline
d. None of the above
Answer: b. Maximise shareholders wealth

3. Finance function involves

a. Sourcing of funds
b. Application or use of funds
c. Sourcing as well as effective use of funds
d. Safe custody of funds
Answer: c. sourcing as well as effective use of funds

4. The goal of wealth maximisation takes into consideration

a. Risk
b. Expected Returns
c. Timing of returns
d. All the above
Answer: d. All the above

5. Financial management is mainly concerned with

a. Acceptance of funds
b. Sourcing as well as effective use of funds
c. Effective management of funds
d. None
Answer: b. sourcing as well as effective use of funds

6. refers to the current value of a future amount.

a. Time Value
b. Present Value
c. Compounded Value
d. Discounted Value
Answer: b. Present Value

7. Time value of money signifies that the value of one unit of money at
different points of time.
a. Increases
 b. Decreases
c. Remains unchanged
d. Differs
Answer: d. Differs

8. Time value of money facilitates comparison of cash flows occurring in different time
periods by
a. Compounding all cash flows to a common point of time
b. Discounting all cash flows to a common point of time
c. Either compounds or discounts all cash flows
d. None
Answer: c. either compounds or discounts all cash flows

9. If the moral rate of return is 10% per annum and the frequency of compounding is 4. What
will be the effective rate of return?
a. 10% p.a
b. 10.25% p.a
c. 10.38% p.a
d. None
Answer: c. 10.38% p.a

10. Relationship between annual effective rate of interest and annual normal rate of interest,
if the frequency of compounding is more than 1, then
a. Effective rate will be greater than normal rate
b. Effective rate will be lesser than normal rate
c. Effective rate will be equal to normal rate
d. None
Answer a. Effective rate will be greater than normal rate

11. If annual effective rate of interest is 0.25% and the annual normal rate of interest is 10%,
what is the frequency at which it compounds?
a. 3
b. 1
c. 2
d. None
Answer: c. 2
12. A person gets a loan for Rs.50,000, for a period of 5 years and the rate of interest is 10%
p.a, what will be total amount that person would repay at the end of 5 years if he pays 5
equal instalments?
a. Rs.11,310
b. Rs.19,310
c. Rs.15,310
d. Rs. 21,310
Answer: b. Rs.19, 310

13. Refers to the overall budget of an organisation.

 a. Sales budget
b. Production budget
c. Cash budget
d. Master budget
Answer: d. Master budget

14. Which of the following are measures of risk?

a. Standard deviation
b. Beta
c. Both
d. None
Answer: c. Both

15. Overall cost of capital considers

a. Cost of debt and cost of preference
b. Cost of debt and cost of equity
c. Cost of equity and cost of preference
d. Cost of debt, preference and equity.
Answer: Cost of debt, preference and equity.

16. "Shareholder wealth" in a firm is represented by

a. The number of people employed in the firm.
b. The book value of the firm's assets less the book value of its liabilities.
c. The amount of salary paid to its employees.
d. The market price per share of the firm's common stock
Answer: d. the market price per share of the firm's common stock

17. With continuous compounding at 10 percent for 30 years, the future value of an initial
investment of Rs. 2,000 is closest to
a. Rs. 34,898.
b. Rs. 40,171.
c. Rs. 164,500.
d. Rs. 328,282.
Answer: a. Rs. 34,898.

18. In 3 years you are to receive Rs. 5,000. If the interest rate were to suddenly increase, the
present value of that future amount to you would
a. Fall
b. Rise
c. Remain unchanged
d. Cannot be determined
Answer: a. Fall

19. In a loan amortisation schedule the amount of interest paid at each instalment keeps .
a. Increasing
b. Decreasing
 c. Remains constant
d. None
Answer: b. Decreasing

20. If the Present Value of Cash Inflows are greater than the Present Value of Cash Outflows,
the project would be

a. Accepted
b. Rejected with condition
c. Rejected with approval
d. Rejected
Answer: a. Accepted

21. Finance functions deals with

a. Planning for funds
b. Raising of funds
c. Allocation of Resources
d. All of the above

Answer: d. All of the above

22. Working capital is obtained by

a. Total assets.
b. Total fixed assets.
c. Current assets
d. Current assets minus current liabilities.
Answer: d. Current assets minus current liabilities.

