Chapter 05 - Test Bank: Multiple Choice Questions

5. Which of the following statements is correct for an investment proposal with a positive NPV?
Chapter 05 - Test Bank

A. The discount rate exceeds the required rate of return.
B. The IRR is greater than the required rate of return.
Multiple Choice Questions C. Accepting the investment proposal has an uncertain effect on shareholders.
D. The present value of the cash flow equals the cost of the investment.
1. An investment decision differs from a financing decision in that: 6. Problems associated with calculating an internal rate of return include:
A. investment decisions relate to assets that the firm has invested in, while financing decisions relate to the A. negative cash flows during the project's lifetime.
firm's financial assets. B. choosing one project from two or more projects.
B. an investment decision first determines what assets the firm will invest in, while a financing decision C. timing of cash flows.
considers if the existing investments should be refinanced. D. All of the given answers.
C. a financing decision first determines what financial assets the firm will invest in, while an investment
decision considers how the funds will be invested. 7. When a company's project results in a return and profits which exceed the cost of its debt borrowing:
D. an investment decision first determines what assets the firm will invest in, while a financing decision
considers how the investments under consideration are to be funded.
A. both the debt holders and shareholders can share in the profits.
2. When a company decides to issue an unsecured note to pay for a new machine, it has made a/an: B. only the shareholders may share in the profits.
C. the interest payments to the debt holders may increase.
D. its cost of capital increases.
A. capital market decision.
B. money market decision. 8. Financial risk refers to the:
C. financing decision.
D. investment decision.
A. risk of owning financial assets.
3. The finance required by a company to fund its day-to-day operations is called: B. overall risk of a financial services firm.
C. risk faced by the shareholders when debt is used.
D. risk of not finding finance for a firm's investment.
A. daily financing.
B. operational financing. 9. Increasing the financial leverage of a company will _______ shareholders' expected returns and ______
C. operational capital. their risk.
D. working capital.
4. When a company decides to pay for an investment project using a short-term bank loan, this is best A. increase; not affect
described as a/an: B. increase; decrease
C. increase; increase
D. decrease; increase
B. money market decision. 10. Which of the following statements about financial risk is incorrect?
A. A rise in interest rates will adversely affect the cost of a corporation's variable debt.
B. If a corporation imports goods from overseas then an appreciation in the exchange rate will adversely
affect the company's profits.
C. If a company (A) has sold goods to another company (B) with payment due in 30 days but company B
has gone into liquidation then company A faces credit default.
D. If a company breaches its debt-to-equity ratio loan covenants the value of the company may be
adversely affected.
11. Which of the following statements about financial risk is incorrect? 16. Compared with retail sector companies, banks have a:
A. The higher the debt-to-equity ratio, the higher the degree of financial risk. A. high equity-to-debt ratio.
B. Interest payments on debt must be paid when they fall due. B. low gearing ratio.
C. When a business fails equity holders rank ahead of providers of debt due to their higher financial risk. C. high debt-to-equity ratio.
D. The higher the proportion of debt the higher the potential return on shareholders' funds. D. conservative gearing ratio.
12. A company's business risk depends on: 17. The claims of the equity holders on the assets of the firm have priority over those of:
A. its use of debt in financing the business. A. the debt holders.

B. the risk of the company's operations and assets. B. the preferred shareholders.
C. how much debt a company has used. C. the unsecured debt holders.
D. the amount of shareholder equity in the company. D. no other holder.
13. Which of the following criteria would be determinants of the appropriate ratio of debt to equity if a 18. Who are sometimes referred to as the residual owners of the corporation?
company should not take on more debt than can be serviced under conservative economic forecasts?
i. Maximisation of shareholder wealth
ii. Industry norms A. The secured creditors
iii. History of the ratio for the firm B. The unsecured creditors
iv. The stage of the current economic cycle C. The common shareholders
v. Limit imposed by lenders D. The preferred shareholders
vi. The company's capacity to service debt
19. What is the function of a proxy statement for a shareholder?
A. i, iii, v, vi
B. ii, iii, v, vi A. It gives them the right of a vote for each share they own.
C. ii, iii, iv, v B. It gives them the right to transfer their share to another party.
D. iii, iv, v, vi C. It gives them the entitlement to new shares when issued.
D. It gives them the right to sell their shares at a premium.
14. Restrictions placed on borrowers by lenders in the loan agreement are called loan:
20. Which of the following statements is NOT a feature of ordinary shares?
A. covenants.
B. limits. A. Ordinary shares are a major source of external equity financing for companies.
C. arrangements. B. Ordinary shares entail voting rights at annual general meetings.
D. contracts. C. Ordinary shares have no fixed payment obligation.
D. Dividends of ordinary shares are always tax deductible.
15. An increase in a firm's level of debt will:
21. Generally, an initial public offering is:
A. reduce the business risk of the firm.

B. increase the variability in earnings per share. A. an offer to potential investors of ordinary shares to newly list a company on a stock exchange.
C. lower the expected return on shareholders' funds. B. an offer to potential investors of preference shares to newly list a company on a stock exchange.
D. increase the return to the debt holders. C. an offer to potential investors of company debentures to newly list a company on a stock exchange.
D. an offer to potential investors of unsecured notes to newly list a company on a stock exchange.
22. Holders of equity capital: 28. Compared with raising debt through a bank, the raising of equity through an IPO is generally:
A. receive interest payments. A. cheaper.

B. own the company. B. dearer.
C. have lent money to the company. C. roughly the same.
D. have a guaranteed right to income from the company. D. much cheaper.
23. Common shareholders are: 29. A financial institution involved in underwriting the sale of new securities by buying them from the issuing
firms and then reselling them to the public in the primary capital market is an:
A. guaranteed a periodic distribution of dividends

B. guaranteed a distribution in the wind-up of the company. A. investment agent.
C. guaranteed both a periodic distribution of dividends and a distribution in the wind-up of the company. B. investment broker.
D. not guaranteed a periodic distribution or a distribution in the wind-up of the company. C. investment dealer.
D. investment banker.
24. Which of the following statements best describes the role or function of the promoter of a flotation?
30. Which of the following is NOT a role of an underwriter in a public offering of shares?
A. The manager of the sub-underwriting panel or group

