Seat No:______________ Enrollment No:______________

PARUL UNIVERSITY
FACULTY OF MANAGEMENT
Master of Business Administration
Model Question Paper
Semester: 2 Date: ……………….
Subject Code: 06200153 Time: 1 Hr. 30 Min.
Subject Name: Financial Management Total Marks: 60

Important information: The question paper contains first question – MCQ Type, second question – Answer in One line.
Question Paper Setter is requested to fill the answers in the ANSWER KEY section of this template.

Q.1 Multiple Choice Questions (1 Mark each, attempt any 30 out of 40 questions) (30 Marks)

1. Deep Discount Bonds are issued at

(a)Face Value (b)Maturity Value
(c)Premium to Face Value (d)Discount to Face Value
2. Principal value of a bond is called the

(a)Maturity Value (b)Issue Price

(c)Par Value (d)Market Price
3. If the required rate of return of a particular bond is less than
coupon rate, it is known as
(a)Discount Bond (b)Premium Bond
(c)Par Bond (d)Junk Bond
4. Market interest rate and bond price have
(a)Positive relationship (b)Inverse relation
(c)No relationship (d)Same relationship
5. If a coupon bond is selling at discount, then which of the following
is true?
(a) Po < Par and YTM < coupon (b) Po < Par and YTM > coupon
(c)Po > Par and YTM < coupon (d) Po > Par and YTM > coupon
6. Capital Budgeting is a part of:

(a)Investment Decision (b) Working Capital Management

(c) Marketing Management (d) Capital Structure

7. Capital Budgeting deals with
Long-term Decisions (b) Short-term Decisions
(c) Both (a) and (b) (d) Neither (a) nor (b)
8. Which of the following is not used in Capital Budgeting?

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 (a) Time Value of Money (b) Sensitivity Analysis
(c) Net Assets Method (d) Cash Flows
9. Capital Budgeting Decisions are:

(a) Reversible (b) Irreversible

(c) Unimportant (d)All of the above
10. Which of the following is not incorporated in Capital Budgeting?
(a) Tax-Effect (b) Time Value of Money
(c) Required Rate of Return (d) Rate of Cash Discount
11. Which of the following is not a capital budgeting decision?
(a) Expansion Program (b) Merger
(c) Replacement of an Asset (d) Inventory Level
12. A sound Capital Budgeting technique is based on:
(a) Cash Flows (b)Accounting Profit,
(c) Interest Rate on Borrowings (d) Last Dividend Paid
13. Which of the following is not a relevant cost in Capital Budgeting?

(a) Sunk Cost (b) Opportunity Cost

(c) Allocated Overheads (d) Both (a) and (c) above
14. In capital budgeting, the term Capital Rationing implies:

(a) That no retained earnings (b) That limited funds are

available available for investment
(c) That no external funds can (d) That no fresh investment is
be raised required in current year
15. Feasibility Set Approach to Capital Rationing can be applied in:
(a) Accept-Reject Situations (b) Divisible Projects

(c) Mutually Exclusive Projects (d) None of the above

16. In case of divisible projects, which of the following can be used to attain maximum NPV?
(a) Feasibility Set Approach (b) Internal Rate of Return
(c) Profitability Index Approach (d) Any of the above
17. In case of the indivisible projects, which of the following may not give the optimum result?
(a) Internal Rate of Return (b) Profitability Index
(c) Feasibility Set Approach (d) All of the above
18. Profitability Index, when applied to Divisible Projects, impliedly assumes that:
(a) Project cannot be taken in parts (b) NPV is linearly proportionate to part of the
project taken up

