ROLL NO.

39

OVERVIEW OF CORPORATE FINANCE

Short Question?
1, Define Finance?

Finance is the art and science of managing money.

2. What is financial services?

Financial services is concerned with the design and delivery of advice and financial product to
individual business an governments.

3. What is the activity of financial managers?

Financial manager activity manages the financial affairs of many types of business namely
financial and non financial private and public large and small profit seeking and not for profit.

4. Name the two board of financial managers?

1. Macroeconomics

2. Microeconomics.

5. What is Corporate Finance?

Corporate finance dealing with the source of trading and the capital structure of corporation
action take by the firm to increase the shareholder wealth.

6. Define Capital budgeting?

Capital budgeting relates to the selection of an asset whose benefits would be available over
the project life.

7. Define working capital management?

Working capital management is concerned with the managements of current and the aspect of
financial decision making with reference to current asset or short term and is popularly termed
as working capital management.

8. Key activities of financial manager?

1. Performing financial analysis and planning

 2. Making investments decision
3. Making financial decision.

9. What is Capitalization?

The rate that reflects the time and risk preference of the owners or supplier of capital.

10. Define term value?

Value is used in terms of worth to the owners that is ordinary shareholders.

11. Define Stockholders?

Stockholders include group such an employee’s customers, supplier, creditor, owners and other
who have direct link to the firm.

12. What is Economic Value added?

Economic value added is equal to offer tax pertaining profit of a firm less the cost of funds used
to finance investments.

13. Define what is Agency Problems?

Agency problem is the likelihood that managers may place personal goals ahead of corporate
goals.

14. What is hostile takeover?

Hostile takeover is the acquisition of the firm by another firm that is not supported by
managements.

15. Agency Costs?

Agency cost borne by shareholders to proceed/minimize agency problems as to contribute to

maximize owner’s wealth.

16. What are the goals of corporate firm?

The managers of the corporation are obliged to make efforts to maximize shareholder wealth.

17. Areas of Finance?

1. The Firm
2. Financial market
3. Financial Intermediaries
 4. Investors.

18. Capital Structure?

Capital structure is have a firm, finances its overall operations and growth by using different
sources of funds. Debts comes in the form of bond issues or long term notes, Payable while
equity is clarified as common stock or retained earnings.

19. What is Capital of Corporation?

The Corporation of a Company’s capital in term of equity, debt and hybrid securities equity
financing is provided by the shareholders.

20. Explain three sources of short finance?

1. Trade credit
2. Bank overdraft
3. Unsecured bond loans.

21. What are the differenced types of working Capital?

1. Cash
2. Inventory/Stock
3. Marketable Securities

22. What are performance share?

Performance share are given to management for meeting the stated performance goals.

23. What are the bonding expenditures’?

They protect the owners against the potential against the potential consequences of dishonest
acts by management.

24. Fidelity Bond?

Fidelity Bond is a contract in which a bonding Company agree to re-imburse a firm upto a stated
amount for financial losses caused by dishonest acts of managers.

25. Performance Shares?

Performance share are given to management for meeting the stated performance goals.
MCQS
1. Which of the following is not one of the three fundamental methods of firm valuation?

a) Disconnected cash flow

b) Income or earning
c) Balance sheet
d) Market share.

2. What is the value of the firm usually based on?

a) The value of debt and equity

b) The value of equity
c) The value of bled
d) The value of assets plus liabilities.

3. Shareholder wealth increases with the increase in?

a) EPs
b) Marked value of the firm
c) Dividend and market value of the firm
d) Market price of the equity shares.

4. Promotion of welfare of human by corporate is called as?

a) Social services
b) Philosophy
c) NGO work
d) Corporate Philanthropy

5. Corporate wealth maximization is the value maximization for?

a) Equity shareholders
b) Stockholders
c) Employees
d) Debt Capital owners.

6. Corporate Finance deal with_____

 a) Source of funding
b) Increasing shareholder’s wealth
c) Both a & b
d) None of the above

7. Leasing of machinery can be categorized as _____

a) Fixed asset
b) Investment decision
c) Financing decision
d) Capital budgeting decision

8. A mutually exclusive decision means ____

a) Accepting of an alternative, level to rejecting of other

b) Accepting of both alternatives
c) Rejecting of both alternatives
d) Both c and d

9. Agency cost consist of __________

a) Monitoring
b) Binding
c) Structuring
d) All of the above

10. The only viable go at the financial management is ____

a) Profit maximization
b) Wealth maximization
c) Sale maximization
d) Asset maximization

11. The basic objective of financial management is_____

(a) Maximization of profit

(b) Maximization of Shareholder’s wealth
(c) Ensuring financial discipline in the organization
(d) None of the above

12. Finance function involves______

a) Procurement of finance only

 b) Expenditure of funds only
c) Safe custody of funds only
d) Procurement and effective utilization of Fund

13. The goals of wealth maximization take into consideration______

(a) Risk related to uncertainty of return

(b) Timing of expected return
(c) Amount of returns expected
(d) All of the above

14. Financial management is concerned with_____

a) Arrangement of debt
b) All aspects of acquiring and utilization means of reason
c) Efficient management of every business
d) None of the above

15. What are the boards of financial manager?

(a) Macroeconomics
(b) Microeconomics
(c) Both a and b
(d) None of above

16. Key activities of financial manger____

a) Performing financial analysis and planning

b) Marketing investment decision
c) Making financing decision
d) All of the above

17. Areas of Finance are_____

(a) The Firm

(b) Investors
(c) Financial Market
(d) All of the above

18. Which one is not a type of working Capital_____?

a) Cash
b) Credit
 c) Inventory
d) Marketable Securities

19. The main concern of treasurer is____

(a) Financing activities

(b) Source of funding
(c) Maximization of wealth of shareholders
(d) None of the above

20. The function of controller is_____

a) Financial Accounting
b) Internal Audit
c) Both A and B
d) None of the above

ROLL NO. 36

CORPORATE FINANCES:

Nature, Scope and importance of Corporate Finance’s

SHORT QUESTION & ANSWER:

1. What is Corporate Finance?

Corporate Finance is the area of finance dealing with the source of funding and the capital
structure of corporations, the action that managers take to increase the value of the firm to
shareholders & the tool and analysis used the allocate finance resources.

