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Unit 5: Capital Structure and Dividend Theory - Practice Quiz

FIN212 — Basic Financial Management 50 Questions
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1 Which of the following best defines Capital Structure?

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

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

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

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

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 becomes zero
D. It decreases

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

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

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 process of issuing bonus shares
D. The ratio of sales to variable costs

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

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

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

A.
B.
C.
D.

11 The term 'Trading on Equity' refers to:

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

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. Arbitrage
B. Amortization
C. Speculation
D. Hedging

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

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

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

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

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

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

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

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

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

19 What is a Scrip Dividend?

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

20 The Dividend Payout Ratio is calculated as:

A.
B.
C.
D.

21 Which of the following is a Dividend Relevance Theory?

A. NOI Approach
B. Modigliani-Miller Model
C. Walter’s Model
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. Be indifferent
C. Retain 100% earnings
D. Distribute 50% dividends

23 What is the formula for Walter’s Model?

A.
B.
C.
D.

24 Gordon’s Model assumes that:

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

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

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

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

28 What is the Residual Theory of Dividends?

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

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

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

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

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

31 The Clientele Effect suggests that:

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

32 What is the Information Content (Signaling) Hypothesis?

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

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

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

34 An Interim Dividend is declared:

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

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

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

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

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

37 The Ex-Dividend Date is:

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

38 Which factor is LEAST likely to influence dividend policy?

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

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

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

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

A. Retained Earnings first, then Debt, then Equity
B. External Equity first
C. Debt first
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 Operating Income Approach
B. MM Approach
C. Net Income Approach
D. Traditional Approach

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

A. Shareholders and Managers
B. Customers and Suppliers
C. Shareholders and Bondholders/Creditors
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 never pays dividends
D. It pays a fixed dollar amount regardless of earnings

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

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

49 Which of the following describes a Regular Dividend Policy?

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

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

A.
B.
C.
D.
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