BUSINESS FINANCE MCQs

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BUSINESS FINANCE

1) The cost to a corporation of each type of capital is dependent upon
A) the risk-free rate of each type of capital plus the financial risk of the firm.
B) the risk-free rate of each type of capital plus the business risk and the financial risk of the firm.
C) the risk-free rate of bonds plus the business risk of the firm.
D) the risk-free rate of each type of capital plus the business risk of the firm.

2) The specific cost of each source of long-term financing is based on and costs.
A) after-tax; historical
B) before-tax; book value
C) after-tax; current
D) before-tax; historical

3) In order to recognize the interrelationship between financing and investments, the firm should use
when evaluating an investment.
A) the weighted average cost of all financing sources
B) the current opportunity cost
C) the most costly source of financing
D) the least costly source of financing

4) A corporation has concluded that its financial risk premium is too high. In order to decrease this, the firm car
A) increase the proportion of long-term debt to decrease the cost of capital.
B) increase the proportion of common stock equity to decrease financial risk.
C) increase short-term debt to decrease the cost of capital.
D) decrease the proportion of common stock equity to decrease financial risk,

5) The before-tax cost of debt for a firm which has a 40 percent marginal tax rate is 12 percent. The after-tax cost
of debt is
A) 7.2 percent.
B) 4.8 percent.
C) 6.0 percent.
D) 12 percent.

6) A firm has issued 10 percent preferred stock, which sold for $100 per share par value. The cost of issuing and
selling the stock was $2 per share. The firm’s marginal tax rate is 40 percent. The after-tax cost of the preferred stock is
A) 6.1 percent.
B) 3.9 percent.
C) 9.8 percent.
D) 10.2 percent.

7) The approximate before-tax cost of debt for a 10-year, 8 percent, $1,000 par value bond selling at $1,150 is
A) 8.8 percent.
B) 8.3 percent.
C) 9 percent.
D) 6 percent.

8) Debt is generally the least expensive source of capital. This is primarily due to
A) its position in the priority of claims on assets and earnings in the event of liquidation
B) fixed interest payments.
C) the secured nature of a debt obligation.
D) the tax deductibility of interest payments.

9) The cost of new common stock financing is higher than the cost of retained earnings due tc
A) flotation costs and commission costs.
B) flotation costs and overpricing.
C) flotation costs and underpricing.
D) commission costs and overpricing.

10) The constant growth valuation model-the Gordon model-is based on the premise that the value of a share of
common stock is
A) determined based on an industry standard P/E multiple.
B) equal to the present value of all expected future dividends.
C) determined by using a measure of relative risk called beta.
D) the sum of the dividends and expected capital appreciation.

11) A firm has a beta of 1.2. The market return equals 14 percent and the risk-free rate of return equals 6 percent.
The estimated cost of common stock equity is
A) 14 percent.
B) 7.2 percent.
C) 15.6 percent.
D) 6 percent.

12) Firms underprice new issues of common stock for the following reason(s).
A) When the market is in equilibrium, additional demand for shares can be achieved only at a lower price.
B) Many investors view the issuance of additional shares as a signal that management is using common stock
equity financing because it believes that the shares are currently overpriced.
C) When additional shares are issued, each share’s percent of ownership in the firm is diluted, thereby
justifying a lower share value.
D) all of the above.

13) A firm has common stock with a market price of $25 per share and an expected dividend of $2 per share at the
end of the coming year. The growth rate in dividends has been 5 percent. The cost of the firm’s common stock
equity is
A) 10 percent.
B) 15 percent.
C) 12 percent.
D) 13 percent.

14) Generally, the order of cost, from the least expensive to the most expensive, for long-term capital of a
corporation is
A) preferred stock, retained earnings, common stock, new common stock.
B) new common stock, retained earnings, preferred stock, long-term debt.
C) common stock, preferred stock, long-term debt, short-term debt.
D) long-term debt, preferred stock, retained earnings, new common stock.

15) A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the
following sources and target market value proportions:

Target Market
Source of Capital Proportions After-Tax Cost
Long-term debt 40% 6%
Preferred stock 10 11
Common stock equity 50 15

The weighted average cost of capital is
A) 16 percent.
B) 15 percent.
C) 11 percent.
D) 10.7 percent.

16) A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the
following sources and target market value proportions:

Target Market After-Tax
Source of Capital Proportions Cost
Long-term debt 45% 5%
Preferred stock 10 14
Common stock equity 45 22
If the firm were to shift toward a more leveraged capital structure (i.e., a greater percentage of debt in the capital structure), the weighted average cost of capital would
A) increase.
B) remain unchanged.
C) decrease.
D) not be able to be determined.

