Business Finance — Part 1 MCQs with Explanations

What is a perpetual debt? A perpetual debt is a loan that never needs to be repaid. The company keeps paying interest forever. Premium on debt: The company issued the debt at a 5% premium. This means the company actually received Rs. 1,00,000 + (5% of Rs. 1,00,000) = Rs. 1,05,000. Tax effect: The interest the company pays on its debt is tax-deductible. This means the company can reduce its tax bill by the amount of interest it pays. The tax rate is 30%. Calculating the cost of debt: The cost of debt is the effective interest rate after considering the tax savings. It's calculated as follows: 1. Interest payment: 10% of Rs. 1,00,000 = Rs. 10,000 2. Tax saving: 30% of Rs. 10,000 = Rs. 3,000 3. Net interest payment: Rs. 10,000 - Rs. 3,000 = Rs. 7,000 4. Cost of debt: (Net interest payment / Amount received) * 100 = (Rs. 7,000 / Rs. 1,05,000) * 100 = 6.66% Therefore, the correct answer is C: 6.66%

Gordon’s Dividend Capitalization Model is used to calculate the value of an equity share using the formula: P = E(1 – b) / (k – br) Where: P = Price of the share (Value of equity share) E = Earnings per share = Rs. 10 b = Retention ratio = 60% = 0.6 k = Cost of capital = 10% = 0.10 r = Internal rate of return = 8% = 0.08 Substitute the values into the formula: P = 10(1 – 0.6) / (0.10 – 0.6 × 0.08) P = 10(0.4) / (0.10 – 0.048) P = 4 / 0.052 P ≈ Rs. 76.92 ≈ Rs. 77 (rounded) Therefore, the correct value of the equity share as per Gordon's Model is Rs. 77.

First, let's understand what operating leverage is. It basically measures how sensitive a company's operating income (profit from its core business) is to changes in sales. A high operating leverage means a small change in sales can lead to a big change in profit. To calculate operating leverage, we use a simple formula: Operating Leverage = Contribution Margin / Earnings Before Interest and Taxes (EBIT) Let's find each of these components. 1. Contribution Margin: This is the difference between your sales revenue and your variable costs. In this case: Contribution Margin = Sales - Variable Costs = Rs. 74 lakh - Rs. 40 lakh = Rs. 34 lakh 2. Earnings Before Interest and Taxes (EBIT): This is also known as operating income or operating profit. It's what's left after you subtract both variable and fixed costs from your sales. EBIT = Sales - Variable Costs - Fixed Costs = Rs. 74 lakh - Rs. 40 lakh - Rs. 8 lakh = Rs. 26 lakh Now we can plug these values into the operating leverage formula: Operating Leverage = Rs. 34 lakh / Rs. 26 lakh = 1.3076 Rounding this value we get 1.31 Therefore, the operating leverage of the firm is approximately 1.31. So, the correct answer is Option C: 1.31 .

Acid test ratio is the correct answer to “The appropriate ratio for indicating liquidity crisis is”. This question is standard in competitive examination syllabi for Business Finance.

Internal rate of return method is the correct answer to “Interim cash inflows are reinvested at a rate of return equal to the internal rate of return is the built-in mechanism for”. This question is standard in competitive examination syllabi for Business Finance.

a-3, b-4, c-1, d-2 is the correct answer to “Match List-I with List-II and select the correct answer: List-I List-II a. Modigliani Miller approach 1. Commercial papers b. Net operating income approach 2. Working capital management c. Short-term money market instrument 3. Capital structure d. Factoring 4. Arbitrage”. This question is standard in competitive examination syllabi for Business Finance.

The firm has finite life is the correct answer to “Which one of the following assumptions is not included in the James E. Walter Valuation model”. This question is standard in competitive examination syllabi for Business Finance.

Equity shareholders would demand higher return is the correct answer to “Which of the following is an implicit cost of increasing proportion of debt of a company”. This question is standard in competitive examination syllabi for Business Finance.

18.8% is the correct answer to “Indicate the cost of equity capital based on capital asset pricing model with the following information. Beta coefficient 1.40 Risk free rate of interset 9% Expected rate of return on equity in the market 16%”. This question is standard in competitive examination syllabi for Business Finance.

Present value of cash outflows is the correct answer to “Profitability index of a project is the ratio of present value of cash inflows to”. This question is standard in competitive examination syllabi for Business Finance.

M. M. model is the correct answer to “Dividend irrelevance hypothesis implied in the”. This question is standard in competitive examination syllabi for Business Finance.

1, 3, 5, 2, 4 is the correct answer to “The international monetary system went through several distinct stages of evolution. These stages are summarised, in alphabetic order, as follows 1. Bimetallism 2. Brettonwoods system 3. Classical gold standard 4. Flexible exchange rate regime 5. Interwar period The chronological order that they actually occurred is”. This question is standard in competitive examination syllabi for Business Finance.

Discount rate is the correct answer to “If we move from present value to calculate the future value, we can use the concept of compounding rate. If we were to move from future value towards the calculation of present value, the concept used will be”. This question is standard in competitive examination syllabi for Business Finance.

Intangible benefits is the correct answer to “Positive NPV in project appraised by a firm may not occur an account of”. This question is standard in competitive examination syllabi for Business Finance.

a-2, b-3, c-4, d-1 is the correct answer to “Match List-I with List-II and select the correct answer: List-I List-II a. Realised yield method 1. Cost of equity share capital b. Taxation 2. Cost of equity capital c. Cost of total capital employed 3. Cost of debt capital d. Dividend growth is a consideration 4. Weighted cost of capital”. This question is standard in competitive examination syllabi for Business Finance.

