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Unit 5 - Practice Quiz

FIN212

1 Which of the following best defines Capital Structure?

A. The mix of current assets and current liabilities
B. The mix of a firm's permanent long-term financing represented by debt, preferred stock, and common equity
C. The total assets of the company
D. The ratio of dividends to earnings

2 What is the primary objective of achieving an Optimum Capital Structure?

A. To maximize the Weighted Average Cost of Capital (WACC)
B. To minimize the Value of the Firm
C. To minimize the WACC and maximize the Value of the Firm
D. To eliminate all debt from the balance sheet

3 Under the Net Income (NI) Approach, what is the assumed relationship between the cost of debt () and the cost of equity ()?

A.
B.
C.
D. There is no relationship

4 According to the Net Operating Income (NOI) Approach, how does the overall cost of capital () behave as leverage increases?

A. It decreases continuously
B. It increases continuously
C. It remains constant
D. It first decreases and then increases

5 Which of the following is considered an Irrelevance Theory of capital structure?

A. Net Income Approach
B. Traditional Approach
C. Modigliani-Miller (MM) Approach without taxes
D. Pecking Order Theory

6 In the Traditional Approach to capital structure, what happens to the overall cost of capital () initially when debt is introduced?

A. It increases immediately
B. It remains constant
C. It decreases
D. It becomes zero

7 The Modigliani-Miller (MM) Hypothesis with corporate taxes suggests that:

A. Capital structure is irrelevant
B. Value of the firm decreases with debt
C. Value of the firm increases with debt due to the tax shield
D. Dividends are irrelevant

8 What is Financial Leverage?

A. The use of fixed-cost assets in operations
B. The use of fixed-income securities (debt/preference shares) in the capital structure
C. The ratio of sales to variable costs
D. The process of issuing bonus shares

9 In the context of capital structure, what is the Point of Indifference?

A. The EBIT level where EPS is the same for two different financing plans
B. The level of sales where total revenue equals total cost
C. The point where the firm declares bankruptcy
D. The dividend payout ratio where share price is maximized

10 Which formula represents the Value of the Firm ()?

A.
B.
C.
D.

11 The term 'Trading on Equity' refers to:

A. Buying and selling shares in the stock market
B. Using borrowed funds to increase the return on owner's equity
C. Exchanging equity for debt
D. Issuing shares at a premium

12 Under the MM Hypothesis, the mechanism that restores equilibrium between the value of levered and unlevered firms (in a no-tax world) is called:

A. Hedging
B. Speculation
C. Arbitrage
D. Amortization

13 Which of the following is NOT an assumption of the Modigliani-Miller (MM) Theory?

A. Perfect capital markets
B. No transaction costs
C. Asymmetric information
D. Homogeneous risk classes

14 In the Net Income Approach, what happens to the Weighted Average Cost of Capital (WACC) as the Debt-Equity ratio increases?

A. WACC increases
B. WACC decreases
C. WACC remains constant
D. WACC becomes zero

15 According to the NOI Approach, the cost of equity ():

A. Remains constant as leverage increases
B. Decreases as leverage increases
C. Increases linearly with leverage to offset cheap debt
D. Fluctuates randomly

16 Which of the following represents the formula for the Value of a Levered Firm () under MM with taxes?

A.
B.
C.
D.

17 Business Risk depends on:

A. The capital structure decision
B. The firm's operating environment and nature of business
C. The dividend policy
D. The amount of debt issuance

18 Which form of dividend involves the distribution of shares in lieu of cash?

A. Scrip Dividend
B. Bond Dividend
C. Stock Dividend (Bonus Shares)
D. Property Dividend

19 What is a Scrip Dividend?

A. Payment in cash
B. Promise to pay dividend at a future date via a promissory note
C. Distribution of inventory
D. Buying back shares

20 The Dividend Payout Ratio is calculated as:

A.
B.
C.
D.

21 Which of the following is a Dividend Relevance Theory?

A. Modigliani-Miller Model
B. Walter’s Model
C. NOI Approach
D. Arbitrage Pricing Theory

22 In Walter’s Model, if the return on investment () is greater than the cost of equity capital (), the firm should:

A. Distribute 100% dividends
B. Retain 100% earnings
C. Distribute 50% dividends
D. Be indifferent

23 What is the formula for Walter’s Model?

A.
B.
C.
D.

24 Gordon’s Model assumes that:

A. Internal rate of return () changes with investment
B. The firm has a finite life
C. Retention ratio () and internal rate of return () are constant
D. External financing is used extensively