23. On the recommendations of the Finance Manager, the board of directors will accept the
project if
a. Benefit Cost Ratio is less than one
b. Net Present Value is greater than zero
c. Internal Rate of Return is less than cost of capital
d. Pay Back Period is greater than target period
Answer: b. Net Present Value is greater than zero

24. From the following sources of finance, find out the free source of finance
a. Equity Capital
b. Preference Capital
c. Retained Earnings
d. None of the above
Answer: d. None of the above

25. Agency cost consists of

a. Binding
b. Monitoring
 c. Opportunity and structure cost
d. All of the above
Answer: d. All of the above
26. The objective of wealth maximization takes into account
a. Amount of returns expected
b. Timing of anticipated returns
c. Risk associated with uncertainty of returns
d. All of the above
Answer: d. All of the above
27. Time value of money indicates that
a. A unit of money obtained today is worth more than a unit of money obtained in future
b. A unit of money obtained today is worth less than a unit of money obtained in future
c. There is no difference in the value of money obtained today and tomorrow
d. None of the above
Answer: a. a unit of money obtained today is worth more than a unit of money obtained in
future
28. Capital Budgeting is a part of:
a. Investment Decision
b. Working Capital Management
c. Marketing Management
d. Capital Structure.
Answer: a. Investment Decision
29. Capital Budgeting deals with
a. Long-term Decisions
b. Short-term Decisions
c. Both
d. None
Answer: a. Long term decisions
30. Which of the following is not used in Capital Budgeting?
a. Time Value of Money
b. Sensitivity Analysis
c. Net Assets Method
d. Cash Flows.
Answer: c. Net Assets Method
31. Capital Budgeting Decisions are:
a. Reversible
b. Irreversible
c. Unimportant
d. All of the above.
Answer: b. Irreversible
32. A sound Capital Budgeting technique is based on:
a. Cash Flows
b. Accounting Profit
c. Interest Rate on Borrowings
d. Last Dividend Paid.
Answer: a. Cash Flows
33. Which of the following is not a relevant cost in Capital Budgeting?
a. Sunk Cost
b. Opportunity Cost
c. Allocated Overheads
d. Both a and c
Answer: d. Both a and c
34. Evaluation of Capital Budgeting Proposals is based on Cash Flows because:
a. Cash Flows are easy to calculate
b. Cash Flows are suggested by SEBI
c. Cash is more important than profit
d. None of the above.
Answer: c. Cash is more important than profit
35. Cost of Capital refers to
a. Flotation Cos
b. Dividend
c. Required Rate of Return
d. None of the above
Answer: c. Required Rate of Return
36. Which of the following has the highest cost of capital?
a. Equity shares
b. Loans
c. Bonds
d. Preference shares
Answer: a. Equity shares,
37. Cost of Capital for Government securities is also known as:
a. Risk-free Rate of Interest
b. Maximum Rate of Return
c. Rate of Interest on Fixed Deposits
d. None of the above.
Answer: a. Risk-free Rate of Interest
38. Weighted Average Cost of Capital is generally denoted by:
 a. KA
b. KW
c. K0
d. KC
Answer: c. K 0
39. Which of the following cost of capital require tax adjustment?
a. Cost of Equity Shares
b. Cost of Preference Shares
c. Cost of Debentures
d. Cost of Retained Earnings.
Answer: c. Cost of Debentures
40. Which is the most expensive source of funds?
a. New Equity Shares
b. New Preference Shares
c. New Debts
d. Retained Earnings.
Answer: a. New Equity Shares
41. Cost of Equity Share Capital is more than cost of debt because:
a. Face value of debentures is more than face value of shares
b. Equity shares have higher risk than debt
c. Equity shares are easily saleable
d. All of the three above.
Answer: b. Equity shares have higher risk than debt
42. Operating leverage helps in analysis of:
a. Business Risk
b. Financing Risk
c. Production Risk
d. Credit Risk
Answer: a. Business Risk
43. Which of the following is studied with the help of financial leverage?
a. Marketing Risk
b. Interest Rate Risk
c. Foreign Exchange Risk
d. Financing risk
Answer: d. financing risk