2. Primary Goal of Corporate Finance?

The primary goal of corporate finance is to maximize or increase share holder value.

3. What is three major decision of finance?

(i) The Investment decision

(ii) The financing decision

(III) The dividend policy decision.

4. What is investment decision?

Investment decision relates to the selection of assets in which funds will be invested by a firm.
These assets are long term assets and short term or current assets.

5. Capital Budgeting?

Capital budgeting is probably the most crucial financial decision of the firm. It relates to the
selection of an asset or investment proposal or course of action whose benefit are to be
available in future over the lifetime.

6. Working Capital Management?

Working Capital Management is concerned with the management of current assets. It is an

important and integral part of financial management as short term survival is perquisite of long
term sources.

7. Two ingredients of management of working capital?

(i) An overview of working capital management;

(ii) Efficient management of the individual current asset such as cash receivable
inventory.

8. Financing decision?

Financing decision relates to the choice of the proportion of debt and equity source of
financing.

9. Capital Structure?

The term capital structure return to the proportion of debt (fixed interest source of funds of
financing) and equity capital (variable-dividend securities).

10. Risk?

Risk is the chance that actual outcomes many differ from those expected.

11. Agency Problem?

Agency problem is the likelihood that managers may place personal goals ahead of corporate
goals.

12. Hostile takeover?

Hostile takeover is the acquisition of the firm by another firm that is not supported by
management.

13. Agency Costs?

Agency costs are costs borne by shareholders to prevent minimize agency problem as to
contribute to minimize owners’ wealth.

14. Opportunity Costs?

Such costs result from the inability of large corporate from responding to new opportunities.

15. What are the importances of Corporate Finance?

 Research & Development

 Motivating Employees
 Promoting a Company
 Smooth conduct of business
 Expansion & diversification
 Meeting Contingencies
 Government Agencies
 Dividend & Interest
 Replacement of Assets.

ROLL NO.6

Risk & Return

1. PORTFOLIO:
A Collection or group of assets.

2. Risk:
The chance of financial loss or more formally, the variability of returns associated with a
given asset.

3. Return:
The total gain or loss experienced on an investment over a given period of time.
Popular sources of risk affecting financial managers and shareholders.

4. Source of risk:
Description Firm specific risk

5. Business Risk:
The chance that the firm will be unable to cover its operating costs.
6. Financial Risk:
The chance that the firm will be unable to cover its financial obligations.

7. Interest Rate Risk:

The chance that changes in interest rates will adversely affect the value of an
investment.

8. Liquidity Risk:
The chance that investment cannot be easily liquidated at a reasonable prices.
9. Market Risk:
The chance that the value of an investment will decline because of market factors that
are independent of the investment (such as economic, political and social events).

10. Event Risk:

The chance that a totally unexpected event will have a significant effect on the value of
the firm or specific investment.

11. Exchange Rate Risk:

The exposure of future expected cash flows to fluctuations in the currency exchange.

12. Purchasing Power Risk:

The chance that charging price levels caused by inflation or deflation in the economy
will adversely affect the firm’s or investment’s cash flow and value.

13. Tax Risk:

The chance that unfavorable changes in tax will occur.

14. Risk indiffent :

The attitude toward risk in which no change in return would be required for an increase
in risk.

15. Risk-averse:
The attitude toward risk in which an increased return would be required for an increase
in risk.

16. Risk Seeking:

The attitude toward risk in which a decreased return would be accepted for an increase
in risk.

17. Sensitivity analysis:

An approach for assessing risk that uses several possible return estimates to obtain a
sense of the variability among outcomes.
18. Range:
A measure of a assets’ risk, which is found by subtracting the pessimistic (worst)
outcome from the optimistic (best) outcome.

19. Probability distribution:

A model that relates probabilities to the associated outcomes.

20. Standard Deviation:

It measures the dispersion around the expected value. It is most common statistical
indicator of an asset risk.
21. Variance:
The average squared difference between the actual return and the average returns.

22. Co-efficient of variation:

A measure of relative dispersion that the useful in comparing the risk of assets with
differing expected returns.

23. Efficient Portfolio:

A portfolio that maximizes return for a given level of risk or minimizes risk for a given
level of return.

24. Return of port folio:

The return of a portfolio is a weighted average of the returns on the individual assets
from which it is formed.

25. Correlation:
Statistical measure of the relationship between any two series of members representing
data of any kind.

26. Positively Correlated:

Describes two series that more in the same direction.

27. Negatively Correlated:

Describes two series that move in opposite direction.

28. Correlation Co-efficient:

A measure of the degree of correlation between two series.

29. Perfect positively Correlated:

Describes two positively correlated series that have a correlation co-efficient of +1.
Perfect Negatively Correlated; Describes two negatively correlated series that have a
correlation co-efficient of – 1.

30. Cln correlated:

 Describes two series that lack any interaction and therefore have a correlation co-
efficient close to zero.