B. The broker responsible for the initial sale of shares to investors A. To provide pricing of the issue
C. The party seeking the flotation of the company B. To provide advice on the structure of the issue
D. The agency responsible for marketing the issue to the public C. To invest the funds raised in the offering
D. To provide guidance on the timing of the issue
25. Potential investors learn of the information concerning the company and its new issue by being sent a
_____ by the broker. 31. If, for an IPO, circumstances change and the issue becomes unattractive, the underwriters:
A. registration statement A. charge the company more for raising the funds.
B. prospectus B. charge the company less for the IPO.
C. letter of commitment C. may purchase unsubscribed shares.
D. memorandum offering D. offer the shares at a lower price.
26. As part of the listing process for an unlisted organisation, a document that provides detailed information on 32. If, for an IPO, market prices have fallen, then underwriters with an out-clause that gives a level of a
the past and forecast performance for it is a: specified price index that the index cannot fall below, then:
A. flotation statement. A. the underwriters have the right to charge the company more for raising the funds.
B. prospectus. B. the underwriters need to only purchase a specified number of shares and not the total unsold.
C. promotion report. C. the underwriters may be released from their obligations.
D. memorandum offering. D. the underwriters may offer the shares at a lower price.
27. When a company undertakes an initial public offering (IPO) it may: 33. Ordinary shares in limited liability companies are the major source of external equity funding for
Australian companies. Which of the following statements regarding the issuance of ordinary shares by a
newly listed limited liability company is incorrect?
A. issue and list debentures in the capital markets.
B. offer shares to a few public institutional investors.
C. issue and list shares in the primary share market. A. Shares may be issued on a fully paid or partly paid basis.
D. directly list corporate bonds in the capital markets. B. A holder of instalment receipts only has to pay the remaining amount when due or called.
C. Share price is determined with reference to a range of variable factors.
D. No liability company can issue shares only on a fully paid basis because of the risk.
34. Companies can raise equity capital through: 40. A company may seek to raise further funds by issuing additional ordinary shares. The terms and conditions
of the new share issue are determined by the board of directors in consultation with its financial advisers
and others, and having regard to the preferences of existing shareholders and the needs of the company.
A. the money markets. Which of the following is LEAST likely to be a determinant of the price that is eventually struck?
B. the inter-bank market.
C. retained earnings and the share market.
D. a major bank. A. The discount to current market price that can be offered to shareholders.
B. The company's cash requirements.
35. A person who is authorised to vote on a shareholder's behalf is called: C. The projected earnings flow from the new investments.
D. The cost of alternative funding sources.
A. an underwriter. 41. Some of the main principles that form the basis of a stock exchange's listing rules are:
B. a proxy.
C. an authorised shareholder.
D. a substitute. A. sufficient investor interest must be shown to warrant an entity's participation in the markets.
B. information must be produced according to the highest standards.
36. Which of the following statements about a no liability company is incorrect? C. minimum standards of quality size, operations and disclosure must be satisfied.
D. security holders must be consulted on matters of significance except for agreements between the entity
and related parties.
A. A no liability company will issue shares on a partly paid basis.
B. In Australia only mining companies can list as a no liability company. 42. A rights offering is the issue of:
C. A no liability company may also offer shareholders an option to sell shares back to the company if the
company exploration is not successful.
D. If a no liability gold-mining company discovers gold then for the product phase the company may issue A. proxies to the shareholders to use their voting rights at the annual general meeting.
a further call on the partly paid shares. B. options on shares to the general public.
C. an option to purchase shares directly to the shareholders.
37. Financing for high-risk companies is often in the form of: D. special options to the management.
43. A company may raise additional equity capital through:
A. limited liability shares.
B. no-liability shares.
C. limited instalment receipts. A. a rights issue.
D. contributing shares. B. a placement.
C. a dividend reinvestment scheme.
38. Which of the following requirements does NOT apply to a company seeking a public listing on the D. all of the given answers.
Australian Securities Exchange (ASX)?
44. A right that can only be exercised by the shareholder and not sold is called a:
A. The entity must adhere to minimum standards of quality.

B. The entity must adhere to minimum standards of disclosure. A. non-saleable right.
C. The company must issue a prospectus that is to be lodged with the ASX. B. renounceable right.
D. The company must have a structure and operation appropriate for a listed entity. C. non-renounceable right.
D. pro-rata right.
39. Most companies raise funds by selling their securities in a:
A. public float.
B. private placement.
C. stock exchange.
D. direct placement.
45. Before making a rights issue, a company's management must consider several important variables. Which 51. For a share placement, the Australian authority ASIC or ASX listing rules require:
of the following is NOT one of these variables?
A. that a placement must consist of subscriptions of not less than $1 000 000.
A. The ability of the company to service the increased equity on issue B. there must be no more than 20 participants.
B. The costs of alternative funding sources C. the discount from market price must not be above 50 per cent.
C. Whether there will be a sufficient take-up rate of the issue D. that for a company that has had total placements of more than 15 per cent in the last 12 months,
D. The effect on the firm's profits agreement for another must be sought from shareholders at the annual general meeting.
46. The subscription price in a rights offering is generally: 52. Share placements may, subject to compliance with certain regulations, be made to institutional investors.
Which of the following conditions is NOT a requirement of the Australian authority ASIC for share
placements?
A. below the current share price.
B. equal to the current share price.
C. above the current share price. A. The placement should consist of minimum subscriptions of $500 000, or be made up of not more than
D. not related to the share price. 20 participants.
B. The discount from current market price should not be excessive.
47. Which of the following is generally NOT a characteristic of rights? C. Under no circumstances should placements be in excess of 10% of the issued shares permitted.
D. There is no need to register a prospectus, but a memorandum of information detailing the company's
activities should be sent to all participants.
A. No expiration date
B. If exercised, results in the dilution of earnings for existing shareholders 53. If a company raises equity funds by issuing shares to a selected number of institutional investors, this is
C. Saleability known as:
D. Potential listing on a stock exchange
48. A pro-rata share rights offer means that the offer: A. a share appointment.
B. a placement.
C. a share rights issue.
A. must be made to all the stakeholders of a company. D. share transfer.
B. must be made to bond holders and shareholders who get their offer in before a cut-off date.
C. must be made to shareholders on the basis of the number of shares already held. 54. Compared with a pro-rata issue of shares, placements usually:
D. is made only to the shareholders with the largest number of shares on the share register at a cut-off date.
49. A pro-rata share rights offer of 1:5 gives existing shareholders: A. take a longer time to organise.
B. can be carried out much more quickly.
C. involve a far greater discount to the current market price.
A. the right to purchase one new share for every five shares held. D. involve no more than 50 participants.
B. the right to purchase five new shares for every one share held.
C. the right to purchase one share for every 1/5 shares held. 55. The main advantage of placements to raise additional equity funds compared to a rights issue is:
D. the right to purchase 10 shares for every five shares held.
50. For a share placement, the Australian authority ASIC requires: A. the discount to current market price may be less.
B. it can be carried out much more quickly.
C. a selective placement can sell shares to friendly institutional investors.
A. that a placement must consist of subscriptions of not less than $1 000 000. D. it reduces the proportion of ownership by existing shareholders.
B. that any discount from the current market price not be more than 10%.
C. a memorandum of information to be sent to all participating institutions.
D. a prospectus, which can be filed with them after the event.
56. When a takeover company issues additional shares to fund the acquisition of the shares in a target company 62. Any unpaid dividends that must be paid before payment of dividends to ordinary shareholders are called
this is called: _________ preference shares.
A. a seasoned share offering. A. participating

B. an equity-funded takeover. B. cumulative
C. an initial share takeover. C. non-cumulative
D. a rights offering. D. secured
57. Which of the following does NOT apply to a dividend reinvestment plan? 63. A company is likely to issue _____ if it has reached its optimal gearing level.
A. A dividend reinvestment plan forms additional equity financing for the company. A. options
B. For a dividend reinvestment scheme the company typically bears the associated transaction costs. B. rights
C. Companies have encouraged shareholders to use dividend reinvestment plans. C. ordinary shares
D. Shareholders have the chance of purchasing additional shares through a dividend reinvestment plan. D. preference shares
58. Which of the following is NOT a feature of a dividend reinvestment scheme for a company? 64. Holders of _________ preference shares are entitled to dividend payments beyond the stated dividend rate.
A. Shareholders can acquire company shares at little or no transaction cost. A. participating

B. Shareholders can increase their return on the company share concerned. B. cumulative
C. The company can obtain additional equity funding. C. non-cumulative
D. The shareholders can redeem shares for dividends. D. secured
59. A dividend reinvestment plan generally _______ on the security. 65. A preference share issue offers all of the following advantages to a company except:
A. decreases the return A. a flexible dividend policy.