All of the above is the correct answer to “Which of the following statement(s) is/are false? 1. Capital profits can never be distributed as dividends to the shareholders. 2. Dividends are paid out of profits and, therefore, do not affect the liquidity position of the firm. 3. Every company should follow the policy of low dividend payment. 4. Walter's model suggests that dividend payment dose not affect the market price of the share. Choose the correct answer”. This question is standard in competitive examination syllabi for Business Finance.

Both A and C is the correct answer to “Operational techniques include”. This question is standard in competitive examination syllabi for Business Finance.

All investors hold the market portfolio is the correct answer to “Which of the following is an assumption of the APT”. This question is standard in competitive examination syllabi for Business Finance.

Both 1 and 2 is the correct answer to “Which of the following are the examples of systematical risk. 1. Elimination of Government Subsidy 2. Increase in bank rate 3. Labour problem 4. High levered fund Select the correct answer:”. This question is standard in competitive examination syllabi for Business Finance.

Capital asset pricing model is the correct answer to “Which one of the following is the most popular method for estimating the cost of equity”. This question is standard in competitive examination syllabi for Business Finance.

(R) is a correct explanation of (A) is the correct answer to “Assertion (A): A furores contract specifies in advance the exchange rate to be used, but it is not as flexible as a forward contract. Reason (R): A futures contract is for a specific currency amount and a specific marurity date.”. This question is standard in competitive examination syllabi for Business Finance.

1, 2 and 4 is the correct answer to “The issues in international capital budgeting include 1. Exchange rate risk 2. Political risk 3. Geographical risk 4. Parent vs project cash flow”. This question is standard in competitive examination syllabi for Business Finance.

Retained earnings is the correct answer to “Which of the following sources of finance has an implicit cost ofcapital”. This question is standard in competitive examination syllabi for Business Finance.

Short-term funds have been used for fixed assets is the correct answer to “Negative net working capital means assets are not being used effectively, and a company may face a liquidity crisis. This implies”. This question is standard in competitive examination syllabi for Business Finance.

A company's sales prospects in foreign markets is the correct answer to “When assessing economic exposure, financial managers should consider how variations in exchange rates influence . . . . . . . .”. This question is standard in competitive examination syllabi for Business Finance.

Arbitrage is the correct answer to “Dividend irrelevance argument of MM model is based on”. This question is standard in competitive examination syllabi for Business Finance.

Short-term funds have been used for fixed assets is the correct answer to “Negative net working capital implies that”. This question is standard in competitive examination syllabi for Business Finance.

Existing investment in a project is not treated as sunk cost is the correct answer to “Which of the following is not true with reference to capital budgeting”. This question is standard in competitive examination syllabi for Business Finance.

All of these is the correct answer to “The conflicts in project ranking in capital budgeting as per NPV and IRR may arise because of”. This question is standard in competitive examination syllabi for Business Finance.

1, 2, 4 and 5 is the correct answer to “What are the main objectives of financing decision? 1. To get optimal working capital figure. 2. To get optimal capital structure. 3. To make the company exposed to high risk. 4. To keep the cost of capital lowest. 5. To make the value of share highest.”. This question is standard in competitive examination syllabi for Business Finance.

Both (A) and (R) are correct and (R) is the correct explanation of (A) is the correct answer to “Assertion (A): The important aspect of dividend policy is to determine the amount of earnings to be distributed to shareholders and the amount to be retained in the firm. Reason (R): Dividend policy of the firm has its effect on both the long term financing and the wealth of shareholders.”. This question is standard in competitive examination syllabi for Business Finance.

William J. Baumol is the correct answer to “Who proposed a model to apply economic order quantity concept of inventory mangement to determine the optimum cash holding in a firm”. This question is standard in competitive examination syllabi for Business Finance.

Composite cost is the correct answer to “The cost of capital from all the sources of funds is called”. This question is standard in competitive examination syllabi for Business Finance.

Time value of money is the correct answer to “Which of the following concepts deals with discounted cash flows”. This question is standard in competitive examination syllabi for Business Finance.

1, 2 and 3 is the correct answer to “Which of the following are the main features of Zero Coupon Bonds? 1. They are called deep discount bonds. 2. The price paid by investors is less than their face value. 3. The bonds are redeemed at par.”. This question is standard in competitive examination syllabi for Business Finance.

1, 2 and 3 is the correct answer to “Which combination of the following represents the assumptions of the Walter's dividend model? 1.The company has a very long or perpetual life. 2. All earnings are either reinvested intemally or distributed as dividend. 3. There is no floatation cost for the company. 4. Cost of capital of the company is constant. Select the correct one:”. This question is standard in competitive examination syllabi for Business Finance.

Market risk premium for the firm is the correct answer to “Which one of the following is not the internal factor affecting the weighted average cost of capital of a firm”. This question is standard in competitive examination syllabi for Business Finance.

The current assets of the typical manufacturing firm account for over half of its total assets is the correct answer to “Which of the following statements is most correct”. This question is standard in competitive examination syllabi for Business Finance.

1875 is the correct answer to “The concept of bimetallism, with gold and silver full-bodied coins in circulation continued up to the year”. This question is standard in competitive examination syllabi for Business Finance.

Hedging payables is the correct answer to “Hedging with options is best recommended for”. This question is standard in competitive examination syllabi for Business Finance.