44. Operating leverage arises because of:
a. Fixed Cost of Production
 b. Fixed Interest Cost
c. Variable Cost
d. None of the above
Answer: a. Fixed Cost of Production
45. Financial Leverage arises because of:
a. Fixed cost of production
b. Variable Cost
c. Interest Cost
d. None of the above
Answer: c. Interest Cost
46. Operating Leverage is a result of which of the two elements.
a. Contribution, EBIT
b. EBIT, PBT
c. EBIT, Interest
d. EBIT, Tax
Answer: a. Contribution, EBIT
47. Financial Leverage is a result of which of the two elements.
a. Contribution, EBIT
b. EBIT, PBT
c. EBIT, Sales
d. EBIT, Variable cost
Answer: b. EBIT, PBT
48. FL is zero if:
a. EBIT = Interest
b. EBIT = Zero
c. EBIT = Fixed Cost
d. EBIT = Pref. Dividend
Answer: b. EBIT = Zero
49. Financial Leverage measures relationship between
a. EBIT and PBT
b. EBIT and EPS
c. Sales and PBT
d. Sales and EPS
Answer: b. EBIT and EPS
50. Walter's Model suggests for 100% DP Ratio when
a. k e = r
b. k e < r
 c. k e > r
d. k e = 0
Answer: c. k e > r
51. 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
Answer: a. the value of the firm depends upon earning power
52. Which of the following represents a dividend policy?
a. The dividend is paid as a % of EPS
b. The dividend is paid as a constant amount
c. The dividend is paid after retaining profits for reinvestment
d. None
Answer: c, the dividend is paid after retaining profits for reinvestment
53. _______ measures the present value of returns per rupee invested
a. Profitability Index
b. NPV
c. IRR
d. ARR
Answer: a. Profitability index
54. _________ implies buying securities in one market where price is low and selling
where it is high.
a. Arbitrage Process
b. Speculation
c. Investment
d. None of the above
Answer: a. Arbitrage process.
55. ____________is the proportion of debt and preference and equity shares on a firm’s
balance sheet.
a. Capital structure
b. Capital budgeting
c. Cost of capital
d. None of the above
Answer: a. Capital structure
56. ___________is the fixed cost of placing and receiving an inventory order.
a. Carrying cost
b. Holding Cost
c. Ordering cost
d. All the above
Answer: c. Ordering cost
57. There is a direct relationship between fixed costs and _________.
a. Direct Cost
b. Indirect Cost
c. Leverage
d. None of the above
Answer: c. Leverage.
58. ____________is the financial situation in which a firm has only fixed amount to allocate
among competing capital expenditures.
a. Capital budgeting
b. Capital rationing
c. Capital Structuring
d. None of the above
Answer: b. Capital rationing.
59. _______________indicates the percentage earnings distributed to shareholders in cash,
calculated dividing the cash dividend per share by its earnings per share.
a. Dividend pay out ratio
b. Debt equity ratio
c. P/V ratio
d. None of the above
Answer: a. Dividend pay out ratio
60. Higher Financial Leverage is related the use of:
a. Higher Equity
b. Higher Debt
c. Lower Debt
d. None of the above
Answer: b. Higher Debt
Fill in the blanks
61. is an art of managing money.
Answer: Finance

62. The term refers to employees, suppliers, customers, owners, creditors,

debtors and others who have a direct link to the firm.
Answer: Stakeholders

63. Costs are costs borne by shareholders to minimise agency problems to

contribute to maimising ownerswealth.
Answer: Agency

64. The value of one unit of money differsin different time periods, is called as
Answer: Time Value of Money
65. Budget refers to physical activities, operations such s sales, production,
etc.,
Answer: Operating

66. Budget is concerned with expected cash flows, financial position and result
of operations.
Answer: Finance

67. is the process of evaluating and selecting long term investments that are
consistent with the goals of maximising shareholders wealth.
Answer: Capital Budgeting

68. Present value table can be used only when cash flows are uniform to
determine NPV.
Answer: Annuity

69. Present value table can be used when cash flows are uneven while
determining NPV.
Answer: Simple

70. is a measure of unsystematic risk.