B. increases the return B. fixed interest borrowings that can count as equity.
C. has no effect on the return C. extension of the equity base of the company.
D. has an uncertain effect D. an indefinite maturity.
60. Dividend reinvestment schemes are a significant source of equity for many Australian companies. Which of 66. Which of the following is NOT a feature of preference shares?
the following advantages of dividend reinvestment schemes may, at times, also be regarded as a
disadvantage?
A. Convertible
B. Redeemable
A. The shareholder avoids transaction costs on the share issue. C. Cumulative
B. The share issue price is usually at a discount to the average market price. D. An important source of company funding
C. Such schemes allow dividends to be paid while retaining cash for future growth.
D. The company is able to pass on franking credit to its shareholders. 67. Preference shares:
61. _______ are promised a fixed periodic dividend, the payment of which must be paid before that of ordinary
shares. A. have their dividend fixed at the issue date.
B. rank behind ordinary shares in the payment of dividends.
C. rank behind ordinary shareholders in their claim on company assets in the event of liquidation.
A. Common shareholders D. rank ahead of the company creditors.
B. Preferred shareholders
C. Stakeholders
D. Creditors
68. Preference shares have a number of features similar to debt that distinguish them from ordinary shares. 73. Which of the following is NOT a feature of convertible notes?
Which of the following features may be incorporated in a preference share issue?
i. Cumulative or non-cumulative
ii. Convertible or non-convertible A. Convertible notes are usually issued at a price close to the market price of the share.
iii. Redeemable or non-redeemable B. The expectation of the note holder is that the share price will increase over the term of the note.
iv. Issued at different rankings C. Convertible notes offer a higher interest rate than straight debt instruments.
v. Participating or non-participating D. A convertible note may be made by direct placement to shareholders.
74. An advantage of a convertible security for a company is that it can generally be sold with interest rates
A. i, ii, iii, iv _______ other non-convertible debt securities.
B. i, ii, iv, v
C. ii, iii, iv, v
D. All of the given answers A. higher than
B. equal to
69. Convertible preference shares are normally converted into: C. lower than
D. unrelated to
A. debentures. 75. The buyer of a convertible security accepts a lower rate of interest because of:
B. bonds.
C. shares.
D. warrants. A. a lower default risk.
B. the possibility that the company may recall the security.
70. Compared with ordinary shares, preference shares usually: C. the accessibility of funds.
D. the possibility of becoming a shareholder in the future.
A. rank ahead of a company's creditors in the case of a wind-up. 76. When a convertible security is issued, the issue price is usually _______ the current market price of the
B. have dividends set at issue. company's share.
C. are viewed as debt financing.
D. pay their dividends after ordinary shares.
A. well below
71. A convertible note is a/an: B. close to
C. well above
D. not related to
A. equity instrument that converts into debt at maturity.
B. equity instrument that converts into a specified number of shares at maturity. 77. Which of the following is NOT an advantage for a company that issues a convertible note?
C. debt instrument that the holder has the option to convert into an initially specified number of shares.
D. warrant that the holder has the option to convert into an initially agreed-upon number of shares.
A. A lower interest rate can be offered, compared with straight debt.
72. Which of the following statements is NOT a feature of convertible notes? B. It offers a method of raising cheap funds for the time being.
C. A longer maturity can often be offered.
D. There is an increase in financial leverage upon conversion.
A. Convertible notes offer a lower interest rate than straight debt instruments.
B. Convertible notes are usually made available to ordinary shareholders. 78. A company is advised to issue convertible notes. They are advised of the conditions applicable to the
C. Maturity of convertible notes is usually shorter than straight debt instruments. convertible note issue. Which of the following conditions is incorrect?
D. Note holders can generally participate in new issues of equity.
A. The holder of the note has the right to convert the note into preference shares.
B. Notes are generally available on a pro-rata entitlement to shareholders.
C. Entitlements to convertible notes are generally not renounceable.
D. Notes are usually issued at a price close to the current share price at the time of issue.
79. Compared with straight debt, convertible notes may offer a company: 85. Which one of the following conditions for an equity warrant that is generally attached to a bond issue is
NOT correct?
A. lower borrowing costs.

B. higher borrowing costs. A. The holder has a conditional option to convert into ordinary shares of a company.
C. a chance to issue more shares at maturity. B. A warrant holder receives dividend payments over the life of the warrant.
D. the opportunity to reduce debt. C. Warrants may be detachable and traded separately from the bond issue.
D. The cost of borrowing through a bond issue may be lower with a warrant attached.
80. When a company wants to increase the marketability of a rights issue, it may offer:
86. Which of the following factors of company-issued equity warrants is NOT correct?
A. preference shares attached.

B. options attached. A. They are often detachable.
C. convertible notes attached. B. They add to the marketability of an issue.
D. dividends attached. C. They may offer an investor an opportunity of buying stock at a discount.
D. Their exercise period is usually shorter than three months.
81. When warrants are converted by a holder:
87. Which of the following about equity warrants is NOT correct?
A. debt is decreased.
B. debt is decreased but equity also increases. A. If the warrant is non-detachable it can only be sold with the associated bond.
C. only the number of shares increases. B. Equity warrants add to the marketability of a corporate bond issue.
D. there is no impact on the company's capital structure. C. Equity warrants give an investor the right to convert the warrant into shares at a specified price.
D. A warrant holder receives a dividend, unlike a rights holder.
82. Which of the following is NOT an advantage for a company that sells a company-issued option with a
rights issue? 88. Which of the following statements about company-issued equity warrants is incorrect?
A. It may add to the marketability of the associated rights issue. A. The terms of a warrant may allow the warrant to be detachable from the bond issue.
B. It reduces the necessity for the company to increase dividend payments immediately. B. A company-issued equity warrant generally attaches to a bond issue.
C. If the holder of the option exercises the right to buy the shares offered then the company raises C. Because company-issued equity warrants are attached to a bond they have no value.
additional equity funds. D. Warrants may lower the costs of borrowing associated with the issue of the underlying corporate bond.
D. There is no certainty that the future funds from the exercise of the option will eventuate.
89. Which of the following is NOT a similarity between a right and a warrant?
A. They both provide the right, without the obligation, to purchase a specified number of shares at a
A. Adding equity warrants to a bond issue increases its marketability. predetermined price.
B. Warrants are similar to conversion features on some bonds. B. A right and a warrant both result in the company raising additional equity capital.
C. Warrants can be detached from the bond issue and sold separately. C. A right and a warrant can both be detached from the debt issue and traded separately.
D. Dividends for warrants are usually lower than for ordinary shares. D. A right and a warrant both have similar maturities.
84. Which financial instrument gives the holder an option to purchase a specified number of shares at a 90. Which of the following requirements does NOT apply to a company seeking a public listing on the ASX?
predetermined price over a given period?
A. The entity must satisfy either the profit test or the net tangible assets test.
A. An equity warrant B. The company must have at least 500 holders of a parcel of main class securities valued at least $2000.
B. A put option C. The company must lodge a prospectus with the ASX on an annual basis.
C. An ordinary preference share D. The company must have a structure and operation appropriate for a listed entity.
D. A debenture
91. The internal relationship between shareholders, the board of directors and the managers of a company is 100. Limited liability shares are generally sold to investors on a fully paid basis.
called:
True False
A. agency theory. 101. A pro-rata offer of rights to existing shareholders must be accompanied by a prospectus.
B. corporate governance.
C. commercial theory. True False
D. organisational governance.
Short Answer Questions