17) As the volume of financing increases, the costs of the various types of financing will the
firm’s weighted average cost of capital.
A) decrease, lowering
B) decrease, raising
C) increase, lowering
D) increase, raising

Table 11.1

A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions.

Target Market
Source of Capital Proportions
Long-term debt 20%
Preferred stock 10
Common stock equity 70

Debt: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of
2 percent of the face value would be required in addition to the discount of $40.
Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3 per share.
Common Stock: A firm’s common stock is currently selling for $18 per share. The dividend expected to be paid at the end of
the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in floatation costs. Additionally, the firm’s marginal tax rate is 40 percent.

18) The firm’s before-tax cost of debt is (See Table 11.1.)
A) 7.7 percent.
B) 11.2 percent.
C) 10.6 percent.
D) 12.7 percent.

19) The firm’s after-tax cost of debt is (See Table 11.1.)
A) 8.13 percent.
B) 8 percent.
C) 3.25 percent.
D) 4.6 percent.

20) The firm’s after-tax cost of preferred stock is (See Table 11.1.)
A) 13.3 percent.
B) 7.2 percent.
C) 13.9 percent.
D) 8.3 percent.

21) The firm’s cost of a new issue of common stock is (See Table 11.1.)
A) 9.08 percent.
B) 13.2 percent.
C) 7 percent.
D) 14.4 percent.

22) The firm’s cost of retained earnings is (See Table 11.1.)
A) 10.2 percent.
B) 13.6 percent.
C) 1.2.7 percent. Guessing says 12.4 which is correct
D) 13.9 percent.

23) The weighted average cost of capital up to the point when retained earnings are exhausted is (See Table 11.1.)
A) 7.5 percent.
B) 11.2 percent.
C) 10.4 percent.
D) 8.65 percent.

24) The weighted average cost of capital after all retained earnings are exhausted is (See Table 11.1.)
A) 11.0 percent.
B) 10.4 percent.
C) 13.6 percent.
D) 11.55 percent.

Table 11.3
Balance Sheet
General Talc Mines December 31, 2003
Assets
Current Assets
Cash $25,000
Accounts Receivable 120,000
Inventories 300,000
Total Current Assets $445,000
Net Fixed Assets $500,000
Total Assets $945000

Liabilities and Stockholders’ Equity
Current Liabilities
Accounts Payable $80,000
Notes Payable 350,000
Accruals 50,000
Total Current Liabilities $480,000
Long-Term Debts(150 bonds issued at $1,000 par) 150,000
Total Liabilities $630,000
Stockholders’ Equity Common Stock (7,200 shares outstanding) $180,000
Retained Earnings 135,000
Total Stockholders’ Equity $315,000
Total Liabilities and Stockholders’ Equity $945,000

25)
Source of Capital After-Tax Cost
Long-term debt 8%
Common stock equity 19

Given this after-tax cost of each source of capital, the weighted average cost of capital using book weights for General Talc Mines is (See Table 113.)
A) 17.5 percent.
B) 16.6 percent.
C) 15.4 percent.
D) 11.6 percent.

26) A corporation expects to have earnings available to common shareholders (net profits minus preferred
dividends) of $1,000,000 in the coming year. The firm plans to pay 40 percent of earnings available in cash
dividends. If the firm has a target capital structure of 40 percent long-term debt, 10 percent preferred stock, and
50 percent common stock equity, what capital budget could the firm support without issuing new common stock?
A) $ 600,000.
B) $2,000,000.
C) $1,200,000.
D) $800,000.

27) Tough Question, think about it before you answer: The investment opportunity schedule combined with the
weighted marginal cost of capital indicates
A) those projects that will result in the highest cash flows.
B) which projects are acceptable given the firm’s cost of capital.
C) those projects that a firm should select.
D) which combination of projects will fit within the firm’s capital budget.

28) According to the investment opportunity schedule (IOS), as the cumulative amount of money invested in z
project increases, the return on the projects will
A) not be a factor.
B) remain unchanged.
C) decrease.
D) increase.

29) The wealth-maximizing investment decision for a firm occurs when
A) the weighted marginal cost of capital equals the investment opportunity schedule.
B) the weighted cost of capital exceeds the marginal cost of capital.
C) the cost of capital equals the return on the project.
D) the weighted marginal cost of capital is less than the investment opportunity schedule,

30) A firm’s current investment opportunity schedule and the weighted marginal cost of capital schedule are shover
below.