31. Diversification:
Combining negatively correlated assets to reduce or diversity risk. OR Spreading an
investment across a number of assets will eliminate some, but not all, of the risk.

32. Geometric Average Return:

The average compound return earned per year over a multi-year period.

33. Arithmetic Average Return:

The return earned in an average year over a multi-year period.

34. Expected Return:

The return on a risky asset expected in the future.

35. Portfolio Weights:

A percentage of a portfolio’s total value that is in a particular asset.

36. Naïve Diversification:

it means a portfolio consisting of stock chosen at random.

37. CAPM: The basic theory that links risk and returns for all assets.

38. Total Risk:

The combination of a security’s diversifiable and non-diversifiable risk.

39. Diversifiable/Unsystematic Risk: The portion of an asset’s risk that is attributable to

firm specific causes: can be eliminated through diversification.

40. Non-Diversifiable/Systematic Risk: The relevant portion of an asset’s risk attributable to

market factors that affect all firms; cannot be eliminated through diversification.

41. Beta Coefficient: A relative measure of non diversifiable risk. An index of the degree of
movement of an asset’s return in response to a change in the market return.

42. Market Return: The return on the market portfolio of all traded securities.

43. Risk-free rate of return: The required return on a risk free asset.

44. Security market line: The depiction of CAPM as a graph that reflects the required return
in the marketplace for each level of non-diversifiable risk (Beta).
 45. Efficient Market: A market with following charters tics. Many small investors, all having
the same information and expectations with respect to securities, no restrictions on
investment, no taxes and no transaction costs: and rational investors who view
securities similarly and are risk averse. Preferring higher returns and lower risks.

46. Short Sales: A short sale occurs when a person sells a second person an asset (security)
borrowed from a third person (broker).

47. Capital allocation Line: it shows the reward to variability ratio in terms of additional
beta.

48. Capital Market Line: it depicts the risk return relationship for efficient portfolios.

49. Arbitrage Pricing Theory: Markets equilibrating across securities through arbitrage
driving out mispricing.

Capital Budgeting (49)

Short Questions and Answers
1. Define Capital budgeting
Capital Budgeting is the process of evaluating and selecting long term investments that
are considered with the goal of shareholder wealth maximization.
2. What is Capital Expenditure
Capital Expenditure is an outlay of funds that is expected to produce benefits over a
period of time exceeding one year.
3. Discuss Capital Budgeting process
Capital budgeting process includes four distinct but interrelated steps used to select and
evaluate long term proposals
1. Proposal generation 2. Evaluation 3.selection 4. follow up
4. Which are independent projects
Independent projects whose cash flows are independent of one another. The
acceptance one dose not eliminate the others from consideration
5. Define mutually Exclusive projects
Mutually exclusive projects are project that compete with one another. The acceptance
of one rejects the others from further consideration.
6. What is Capital rationing?
Capital rationing is financial situation in which a firm has only fixed amount to allocate
among competing capital expenditure.
7. Define unlimited funds:
 It is the financial situation in which a firm is able to accept all independent projects that
provide an acceptable return.
8. What is relevant cash flow?
Relevant cash flow is incremental after tax cash outflow and subsequent resulting cash
flows associated with a proposed capital expenditure.
9. Discuss Incremental Cash Flows:
Incremental cash flows are additional cash outflow as well as cash inflows resulting from
proposed capital expenditure.
10. Define Sunk Costs:
Sunk costs are cash outflows that have been already made and therefore have no effect
on the cash flows relevant to a current decision.
11. What is difference between conventional cash flow pattern and non-cash flow pattern:
Conventional Cash Flow Pattern
An initial outflow followed by only a series of outflows.
Non-Conventional Cash Flows:
An initial outflow not followed by a series of inflows.
12. What is depreciation or depiction effect on cash flow?
Depreciation is non-cash expense that affects the tax paid in cash

13. What do you know about block of assets?

Block of assets is assets which fall in same class and in respect of which the
depreciation rate is applicable irrespective of their nature.
14. What is net working capital change:
Net working capital change is the difference between change in current assets and
change in current liabilities.
15. What are categories of Capital projects:
Capital projects are categorized in type of projects:
Single proposal (2) Mutually exclusives (3) Replacement situation
16. What are major types of evaluation techniques for capital budgeting:
There two types of techniques (1) traditional techniques and (2) Time adjusted/DCF
(Discounted Cash Flow) techniques
17. Which techniques are included in traditional techniques and DCF techniques
Traditional techniques includes (1) Average rate of return (2) Payback period method
which DCF methods includes: (1) Net present value (2) Profitability index (3) Internal
rate of return and (4) Terminal value methods
18. What is the payback method:
Payback method is used to find the exact amount of time required for firm to recover its
initial investment as a calculated from of cash inflows.
19. What is NPV
NPV is founded by subtracting a project initial investment from the present value of its
cash inflows discounted at firm’s cost of capital.
20. What are other names of IRR Method:
The techniques is also known as yield on investment. Marginal efficiency of capital.
Marginal productivity of capital and time adjusted rate of return.
21. What is internal rate of return:
IRR is the discount rate that equate PV of cash inflow with initial cash outflow associated
with a project.
22. What is profitability index:
Profitability index (PI), also known as profit investment ratio (PIR) and value
investment ratio (VIR), is the ratio of payoff to investment of a proposed project.
OrProfitability of index measure that PV of return per $ invested.
23. Why Capital Budgeting Decisions are important
Capital budgeting decisions are important because they affect the profitability of the firm
and are the major determinants of its efficiency and competing power.
24. What are difficultiesin capital expenditure:
Follow are major difficulties:
(1) The benefits from long term investment are received in some future period which is
uncertain (2) It is is possible to calculate all benefits in strict quantitative firm.