True / False Questions
102. What is capital budgeting and explain its importance for a company.
92. A principal objective of a business organisation is the maximisation of its profits.
True False
93. The investment decision for a corporation involves the types of securities it is going to issue or invest in.
True False
94. If the calculated IRR on an investment proposal is greater than the required rate of return, the company
should proceed with the project.
103. Discuss relevant issues for a company that needs to decide on how to finance its investment decisions.
True False
95. Business risk is determined in part by a corporation's choice of business activity and the manner in which it
has financed those activities.
True False
96. A low debt-to-equity ratio for a company means that a rise in interest rates will not affect the variable-rate
debt issued by the company.
True False 104. A stock exchange seeks to maintain the integrity and efficiency of its markets. Discuss some ways it may
achieve this.
97. Financial risk refers to risks arising from the different types of debt securities issued by a company.
True False
98. A company's debt-to-equity ratio is determined in practice with reference to four main criteria and not by
finance theory.
True False
99. In consultation with a company, the promoter (an investment bank) will seek flotation of the company
shares.
True False
105. Discuss the attractions of a private placement for a company.
Chapter 05 - Test Bank Key
Multiple Choice Questions
1. An investment decision differs from a financing decision in that:
106. What is an equity-funded takeover? A. investment decisions relate to assets that the firm has invested in, while financing decisions relate to
the firm's financial assets.
B. an investment decision first determines what assets the firm will invest in, while a financing decision
considers if the existing investments should be refinanced.
C. a financing decision first determines what financial assets the firm will invest in, while an investment
decision considers how the funds will be invested.
D. an investment decision first determines what assets the firm will invest in, while a financing decision
considers how the investments under consideration are to be funded.
Difficulty: Medium
Est time: <1 minute
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision.
Section: 5.1 The investment decision: capital budgeting
2. When a company decides to issue an unsecured note to pay for a new machine, it has made a/an:

B. money market decision.
Difficulty: Easy
Est time: <1 minute
3. The finance required by a company to fund its day-to-day operations is called:
A. daily financing.
B. operational financing.
C. operational capital.
D. working capital.
Difficulty: Easy
Est time: <1 minute
Section: Introduction
4. When a company decides to pay for an investment project using a short-term bank loan, this is best 8. Financial risk refers to the:
described as a/an:
A. risk of owning financial assets.

A. capital market decision. B. overall risk of a financial services firm.
B. money market decision. C. risk faced by the shareholders when debt is used.
C. financing decision. D. risk of not finding finance for a firm's investment.
Difficulty: Easy
Est time: <1 minute
Difficulty: Easy
Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity.
Est time: <1 minute
Section: 5.2 The financing decision: equity, debt and risk
9. Increasing the financial leverage of a company will _______ shareholders' expected returns and ______
5. Which of the following statements is correct for an investment proposal with a positive NPV? their risk.
A. The discount rate exceeds the required rate of return. A. increase; not affect
B. The IRR is greater than the required rate of return. B. increase; decrease
C. Accepting the investment proposal has an uncertain effect on shareholders. C. increase; increase
D. The present value of the cash flow equals the cost of the investment. D. decrease; increase
Difficulty: Medium Difficulty: Medium
Est time: <1 minute Est time: <1 minute
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision. Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity.
Section: 5.1 The investment decision: capital budgeting Section: 5.2 The financing decision: equity, debt and risk
6. Problems associated with calculating an internal rate of return include: 10. Which of the following statements about financial risk is incorrect?
A. negative cash flows during the project's lifetime. A. A rise in interest rates will adversely affect the cost of a corporation's variable debt.
B. choosing one project from two or more projects. B. If a corporation imports goods from overseas then an appreciation in the exchange rate will
C. timing of cash flows. adversely affect the company's profits.
D. All of the given answers. C. If a company (A) has sold goods to another company (B) with payment due in 30 days but company
B has gone into liquidation then company A faces credit default.
Difficulty: Medium
Est time: <1 minute D. If a company breaches its debt-to-equity ratio loan covenants the value of the company may be
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision. adversely affected.
Difficulty: Easy
7. When a company's project results in a return and profits which exceed the cost of its debt borrowing: Est time: <1 minute
A. both the debt holders and shareholders can share in the profits. 11. Which of the following statements about financial risk is incorrect?
B. only the shareholders may share in the profits.
C. the interest payments to the debt holders may increase.
D. its cost of capital increases. A. The higher the debt-to-equity ratio, the higher the degree of financial risk.
B. Interest payments on debt must be paid when they fall due.
Difficulty: Medium
Est time: <1 minute C. When a business fails equity holders rank ahead of providers of debt due to their higher financial
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision. risk.
D. The higher the proportion of debt the higher the potential return on shareholders' funds.
Difficulty: Easy
Est time: <1 minute
12. A company's business risk depends on:
16. Compared with retail sector companies, banks have a:
A. its use of debt in financing the business.

B. the risk of the company's operations and assets. A. high equity-to-debt ratio.
C. how much debt a company has used. B. low gearing ratio.
D. the amount of shareholder equity in the company. C. high debt-to-equity ratio.
D. conservative gearing ratio.
Difficulty: Easy
Est time: <1 minute Difficulty: Medium
Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity. Est time: <1 minute
Section: 5.2 The financing decision: equity, debt and risk Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity.
13. Which of the following criteria would be determinants of the appropriate ratio of debt to equity if a
company should not take on more debt than can be serviced under conservative economic forecasts? 17. The claims of the equity holders on the assets of the firm have priority over those of:
i. Maximisation of shareholder wealth
ii. Industry norms
iii. History of the ratio for the firm A. the debt holders.
iv. The stage of the current economic cycle B. the preferred shareholders.
v. Limit imposed by lenders C. the unsecured debt holders.
vi. The company's capacity to service debt D. no other holder.
Difficulty: Easy
Est time: <1 minute
A. i, iii, v, vi Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity.
B. ii, iii, v, vi
C. ii, iii, iv, v 18. Who are sometimes referred to as the residual owners of the corporation?
D. iii, iv, v, vi
Difficulty: Hard
Est time: <1 minute
A. The secured creditors
Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity. B. The unsecured creditors
C. The common shareholders
14. Restrictions placed on borrowers by lenders in the loan agreement are called loan: D. The preferred shareholders
Difficulty: Easy
Est time: <1 minute
A. covenants. Learning Objective: 05-03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-funding alternatives that
are available to a newly listed corporation.
B. limits. Section: 5.3 Initial public offering
C. arrangements.
19. What is the function of a proxy statement for a shareholder?
D. contracts.
Difficulty: Easy
Est time: <1 minute
A. It gives them the right of a vote for each share they own.
Section: 5.2 The financing decision: equity, debt and risk B. It gives them the right to transfer their share to another party.
C. It gives them the entitlement to new shares when issued.
15. An increase in a firm's level of debt will:
D. It gives them the right to sell their shares at a premium.
Difficulty: Easy
A. reduce the business risk of the firm. Est time: <1 minute
Learning Objective: 05-03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-funding alternatives that
B. increase the variability in earnings per share. are available to a newly listed corporation.
Section: 5.3 Initial public offering
C. lower the expected return on shareholders' funds.
D. increase the return to the debt holders.
Difficulty: Medium
Est time: <1 minute
20. Which of the following statements is NOT a feature of ordinary shares? 24. Which of the following statements best describes the role or function of the promoter of a flotation?
A. Ordinary shares are a major source of external equity financing for companies. A. The manager of the sub-underwriting panel or group
B. Ordinary shares entail voting rights at annual general meetings. B. The broker responsible for the initial sale of shares to investors
C. Ordinary shares have no fixed payment obligation. C. The party seeking the flotation of the company
D. Dividends of ordinary shares are always tax deductible. D. The agency responsible for marketing the issue to the public
Difficulty: Easy Difficulty: Easy
Learning Objective: 05-03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-funding alternatives that Learning Objective: 05-03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-funding alternatives that
are available to a newly listed corporation. are available to a newly listed corporation.
Section: 5.3 Initial public offering Section: 5.3 Initial public offering
21. Generally, an initial public offering is: 25. Potential investors learn of the information concerning the company and its new issue by being sent a
_____ by the broker.
A. an offer to potential investors of ordinary shares to newly list a company on a stock exchange.
B. an offer to potential investors of preference shares to newly list a company on a stock exchange. A. registration statement
C. an offer to potential investors of company debentures to newly list a company on a stock exchange. B. prospectus
D. an offer to potential investors of unsecured notes to newly list a company on a stock exchange. C. letter of commitment
D. memorandum offering
Difficulty: Easy
Est time: <1 minute
Difficulty: Easy
Est time: <1 minute
22. Holders of equity capital:
26. As part of the listing process for an unlisted organisation, a document that provides detailed information
on the past and forecast performance for it is a:
A. receive interest payments.
B. own the company.
C. have lent money to the company. A. flotation statement.
D. have a guaranteed right to income from the company. B. prospectus.
C. promotion report.
Difficulty: Easy
Est time: <1 minute D. memorandum offering.
are available to a newly listed corporation. Difficulty: Easy
Section: 5.3 Initial public offering Est time: <1 minute
23. Common shareholders are: Section: 5.3 Initial public offering
27. When a company undertakes an initial public offering (IPO) it may:

A. guaranteed a periodic distribution of dividends
B. guaranteed a distribution in the wind-up of the company.
C. guaranteed both a periodic distribution of dividends and a distribution in the wind-up of the A. issue and list debentures in the capital markets.
company. B. offer shares to a few public institutional investors.
D. not guaranteed a periodic distribution or a distribution in the wind-up of the company. C. issue and list shares in the primary share market.
D. directly list corporate bonds in the capital markets.
Difficulty: Medium
Est time: <1 minute
Difficulty: Medium
Est time: <1 minute
28. Compared with raising debt through a bank, the raising of equity through an IPO is generally: 32. If, for an IPO, market prices have fallen, then underwriters with an out-clause that gives a level of a
specified price index that the index cannot fall below, then:
A. cheaper.
B. dearer. A. the underwriters have the right to charge the company more for raising the funds.
C. roughly the same. B. the underwriters need to only purchase a specified number of shares and not the total unsold.
D. much cheaper. C. the underwriters may be released from their obligations.
D. the underwriters may offer the shares at a lower price.
Difficulty: Medium
Est time: <1 minute
Difficulty: Easy
Est time: <1 minute
29. A financial institution involved in underwriting the sale of new securities by buying them from the
issuing firms and then reselling them to the public in the primary capital market is an: 33. Ordinary shares in limited liability companies are the major source of external equity funding for
Australian companies. Which of the following statements regarding the issuance of ordinary shares by a
newly listed limited liability company is incorrect?
A. investment agent.
B. investment broker.
C. investment dealer. A. Shares may be issued on a fully paid or partly paid basis.
D. investment banker. B. A holder of instalment receipts only has to pay the remaining amount when due or called.
C. Share price is determined with reference to a range of variable factors.
Difficulty: Easy
Est time: <1 minute D. No liability company can issue shares only on a fully paid basis because of the risk.
are available to a newly listed corporation. Difficulty: Hard
30. Which of the following is NOT a role of an underwriter in a public offering of shares? Section: 5.3 Initial public offering
34. Companies can raise equity capital through:

A. To provide pricing of the issue
B. To provide advice on the structure of the issue
C. To invest the funds raised in the offering A. the money markets.
D. To provide guidance on the timing of the issue B. the inter-bank market.
C. retained earnings and the share market.
Difficulty: Easy
Est time: <1 minute D. a major bank.
31. If, for an IPO, circumstances change and the issue becomes unattractive, the underwriters: Section: 5.3 Initial public offering
35. A person who is authorised to vote on a shareholder's behalf is called:

A. charge the company more for raising the funds.
B. charge the company less for the IPO.
C. may purchase unsubscribed shares. A. an underwriter.
D. offer the shares at a lower price. B. a proxy.
C. an authorised shareholder.
Difficulty: Easy
Est time: <1 minute D. a substitute.
36. Which of the following statements about a no liability company is incorrect? 40. A company may seek to raise further funds by issuing additional ordinary shares. The terms and
conditions of the new share issue are determined by the board of directors in consultation with its
financial advisers and others, and having regard to the preferences of existing shareholders and the
A. A no liability company will issue shares on a partly paid basis. needs of the company. Which of the following is LEAST likely to be a determinant of the price that is
B. In Australia only mining companies can list as a no liability company. eventually struck?
C. A no liability company may also offer shareholders an option to sell shares back to the company if
the company exploration is not successful.
D. If a no liability gold-mining company discovers gold then for the product phase the company may A. The discount to current market price that can be offered to shareholders.
issue a further call on the partly paid shares. B. The company's cash requirements.
C. The projected earnings flow from the new investments.
Difficulty: Easy
Est time: <1 minute D. The cost of alternative funding sources.
are available to a newly listed corporation. Difficulty: Hard
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities.
37. Financing for high-risk companies is often in the form of: Section: 5.5 Equity-funding alternatives for listed companies
41. Some of the main principles that form the basis of a stock exchange's listing rules are:
A. limited liability shares.
B. no-liability shares.
C. limited instalment receipts. A. sufficient investor interest must be shown to warrant an entity's participation in the markets.
D. contributing shares. B. information must be produced according to the highest standards.
C. minimum standards of quality size, operations and disclosure must be satisfied.
Difficulty: Medium
Est time: <1 minute D. security holders must be consulted on matters of significance except for agreements between the
Learning Objective: 05-03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-funding alternatives that entity and related parties.
Difficulty: Medium
Est time: <1 minute
38. Which of the following requirements does NOT apply to a company seeking a public listing on the Learning Objective: 05-04 Consider important issues associated with listing a business on a stock exchange.
Section: 5.4 Listing a business on a stock exchange
Australian Securities Exchange (ASX)?
42. A rights offering is the issue of:
A. The entity must adhere to minimum standards of quality.
B. The entity must adhere to minimum standards of disclosure. A. proxies to the shareholders to use their voting rights at the annual general meeting.
C. The company must issue a prospectus that is to be lodged with the ASX. B. options on shares to the general public.
D. The company must have a structure and operation appropriate for a listed entity. C. an option to purchase shares directly to the shareholders.
Difficulty: Hard D. special options to the management.
Est time: <1 minute
Learning Objective: 05-04 Consider important issues associated with listing a business on a stock exchange. Difficulty: Easy
Section: 5.4 Listing a business on a stock exchange Est time: <1 minute
39. Most companies raise funds by selling their securities in a: Section: 5.5 Equity-funding alternatives for listed companies
43. A company may raise additional equity capital through:

A. public float.
B. private placement.
C. stock exchange. A. a rights issue.
D. direct placement. B. a placement.
C. a dividend reinvestment scheme.
Difficulty: Medium
Est time: <1 minute D. all of the given answers.
Learning Objective: 05-04 Consider important issues associated with listing a business on a stock exchange.
Section: 5.4 Listing a business on a stock exchange Difficulty: Easy
Est time: <1 minute
Section: 5.5 Equity-funding alternatives for listed companies
48. A pro-rata share rights offer means that the offer:
44. A right that can only be exercised by the shareholder and not sold is called a:
A. must be made to all the stakeholders of a company.

