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Financial Management Test - 30

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Financial Management Test - 30
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Weekly Quiz Competition
  • Question 1
    1 / -0
    The working capital term loan representing excess borrowings
  • Question 2
    1 / -0
    Which of the following ratios are taken into consideration by a banker before sanctioning the loan?
    Solution
    Debt service coverage ratio is also known as debt coverage ratio. Generally this ratio gives an idea to the bankers about lenders that how many times lender can make loan payment with there net income.
  • Question 3
    1 / -0
    The degree of super-leverage would be calculated by________.
    Solution
    Degree of super leverage=Degree of operating leverage x Degree of financial leverage
    $$DOL$$ = $$\cfrac{contribution}{EBIT}$$ 
    $$DFL$$= $$\cfrac{EBIT}{PBT}$$                                  
    Degree of super leverage = $$\cfrac{Contribution}{PBT}$$

    $$EBIT$$= Earning before intrest and tax
    $$PBT$$= Profit before tax
  • Question 4
    1 / -0
    Pay-back period method is also called as ________.
    Solution
    The payback period is the time required for the amount invested in an asset to be repaid by the net cash flow generated by the asset. It is a simple way to evaluate the risk associated with a proposed project. An investment with a shorter payback period is considered to be better, since the investor's initial outlay is at risk for a shorter period of time. The calculation used to derive the payback period is called the payback method. The payback period is expressed in years and fractions of years
  • Question 5
    1 / -0
    Which one of the following is not the internal factor affecting the weighted average cost of capital of a firm?
    Solution
    Internal factors that affect the Weighted Average Cost of Capital (WACC) of a firm includes the following:
    • Capital structure of the firm: A business entity has a control over its capital structure. The more the debt, higher will be the cost of such debts; higher the equity, higher will the cost of equity.
    • Dividend Policy of the firm: It relates to studying the Price-Earning ratio. If this ratio increases, cost of retained earnings decrease which is the result of reduced earnings that are retained to be used as a source of fund.
    • Investment policy of the firm: Company makes investments with lesser risks. As the policy changes, so does the impact on cost of debt and cost of equity.

    The market risk premium is the difference between the expected return on a market portfolio and the risk-free rate. It does not form a part of internal factors affecting the WACC of a firm.
  • Question 6
    1 / -0
    The most suitable coverage ratio for deciding the debt capacity of a firm is _________.
    Solution
    Generally, cash flow coverage ratio measures the ability of company's operating cash flow to meet it's current obligations (short term borrowings, long term debt).

    Larger the operating cash flow coverage, greater the company's ability to meet it's obligations.
    Cash Flow Coverage Ratio = Operating cash flow / Short term debt coverage
  • Question 7
    1 / -0
    Which one of the following assumptions is not covered in the Walter's Model of the dividend policy?
    Solution
    Assumptions of Walter's Model of the dividend policy include:
    • Financing of the company's requirements is done through the retained earnings, with no external financing.
    • The rate of return (r) and the cost of capital (K) remain constant irrespective of any changes in the investments.
    • The earnings per share (EPS) and Dividend per share (DPS) remains constant.
    • The firm has a perpetual life.
  • Question 8
    1 / -0
    Financial leverage is called favorable if ____________.
    Solution
    Firstly, debt is considered a more effective source of positive financial leverage than preferred stock because the interest on debt is tax deductible but dividend on preferred stock is not. 

    Secondly, financial leverage is desirable when rate or return on investment  using these amounts of money have been obtained from bank loan is more than the bank interests or dividend payable.
  • Question 9
    1 / -0
    Financial leverage in a firm is positively affected by:
    Solution
    Financial leverage means acquiring assets with the funds provided by creditors and preferred stockholders for the benefit of common stockholders. Financial leverage is a two-edged sword. It may be positive or negative. Tangible assets, many of which can be easily used as collateral, support debt.
    Accordingly, the amount of tangible assets is well-established as a principal driver of leverage. As investing is shifting more and more from tangible to intangible assets, it becomes crucial to understand to what extent intangible assets support debt.
  • Question 10
    1 / -0
    Who formulated the following model for estimating the market price of equity share?
    $$P = \dfrac {D + \dfrac {R_{a}}{R_{c}}(E - D)}{R_{c}}$$
    Where, $$P =$$ Market price of equity share
    $$D = DPS$$
    $$E = EPS$$
    $$E - D =$$ Retained earning per share
    $$R_{a} =$$ Internal rate of return on investment
    $$R_{c} =$$ Cost of capital.
    Solution
    Professor James E. Walter that the choice of dividend policies almost always affects the value of the enterprise. His model shows clearly the importance of the relationship between the firm’s internal rate of return (r) and its cost of capital $$(k)$$ in determining the dividend policy that will maximize the wealth of shareholders.

    Walter’s formula to calculate the market price per share (P) is:

    $$P=\cfrac {\cfrac {D}{k}+\cfrac {E-D}{k} \times r} {k}$$

    P = market price per share
    D = dividend per share
    E = earnings per share

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