Unit 2: Sources of Finance - Practice Quiz

1 Which source of finance is generally used to fund the purchase of a new factory?

2 Long-term finance is usually required for a period of:

3 Which of the following is a long-term source of borrowed finance?

4 Which short-term source allows a business to withdraw more than its bank balance?

5 What is trade credit?

6 Short-term finance is mainly used to support a company's:

7 Who are the ordinary shareholders of a company?

8 Which right is commonly held by ordinary shareholders?

9 The dividend paid on ordinary shares is generally:

10 What happens to ordinary share capital under normal circumstances?

11 Preference shareholders normally receive dividends:

12 A preference share dividend is commonly expressed as:

13 Compared with ordinary shareholders, preference shareholders usually have:

14 What is a debenture?

15 A redeemable debenture is one that:

16 An irredeemable debenture normally has:

17 Payments made to debenture holders are known as:

18 Which statement correctly distinguishes debt from equity?

19 Which payment is normally a legal obligation for a company using debt finance?

20 Issuing additional ordinary shares may reduce existing shareholders' percentage of:

21 A company is financing a factory expected to operate for 15 years. Which source best follows the principle of matching the financing period with the asset's useful life?

22 A profitable company wants to finance permanent expansion without increasing its contractual interest payments or issuing new securities. Which source is most suitable?

23 A business owns its headquarters but needs long-term cash while continuing to occupy the building. Which financing arrangement is most appropriate?

24 A company has $2 million of working capital that is expected to remain permanently invested in the business. Under a matching financing policy, how should it primarily finance this amount?

25 A supplier offers terms of 2/10, net 30. Using a 365-day year, what is the approximate annualized cost of not taking the discount?

26 A retailer needs extra cash for a three-month seasonal increase in inventory, after which customer receipts will repay the borrowing. Which source is most appropriate?

27 A company factors its receivables without recourse. What important financial risk is transferred to the factor?

28 Which company is most likely to obtain short-term funds efficiently by issuing commercial paper?

29 A company has four ordinary shares trading at $10 each and offers one new share at $8 for every four shares held. Ignoring issue costs, what is the theoretical ex-rights price per share?

30 Why might an existing shareholder exercise rights offered in a rights issue rather than sell or ignore them?

31 An ordinary share is priced at $15. The dividend expected next year is $1.20, and dividends are expected to grow at 4% annually. Using the dividend growth model, what is the estimated cost of equity?

32 A company has 8% cumulative preference shares with a par value of $100. It omitted dividends for two years. If it resumes dividends in the third year, how much per share must be paid to preference shareholders before any ordinary dividend?

33 A non-growing preference share pays an annual dividend of $9. If investors require a 10% return, what is its estimated value?

34 A company wants to issue shares that provide a fixed preferential dividend but may also receive an additional dividend when profits are high. Which type is appropriate?

35 A company issues debentures that must be repaid at par after ten years. Which action would best reduce the risk of a large cash shortage at maturity?

36 An irredeemable debenture pays annual interest of $80. If investors require a return of 10%, what is its estimated market value?

37 A redeemable debenture has a 7% annual coupon, is issued for $96 per $100 of par value, and will be redeemed at par. How will its pre-tax yield to maturity generally compare with 7%?

38 A company is comparing two financing plans and ignoring tax. Plan E has 100,000 ordinary shares and no interest. Plan D has 60,000 ordinary shares and annual interest of $40,000. At what EBIT will earnings per share be equal?

39 A company has $1,000,000 of debt at an annual interest rate of 8%. If its corporate tax rate is 25%, what is the annual interest tax shield?

40 A company has highly volatile operating cash flows and already has substantial borrowing. Why might issuing equity be safer than taking on more debt?

41 A company announces a 1-for-4 rights issue at 12 currency units per share. Immediately before the announcement, each ordinary share trades at 15 currency units. Assuming perfect markets and full subscription, what are the theoretical ex-rights price and the value of one right attached to each existing share?