25. Differentiate revenue expending investment & cost reducing investment.

Revenue expending investments are expected to bring in additional revenue by
expending present operation or establishing new product line. Cost reducing investment
reduces the cost & increase the total earning.

26. How depreciation is treated in Accounting Profit & Cash flow:

Depreciation is treated as cost in accounting profit while in cash flow it is source of cash
to the extent of tax advantage.

27. Incremental analysis:

Incremental analysis involves computation of IRR of the incremental outlay of firm
requiring biggest initial investment.

28. What is conflicting ranking:

Conflicting ranking is conflict in the ranking of a given project by NPU or IRR resulting
firm differences in magnitude or timing of cash flows.
29. How we can resolve in conflict in ranking\;
Conflict in ranking can be resolved by (1) Common time horizon approach and (2)
equivalent annual value/cost approach.

30. What is common time borazon approach:

Common time borazon approach make is a comparison between the project that
extends over multiples of the lives of each.

31. What is EANPU:

This approach evaluates unequal lived projects that convert the net present value of
unequal lived mutual exclusive projects into an equivalent annual amount.

32. What is equal annual cost:

 This approach converts the present value of cost of unequal live mutual exclusive
projects into an equivalent annual amount/cost.

33. What is difference between divisible and indivisible projects:

Indivisible project is a project which can be accepted/rejected in its entirely whiledivisible
projects can be accepted in parts.

34. What is real cost of capital:

Real cost of capital is cost of capital adjusted for inflation effect.

35. What are problems of payback method:

(i) It does not consider the timing of cash flows within the pay back method;
(ii) It does not consider payments after payback period; and
(iii) There is no arbitrary standard for this method.

36. What is opportunity cost:

If asset is used in one project potential revenues from alternative used is lost. These lost
revenues are called opportunity cost.

37. What is sensitivity analysis:

It examines how a sensitive a particular NPV calculation is to changes in underlying
assumption.

38. What is real option:

Real options are adjustment that can be made after approval of project.

39. What is Depreciable Basis

Taxing authorities allow the fully installed cost of an asset to be written off for tax
purposes. This amount is called the asset's Depreciable asset.

MCQS
1. A project whose cash flows are more than capital invested for rate of return then net
present value will be

A. positive.
B. independent.
C. negative.
D. zero.
2. In mutually exclusive projects, project which is selected for comparison with others must
have

A. higher net present value.

B. lower net present value.
C. zero net present value.
D. all of above.

3. In independent projects evaluation, results of internal rate of return and net present value
lead to
A. cash flow decision.
B. cost decision.
C. same decisions.
D. different decisions.

4. Modified rate of return and modified internal rate of return with exceed cost of capital if net
present value is

A. positive.
B. negative.
C. zero.
D. one.

5. Payback period in which an expected cash flows are discounted with help of project cost of
capital is classified as

A. discounted payback period.

B. discounted rate of return.
C. discounted cash flows.
D. discounted project cost.

6. Number of years forecasted to recover an original investment is classified as

A. payback period.
B. forecasted period.
C. original period.
D. investment period.

7. Process in which managers of company identify projects to add value is classified as

A. capital budgeting.
 B. cost budgeting.
C. book value budgeting.
D. equity budgeting.

8. Project whose cash flows are sufficient to repay capital invested for rate of return then net
present value will be
A. negative.
B. zero.
C. positive.
D. independent.

9. Present value of future cash flows is $2000 and an initial cost is $1100 then profitability
index will be

A. 55%.
B. 1.82.
C. 0.55.
D. 1.82%.

10. Profitability index in capital budgeting is used for

A. negative projects.
B. relative projects.
C. evaluate projects.
D. earned projects.

11. In calculation of internal rate of return, an assumption states that received cashflow from
project must

A. be reinvested.
B. not be reinvested.
C. be earned.
D. not be earned.

12. Situation in which firm limits expenditures on capital is classified as

A. optimal rationing.
B. capital rationing.
C. marginal rationing.
D. transaction rationing.
13. Initial cost is $5000 and probability index is 3.2 then present value of cash flows is

A. $8,200.
B. $16,000.
C. 0.0064.
D. $1,562.50.

14. If net present value is positive then profitability index will be

A. greater than two.

B. equal to.
C. less than one.
D. greater than one.

15. First step in calculation of net present value is to find out

A. present value of equity.

B. future value of equity.
C. present value cash flow.
D. future value of cash flow.

16. Situation in which one project is accepted while rejecting another project in comparison is
classified as

A. present value consent.

B. mutually exclusive.
C. mutual project.
D. mutual consent.

17. Sum of discounted cash flows is best defined as

A. technical equity.
B. defined future value.
C. project net present value.
D. equity net present value.

18. Life that maximizes net present value of an asset is classified as

A. minimum life.
B. present value life.
C. economic life.
D. transaction life.
19. If two independent projects having hurdle rate then both projects should