Answer: Standard Deviation

71. Costs of holding inventory are called as ________________.

Answer: Carrying cost.

72. According to NOI approach, cost of equity is ___________.

Answer: Residual.

73. _________ decision relates to the choice of the proportion of debt and equity of sources
of finance
Answer: Financing

74. _______________ is inventory plus receivable minus payables.

Answer: Zero working Capital

75. According to NOI approach, cost of equity is ____________.

Answer: Residual

76. Market price per share _____________ if more debt is used in NI approach.
Answer: Increases

77. According to NOI approach, with increase in debt/equity ratio the financial risk of the
equity holders _____________.
Answer: Increases
78. ____________is the financial situation in which a firm has only fixed amount to allocate
among competing capital expenditures.
Answer: Capital budgeting

79. _________ implies buying securities in one market where price is low and selling where it
is high.
Answer: Arbitrage process

80. _________ has the highest cost of capital?

Answer: Equity Share Capital

True or false
81. Financial management deals mainly with two major functions such as investments and
financial decisions.
Answer: False

82. Profit maximisation is the sole objective of financial management.

Answer: False

83. A rupee today is worthier than a rupee tomorrow.

Answer: True

84. Effective rate of interest and normal rate of interest are equal irrespective of the
frequency of compounding.
Answer: False

85. Time value of money emphasis that the value of one unit of money differs to different
points of time.
Answer: True

86. Effective rate of interest is positively correlated with the frequency of compounding.
Answer: Tue

87. Beta is measure of systematic risk.

Answer: True

88. Cost of debt is higher than cost of equity.

Answer: False

89. Cost of preference capital is higher than cost of debt.

Answer: True

90. Cost of Equity capital is higher than cost of preference capital.

Answer: True
91. Different sources of funds have a specific cost of capital related to that source only.
Answer: True

92. Risk free interest rate and cost of capital are same things.
Answer: False

93. Cost of debt is the same as the rate of interest.

Answer: False

94. In NOI approach, Kd and Ko are taken as constant.

Answer: True

95. Cost of Pref. share capital is determined by the rate of fixed dividend.
Answer: True

96. Operating leverage analyses the relationship between sales level and EPS.
Answer: False

97. Financial leverage depends upon the fixed financial charges.

Answer: True

98. Dividend is a part of retained earnings.

Answer: False

99. Dividend is compulsorily payable to preference shareholders.

Answer: False

100. Dividend pay-out ratio refers to that portion of total earnings which is distributed
among shareholders.
Answer: True

1. Profit maximisation and wealth maximisation are the contradicting objectives of financial
management. Discuss
2. Write a note on the key functions of a finance manager.
3. List the significance of financial management to organisations.
4. What is agency problem? How do market forces act to prevent /minimize this problem?
5. How the finance function is typically organized in a large organization?
6. Explain the significance of capital budgeting.
7. What re the components of cash outlays in capital budgeting?
8. An investor deposits Rs.10, 000 in a bank account for 5 years at 8% rate of interest. Find
out the amount he will have in his account if the interest compounds
a) Annually
b) Semi annually
c) Quarterly
9. Compute the present value of a property of Rs.10, 000, if the discount rate is 10%.
10. A company borrowed Rs.30, 00,000 from a NBFC for 15 years. The rate of interest is 20%
per annum. Compute the amount of annual instalment.
11. Mr. X deposits each year Rs 500, Rs 1,000, Rs 1,500, Rs 2,000 and Rs 2,500 in his saving
bank account for 5 years. The interest rate is 5 per cent. Find out the future value of his
deposits at the end of the 5th year
12. Determine the present value of the annuity consisting of cash inflows of Rs 1,000 per year
for 5 years. The rate of interest he can earn from his investment is 10 per cent.
13. Briefly explain the concept of time value of money.
14. What is annuity? Explain how can a future value of an annuity can be determined?
15. Differentiate present value from future value.
16. Explain effective rate of interest.
17. What does the profitability index signify? What is the criterion for judging the worth of
investments based on profitability index?
18. Briefly explain the process of capital budgeting.
19. A project costs Rs 36,000 and is expected to generate cash inflows of Rs 11,200 annually
for 5 years. Calculate the IRR of the project.
20. Determine the average rate of return from the following data of two machines, A and B.

