Q.1.
In case of Net Income Approach, when the debt proportion is increased, the cost of debt:
A. Increases
B. Decreases
C. Constant
D. None of the above.
Q.2. The common stock of Metal Magic has a negative growth rate of 1.5 percent and a required return
of 18 percent. The current stock price is Rs. 11.40. What was the amount of the last dividend paid?
A. Rs. 2.07
B. Rs. 2.19
C. Rs. 2.22
D. Rs. 2.26
Q.3. The term "capital structure" refers to:
A. long-term debt, preferred stock, and common stock equity.
B. current assets and current liabilities.
C. total assets minus liabilities.
D. shareholders' equity.
Q.4. A critical assumption of the net operating income (NOI) approach to valuation is:
A. that debt and equity levels remain unchanged.
B. that dividends increase at a constant rate.
C. that ko remains constant regardless of changes in leverage.
D. that interest expense and taxes are included in the calculation.
Q.5. The traditional approach towards the valuation of a company assumes that __________.
A. the cost of capital is independent of the capital structure of the firm
B. the firm maintains constant risk regardless of the type of financing employed
C. there exists no optimal capital structure
D. that management can increase the total value of the firm through the judicious use of
financial leverage
Q.6. Springer, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is
34 percent. What is the cost of equity if the after-tax cost of debt is 5.5 percent?
A. 13.75 percent
B. 14.41 percent
C. 14.79 percent
D. 15.82 percent
Q.7. Mangrove Fruit Farms has a Rs. 200,000 bond issue outstanding that is selling at 92 percent of
face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock
outstanding. The preferred stock has a market price of Rs. 35 a share compared to a price of Rs. 24 a
share for the common stock. What is the weight of the preferred stock as it relates to the firm's
weighted average cost of capital?
A. 8.80 percent
B. 8.30 percent
C. 7.75 percent
D. 6.75 percent
Q.8. Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar
characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred
stock and 2.5 million shares of common stock outstanding. The preferred stock sells for Rs. 53 a share.
The common stock has a beta of 1.34 and sells for Rs. 42 a share. The U.S. Treasury bill is yielding 2.8
percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is
the firm's weighted average cost of capital?
A. 10.39 percent
B. 10.64 percent
C. 11.18 percent
D. 11.30 percent
Q.9. Flex Company has net operating income of Rs. 10 million and Rs. 20 million of debt with a 7
percent interest rate. The earnings of the company are not expected to grow, and all earnings are paid
out to shareholders in the form of dividends. In all cases, assume no taxes. Using the net operating
income approach with an equity capitalization rate of 12.5 percent at the Rs. 20 million debt level,
what is the total value of the firm (in Rs.) and the implied overall capitalization rate, ko?
A. 62,700,000 and 13.37 percent
B. 88,800,000 and 11.26 percent
C. 76,400,000 and 10.54 percent
D. None of these
Q.10. DLKH Inc. is currently at its target debt-equity ratio of 2:3. It is evaluating a proposal to expand
capacity which is expected to cost Rs. 10 million and generate after-tax cash flows of Rs. 4 million per
year for the next 5 years. The tax rate for the company is 35 percent. Two financing options are being
looked at:
• Issue of equity stock. The required return on the company’s new equity is 20 percent. The
issuance cost will be 10 percent.
• Issue of debentures carrying a yield of 15 percent. The issuance cost will be 3 percent.
What is the NPV of the expansion project?
A. Rs. 51,23,378
B. Rs. 38,32,153
C. Rs. 23,51,738
D. Rs. 27,15,862
Q.11. A Limited and B Limited are identical except for capital structures. A Ltd. Has 50 % debt and 50
% equity, whereas B Ltd. has 20 % debt and 80 % equity (all percentages are in market value terms).
The borrowing rate for both companies is 8 % in a no-tax world, and capital markets are assumed to
be perfect. If you own 2 % of the shares of A Ltd. and the company has a net operating income of Rs.
3,60,000 and the overall capitalization rate of the company, k0 is 18%, what is the implied required
rate of return on equity?
A. 26%
B. 27%
C. 28%
D. 29%
Q.12. In the above question, if B Ltd. has the same net operating income as A Ltd., what is the implied
equity return of B Ltd.?
A. 20.2%
B. 20.5%
C. 20.8%
D. 20.9%
ANSWERS
Q.1 Q.2 Q.3 Q.4 Q.5 Q.6 Q.7 Q.8 Q.9 Q.10 Q.11 Q.12
C D A C D D A A B C C B