A. be accepted.
B. not be accepted.
C. have capital acceptance.
D. have return rate acceptance

20. Cash outflows are costs of project and are represented by

A. negative numbers.
B. positive numbers.
C. hurdle number.
D. relative number

21. In capital budgeting, two projects who have cost of capital as 12% is classified as

A. hurdle rate.
B. capital rate.
C. return rate.
D. budgeting rate.

22. In estimating value of cash flows, compounded future value is classified as its

A. terminal value.
B. existed value.
C. quit value.

23. In capital budgeting, a technique which is based upon discounted cash flow is classified as

A. net present value method.

B. net future value method.
C. net capital budgeting method.
D. net equity budgeting method.

24. Cash inflows are revenues of project and are represented by

A. hurdle number.
 B. relative number.
C. negative numbers.
D. positive numbers.

25. Project whose cash flows are less than capital invested for required rate of return then net
present value will be

A. negative.
B. zero.
C. positive.
D. independent.

26. A type of project whose cash flows would not depend on each other is classified as

A. project net gain.

B. independent projects.
C. dependent projects.
D. net value projects.

27. Net present value, profitability index, payback and discounted payback are methods to

A. evaluate cash flow.

B. evaluate projects.
C. evaluate budgeting.
D. evaluate equity.

28. All of the following influence capital budgeting cash flows EXCEPT:
A. accelerated depreciation.
B. salvage value.
C. tax rate changes.
D. method of project financing used.
29. The estimated benefits from a project are expressed as cash flows instead of income flows
because:
A. it is simpler to calculate cash flows than income flows.
B. it is cash, not accounting income, that is central to the firm's capital
budgeting decision.
C. this is required by the Internal Revenue Service.
D. this is required by the Securities and Exchange Commission.
30. In estimating "after-tax incremental operating cash flows" for a project, you should include all
of the following EXCEPT:
 A. sunk costs.
B. opportunity costs.
C. changes in working capital resulting from the project, net of spontaneous changes
incurrent liabilities.
D. effects of inflation.
31. A capital investment is one that
A. has the prospect of long-term benefits.
B. has the prospect of short-term benefits.
C. is only undertaken by large corporations.
D. applies only to investment in fixed assets.
32. Taxing authorities allow the fully installed cost of an asset to be written off for tax purposes.
This amount is called the asset's
A. cost of capital.
B. initial cash outlay.
C. depreciable basis.
D. sunk cost.
33. Under the Modified Accelerated Cost Recovery System (MACRS), an asset in the "5-year
property class" would typically be depreciated over years.
A. FOUR
B. Five
C. Six
D. Seven

34. A project's profitability index is equal to the ratio of the of a project's future cash flows
to the project's .
A. present value; initial cash outlay
B. net present value; initial cash outlay
C. present value; depreciable basis
D. net present value; depreciable basis
35. Which of the following is an example of a capital investment project?
A. Replacement of worn out equipment
B. Expansion of production facilities
C. Development of employee training programs
D. All of the above are examples of capital investment projects.

ROLL NO.30
COST OF CAPITAL

MCQ’S

1, During planning period, a marginal cost for raising a new debt is classified as ---

a) Debt Cost
b) Relevant Cost
c) Borrowing Cost
d) Embedded Cost

2, Cost of common stock is 14% and bond risk premium is 9% then bond yield will be ____

(a) 15.6%
(b) 5%
(c) 11%
(d) 23%

3 In weighted average cost of capital, a company can affect its capital cost through____

a) Policy of Capital Structure

b) Policy of dividends
c) Policy of Investment
d) All of above

4, A risk associated with project and way considered by well diversified is classified as
_____

(a) Expected Risk

(b) Beta Risk
(c) Industry Risk
(d) Returning Risk

5, Cost of common stock is 13% and bond risk premium is 5% then bond yield would be
_____

a) 18%
b) 2.60%
c) 8%
d) 13%

6, Cost of capital is equal to required return rate on equity in case if investors are only____
 (a) Valuation Manager
(b) Common Stockholders
(c) Assets Seller
(d) Equity Dealer

7, Interest rate is 12% and tax savings (1-0.40) then after tax component cost of debt will
be___

a) 7.20%
b) 7.20 times
c) 17.14 times
d) $ 17.14

8. Retention Ratio is 0.60 and return on equity is 15.5% then growth retention would
be____

(a) 14.90%
(b) 25.84%
(c) 16.10%
(d) 9.30%

9. WACC is a function of a firm’s ____

a) Growth rate and investment potential

b) Earning and total assets
c) Total Assets
d) None of the above

10. When estimating a firm’s WACC the capital structure must be based on_____

(a) A combination of book market value

(b) Market value
(c) Book value
(d) None of the above

11. Cost of Equity is_______

a) Lower than net borrowing cost

b) At the same level as net borrowing Cost
c) Higher than net borrowing Cost
d) None of the above
12. Beta equal to 1.2 indicates that the risk____

(a) Is below the market level

(b) Is above the market level
(c) Is at the market level
(d) None of the above

13 On a mature market the average risk premium is between_____

a) 1% - 2%
b) 10% - 12%
c) 4% - 6%
d) 15% - 20%

14. Beta equity is positively correlated with _______

(a) A firm growth rate

(b) Financial leverage
(c) Investment potential
(d) None of the above

15 Systematic risk can be estimated based on ------

A) Historical Stock return

B) Fundamental risk factor
C) Both A and B
D) None of the above

16 Method uses for an estimation of cost of equity is classified as ______

(A) Market cash flow

(B) Future cash flow method
(C) Discounted Cash flow method
(D) Present cash flow method

17. Bond risk premium is added in the bond yield to calculate____

A) Cost of Common Stock

B) Cost of Preferred Stock
C) Cost of American Option
D) None of the Above
18 Stock selling price is $45/- an expected dividend is $10/- and an expected growth rate is
8% then cost of common stock would be_____

(A) $ 55
(B) 58%
(C) $ 37.47
(D) 30.22%

19 Dividend per share is $ 18/- and sell it for $ 122/- and flotation cost is $4/- then
component cost of preferred stock will be ____

