1Which of the following is strictly a short-term source of finance?
A.Equity Share Capital
B.Debentures
C.Trade Credit
D.Preference Shares
Correct Answer: Trade Credit
Explanation:Trade credit is an arrangement to buy goods or services on account without immediate payment, typically used for short-term working capital needs.
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2Financial leases are classified as which type of source of finance based on duration?
A.Short-term source
B.Medium to Long-term source
C.Spontaneous source
D.Overnight source
Correct Answer: Medium to Long-term source
Explanation:Financial leases typically cover the major part of the economic life of an asset, making them medium to long-term sources of finance.
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3In the context of sources of finance, what does ADR stand for?
A.American Depository Receipt
B.Authorized Debt Ratio
C.Annual Dividend Rate
D.Asset Depreciation Reserve
Correct Answer: American Depository Receipt
Explanation:ADR stands for American Depository Receipt, a negotiable certificate issued by a U.S. bank representing a specified number of shares in a foreign stock.
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4Which of the following is an internal source of long-term finance?
A.Bank Loan
B.Retained Earnings
C.Public Deposits
D.Factoring
Correct Answer: Retained Earnings
Explanation:Retained earnings represent the portion of net income not distributed as dividends but kept by the company for reinvestment, making it an internal source.
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5Commercial Paper (CP) is an unsecured money market instrument issued in the form of:
A.Promissory Note
B.Bill of Lading
C.Equity Warrant
D.Mortgage Deed
Correct Answer: Promissory Note
Explanation:Commercial Paper is an unsecured promissory note issued by corporations with a fixed maturity, usually ranging from a few days to a year.
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6The Cost of Capital is best defined as:
A.The maximum rate of return a firm must earn
B.The minimum required rate of return to maintain the market value of the firm
C.The interest rate charged by the bank on overdrafts
D.The total administrative cost of issuing shares
Correct Answer: The minimum required rate of return to maintain the market value of the firm
Explanation:Cost of capital acts as a hurdle rate; it is the minimum return a project must generate to satisfy debt and equity holders, preserving the firm's value.
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7Which component of capital structure usually has the lowest cost due to tax deductibility?
A.Equity Capital
B.Preference Capital
C.Retained Earnings
D.Debt Capital
Correct Answer: Debt Capital
Explanation:Interest payments on debt are tax-deductible expenses, which creates a tax shield, effectively lowering the cost of debt compared to equity or preference shares.
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8The formula for the Cost of Irredeemable Debt () after tax is:
A.
B.
C.
D.
Correct Answer:
Explanation:The cost of irredeemable debt is calculated as the Interest () adjusted for the tax shield (), divided by the Net Proceeds ().
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9If a company issues 10% debentures of $100,000 at par and the tax rate is 30%, what is the after-tax cost of debt?
A.10%
B.7%
C.13%
D.3%
Correct Answer: 7%
Explanation:Cost of Debt . .
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10Which of the following creates a 'Tax Shield'?
A.Dividend on Equity Shares
B.Dividend on Preference Shares
C.Interest on Debentures
D.Retained Earnings
Correct Answer: Interest on Debentures
Explanation:Interest is an expense on the income statement before taxes are calculated, reducing taxable income. Dividends are paid from profit after tax.
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11The cost of preference share capital () is generally calculated as:
A.
B.
C.
D.
Correct Answer:
Explanation:Unlike debt interest, preference dividends are not tax-deductible. Therefore, (assuming irredeemable).
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12Which of the following statements regarding the Cost of Equity () is TRUE?
A.It is usually lower than the cost of debt.
B.It carries a legal obligation to pay.
C.It is the most expensive source of finance because of higher risk.
D.It is tax-deductible.
Correct Answer: It is the most expensive source of finance because of higher risk.
Explanation:Equity holders bear the highest risk (residual claimants), so they demand the highest return, making higher than or .
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13In the Dividend Price Approach (constant dividend), the Cost of Equity () is:
A.
B.
C.
D.
