1/23/23, 3:22 AM CF - Quiz- 1: Attempt review

Corporate Finance -II-Sec-A & B & C

Home / My courses / CF-II-Term-III-Sec-A & B & C / 28 February - 6 March / CF - Quiz- 1

Started on Monday, 28 February 2022, 2:30 PM

State Finished

Completed on Monday, 28 February 2022, 3:00 PM

Time taken 29 mins 37 secs

Grade 13.00 out of 15.00 (87%)

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Question 1
Modigliani and Miller's proposition of capital structure irrelevance does not hold good in the presence of
Correct corporate taxes because:
Mark 1.00 out of 1.00

Select one:
a. Stockholders require higher rates of return compared with bondholders

b. None of the other options are correct

c. Earnings per share are no longer relevant with taxes

d. Levered firms pay lower taxes when compared with otherwise identical but unlevered firms 

Your answer is correct.

The correct answer is: Levered firms pay lower taxes when compared with otherwise identical but
unlevered firms

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Question 2
A start-up wants to raise equity capital of Rs.75 crores from a venture capital fund (VCF). If the VCF’s
Correct shareholding in the start-up is not to exceed 30%, what is the minimum pre-money valuation that should
Mark 1.00 out of 1.00 be negotiated with the VCF? Assume the VCF is not currently a shareholder of the start-up.

Note : Your answer should be in Rs. crores without commas, units, etc. For instance, if your
answer is Rs. 200 crores, write '200' in the answer box.

Answer: 175 

Pre-money valuation = Post-money valuation - Amount invested = Investment by VCF/ VCF's stake -
Amount invested

The correct answer is: 175

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Question 3
If a firm has a cost of debt of 8%, debt-equity ratio of 1:2, and expected return on its assets is 12%, what
Correct would the expected return on its equity be? Assume no taxes.
Mark 1.00 out of 1.00

Answer: 14% 

Using MM Proposition 2, rE = rA + (rA - rD) x D/E

The correct answer is: 14 %

Question 4
What is the degree of financial leverage of a firm with EBIT of Rs. 20 crores, interest expenditure of Rs. 10
Correct crores, and tax rate of 25%?
Mark 1.00 out of 1.00

Answer: 2 

DFL = EBIT/PBT = EBIT/(EBIT - Interest).

Alternatively, the DFL can be worked out from first principles by calculating the perecntage change in
PBT (or PAT or EPS) for a 1% change in Sales.

The correct answer is: 2

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Question 5
A firm borrows Rs. 60 crores at an interest rate of 4% and expects to continue this amount of debt in
Correct perpetuity. What is the present value of the interest tax shield? Assume a 30% tax rate.
Mark 1.00 out of 1.00

Note : Your answer should be in Rs. crores without commas, units, etc. For instance, if your answer is Rs.
200 crores, write '200' in the answer box.

Answer: 18 

Since the debt will be in perpetuity, the present value of the tax shield would be tC x rD x D/ rD = tc.D

The correct answer is: 18

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Question 6
Which of the following affect the asset beta?
Incorrect

Mark 0.00 out of 1.00

A. The cyclicality of the business

B. The degree of operating leverage

C. The “noise” affecting the performance of the business

D. The degree of financial leverage

Select one:
a. A, B & D

b. A, B, C & D

c. A & B

d. A, B & C 

Your answer is incorrect.

The correct answer is: A & B

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Question 7
A firm has annual sales of Rs. 100 crores, contribution margin of 30%, operating profit margin (OPM =
Correct EBIT/ Sales) of 20%, and suffers tax at 25% of PBT. It has interest costs of Rs. 15 crores per year. It has
Mark 1.00 out of 1.00 issued 7 crore equity shares. When sales of this firm increase by 1%, how much will its EPS change?

Answer: 6% 

The %age change in EPS for a 1% change in sales is measured by the Degree of Total Leverage

DTL = Contribution/PBT = (Sales x Contribution Margin)/(Sales x OPM - Interest)

%age change in EPS for a 1% change in Sales = DTL%

Alternatively, the DTL can be worked out from first principles by calculating the %age change in PBT (or
PAT) for a 1% change in EBIT.

The correct answer is: 6 %

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Question 8
A firm has a (market value based) debt-equity ratio of 1:4. Its stock has a beta of 2. It plans to raise fresh
Correct equity, use the money thus raised to pay off all its debt, and thereafter continue to be debt-free. What is
Mark 1.00 out of 1.00 the new beta of its stock likely to be? Assume beta of the debt to be zero. Disregard impact of taxes, if
any.