A) 15.25%
B) O.1525 times
C) $ 15.25
D) 0.15%

20 In weighted average capital. Capital structure weights estimation does not rely on value
of ____

(A) Investors equity

(B) Market value of equity
(C) Book value of equity
(D) Stock equity

21 Interest rates, tax rates and risk premium which an/a____

A) Industry cannot Control

B) Industry Control
C) Firm must Control
D) Firm cannot Control

22 If payout ratio is 0.45 then retention ratio will be____

(A) 0.55
(B) 1.45
(C) 1.82
(D) 0.45

23 In weighted average cost of capital, rising in interest rates leads to_____

A) Income in cost of debt

B) Increase Capital Structure
C) Decrease in cost of debt
 D) Decrease Capital Structure

24 Cost of new debt or marginal debt is also classified as _____

(A) Historical rate

(B) Embedded rate
(C) Marginal rate
(D) Both A and B

25 Beta which is estimated as regression stop coefficient is classified as _____

A) Historical Beta
B) Market Beta
C) Coefficient Beta
D) Riskier Beta

COST OF CAPITAL

DEFINITION:

1. Cost of Capital:

The rate of return that a firm must earn on the projects in which it invests to maintain its
market value and attract funds.

2. Business Risk:

The risk to the firm of being unable to cover operating cost.

3. Financial Risk:

The risk to the firm of being unable to cover required financial obligation (Interest, Lease
Payments, Preferred Stock, Dividend).

4. Target Capital Structure:

The desired optimal mix of debt and equity financing that most firms attempt to maintain.

5. Specific Sources of Capital:

Basic sources of long-term funds for the business firm:

i) Long term debt

 ii) Preferred Stock
iii) Common Stock
iv) Retained Earnings

6. Cost of Long term debt: (Ki)

The after tax cost today of raising long term funds through borrowing.

Ki =Kd x (1 – Tax)

7. Net Proceeds:

Funds actually received from the sale of a security.

8. Flotation Cost:

The total costs of issuing and selling a security.

9. Cost of Preferred Stock: (K)

The ratio of the preferred stock dividend to the firm’s net proceeds from the scale of preferred
stock.

Calculated by dividing the annual dividend Dp by the net proceeds from the sale of the
preferred stock Np.

Kp= DP
NP

10. Cost of Common Stock equity: (k)

The rate at which investors discount the expected dividends of the firm to determine its share
value.

11. Two techniques are used to measure the cost of common stock equity.

1) Using the Constant – Growth Valuation (Gorden) model:

Assume that the value of a share of stock equal the present value of all future dividends that it
is expected to provide over an infinite time horizon.

Po = __D____

Ks – g

Po = Value of common stock

D1 = Per share dividend expected at the end of year 1

Ks = Required return on common stock

g = Content rate of growth in dividends

12. Using CAPM:

Describes the relationship between the required return ks and the nor diversifiable risk of the
firm as measured by the beta coefficient B

Ks = Rf + {B x [Km – Rf]}

Where

Ks = Required Return

Rf = Risk free rate of return

B = Non diversifiable Risk

Km = Market return

13. Cost of Retained Earning: (Kr)

The some as the cost of an equivalent fully subscribed issue of additional common stock, which
is equal to the cost of common stock equity.

Kr = Ks

14. Cost of new issue of Common Stock: (Kn)

The cost of common stock, net of under pricing and associated flotation costs.

15. Stock sold at a price below its current market price.

Po.

16. Weighted Average Cost of Capital:

Reflects the expected average future cost of funds over the long run; found by weighting the
cost of each specific type of optional by its proportion in the firm’s capital structure.

Ka = (Wi x Ki) + (Up x Kp) + (Ws + Ks)

Where

Wi = Proportion of long term debt in Capital Structure

Wp = Proportion of preferred stock in Capital Structure

Ws = Proportion of common stock in Capital Structure

Wi + Wp + Ws = 1

17. Book Value Weights:

Weights that use accounting values to measure the proportion of each type of capital in the
firm’s financial structure.

18. Market value Weights:

Weights that use market values to measure the proportion of each type of capital in the firm
financial structure.

19. Historical Weights:

Either book or market value weights based on desired capital structure proportions.

20. Target Weight:

Either book or market value weights based on desired capital structure propositions.

21. Weighted Marginal cost of capital: (WMCC)

The firm’s weighted average cost of capital (WACC) associated with its next dollar of total new
financing.

22. Break Point:

The level of total new financing at which the cost of one of the financing components rises,
thereby causing on upward shift in the weighted marginal cost of capital (WMCC):

BP; = AFi
Wi

Where
Bpi = Break point for financing source J
AFi = Amount of Funds
Wi = Capital Structure weight

23. Investment opportunities Schedule (IOS):

A ranking of investment possibilities from best (highest return) to worst (lowest Return).
24. Opportunity Cost:
The return stockholders could earn an alternative investment of equal risk.

25. Market Risk:

Market risk is that part of a security stand alone risk that cannot be eliminated by
diversification.

26. Firm – Specific Risk:

Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
 CAPITAL STRUCTURE ROLL No. 58
SHORT TERMS/DEFINITIONS:

1. Capital Structure: The mixture of debt and equity maintained by a firm (Ross).
Capital Structure is the proposition of debt and preference and equity shares on a firms
balance sheet. (M Y Khan).

2. Optimum Capital Structure: Optimum capital structure is the capital structure of which
the weighted average cost of capital is minimum and thereby maximum value of the
firm.

3. Concepts: The capital structure of a company is made up of debt and equity securities
that comprise a firm’s financing of its assets.

4. Capitalization Rate: The discount rate used to determine the present value of a stream
of expected future cash flows.

5. Recapitalization: An alteration of a firm’s capital structure. For example, a firm may sell
bonds to acquire the cash necessary to repurchase some of its outstanding common
stock.