Correct Answer:
Explanation:When dividends are constant with no growth, the cost of equity is simply the expected dividend () divided by the current market price ().
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14Under the Dividend Growth Model (Gordon's Model), the formula for Cost of Equity is:
A.
B.
C.
D.
Correct Answer:
Explanation:Gordon's model adds the dividend yield (based on next year's dividend ) to the constant growth rate ().
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15In the formula , what does represent?
A.Government tax rate
B.Growth rate of dividends
C.Gross profit margin
D.Gearing ratio
Correct Answer: Growth rate of dividends
Explanation:The variable represents the constant annual growth rate of dividends.
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16The Capital Asset Pricing Model (CAPM) calculates the cost of equity based on:
A.Past dividend trends only
B.Risk-free rate, Market return, and Beta
C.Book value of assets
D.Interest coverage ratio
Correct Answer: Risk-free rate, Market return, and Beta
Explanation:CAPM relates risk to return: .
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17According to CAPM, the formula for Cost of Equity is:
A.
B.
C.
D.
Correct Answer:
Explanation:This is the standard CAPM equation where measures systematic risk and is the market risk premium.
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18What does 'Beta' () measure in the CAPM model?
A.Unsystematic risk
B.Systematic (Market) risk
C.Credit risk
D.Liquidity risk
Correct Answer: Systematic (Market) risk
Explanation:Beta measures the volatility of a security in relation to the market as a whole (Systematic risk).
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19The Cost of Retained Earnings () is usually considered equal to:
A.Cost of Debt
B.Cost of Equity ()
C.Risk-free rate
D.Zero
Correct Answer: Cost of Equity ()
Explanation:Retained earnings is opportunity cost for shareholders. It is usually equal to , though sometimes slightly lower if personal taxes/flotation costs are considered.
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20Why is the Cost of New Equity () typically higher than the Cost of Retained Earnings ()?
A.Due to flotation costs
B.Due to lower risk
C.Due to tax advantages
D.They are always exactly the same
Correct Answer: Due to flotation costs
Explanation:Issuing new shares involves flotation costs (underwriting fees, brokerage, etc.), which reduces the net proceeds, effectively increasing the cost of capital compared to retaining earnings.
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21WACC stands for:
A.Weighted Average Cost of Capital
B.Weighted Annual Cost of Capital
C.Working Assets Cost Capital
D.Weighted Average Credit Cost
Correct Answer: Weighted Average Cost of Capital
Explanation:WACC is the Weighted Average Cost of Capital, representing the average rate a company must pay to finance its assets.
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22To calculate WACC, the specific costs of each source of finance are weighted by their:
A.Maturity period
B.Proportion in the capital structure
C.Coupon rate
D.Profitability index
Correct Answer: Proportion in the capital structure
Explanation:WACC uses weights based on the proportion of debt, equity, and preference shares in the total capital structure.
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23Which weights are generally preferred for calculating WACC?
A.Book Value Weights
B.Market Value Weights
C.Historical Cost Weights
D.Par Value Weights
Correct Answer: Market Value Weights
Explanation:Market value weights are preferred because they reflect the current economic value and the actual cost to raise new capital.
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24Factoring is a method of raising short-term finance against:
A.Inventory
B.Accounts Receivable / Debtors
C.Fixed Assets
D.Goodwill
Correct Answer: Accounts Receivable / Debtors
Explanation:Factoring involves selling accounts receivable (invoices) to a third party (factor) at a discount to obtain immediate cash.
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25Which of the following is NOT a component of Cost of Capital?
A.Risk-free rate
B.Business risk premium
C.Financial risk premium
D.Sunk costs
Correct Answer: Sunk costs
Explanation:Cost of capital is forward-looking and based on required returns and risk. Sunk costs are past costs and irrelevant to future cost of capital calculations.
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26If , , and , what is using CAPM?
A.10.5%
B.15.5%
C.17.0%
D.23.0%
Correct Answer: 15.5%
Explanation:.