Investment Initial
Opportunity Schedule IRR Investment
A 15% 200,000
B 12 300,000
C 19 100,000
D 10 400,000
E 16 300,000

Weighted Marginal Cost of Capital
Range of Total New Financing WMCC
$0-$250,000 7.5%
250,001-500,000 8.9
500,001-1,000,000 10.0
1,000,001-1,500,000 12.0

The investment opportunities which should be selected are
A) B, C, D, and E.
B) A, B, C, and D.
C) A, B, D, and E.
D) A, B, C, and E.

31) If a firm’s fixed operating costs decrease, the firm’s operating breakeven point will
A) increase.
B) remain unchanged.
C) decrease.
D) change in an undetermined direction.

32) If a firm’s sale price per unit decreases, the firm’s operating breakeven point will
A) remain unchanged.
B) decrease.
C) change in an undetermined direction.
D) increase.

33) A firm has fixed operating costs of $525,000, of which $125,000 is depreciation expense. The firm’s sales price
per unit is $35 and its variable cost per unit is $22.50. The firm’s cash operating breakeven point in units is
A) 42,000.
B) 52,000.
C) 23,330.
D) 32,000.

34) A major assumption of breakeven analysis and one which causes severe limitations in its use is that
A) total revenue is nonlinear.
B) revenues and operating costs are linear.
C) fixed costs really are fixed.
D) all costs are really semi-variable.

35) A firm has fixed operating costs of $10,000, the sale price per unit of its product is $25, and its variable cost pex

unit is $15. The firm’s operating breakeven point in units is

A) 250; $ 6,250
B) 667; $16,675
C) 1,000; $25,000
D) 400; $10,000

and its breakeven point in dollars is

36) A firm has fixed operating costs of $150,000, total sales of $1,500,000, and total variable costs of $1,275,000. The

firm’s operating breakeven point in dollars is
A) $1,425,000.
B) $1,000,000.
C) $176,471.
D) $150,000.

37) A decrease in fixed financial costs will result in
A) no change
B) an undetermined change
C) a decrease
D) an increase

38) Generally, in leverage result in
A) increases; increased; increased
B) decreases; increased; decreased
C) increases; decreased; increased
D) increases; decreased; decreased

in financial risk.

return and risk.

39) Because the degree of total leverage is multiplicative and not additive, when a firm has very high operating
leverage it can moderate its total risk by
A) using more financial leverage.
B) increasing EBIT.
C) using a lower level of financial leverage.
D) increasing sales.

40) In theory, the firm should maintain financial leverage consistent with a capital structure that
A) meets the industry standard.
B) maximizes dividends.
C) maximizes the owner’s wealth.
D) maximizes the earnings per share.

41) Which of the following is NOT a reason why debt capital is considered to be the least risky source of capital?
A) It is a low cost source of capital because interest payments are tax deductible.
B) It does not normally have to be repaid at a specific future date.
C) It has a strong legal position.
D) It has a high priority claim against assets and earnings.

42) Probability of bankruptcy is determined by
A) total risk.
B) business risk.
C) interest rate risk.
D) financial risk.

43) A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate. The amount
of earnings before interest and taxes (EBIT) required to pay the preferred dividends is
A) $1,666,667.
B) $ 600,000.
C) $1,000,000.
D) $ 400,000.

44) A corporation has $5,000,000 of 10 percent bonds and $3,000,000 of 12 percent preferred stock outstanding. The
firm’s financial breakeven (EBIT) assuming a 40 percent tax rate is
A) $716,000.
B) $1,400,000
C) $860,000.
D) $1,100,000.

45) The optimal capital structure is the one that balances
A) return and risk factors in order to maximize profits.
B) return and risk factors in order to maximize dividends.
C) return and risk factors in order to maximize market value.
D) return and risk factors in order to maximize earnings per share.

46) As debt is substituted for equity in the capital structure and the debt ratio increases, all of the following
statements about the component costs of capital which answer is FALSE.
A) the cost of equity continually increases.
B) the cost of debt continually increases.
C) the overall cost of capital continually increases.
D) the overall cost of capital first declines, reaches a minimum, and then rises again.

47) A firm has a current capital structure consisting of $400,000 of 12 percent annual interest debt and 50,000 shares
of common stock. The firm’s tax rate is 40 percent on ordinary income. If the EBIT is expected to be $200,000, the
firm’s earnings per share will be
A) $2.40
B) $7.04
C) $3.04
D) $1.82

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