A. non-saleable right. B. must be made to bond holders and shareholders who get their offer in before a cut-off date.
B. renounceable right. C. must be made to shareholders on the basis of the number of shares already held.
C. non-renounceable right. D. is made only to the shareholders with the largest number of shares on the share register at a cut-off
D. pro-rata right. date.
Difficulty: Easy
Difficulty: Medium
Est time: <1 minute
Est time: <1 minute
45. Before making a rights issue, a company's management must consider several important variables. 49. A pro-rata share rights offer of 1:5 gives existing shareholders:
Which of the following is NOT one of these variables?
A. the right to purchase one new share for every five shares held.
A. The ability of the company to service the increased equity on issue B. the right to purchase five new shares for every one share held.
B. The costs of alternative funding sources C. the right to purchase one share for every 1/5 shares held.
C. Whether there will be a sufficient take-up rate of the issue D. the right to purchase 10 shares for every five shares held.
D. The effect on the firm's profits
Difficulty: Medium
Difficulty: Medium Est time: <1 minute
Est time: <1 minute Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities.
placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities. Section: 5.5 Equity-funding alternatives for listed companies
50. For a share placement, the Australian authority ASIC requires:
46. The subscription price in a rights offering is generally:
A. below the current share price. B. that any discount from the current market price not be more than 10%.
B. equal to the current share price. C. a memorandum of information to be sent to all participating institutions.
C. above the current share price. D. a prospectus, which can be filed with them after the event.
D. not related to the share price.
Difficulty: Medium
Difficulty: Medium Est time: <1 minute
Est time: <1 minute Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities.
placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities. Section: 5.5 Equity-funding alternatives for listed companies
51. For a share placement, the Australian authority ASIC or ASX listing rules require:
47. Which of the following is generally NOT a characteristic of rights?
A. No expiration date B. there must be no more than 20 participants.
B. If exercised, results in the dilution of earnings for existing shareholders C. the discount from market price must not be above 50 per cent.
C. Saleability D. that for a company that has had total placements of more than 15 per cent in the last 12 months,
D. Potential listing on a stock exchange agreement for another must be sought from shareholders at the annual general meeting.
Difficulty: Medium
Difficulty: Medium
Est time: <1 minute
Est time: <1 minute
52. Share placements may, subject to compliance with certain regulations, be made to institutional
investors. Which of the following conditions is NOT a requirement of the Australian authority ASIC for 56. When a takeover company issues additional shares to fund the acquisition of the shares in a target
share placements? company this is called:
A. The placement should consist of minimum subscriptions of $500 000, or be made up of not more A. a seasoned share offering.
than 20 participants. B. an equity-funded takeover.
B. The discount from current market price should not be excessive. C. an initial share takeover.
C. Under no circumstances should placements be in excess of 10% of the issued shares permitted. D. a rights offering.
D. There is no need to register a prospectus, but a memorandum of information detailing the company's
activities should be sent to all participants. Difficulty: Medium
Est time: <1 minute
Difficulty: Hard
Est time: <1 minute
Section: 5.5 Equity-funding alternatives for listed companies 57. Which of the following does NOT apply to a dividend reinvestment plan?
53. If a company raises equity funds by issuing shares to a selected number of institutional investors, this is
known as: A. A dividend reinvestment plan forms additional equity financing for the company.
B. For a dividend reinvestment scheme the company typically bears the associated transaction costs.
C. Companies have encouraged shareholders to use dividend reinvestment plans.
A. a share appointment.
D. Shareholders have the chance of purchasing additional shares through a dividend reinvestment plan.
B. a placement.
C. a share rights issue. Difficulty: Medium
Est time: <1 minute
D. share transfer. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Easy Section: 5.5 Equity-funding alternatives for listed companies
Est time: <1 minute
58. Which of the following is NOT a feature of a dividend reinvestment scheme for a company?
54. Compared with a pro-rata issue of shares, placements usually: A. Shareholders can acquire company shares at little or no transaction cost.
B. Shareholders can increase their return on the company share concerned.
C. The company can obtain additional equity funding.
A. take a longer time to organise.
D. The shareholders can redeem shares for dividends.
B. can be carried out much more quickly.
C. involve a far greater discount to the current market price. Difficulty: Medium
Est time: <1 minute
D. involve no more than 50 participants. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Medium Section: 5.5 Equity-funding alternatives for listed companies
Est time: <1 minute
59. A dividend reinvestment plan generally _______ on the security.
55. The main advantage of placements to raise additional equity funds compared to a rights issue is: A. decreases the return
B. increases the return
C. has no effect on the return
A. the discount to current market price may be less.
D. has an uncertain effect
B. it can be carried out much more quickly.
C. a selective placement can sell shares to friendly institutional investors. Difficulty: Medium
Est time: <1 minute
D. it reduces the proportion of ownership by existing shareholders. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Medium Section: 5.5 Equity-funding alternatives for listed companies
Est time: <1 minute
60. Dividend reinvestment schemes are a significant source of equity for many Australian companies. 64. Holders of _________ preference shares are entitled to dividend payments beyond the stated dividend
Which of the following advantages of dividend reinvestment schemes may, at times, also be regarded as rate.
a disadvantage?
A. participating
A. The shareholder avoids transaction costs on the share issue. B. cumulative
B. The share issue price is usually at a discount to the average market price. C. non-cumulative
C. Such schemes allow dividends to be paid while retaining cash for future growth. D. secured
D. The company is able to pass on franking credit to its shareholders.
Difficulty: Medium
Est time: <1 minute
Difficulty: Medium
Est time: <1 minute
65. A preference share issue offers all of the following advantages to a company except:
61. _______ are promised a fixed periodic dividend, the payment of which must be paid before that of
ordinary shares.
A. a flexible dividend policy.
B. fixed interest borrowings that can count as equity.
A. Common shareholders C. extension of the equity base of the company.
B. Preferred shareholders D. an indefinite maturity.
C. Stakeholders
Difficulty: Medium
D. Creditors Est time: <1 minute
Difficulty: Medium placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities.
Est time: <1 minute Section: 5.5 Equity-funding alternatives for listed companies
66. Which of the following is NOT a feature of preference shares?
62. Any unpaid dividends that must be paid before payment of dividends to ordinary shareholders are called
_________ preference shares. A. Convertible
B. Redeemable
C. Cumulative
A. participating D. An important source of company funding
B. cumulative
Difficulty: Easy
C. non-cumulative Est time: <1 minute
D. secured Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Medium
Est time: <1 minute
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, 67. Preference shares:
63. A company is likely to issue _____ if it has reached its optimal gearing level. A. have their dividend fixed at the issue date.
B. rank behind ordinary shares in the payment of dividends.
C. rank behind ordinary shareholders in their claim on company assets in the event of liquidation.
A. options D. rank ahead of the company creditors.
B. rights
Difficulty: Medium
C. ordinary shares Est time: <1 minute
D. preference shares Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Easy
Est time: <1 minute
68. Preference shares have a number of features similar to debt that distinguish them from ordinary shares. Section: 5.5 Equity-funding alternatives for listed companies
Which of the following features may be incorporated in a preference share issue?
i. Cumulative or non-cumulative 72. Which of the following statements is NOT a feature of convertible notes?
ii. Convertible or non-convertible
iii. Redeemable or non-redeemable
iv. Issued at different rankings A. Convertible notes offer a lower interest rate than straight debt instruments.
v. Participating or non-participating B. Convertible notes are usually made available to ordinary shareholders.
C. Maturity of convertible notes is usually shorter than straight debt instruments.
D. Note holders can generally participate in new issues of equity.
A. i, ii, iii, iv
Difficulty: Medium
B. i, ii, iv, v Est time: <1 minute
C. ii, iii, iv, v Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
D. All of the given answers Section: 5.5 Equity-funding alternatives for listed companies
Difficulty: Medium
Est time: <1 minute
73. Which of the following is NOT a feature of convertible notes?
A. Convertible notes are usually issued at a price close to the market price of the share.
69. Convertible preference shares are normally converted into: B. The expectation of the note holder is that the share price will increase over the term of the note.
C. Convertible notes offer a higher interest rate than straight debt instruments.
D. A convertible note may be made by direct placement to shareholders.
A. debentures.
Difficulty: Medium
B. bonds. Est time: <1 minute
C. shares. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
D. warrants. Section: 5.5 Equity-funding alternatives for listed companies
Difficulty: Easy
Est time: <1 minute
74. An advantage of a convertible security for a company is that it can generally be sold with interest rates
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, _______ other non-convertible debt securities.
70. Compared with ordinary shares, preference shares usually: A. higher than
B. equal to
C. lower than
A. rank ahead of a company's creditors in the case of a wind-up. D. unrelated to
B. have dividends set at issue.
Difficulty: Medium
C. are viewed as debt financing. Est time: <1 minute
D. pay their dividends after ordinary shares. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Easy
Est time: <1 minute
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, 75. The buyer of a convertible security accepts a lower rate of interest because of:
71. A convertible note is a/an: A. a lower default risk.

