Capital Structure Decisions – Financial and Strategic Management MCQ

IPL Ltd. has an EBIT of ₹ 1,00,000. The company makes use of debt and equity capital. The firm has 10% debentures of ₹ 5,00,000 and the firm’s equity capitalization rate is 15%. You are required to compute: (i) the Current value of the firm; (ii) the Overall cost of capital.

One-third of the total market value of X Ltd. consists of loan stock, which has a cost of 10%. Another company, Y Ltd. is identical in every respect to X Ltd., except that its capital structure is all-equity, and its cost of equity is 16%. According to Modigliani and Miller, if we ignored taxation and tax relief on debt capital, what would be the cost of equity of X Ltd.?

Ganesha Ltd. is setting up a project with a capital outlay of ₹ 60,00,000. It has two alternatives in financing the project cost.Alternative (a): 100% equity finance
Alternative (b): Debt-equity ratio 2:1
The rate of interest payable on the debts is 18% p.a. Corporate tax rate is 40%. Calculate the indifference point between the two alternative methods of financing.

What is the market value of common equity under the NOI approach? The firm has an expected net operating income of ₹ 5,000 with ₹ 4,000 of debt (market value). Assume that the overall capitalization rate is 20%.

Bharat Cylinders has 15,000 shares of stock outstanding and no debt, as the original founder of the firm did not approve of debt financing. The new CEO is considering issuing ₹ 2,50,000 of debt and using the proceeds to retire 5.0___shares of stock. The interest rate on debt is 7.5%. What is the break-even level of EBIT between these two capital structure options?

Trade International is an all-equity firm that has projected earnings before interest and taxes of ₹ 4,97,000 forever. The current cost of equity is 16% and the tax rate is 34%. The company is in the process of issuing ₹ 1.5 million of bonds at par that carries a 6% annual coupon. What is the levered value of the firm?

A student studying Financial Management subject is not able to understand when total market value will be the same for Company X and Company Y if both companies have the same total assets.Company X calculates total value under Net Income (NI) approach and Company Y calculates total value under Net Operating Income (NOI) approach. Help him by selecting the correct option.

The following data is available for Q Ltd.:Total Assets: ₹ 15,00,000
Debt: Nil
EBIT: 20% of total assets
Tax rate: 50%
Capitalization rate =15%
Calculate the total value of the firm using the Net Operating Income (NOI) approach.

Following data is available for P Ltd.:Total Assets: ₹ 15,00,000
10% Debt: ₹ 9,00,000
EBIT: 20% of total assets
Tax rate: 50%
Capitalization rate = 15%
Calculate the total value of the firm using the Net Operating Income (NOI) approach.

The following data is available for Company Y:Total Assets : ₹ 15,00,000
Debt: Nil
EBIT: 20% of total assets
Tax rate: 50%
Capitalization rate = 15%
Calculate the market value of equity using the Net Income (NI) approach.

Following data is available for Company X:Total Assets: ₹ 15,00,000
10%Debt: ₹ 9,00,000
EBIT: 20% of total assets
Tax rate : 50%
Capitalization rate =15%
Calculate the market value of equity using the Net Income (NI) approach.

Alpha Ltd. is contemplating the conversion of .500 14% convertible bonds of ₹ 1,000 each. The market price of the bond is ₹ 1,080. Bond indenture provided that 1 bond will be exchanged for 10 shares. P/E ratio before redemption is 20:1 and anticipating price-earnings ratio after redemption is 25:1. The number of shares outstanding prior to redemption are 10,000. EBIT amounts to ₹ 2,00,000. The company is in the 35% tax bracket.Calculate market price – (i) Pre-redemption and (ii) Post redemption.

Skyline Software Ltd. wants to implement a project for which ₹ 30 lakhs is required. Following financing options are at hand:

B Ltd. requires ₹ 12 lakh to finance its activities. Its earnings before interest and tax amount to ₹ 2 lakh. The Finance Manager has forwarded three proposals:
The market price of a share of the company is ₹ 40 which is expected to come down to ₹ 25 a share if the market borrowings exceed ₹ 7,50,000.
Which proposal is a most profitable proposal from the shareholders’ point of view?

There are two firms P and Q which are identical except P does not use any debt in its capital structure while Q has ₹ 8,00,000, 9% debentures in its capital structure. Both the firms have EBIT of ₹ 2,60,000 p.a. and the capitalization rate is 10%. Corporate tax is 30%. Calculate the total market value of these firms according to MM Hypothesis.

Domino is an all-equity firm with a current cost of equity of 18%. The EBIT of the firm is ₹ 2,04,000 annually forever. Currently, the firm has no debt but is in the process of borrowing ₹ 5,00,000 at 9% interest. The tax rate is 34%. What is the value of the un-levered firm?

M Ltd. requires ₹ 25,00,000 for a new plant. This plant is expected to yield an EBIT of ₹ 5,00,000. The company considers the objectives of maximizing EPS. It has 3 options to finance the project – by raising debt of ₹ 2,50,000 or ₹ 10,00,000 or ₹ 15,00,000 and the balance, in each case, by issuing equity shares. The company’s shares are currently selling at ₹ 150, but it is expected to decline to ₹ 125 in case the funds are borrowed in excess of ₹ 10,00,000. The funds can be borrowed at the rate of 10% up to ₹ 2,50,000 and 15% up to ₹ 10,00,000 and at 20% over ₹ 10,00,000. The tax rate is 50%. Which form of financing should the company choose?