42 A company issues new ordinary shares at 30 currency units each and incurs flotation costs equal to 10% of the issue price. The expected dividend in one year is 1.80 currency units, and dividends are expected to grow perpetually at 4%. Using the Gordon model, what is the cost of the new equity?

43 A redeemable preference share pays an annual dividend of 8 currency units, provides net issue proceeds of 92 currency units, and will be redeemed for 105 currency units after five years. Using the standard approximate redemption-yield formula, what is its cost?

44 A company has 10,000 cumulative preference shares with a par value of 100 currency units and a 7% annual dividend. Preference dividends are two years in arrears. If the company now declares a total cash dividend of 260,000 currency units and must clear all arrears, how much can be distributed to ordinary shareholders?

45 An irredeemable debenture has a par value of 100 currency units, pays a 9% annual coupon, and trades at 96 currency units. If corporate tax is 25% and interest is fully deductible, what is the after-tax cost of debt?

46 A debenture pays an annual coupon of 10 currency units and will be redeemed for 105 currency units in four years. If investors require a pre-tax return of 8%, what is its current theoretical value?

47 A company needs 4 million currency units. Under an equity plan, it would issue 400,000 new shares, increasing total shares to 1.4 million. Under a debt plan, it would retain 1 million shares and borrow the entire amount at 8%. If the tax rate is 25%, at what EBIT are the two plans' earnings per share equal?

48 A company has equity with a market value of 6 million currency units and debt worth 4 million. Its cost of equity is 14%, its pre-tax cost of debt is 8%, and its corporate tax rate is 25%. Assuming these weights and costs remain valid, what is its WACC?

49 Under a trade-off view of capital structure, which statement best describes the effect of increasing financial leverage on a firm's WACC?

50 A firm has annual credit sales of 1.2 million currency units and average receivables equal to 60 days of sales, using a 360-day year. A factor advances 80% of receivables, charges 2% of annual sales, and charges 12% annual interest on the advance. Ignoring service savings and bad-debt protection, what is the simple annual cost as a percentage of usable funds?

51 A supplier offers terms of 2/10, net 40. Using a 360-day year and a simple annualized calculation, what is the approximate opportunity cost of not taking the discount?

52 A bank offers a 500,000 currency-unit, 90-day discount loan at a quoted annual rate of 12%, based on a 360-day year. It also requires a compensating balance equal to 10% of the loan's face value. If the balance is otherwise unavailable, what is the effective annual rate with quarterly compounding?

53 A firm issues 120-day commercial paper with a face value of 1 million currency units. Investors pay 970,000, and a dealer fee of 5,000 is deducted from those proceeds. Using a 360-day year, what is the effective annual financing cost?

54 A firm has fixed assets, permanent current assets of 6 million currency units, and seasonal current assets that fluctuate between zero and 3 million. Which financing policy most closely follows strict maturity matching?

55 A financially healthy company sells a specialized factory to an investor and immediately leases it back for 20 years. Which interpretation of this transaction is most accurate?

56 A profitable company can retain earnings or distribute them to ordinary shareholders. Ignoring personal taxes and transaction costs, what is the economically appropriate cost assigned to retained earnings?

57 An investor owns 400 shares worth 15 currency units each before a 1-for-4 rights issue at 12 currency units. The theoretical ex-rights price is 14.40. If the investor sells every right at its theoretical value instead of subscribing, what is the investor's total theoretical wealth immediately afterward?

58 An ordinary share has just paid a dividend of 2 currency units. Dividends will grow by 20% annually for two years and then by 5% perpetually. If the required return is 12%, what is the share's intrinsic value?

59 A company has 1 million currency units of ordinary share capital and 500,000 of 8% participating preference capital. Its terms grant preference shareholders their fixed dividend, then ordinary shareholders receive 8% of nominal capital, after which any remaining dividend is shared in proportion to nominal capital. If 180,000 is distributed, how much do preference shareholders receive?

60 A convertible debenture pays a 6% annual coupon on a par value of 100 currency units, is redeemable at par in three years, and can be converted into eight ordinary shares. The shares trade at 11, while comparable straight debt yields 8%. Ignoring any additional option premium, what is the debenture's minimum rational value?