B. the possibility that the company may recall the security.
C. the accessibility of funds.
A. equity instrument that converts into debt at maturity. D. the possibility of becoming a shareholder in the future.
B. equity instrument that converts into a specified number of shares at maturity.
Difficulty: Medium
C. debt instrument that the holder has the option to convert into an initially specified number of shares. Est time: <1 minute
D. warrant that the holder has the option to convert into an initially agreed-upon number of shares. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
Difficulty: Easy
Est time: <1 minute
76. When a convertible security is issued, the issue price is usually _______ the current market price of the 80. When a company wants to increase the marketability of a rights issue, it may offer:
company's share.
A. preference shares attached.

A. well below B. options attached.
B. close to C. convertible notes attached.
C. well above D. dividends attached.
D. not related to
Difficulty: Medium
Est time: <1 minute
Difficulty: Medium
Est time: <1 minute
81. When warrants are converted by a holder:
77. Which of the following is NOT an advantage for a company that issues a convertible note?
A. debt is decreased.
A. A lower interest rate can be offered, compared with straight debt. B. debt is decreased but equity also increases.
B. It offers a method of raising cheap funds for the time being. C. only the number of shares increases.
C. A longer maturity can often be offered. D. there is no impact on the company's capital structure.
D. There is an increase in financial leverage upon conversion.
Difficulty: Hard
Est time: <1 minute
Difficulty: Hard
Est time: <1 minute
82. Which of the following is NOT an advantage for a company that sells a company-issued option with a
78. A company is advised to issue convertible notes. They are advised of the conditions applicable to the rights issue?
convertible note issue. Which of the following conditions is incorrect?
A. It may add to the marketability of the associated rights issue.

A. The holder of the note has the right to convert the note into preference shares. B. It reduces the necessity for the company to increase dividend payments immediately.
B. Notes are generally available on a pro-rata entitlement to shareholders. C. If the holder of the option exercises the right to buy the shares offered then the company raises
C. Entitlements to convertible notes are generally not renounceable. additional equity funds.
D. Notes are usually issued at a price close to the current share price at the time of issue. D. There is no certainty that the future funds from the exercise of the option will eventuate.
Difficulty: Medium Difficulty: Medium
Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities. placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities.
Section: 5.5 Equity-funding alternatives for listed companies Section: 5.5 Equity-funding alternatives for listed companies
79. Compared with straight debt, convertible notes may offer a company: 83. Which of the following about equity warrants is NOT correct?
A. lower borrowing costs. A. Adding equity warrants to a bond issue increases its marketability.
B. higher borrowing costs. B. Warrants are similar to conversion features on some bonds.
C. a chance to issue more shares at maturity. C. Warrants can be detached from the bond issue and sold separately.
D. the opportunity to reduce debt. D. Dividends for warrants are usually lower than for ordinary shares.
Difficulty: Medium Difficulty: Easy
84. Which financial instrument gives the holder an option to purchase a specified number of shares at a 88. Which of the following statements about company-issued equity warrants is incorrect?
predetermined price over a given period?
A. The terms of a warrant may allow the warrant to be detachable from the bond issue.
A. An equity warrant B. A company-issued equity warrant generally attaches to a bond issue.
B. A put option C. Because company-issued equity warrants are attached to a bond they have no value.
C. An ordinary preference share D. Warrants may lower the costs of borrowing associated with the issue of the underlying corporate
D. A debenture bond.
Difficulty: Easy Difficulty: Medium
85. Which one of the following conditions for an equity warrant that is generally attached to a bond issue is 89. Which of the following is NOT a similarity between a right and a warrant?
NOT correct?
A. They both provide the right, without the obligation, to purchase a specified number of shares at a
A. The holder has a conditional option to convert into ordinary shares of a company. predetermined price.
B. A warrant holder receives dividend payments over the life of the warrant. B. A right and a warrant both result in the company raising additional equity capital.
C. Warrants may be detachable and traded separately from the bond issue. C. A right and a warrant can both be detached from the debt issue and traded separately.
D. The cost of borrowing through a bond issue may be lower with a warrant attached. D. A right and a warrant both have similar maturities.
Difficulty: Hard Difficulty: Medium
86. Which of the following factors of company-issued equity warrants is NOT correct? 90. Which of the following requirements does NOT apply to a company seeking a public listing on the
ASX?
A. They are often detachable.