25 The 'Bird-in-the-hand' argument supports which view?

A. Dividend Irrelevance
B. High dividend payout is preferred to reduce uncertainty
C. Capital gains are preferred over dividends
D. Dividends should never be paid

26 In Gordon’s Model, the value of a share () is given by:

A.
B.
C.
D.

27 The MM Dividend Irrelevance Theory relies heavily on the concept of:

A. Tax Shields
B. Arbitrage
C. Bird-in-the-hand
D. Variable Growth

28 What is the Residual Theory of Dividends?

A. Dividends are paid before anything else
B. Dividends are paid only if there are leftover funds after meeting all attractive investment opportunities
C. Dividends are constant every year
D. Dividends are equal to the residual value of assets

29 Which of the following is a legal constraint on paying dividends?

A. Target Payout Ratio
B. Capital Impairment Rule
C. Stock Market Reaction
D. Shareholder Preference

30 According to Walter's Model, for a declining firm where , the optimal payout ratio is:

A. 0%
B. 50%
C. 100%
D. Variable

31 The Clientele Effect suggests that:

A. All investors want the same dividend policy
B. Investors choose stocks based on the company’s dividend policy matching their own needs
C. Companies should change their dividend policy frequently
D. Dividends are irrelevant

32 What is the Information Content (Signaling) Hypothesis?

A. Dividends convey information about future earnings prospects
B. Dividends reduce the cash balance
C. Investors ignore dividends
D. Dividends are taxed higher than capital gains

33 Which of the following is a form of dividend where assets other than cash are distributed?

A. Cash Dividend
B. Property Dividend
C. Stock Dividend
D. Interim Dividend

34 An Interim Dividend is declared:

A. At the Annual General Meeting
B. Between two Annual General Meetings
C. Only when the company is winding up
D. After the financial year ends

35 Under the MM Dividend Model, the value of the firm at the end of the period () is calculated assuming:

A. New shares are issued to finance investment and dividends
B. No new shares can be issued
C. Debt is increased
D. Assets are sold

36 What effect does a Bonus Issue have on the net worth of the company?

A. Increases net worth
B. Decreases net worth
C. No change in total net worth
D. Increases liabilities

37 The Ex-Dividend Date is:

A. The date dividends are paid
B. The date the board declares the dividend
C. The date on or after which a security is traded without a previously declared dividend
D. The date shareholders must be registered to receive dividends

38 Which factor is LEAST likely to influence dividend policy?

A. Liquidity position
B. Legal constraints
C. Access to capital markets
D. The color of the company logo

39 In Gordon's Model, if is the retention ratio, then represents:

A. Growth rate
B. Payout ratio
C. Cost of equity
D. Tax rate

40 The Pecking Order Theory (often discussed alongside Trade-off theory) implies firms prefer:

A. External Equity first
B. Debt first
C. Retained Earnings first, then Debt, then Equity
D. Equity first, then Debt

41 What is the relationship between Growth Rate (), Retention Ratio (), and Return on Equity ()?

A.
B.
C.
D.

42 Which theory suggests that the shape of the average cost of capital curve is saucer-shaped?

A. Net Income Approach
B. Net Operating Income Approach
C. Traditional Approach
D. MM Approach

43 Agency Costs of debt arise due to conflicts of interest between:

A. Shareholders and Managers
B. Shareholders and Bondholders/Creditors
C. Customers and Suppliers
D. Government and Company

44 If a firm has a Target Payout Ratio, it implies:

A. It pays 100% of earnings always
B. It tries to maintain a stable percentage of earnings as dividends over the long run
C. It pays a fixed dollar amount regardless of earnings
D. It never pays dividends

45 The assumption that 'Dividends and Capital Gains are taxed at the same rate' belongs to:

A. MM Hypothesis (Perfect Markets)
B. Traditional View
C. Bird-in-the-hand
D. Real-world tax systems

46 What is the primary formula for the Cost of Equity () in the NI approach if is not given directly?

A.
B.
C.
D.

47 A Bond Dividend is primarily used when:

A. The company has excess cash
B. The company wants to reduce debt
C. The company has no cash but wants to pay a dividend
D. The company is merging

48 In the context of Capital Structure, . If taxes exist, and the firm issues debt to buy back equity, what happens to according to MM?

A. increases by the present value of tax shields
B. decreases
C. remains constant
D. drops to zero

49 Which of the following describes a Regular Dividend Policy?

A. Payment of dividends at the usual rate per share
B. Payment of dividends only in profitable years
C. Payment of a constant percentage of earnings
D. No dividend payment

50 Under Gordon's Model, for the formula to be mathematically valid, which condition must hold?

A.
B.
C.
D.