6. Theories of Capital:
(a) Net Income Approach:
Net Income approach proposes that there is a definite relationship between capital
structure and value of the firm.
(b) Net Operating Income:
A theory of capital structure in which the weighted average cost of capital and the
total value of the firm remain constants as financial leverage is charged.
(c) Modigliani Miller Approach:
The MM approach relating to the relationship between the capital structures, cost
of capital and valuation is akin to the NOI approach.
(d) Traditional Approach:
A theory of capital structure in which there exists an optimal capital structure and
where management can increase the total value of the firm through the judicious
use of financial leverage
7. Optimal Capital Structure: The capital structure that minimizes the firms cost of capital
and thereby maximizes the value of the firm.

8. Arbitrage: Arbitrage implies buying a security in a market where price is low and selling
where it is the high.
9. Homemade Leverage: The use of personal borrowing to change the overall amount of
financial leverage to which the individual is exposed.

10. M&M Proposition (I): The proposition that the value of the firm is independents of the
firm’s capital structure.

11. M&M Proposition (II): The proposition that a firm’s cost of equity capital is a positive
linear function of the firm’s capital structure.

12. Business Risk: The equity risk that comes from the mature of the firm’s operating
activities.

13. Financial Risk: The equity risk that comes from the financial policy of the firm.

14. Interest tax shield: The tax saving attained by a firm from interest expense.

15. Unlevered Cost of Capital: The cost of capital for a firm that has no debt.

16. Direct Bankruptcy Costs: The costs that are directly associated with bankruptcy, such as
legal and administrative expenses.

17. Indirect Bankruptcy Costs: The costs of avoiding a bankruptcy filing incurred by a
financially distressed firm.

18. Financial Distress Costs: The direct and indirect costs associated with going bankruptcy
or experiencing financial distress.

19. Static Theory of Capital Structure: The theory that a firm borrows up to the point where
the tax benefit from an extra dollar in debt is actually equal to the cost that comes from
the increased probability of financial distress.

20. Bankruptcy: A legal proceeding for liquidation or recognizing a business.

21. Liquidation: Termination of the firm as a going concern.

22. Reorganization: Financial restructuring of a failing firm to attempt to continue

operations as a going concern.

23. Cost of Debt: The required rate of return on investments of the lend less of a company.
 24. Cost of Equity: The required rate of return on investment of the common shareholders
of the company.

25. Break-ever Analysis: A technique for studying the relationship among fixed costs,
variable costs, sales volume and profits.

26. Weighted Average Cost of Capital: The weighted average of the cost of equity and the
after tax cost of debt.

27. Balance Sheet: A summary of a firms’ financial position on a given date that shows total
assets – total liabilities + owners’ equity.

28. The levered Firm: A leered firm is a company that has some debt in the capital
structure.

29. The Financial Leverage: The use of fixed financing costs by the firm. The British
expression is gearing.

30. EPS: (Earning Per Share): Earning after tax divided by the member of common shares
outstanding.
Factors Determining Capital Structure:
(1) Trading on Equity
(2) Degree of control
(3) Flexibility of financial Plan
(4) Choice of Investors
(5) Capital market condition
(6) Period of Financing
(7) Cost of financing
(8) Stability of sales
(9) Sizes of a Company

Long term Financing (ROLL NO 42)

Financial System
Financial system includes a complex of institutions and mechanism which effects at savings and
their transfer to those who invests
Financial assets / Investment / Security:
Financial asset is a claim, against another economic units and held as a store at value and for
the expected return
Financial Intermediaries
Financial intermediaries convert direct financial asset into indirect securities.
Financial Markets
Financial markets provide a forum in which supplies of funds and demands of
loans/investments can transect business directly.
Money Market
Money Market is created by a financial relationship between supplies and demands of short
term funds having maturities of one year or less
Capital Market
Capital market/Securities market is a financial relationship created by a number of institutions
and arrangements that allows suppliers and demands of long term funds with maturites
exceeding one year to make transaction
New Securities
New securities are offered to the investing public for first time
Old Securities
Old Securities are securities which have been issued already and listed on a stock exchange
Listing
Listing enables dealings in securities on a stock exchange.
Function of Stock/Secondary Markets/Exchanges
Stock exchanges discharge three vital functions in the orderly growth of capital formation
1. Nexus between savings and investments
2. Market place
3. Continuous price formation
Functions of New Issues/Primary market
There are three functions of new issues and primary market.
1. Origination
2. Underwriting
3. Distribution
Origination
Origination is the work of investigation and analysis and processing of new issue proposals.
Underwriting
Underwriting is a form of guarantee that new issues would be sold by eliminating the risk
arising from uncertainty of public response.
Distribution
Distribution is the sale of securities to the ultimate investors
Public issue
Public issue is securities that are offered to the general public directly at a stated price
Lender/Book Building
Book Building is a price Discovery and investor’s response Mechanism.
Placement of securities
Placement of securities is the sale of unquoted securities. This is also known as private placing
Right issues
Right issues are the sale of securities to the existing shareholders.
Authorized Share capital
Authorized share capital is the measure of ordinary shares capital that a firm can raise without
further shareholder approval
Subscribe share /Capital
Subscribed share/ capital is the numbers of shares /capital outstanding
Voting system
There are two types of voting system
Majority rule voting
Proportionate rule voting
Majority Rule Voting
Majority voting is the system whereby in the election of directors, each share holder is to
entitled to one vote for each share he held and he vote all shares for each director separately
Proportionate Rule Voting
Proportionate rule voting is the system under which each share is allotted a number of votes
Equal to the number of directors to be elected and votes can be given to any director
Pre-emptive rights
Pre-emptive right is a legal right of existing share holders to be offered by the company is the
first opportunity to purchase additional equity shares in proportion to their current holdings.
Dilution of control/Financial Interest
Financial interest occurs when a new share issue results in each existing shareholder having a
claim in a small part of earnings then before.
Initial Public Offerings
IPO is the first issue of equity shares to the public by unlisted company
Differential pricing
Differential pricing is the new issue of shares at different prices in
Public and right issues
Firm allotment category and net offers to public
Book Building
Book building is the process by which
Demand for securities to be issued is elicited and building up.
Price for each security is assessed.
Green shoe option
It is the option of Allocating shares in excess of the shares included in the public issue through
book building and post listing price stabilizing mechanism.
Preferential issues
Preferential issue implies issue of share convertible securities/warrants to any select group of
persons on a private placement basis.
Long term loan/Debt
Long term loan/Debt is a loan made by a bank/ financial institution to a business having an
initial maturity of more than one year.’
Features of long term loans
Maturity
Negotiated
Security