B. They add to the marketability of an issue. A. The entity must satisfy either the profit test or the net tangible assets test.
C. They may offer an investor an opportunity of buying stock at a discount. B. The company must have at least 500 holders of a parcel of main class securities valued at least
D. Their exercise period is usually shorter than three months. $2000.
C. The company must lodge a prospectus with the ASX on an annual basis.
Difficulty: Medium
Est time: <1 minute D. The company must have a structure and operation appropriate for a listed entity.
placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities. Difficulty: Hard
Section: 5.5 Equity-funding alternatives for listed companies Est time: <1 minute
Learning Objective: 05-06 Explain the listing requirements of the Australian Securities Exchange.
Section: Extended learning LO 5.6
91. The internal relationship between shareholders, the board of directors and the managers of a company is
called:
A. If the warrant is non-detachable it can only be sold with the associated bond.
B. Equity warrants add to the marketability of a corporate bond issue.
C. Equity warrants give an investor the right to convert the warrant into shares at a specified price. A. agency theory.
D. A warrant holder receives a dividend, unlike a rights holder. B. corporate governance.
Difficulty: Medium C. commercial theory.
Est time: <1 minute D. organisational governance.
Difficulty: Easy
Est time: <1 minute
Section: Extended learning LO 5.6
True / False Questions 96. A low debt-to-equity ratio for a company means that a rise in interest rates will not affect the variable-
rate debt issued by the company.
92. A principal objective of a business organisation is the maximisation of its profits. FALSE
FALSE As the debt has a variable interest rate it will be affected by an increase in interest rates.
A principal objective is the maximisation of shareholder value within the context of the company's Difficulty: Easy
objectives and policies. Est time: <1 minute
Difficulty: Easy
Est time: <1 minute 97. Financial risk refers to risks arising from the different types of debt securities issued by a company.
FALSE
93. The investment decision for a corporation involves the types of securities it is going to issue or invest
in. Financial risk attaches to both equity and debt issued by a company.
FALSE
Difficulty: Easy
Est time: <1 minute
The investment decision is the capital budgeting decision that determines the strategic activities of the Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision.
firm and what assets it needs to acquire so it can carry out its business.
98. A company's debt-to-equity ratio is determined in practice with reference to four main criteria and not
by finance theory.
Difficulty: Easy
Est time: <1 minute
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision. TRUE
94. If the calculated IRR on an investment proposal is greater than the required rate of return, the company Four main criteria are norms in the industry, history of the gearing ratio, limits imposed by lenders and
should proceed with the project. management decisions.
TRUE
Difficulty: Easy
Est time: <1 minute
The IRR provides an actual rate of return that can be measured against a company's required rate of Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision.
return.
99. In consultation with a company, the promoter (an investment bank) will seek flotation of the company
shares.
Difficulty: Easy
Est time: <1 minute
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision. FALSE
95. Business risk is determined in part by a corporation's choice of business activity and the manner in The promoter is the company seeking to issue new shares.
which it has financed those activities.
Difficulty: Easy
FALSE Est time: <1 minute
Business risk represents a company's exposure to factors that have an impact on the firm's activities and Section: 5.3 Initial public offering
operations but it does not include the manner in which it finances its activities.
Difficulty: Easy
Est time: <1 minute
100. Limited liability shares are generally sold to investors on a fully paid basis. 104. A stock exchange seeks to maintain the integrity and efficiency of its markets. Discuss some ways it
may achieve this.
TRUE
Ordinary shares issued on a limited liability basis are the principal form of funding.
A stock exchange needs to establish listing rule principles that include the interests of listed companies,
combined with investor protection. With regard to the stock exchange, some main principles are
Difficulty: Easy
Est time: <1 minute
minimum standards of quality and size, securities issued in a fair manner, timely release of information,
Learning Objective: 05-03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-funding alternatives that high standards of integrity and accountability of entities and officers, and practices adopted and pursued
that protect the interests of security holders.
101. A pro-rata offer of rights to existing shareholders must be accompanied by a prospectus.

Est time: 1-3 minutes
TRUE Section: Extended learning
105. Discuss the attractions of a private placement for a company.

Generally, regulations require a prospectus to be attached.
Difficulty: Easy
Est time: <1 minute There are a number of advantages—a placement can be arranged more quickly than a rights issue; it
placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities. may also involve less of a discount to current market value than a rights issue and so be less expensive.
Section: 5.5 Equity-funding alternatives for listed companies A placement may also be made directly with institutions without the need to lodge a prospectus but
rather a less comprehensive and less costly memorandum of information.
Short Answer Questions Est time: 1-3 minutes

102. What is capital budgeting and explain its importance for a company.
106. What is an equity-funded takeover?
Capital budgeting is the process of evaluating and selecting long-term investments consistent with the
firms' goal of owner-wealth maximisation. A company needs to determine what assets it needs to invest In the case of a merger or acquisition, a company may decide to issue additional shares to fund a full-
in so it may carry out its planned business operations. Two important quantitative measures it may use equity takeover rather than using other sources of funding such as debt. A company (A) may offer these
are net present value and internal rate of return. shares on a pro-rata basis to existing shareholders in the takeover target, company (B). The target
shareholders may be offered two shares in company A for every five shares they hold in company B.
The pro-rata basis of the offer will be based on the value of company A shares compared to that of
Est time: 1-3 minutes company B.

103. Discuss relevant issues for a company that needs to decide on how to finance its investment decisions. Learning Objective: 05-05 Explore equity-funding alternatives that are available to an established listed corporation, including right issues, share purchase plans,
The financing decision relates to the question of how a business investment is to be funded. There is the
choice of debt or equity and what kind of risk this exposes the firm to. These generally entail business
risk and financial risk.

Chapter 05 - Test Bank Summary
Category # of Que
stions
Difficulty: Easy 46
Difficulty: Hard 9
Difficulty: Medium 46
Est time: <1 minute 101
Est time: 1-3 minutes 5
Learning Objective: 05-01 Understand issues related to the capital budgeting investment decision. 16
Learning Objective: 05-02 Identify issues relevant to a corporation’s funding choice between debt and equity. 10
Learning Objective: 05- 22
03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including equity-
funding alternatives that are available to a newly listed corporation.
Learning Objective: 05-04 Consider important issues associated with listing a business on a stock exchange. 3
Learning Objective: 05-05 Explore equity- 52
funding alternatives that are available to an established listed corporation, including right issues, share purchase plans, placements, takeover
issues, dividend reinvestment schemes, preference shares, convertible notes and other quasi-equity securities.
Learning Objective: 05-06 Explain the listing requirements of the Australian Securities Exchange. 3
Section: 5.1 The investment decision: capital budgeting 15
Section: 5.2 The financing decision: equity, debt and risk 10
Section: 5.3 Initial public offering 22
Section: 5.4 Listing a business on a stock exchange 3
Section: 5.5 Equity-funding alternatives for listed companies 52
Section: Extended learning 1
Section: Extended learning LO 5.6 2
Section: Introduction 1

Chapter 05 - Test Bank: Multiple Choice Questions

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Chapter 05 - Test Bank: Multiple Choice Questions

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5. Which of the following statements is correct for an investment proposal with a positive NPV?

Chapter 05 - Test Bank

A. its use of debt in financing the business. A. the debt holders.

A. reduce the business risk of the firm.

A. receive interest payments. A. cheaper.

A. guaranteed a periodic distribution of dividends

A. The manager of the sub-underwriting panel or group

A. The entity must adhere to minimum standards of quality.

A. a seasoned share offering. A. participating

A. Shareholders can acquire company shares at little or no transaction cost. A. participating

A. decreases the return A. a flexible dividend policy.

A. lower borrowing costs.

A. preference shares attached.

Short Answer Questions

Multiple Choice Questions

1. An investment decision differs from a financing decision in that:

A. capital market decision.

3. The finance required by a company to fund its day-to-day operations is called:

A. risk of owning financial assets.

A. its use of debt in financing the business.

27. When a company undertakes an initial public offering (IPO) it may:

34. Companies can raise equity capital through:

35. A person who is authorised to vote on a shareholder's behalf is called:

43. A company may raise additional equity capital through:

A. must be made to all the stakeholders of a company.

71. A convertible note is a/an: A. a lower default risk.

A. preference shares attached.

A. It may add to the marketability of the associated rights issue.

A. They are often detachable.

101. A pro-rata offer of rights to existing shareholders must be accompanied by a prospectus.

105. Discuss the attractions of a private placement for a company.

Short Answer Questions Est time: 1-3 minutes

Est time: 1-3 minutes

Est time: 1-3 minutes

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