Particulars Machine A (in Rs) Machine B (in Rs)

Cost 56,125 56,125

Annual estimated income after depreciation and income tax:

Year 1 3,375 11,375

Year 2 5,375 9,375

Year 3 7,375 7,375

Year 4 9,375 5,375

Year 5 11,375 3,375

Estimated life (years) 5 5

Estimated salvage value 3,000 3,000

21. Compare and contrast the IRR and the NPV methods.
22. What are the critical factors to be observed while making capital budgeting decisions
under capital rationing?
23. Write a note on cost of capital.
24. Write a short not on Net Income Approach
25. Briefly explain Net Operating Income Approach
26. Explain the difference between net income and net operating income approach
27. What are the assumptions in MM approach?
28. ‘Dividends help companies in maximising shareholders wealth’. Comment
29. Briefly explain the dividend pay-out models that are widely used.
30. List the significance of working capital management
31. Explain the objectives of working capital management.
32. Explain the role of inventory in working capital management.
33. What is the relationship between leverage and cost of capital
34. Write a note on Business risk
35. What is financial risk?
36. Explain why the cost of preference shares is less than equity.
37. Determine the cost of equity, if market price per share is Rs.20. The firm had paid Rs. 2
per share dividend last year. The estimated growth rate is 5%.
38. What is the weighted average cost of capital? Examine the rationale behind the use of it.
39. A firm is considering to buy one of the following two mutually exclusive investment
projects:
Project A: Buy a machine that requires an initial investment outlay of Rs 1,00,000
and will generate the CFAT of Rs 30,000 per year for 5 years.

Project B: Buy a machine that requires an initial investment outlay of Rs 1,25,000

and will generate the CFAT of Rs 27,000 per year for 8 years.

Which project should be undertaken by the firm? Assume 10 per cent as cost of capital.
40. Compare and contrast NPV and Profitability Index.
41. Explain in brief about Dividend valuation model approach
42. A company has 10 per cent perpetual debt of Rs 1, 00,000. The tax rate is 35 per cent.
Determine the cost of capital (before tax as well as after tax) assuming the debt is issued
at (i) par, (ii) 10 per cent Discount and (iii) 10 per cent premium.
43. Write a note on a)Gross working capital, b)Net working capital
44. Length of the operating cycle is a major determinant of working capital needs of a business
firm. Explain
45. Differentiate Permanent and Temporary working capital.
46. Calculate financial leverage and operating leverage if,
Sales = 2000000,
Variable costs= 1400000,
Fixed costs= 400000 (including 15% interest on Rs.1000000).
47. Explain weighted average cost of capital.
48. What is dividend pay-out ratio? Explain.
49. What is stable Dividend Policy?
50. Briefly explain Walter’s model
51. What do you understand by Residual theory of dividend?
52. Explain MM approach of dividend.
53. Explain the dividend policy in India.
54. Calculate EBIT for the following:

Particulars Base Level New Level

1000 1,100
Units sold
10 10
Sales price per unit
6 6
Variable cost per unit
Nil Nil
Fixed operating cost
55. Find EPS if EBIT is Rs.120000, Interest is nil, tax @35%, and no of equity shares is
15000.Also find the EPS if the no of equity shares is 20000.
56. What is optimum capital structure?
57. Explain cost of equity and debt with examples.
58. How the value of the firm is determined under Net income approach.
59. How is cost of equity is determined in the NOI Approach
60. What is home-made leverage
61. What is Arbitrage process
62. Explain trade-off theory of capital structure
63. Discuss the concept of Zero Working Capital
64. How cost of preference shares is determined
65. A company issues 11 per cent debentures of Rs.100 for an amount aggregating Rs.100000
at 10% premium, redeemable at par after five years. The company’s tax rate is 35%.
Determine the cost of debt.
66. The following information is available in respect of a firm. If the Capitalization rate (ke)
=0.10, EPS = Rs.10, Assume rate of return on investments (r) at (i) 15 and (ii) 8. Show the
effect of dividend policy on the market price of shares using Walter model.
67. Explain Internal Rate of Return
68. What are Explicit and Implicit costs?
69. Differentiate business and financial risk.
70. What are the critical factors to be observed while making capital budgeting decisions
under capital rationing?

1. Describe the salient features of modern approaches in financial management.

2. Discuss the objectives of financial management in detail.
3. Explain the role of a financial manager in decision making.
4. Briefly explain the determinants of dividends
5. Explain in detail the determinants of working capital.
6. Explain the role of working capital management in financial management.
7. What is the importance of Capital Budgeting? And what are the various techniques of evaluating
the projects.
8. Examine critically the different approaches to the calculation of cost of capital.
9. Explain time value of money and the discounting and compounding techniques.
10. An investor invests Rest. 500 in bank account that yields an interest rate of 4% p.a for a
period of 5 years. Calculate the future value if the compounding factor is
i. Annual
ii. Semi Annual
iii. Quarterly
iv. Continuous
11. If the discount /required rate of is 10 percent, compute the present value of the cash flow
streams detailed below :
i. Rs 100 at the end of year 1,
ii. Rs 100 at the end of year 3 ,
iii. Rs 100 at the end of year 5
iv. Rs. 100 for the next 10 years.
12. A company is considering the following investment projects:
Cash flows (Rs)
C0 C1 C2 C3
Projects
-10,000 +10,000
A
-10,000 +7,500 +7,500
B
-10,000 +2,000 +4,000 +12,000
C
-10,000 +10,000 +3,000 +13,000
D
Rank the project according to each of the following methods: (assuming discount rate at 10
%.)
(i)Payback
(ii) ARR,
(iii)NPV
13. Suppose two projects X and Y both costing Rs 500 each. Project A returns Rs 1000 after
one year and Rs 250 after two years. On the other hand, project B returns Rs 300 after one
year and Rs 1000 after two years. Calculate NPV of projects at discount rates of 5%.What
happens to projects (NPV – based) rankings at this discount rate?
14. Consider the following projects:

Cash flows (Rs)

Projects C0 C1 C2 C3 C4

A -1,000 +600 +200 +200 +1,000

B -1,000 +200 +200 +600 +1,000

C -1,300 +100 +100 +100 +1,600

D -1,300 0 0 +300 +1,600

i. Calculate the payback period for each project

 ii. If the standard payback period is 2 years, which project will you select? Will your
answer be different if the standard payback is 3 years?
15. Explain in detail how project selection is made under capital rationing?
16. A company has the following long term capital outstanding as on 31 st March 2009:
(a) 10 percent debentures with face value of Rs.500, 000.The debentures were issued in
2002 and are due on 31st March 2009.The current market price of a debenture is Rs 950.
(b)Preference shares with a face value of Rs 400,000.The annual dividend is Rs.6 per share.
The preference shares are currently selling at Rs 60 per share.
(c) Sixty thousand ordinary shares of Rs 10 par value. The share is currently selling at Rs
50 per share. The dividends per share for the past several years are as follows:
Year Rs Year Rs
2002 2.00 2006 2.80