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27Venture Capital is best described as:
A.Short-term loan for working capital
B.Financing for high-risk, high-growth startup potential
C.Government subsidy for agriculture
D.Safe investment in blue-chip companies
Correct Answer: Financing for high-risk, high-growth startup potential
Explanation:Venture capital is a form of private equity provided to startups and small businesses that are believed to have long-term growth potential.
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28In the calculation of Cost of Redeemable Debt, the term 'Redemption Value' refers to:
A.The price at which the bond was issued
B.The amount repayable at maturity
C.The total interest paid over the life
D.The market price today
Correct Answer: The amount repayable at maturity
Explanation:Redemption value is the principal amount (often par or premium) that the issuer must pay to the bondholder at the maturity date.
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29Which source of finance does not dilute the control of existing shareholders?
A.New Equity Issue
B.Debentures
C.Convertible Preference Shares
D.Warrants
Correct Answer: Debentures
Explanation:Debenture holders are creditors, not owners. They do not have voting rights (unless debt covenants are breached), so existing equity control remains undiluted.
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30A Global Depository Receipt (GDR) is usually issued in:
A.USA only
B.India only
C.European markets / Internationally outside the domestic market
D.The company's headquarters
Correct Answer: European markets / Internationally outside the domestic market
Explanation:GDRs are negotiable certificates issued by depositary banks which represent ownership of shares in foreign companies, typically traded in Europe or other international markets (excluding the US which uses ADRs).
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31The approximate formula for Cost of Redeemable Debt involves averaging:
A.Interest and Tax
B.Net Proceeds and Redemption Value
C.Growth and Dividend
D.Risk and Return
Correct Answer: Net Proceeds and Redemption Value
Explanation:The denominator in the approximate formula is the average value of the debt: .
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32For a profit-making company, the 'Effective Cost' of debt is:
A.Higher than the coupon rate
B.Equal to the coupon rate
C.Lower than the coupon rate
D.Equal to the risk-free rate
Correct Answer: Lower than the coupon rate
Explanation:Because interest is tax-deductible, the effective cost is , making it lower than the nominal coupon rate.
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33If the current market price of a share is 5 with no growth, the Cost of Equity is:
A.5%
B.10%
C.15%
D.20%
Correct Answer: 10%
Explanation: or .
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34The 'Realized Yield Approach' for calculating Cost of Equity is based on:
A.Future expectations
B.Historical returns actually earned by shareholders
C.Government bond yields
D.Fixed deposit rates
Correct Answer: Historical returns actually earned by shareholders
Explanation:The Realized Yield Approach assumes that past actual returns (dividends + capital appreciation) are a good proxy for what shareholders expect in the future.
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35When calculating WACC, if the capital structure changes, what happens?
A.The WACC remains constant
B.The weights change, likely altering the WACC
C.Only the cost of debt changes
D.Only the cost of equity changes
Correct Answer: The weights change, likely altering the WACC
Explanation:WACC depends on the proportion (weights) of debt and equity. Changing the structure changes the weights, thus changing the WACC.
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36Term loans provided by financial institutions are typically for:
A.Less than 1 year
B.3 to 10 years or more
C.Overnight only
D.Indefinite period
Correct Answer: 3 to 10 years or more
Explanation:Term loans are medium to long-term sources of finance, typically used for purchasing machinery, expansion, or modernization.
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37What is the primary difference between 'Cum-dividend' and 'Ex-dividend' price when calculating Cost of Equity?
A.Cum-dividend includes the right to receive the declared dividend; Ex-dividend does not.
B.Cum-dividend is for debt; Ex-dividend is for equity.
C.There is no difference.
D.Ex-dividend is always higher than Cum-dividend.
Correct Answer: Cum-dividend includes the right to receive the declared dividend; Ex-dividend does not.
Explanation:When calculating using , one should use the Ex-dividend price (current value of future cash flows). If given Cum-dividend, subtract the declared dividend.
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38In the WACC calculation , what does represent?