A company needs ₹ 31,25,000 for the construction of a new plant. The following two plans are feasible:(i) Company may issue ₹ 3,12,500 equity shares at ₹ 10 per share.
(ii) The company may issue ₹ 1,56,250 equity shares at ₹ 10 per share and 15,625 preference shares at ₹ 100 per share bearing an 8% rate of dividend.
The corporate income-tax rate is 40%.
At indifferent point EPS under both plans will be –

A company needs ₹ 31,25,000 for the construction of a new plant. The following two plans are feasible:(i) Company may issue 3,12,500 equity shares at ₹ 10 per share.
(ii) The company may issue 1,56,250 ordinary equity shares at ₹ 10 per share and 15,625 debentures of ₹ 100 denomination bearing an 8% rate of interest.
The corporate income tax rate is 40%. Calculate indifference point.

FThe alternative I: Equity shares can be issued at ₹ 10 par with a premium of ₹ 40 each. Share issue expenses as also underpricing of the issue in comparison to ruling market price result in net proceeds of ₹ 40 for every new share issued.
inancing alternatives for obtaining the requisite amount of ₹ 20 Crores are under consideration.Alternative II: Company can borrow the requisite amount at a 15% rate of interest per year.The company decided to borrow ₹ 10 Crore at a 15% rate of interest per year and the balance amount obtained by share issue at par terms indicated in the first alternative.How many equity shares are required to be issued for availing finance of ₹ 20 Crore?

Financing alternatives for obtaining the requisite amount of ₹ 20 Crores are under consideration.It was decided to issue equity shares of ₹ 10 par at a premium of ₹ 40 each. Share issue expenses as also underpricing of the issue in comparison to ruling market price result in net proceeds of ₹ 40 for every new share issued. How many equity shares are required to be issued for availing finance of ₹ 20 Crore?

Following details are presented by Y Ltd.:

A new project under consideration requires a capital outlay of ₹ 300 lakhs. The required funds can be raised either fully by equity shares of ₹ 100 each or by equity shares of the value of ₹ 200 lakhs and by the loan of ₹ 100 lakh at 15 % interest. Assuming a tax rate of 50%, calculate the figure of profit, before tax that would keep the equity investors indifferent to the two options.

EBIT of NS Ltd. is ₹ 4,50,000.Debt in capital structure = ₹ 6,00,000
Cost of debt (K_d) = 10%
Cost of equity (K_e) = 12.5%
Ignore taxation.
The total market value of NS Ltd. =?

Take the data of the above question and calculate the overall cost of capital.

EBIT of R Ltd. is ₹ 5,00,000. The company has 10%, ₹ 20,00,000 debentures. The equity capitalization rate i.e. K_e is 16%. Calculate the market value of the firm as per the Net Income (NI) Approach. Ignore taxation.

An EBIT-EPS indifference analysis chart is used for –

Two firms that are virtually identical except for their capital structure are selling in the market at different values. According to M & M:

Market values are often used in computing the weighted average cost of capital because

Which one of the following statements concerning financial leverage is correct?

Which of the following step would you recommend to avoid the negative consequences of overcapitalization?

M & M Proposition I, without taxes, states that:

A firm’s optimal capital structure:

Internal sources of finance do not include:

External sources of finance do not include:

Which term would most likely be associated with the phrase “actions speak louder than words”?

According to Cost Principle, an ideal pattern or capital structure is one that –

In horizontal capital structure –

One can design a capital structure with proper proportions of equity, preference, and debt mix. The choice of the combination of these sources is called –

Horizontal capital structure
Which of the following statement is correct?1. is quite stable.
2. is formed by a small amount of equity share capital.
3. there is the absence of debt.
4. have an increasing component of debt.
Select the correct answer from the options given below.

Assertion (A):The capital structure acts as a tax management tool also.
Reason (R):A relatively lesser component of equity capital is vulnerable to hostile takeovers.
Select the correct answer from the options given below

Capital structure relates to capital deployment for the creation of assets.

If the debt component in the capital structure is predominant –

A critical assumption of the net operating income (NOI) approach to valuation is that:

One can get a reasonably accurate broad idea about the risk profile of the firm from its –

Which of the following statement is false?

Which of the following capital structure consist of zero debt components in the structure mix?

Assertion (A):The capital structure should be determined within the debt capacity of the company and this capacity should not be exceeded.
Reason (R):The debt capacity of a company depends on its ability to generate future cash flows. It should have enough cash to pay creditors’ fixed charges and principal sum.

Financial structure is___ concept while the capital structure is__ concept.

Which of the following statement is incorrect?(1) High debt funds in capital structure increase EPS.
(2) High debt funds increase the operating or business risk.
Select the correct answer from the options given below.

The financial structure involves the creation of ___(1) Long term assets
(2) Short term assets

Which of the following shows the significance of capital structure?

Which of the following is not included in the capital structure?

The optimal capital structure consists of –

The manner in which an organization’s assets are financed is referred to as its –

Which of the following changes in capital structure would you recommend for growth at a faster rate?

While designing a capital structure a finance manager should choose a pattern of capital which –

Which of the following statement is false?I. In case the firm wants to grow at a faster pace, it would be required to incorporate debt in its capital structure to a greater extent.
II. If the firm has no long-term debt in its capital structure, it means that either it is risk-averse or it has a cost of equity capital or cost of retained earnings less than the cost of debt.

The decisions regarding the forms of financing, their requirements, and their relative proportions in total capitalization are known as –

The term “capital structure” refers to:

_____refers to the mix of a firm’s capitalization and includes long term sources of funds.