Merger and acquisition

Corporate restructuring
Any change in company capital structure, operations, or ownership that iis outside of its
ordinary course of business
Basic forms of acquisition
There are three basic legal procedures that one firm can use to acquire other firm
1. Merger or consideration
2. Acquisition of stock
3. Acquisition of assets
Merger
A merger is refers to absorption of one firm by another
Consolidation
A consolidation is same as merger except that an entirely new firm is created. In
consolidation both the acquiring firm and acquired firm terminate their previous legal
existence and become part of the new firm
Acquisition of stock
A second way to acquire another firm is to purchase the firm’s stock in exchange for cash,
shares of stock other securities
Acquiring of assets one firm can acquire other firm assets by buying all of its assets. A
FORMAL VOTE OF THE SHAREHOLDERS IS REQUIRED
Sell Off
The sale of a division of a company known as a partial sell-off or of the company as a whole
known as voluntary liquidation
Spin off
A form of divesture resulting in a subsidiary or division becoming an independent company,
ordinarily, shares in the new company are contributed to the parent company’s
shareholders.
LEVERAGED BUYOUT (LBO)
Acquisition of the firm by a private group using substantial borrowed funds.
Going private
Making a public company private through the repurchase of stock by current management
and/or outside private investors.
Tax- Free transaction
An transaction in which the selling shareholders are considered to have exchanged their old
shares for new ones of equal value, and in which they have experienced no capital gains or
losses.

Good will
Good will is the excess of purchase price over the sum of the firm market of the individual
assets required.
Pooling of interests
Under a pooling of interests, the assets of the new firm are valued at the same level at which
they were carried on the books of the acquired and acquiring firms
Synergy
Economies relied on the merger where performance of the combined firm exceeds that of its
previously separate parts
Economies of scale
The benefits of size in which the average unit cist falls ass volume increases
Cost of Capital
The cost of capital often be reduced when two firms merge because the cost of issuing
securities are subject to economies of scale
Role up
The Combining of multiple small companies in the same industry to create one larger company
Initial public offerings
A company’s first offering of common stock to the general public

MCQ, s
1. Suppose that the market price of company X is 45$ per share and that of company Y is 30$,if
X offers three fourth a share of Y- the ratio of exchange of market price would be
A) 0.667
B) 1.0
C) 1.25
D) 1.5

2.The manufacturing of a corporation should be undertaken if

A) The restructuring can prevent an unwanted takeover

B) The restructuring is expected to create value for shareholders
C) The restructuring is expected to increase the firms revenue
D) The Interest of shareholders are not negatively affects.

3. The “Information Effect” to the notion that

A) A corporation actions may convey information about its future prospect

B) Management is reluctant to provide information which is not required by law
C) Agents incur cost in trying to obtain information
D) The Financial manager should attempt to manage the sensitive information
about the firm
4. In the long run a successful acquisition is one that
A) Enables the acquirer to make an all equity purchase , thereby avoiding
additional financial leverage
 B) Enables the buyer to diversify its asset base
C) Increase the market price of the require’ stock over what it would have been
without the acquisition
D) Increase financial leverage
5. Bidding companies often too much pays for the acquiring the firm, The Hubris
hypothesis explain this by suggesting that the bidders;
A) Have too few information to make an optimal decision
B) Have big egos in this impedes rational decision making
C) Have difficulty in thinking strategically over the long term
D) Are overly influenced by the tax consequence of an acquisition
6. A tender offer is:
A) A good will gesture by a white knight
B) A would be acquirers friendly takeover attempt
C) A would be acquirers offer to buy stock directly from shareholder
D) Viewed as sexual harassment when its occurs in the work place
7. The public sale of common stock in a subsidiary in which parent usually retains majority
control is called
A) A pure play
B) A spin-off
C) A political sale off ;
D) An equity ware out
8. In the United States, good will charges arising from a current acquisition are genraly for
Tax purpose over
A) 15 years
B) 20 years
C) 40 years
D) Not deductible for tax purpose
9. One means for a Company to “Go private” over.
A) Divestiture
B) The pure play ;
C) The leverage buy out
D) The prepackaged reorganization
10. Recent accounting changed in the us:
A) Eliminated the purchase method, allowing only the pooling-of-intersts merger
and acquisition
B) Eliminates the pooling of interest merger and acquisition
C) Allow for both purchase method and for merger and acquisition method
D) Outlawed the recording of good will for only merger or acquisition
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
1
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.
Risk is that part of a security stand-alone risk which can be eliminated by proper diversification.