A.Weight of Dividend
B.Weight of Debt
C.Weighted Depreciation
D.World Debt Index
Correct Answer: Weight of Debt
Explanation: represents the proportion of debt in the total capital structure.
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39Which of the following creates a 'Fixed Financial Charge' for a company?
A.Equity Capital
B.Retained Earnings
C.Long-term Debt
D.Trade Creditors
Correct Answer: Long-term Debt
Explanation:Long-term debt requires mandatory regular interest payments regardless of profit, creating a fixed financial charge.
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40If a company has a Beta of 0, its expected return should theoretically equal:
A.The Market Return ()
B.The Risk-Free Rate ()
C.Zero
D.The Inflation Rate
Correct Answer: The Risk-Free Rate ()
Explanation:In CAPM, if , the term becomes 0, leaving only .
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41Lease financing where the lessor maintains the asset and the lease is short-term is called:
A.Financial Lease
B.Operating Lease
C.Leveraged Lease
D.Sale and Leaseback
Correct Answer: Operating Lease
Explanation:Operating leases are short-term, cancellable, and the lessor usually bears maintenance and obsolescence risks.
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42The marginal cost of capital is:
A.The average cost of existing capital
B.The cost of raising one additional unit of new capital
C.The cost of debt only
D.The cost of the cheapest source available
Correct Answer: The cost of raising one additional unit of new capital
Explanation:Marginal cost of capital refers to the cost of the next dollar of capital raised, which is crucial for new investment decisions.
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43Which of the following is a feature of Preference Shares?
A.Unlimited voting rights
B.Tax-deductible dividends
C.Fixed rate of dividend
D.No claim on assets during liquidation
Correct Answer: Fixed rate of dividend
Explanation:Preference shareholders are entitled to a fixed dividend rate before equity shareholders receive anything.
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44The explicit cost of Retained Earnings is zero. This statement is:
A.True
B.False
C.Depends on the tax rate
D.True only for private companies
Correct Answer: False
Explanation:While there is no cash outflow (explicit cost), there is an implicit opportunity cost. Shareholders could have invested that money elsewhere.
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45If flotation costs are 5%, and the market price of a share is NPK_e$ calculation for new shares?
A.$20
B.$21
C.$19
D.$1
Correct Answer: $19
Explanation:. Cost = . .
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46A bond that is issued at a deep discount and pays no interest during its life is called a:
A.Junk Bond
B.Zero Coupon Bond
C.Floating Rate Bond
D.Convertible Bond
Correct Answer: Zero Coupon Bond
Explanation:Zero coupon bonds do not pay periodic interest; the return is the difference between the discounted issue price and the face value at maturity.
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47In the context of WACC, as the Debt-to-Equity ratio increases significantly, the Cost of Equity () typically:
A.Decreases
B.Remains constant
C.Increases
D.Becomes zero
Correct Answer: Increases
Explanation:As leverage (debt) increases, financial risk increases. Equity holders demand a higher premium for this increased risk, raising .
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48What is 'Ploughing Back of Profits'?
A.Returning capital to shareholders
B.Paying dividends
C.Retaining earnings for internal financing
D.Buying back shares
Correct Answer: Retaining earnings for internal financing
Explanation:Ploughing back of profits is a synonym for retained earnings, meaning profits are reinvested into the business rather than distributed.
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49Which of the following is considered a 'hybrid' security?
A.Common Stock
B.Bank Overdraft
C.Preference Shares
D.Trade Credit
Correct Answer: Preference Shares
Explanation:Preference shares are hybrids because they have features of equity (ownership/dividends) and debt (fixed payments/priority over common stock).
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50The primary significance of calculating the Weighted Average Cost of Capital (WACC) is to:
A.Calculate tax liability
B.Determine the salary of the CFO
C.Serve as a benchmark for accepting or rejecting investment projects
D.Determine the marketing budget
Correct Answer: Serve as a benchmark for accepting or rejecting investment projects
Explanation:WACC is the hurdle rate. Projects yielding returns higher than WACC add value to the firm; those yielding less destroy value.
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