Answer: 1.6 

Initially, the asset beta βA = βE x E/V + βD x D/V

After the change in capital structure, the company plans to be debt-free. Therefore, its equity beta βE
with be equal to the asset beta, βA.

The correct answer is: 1.6

Question 9
A company expects to generate a pre-tax ROI of 15%. It has a pre-tax cost of debt of 10% and is subject to
Correct a tax rate of 30%. If it targets an ROE of 15.75%, what debt-equity ratio should it adopt?
Mark 1.00 out of 1.00

Answer: 1.5 

ROE = [ROI + (ROI - r) x D/E] x (1 - t). The debt-equity ratio can be arrived at by including the other
values given and solving this expression for D/E.

The correct answer is: 1.5

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Question 10
Which of the following statements are correct?
Correct

Mark 1.00 out of 1.00

A. The three key financial decisions of a firm are the investment decision, the financing decision, and the
structuring decision.

B. The financing decision is also called the capital structure decision.

C. The investment decision is also called the capital structure decision.

D. The financing decision is also called the capital budgeting decision.

E. The investment decision is also called the capital budgeting decision.

Select one:
a. None of the others

b. C & D

c. B & E 

d. A only

Your answer is correct.

The correct answer is: B & E

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Question 11
Consider a firm with 1000 shares and 1000 bonds outstanding. The market prices of the stock and the
Correct bonds are Rs. 20 and Rs. 10 respectively. If the firm issues an additional 200 shares at a price of Rs. 20
Mark 1.00 out of 1.00 each, and uses the proceeds of the issue to repay 400 of the bonds, what will the value of the firm be after
the repayment? Assume a Modigliani-Miller world.

Note : Your answer should be accurate to the rupee and without commas, units, etc. For instance, if your
answer is Rs. 50,025, write '50025' in the answer box.

Answer: 30000 

Before the change in capital structure, the value of the firm is the sum of the values of its debt (no. of
bonds x price per bond) and equity (no. of shares x price per share).

In a Modigliani-Miller world, the value of a firm is independent of its capital structure. So, even after the
change in capital structure, there will be no change in value of the firm.

The correct answer is: 30000

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Question 12
Which of the following statements is generally true of venture capitalists (VCs)?
Incorrect

Mark 0.00 out of 1.00 Select one:

a. VCs prefer providing capital in the form of secured debt.

b. VCs invest in publicly traded companies.

c. VCs provide management advice and contacts in addition to capital.

d. VCs are silent partners in the start-up company that they finance. 

Your answer is incorrect.

The correct answer is: VCs provide management advice and contacts in addition to capital.

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Question 13
Which of the following statements are correct?
Correct

Mark 1.00 out of 1.00

A. Compared to lenders, equity shareholders generally have higher control rights.
B. Debt instruments generally have a finite life.
C. Equity shareholders are entitled to a fixed rate of dividend.
D. Companies can claim tax deductions on the dividends they pay to shareholders.

Select one:
a. B only

b. A & B 

c. C & D

d. A only

Your answer is correct.

The correct answer is: A & B

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Question 14
A company is financed entirely by equity and has a cost of equity of 15%. If the company were financed
Correct (almost) entirely by debt, what would its cost of debt be? Assume the Modigliani-Miller propositions are
Mark 1.00 out of 1.00 valid, and that the company is not subject to tax.

Answer: 15% 

For a completely equity financed company, the cost of equity reflects the return required to
compensate for the business risk alone (since there is no financial risk)

When the same business is (almost) entirely financed by debt, the entire risk in the business is borne
by the lenders, and thus they start expecting a return commensurate with the business risk.

Alternatively, rA = rE x E/V + rd x D/V. For a completely equity financed company, rA = rE, and for a
completely debt financed company, rA = rD.

The correct answer is: 15 %

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Question 15
For a levered firm where βA = beta of assets and βD = beta of debt, the equity beta (βE) equals:
Correct

Mark 1.00 out of 1.00 Select one:

a. βE = βA + D/E x (βA – βD) 

b. βE = βA

c. βE = βA + D/(D + E) x (βA – βD)

d. None of the other options are correct

Your answer is correct.

The correct answer is: βE = βA + D/E x (βA – βD)

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