2003 2.16 2007 3.08

2004 2.37 2008 3.38

2005 2.60 2009 3.70

Assuming a tax rate of 35 percent, compute the firm’s weighted average cost of capital.
17. A company issues 11 per cent irredeemable preference shares of the face value of Rs 100
each. Flotation costs are estimated at 5 per cent of the expected sale price.
(a) What is the kp, if preference shares are issued at
I. par value,
II. 10 per cent premium, and
III. 5 per cent discount
18. The Hypothetical Ltd wishes to calculate its cost of equity capital using the capital asset
pricing model approach. From the information provided to the firm by its investment
advisors along with the firms’ own analysis, it is found that the risk-free rate of return
equals 10 per cent; the firm’s beta equals 1.50 and the return on the market portfolio
equals 12.5 per cent. Compute the cost of equity capital.
19. Explain in detail about the factors that determine the working capital requirements.
20. From the following information supplied to you, determine the appropriate weighted
average cost of capital ,relevant for evaluating long term investment projects of the
company:
Cost of Equity 12%
After tax cost of long term debt 7%
After tax cost of short term debt 4 %

Source of capital Book value ( in Rs) Market value (in Rs)

5,00,000 7,50,000
Equity
4,00,000 3,75,000
Long term debt
1,00,000 1,00,000
Short term debt
10,00,000 12,25,000

21. Why must the finance manager keep in mind the degree of financial leverage in evaluating
various financial plans? When does financial leverage become favourable?
22. Give a critical appraisal of the a) traditional approach b) Modigliani-Miller Approach to
the theory of capital structure.
23. Explain briefly the view of traditional approach on the relationship between capital
structure and the value of the firm.
24. Assuming no taxes and given the earnings before interest and taxes (EBIT), interest(I), at
10 % and equity capitalisation rate(Ke) below, calculate the total market value of the firm.
FIRMS EBIT I Ke(%)
200000 20000 12
X
300000 60000 16
Y
500000 200000 15
Z
600000 240000 18
W
Also, determine the weighted average cost of capital for each firm
25. Company X and Y are in the same risk class and are identical in every respect except that
company X uses debt, while company Y does not. The levered firm has Rs.900000
debentures, carrying 10% rate of interest. Both the firms earn 20 % operating profit on
their total assets of Rs.15 lakhs. Assume perfect capital markets, rational investors and so
on. A tax rate of 35 % and capitalisation rate of 15% for an all-equity company.
I. Compute the value of firms X and Y using Net Income(NI) Approach.
II. Compute the value of each firm using the Net operating Income(NOI)
Approach.
III. Using the NOI Approach, calculate the overall cost of capital(Ko) for firms X and
Y.
IV. Which of these two firms has an optimal capital structure according to the NOI
Approach? Why?
26. The EPS of a company is Rs.8 and the rate of capitalisation applicable is 10 %. The company
has before it, an option of adopting (i) 50, (ii) 75, and (iii) 100 per cent dividend pay out
ratio. Compute the market price of the company’s quoted shares as per Walter’s model if
it earn a return of a) 15 b) 10 and C) 5 % on its retained earnings.
27. Explain Dividend Capitalisation and Gorden model of dividends.
28. Explain the irrelevancy approach of dividends.
29. Given (i) The EBIT of Rs.200000, (II) the corporate tax rate of 35 % and (III) the following
data. Determine the amount of debt that should be used by the firm in its capital to
maximise the value of the firm

Debt Ki(before tax)% Ke(%)

Nil 12
NIL
10 12
100000
 10.5 12.6
200000
11 13
300000
12 13.6
400000
14 15.6
500000
30. You are working as a finance manager with Avon Chemicals LTD. The earnings available
for its equity shareholders are Rs.50 lakh. It has 5 lakh equity share outstanding. Its share
are currently sold at Rs.60 per share. The company is currently contemplating the
payment of Rs.5 per share in cash dividend. The Board of Avon has asked you the
following:
i) The Current EPS and P/E ratio.
ii) If the firm can repurchase share at Rs.65 per share, how many equity shares
can be repurchased instead of cash dividend payment.
iii) The EPS after the proposed share repurchase.