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 (c) NPV is additive in nature (d) Both (b) and (c)
19. If there is no inflation during a period, then the Money Cashflow would be equal to:
(a) Present Value (b) Real Cashflow
(c) Real Cashflow + Present Value (d) Real Cashflow - Present Value
20. The Real Cashflows must be discounted to get the present value at a rate equal to:
(a) Money Discount Rate (b) Inflation Rate
(c) Real Discount Rate (d) Risk free rate of interest
21. Cost of Capital refers to:
(a) Flotation Cost (b) Dividend
(c) Required Rate of Return (d) None of the above
22. Which of the following sources of funds has an Implicit Cost of Capital?
(a) Equity Share Capital (b) Preference Share Capital
(c) Debentures (d) Retained earnings
23. Which of the following has the highest cost of capital?
(a) Equity shares (b) Loans
(c) Bonds (d) Preference shares
24. Cost of Capital for Government securities is also known as
(a) Risk-free Rate of Interest (b) Maximum Rate of Return
(c) Rate of Interest on Fixed Deposits (d) None of the above
25. Cost of Capital for Bonds and Debentures is calculated on
(a) Before Tax basis (b) After Tax basis
(c) Risk-free Rate of Interest basis (d) None of the above
26. Weighted Average Cost of Capital is generally denoted by:
(a) ka (b) kw
(c) ko (d) kc
27. Which of the following cost of capital require tax adjustment?
(a) Cost of Equity Shares (b) Cost of Preference Shares
(c) Cost of Debentures (d) Cost of Retained Earnings
28. Operating leverage helps in analysis of:
(a) Business Risk (b) Financing Risk
(c) Production Risk (d) Credit Risk
29. Which of the following is studied with the help of financial leverage?
(a) Marketing Risk (b) Interest Rate Risk
(c) Foreign Exchange Risk (d) Financing risk
30. Combined Leverage is obtained from OL and FL by their:
(a) Addition (b) Subtraction
(c) Multiplication (d) Any of these
31. High degree of financial leverage means:

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 (a) High debt proportion (b) Lower debt proportion
(c) Equal debt and equity (d) No debt
32. Operating leverage arises because of:
(a) Fixed Cost of Production (b) Fixed Interest Cost
(c) Variable Cost (d) None of the above
33. 6. Financial Leverage arises because of:
(a) Fixed cost of production (b) Variable Cost
(c) Interest Cost (d) None of the above
34. Operating Leverage is calculated as
(a) Contribution ÷ EBIT (b) EBIT÷PBT
(c) EBIT ÷Interest (d) EBIT ÷Tax
35. Financial Leverage is calculated as:
(a) EBIT÷ Contribution (b) EBIT÷ PBT
(c) EBIT÷ Sales (d) EBIT ÷ Variable Cost
36. In order to calculate EPS, Profit after Tax and Preference Dividend is divided by
(a) MP of Equity Shares (b) Number of Equity Shares
(c) Face Value of Equity Shares (d) None of the above
37. Trading on Equity is:
(a) Always beneficial (b) May be beneficial
(c) Never beneficial (d) None of the above.
38. Benefit of 'Trading on Equity' is available only if:
(a) Rate of Interest < Rate of Return (b) Rate of Interest > Rate of Return
(c) Both (a) and (b) (d) None of (d) and (b)
39. Indifference Level of EBIT is one at which:
(a) EPS is zero (b) EPS is Minimum
(c) EPS is highest (d) None of these
40. Financial Break-even level of EBIT is one at which:
(a) EPS is one (b) EPS is zero
(c) EPS is Infinite (d) EPS is Negative

Q.2 Answer in One line. (1 Mark each, attempt any 30 out of 40 questions) (30 Marks)

41. What do you understand by the cost of capital?

42. Why is the cost of capital important?
43. Describe some aspects of cost of capital.
44. Illustrate the concept of average cost of capital.
45. What is cost of debt capital?
46. Write an important condition for the adjustment of the cost of debt.
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47. What is the importance of cost of equity capital?
48. What does the cost of equity capital indicate?
49. What is meant by ‘to establish the cost of equity capital’?
50. How many approaches are there for estimating cost of equity?
51.  What points should be taken into consideration in order to calculate the cost of capital?
52. Why are the capital investments important?
53. What are initial cash flows?
54. What do you understand by operational cash flows?
55. Define terminal cash flows.
56. Write the formula for determining payback period of a cash flow project.
57. What is the relation between the pay back period and the quality of project?
58. What are the demerits of the payback period?
59. Define average rate of return.
60. What are the goals of finance function?
61. What is the relation of finance function to other functions of a business enterprise?
62. What is Financial Management?
63. Who are Shareholders?
64. Who are Stakeholders?
65. What is Investment?
66. What are the types of Bonds?
67. What is Time Value of Money?
68. Define Net Present Value (NPV)
69. Define Annuities.
70. Define Internal Rate of Return.
71. Define Amortization
72. Define Operating revenues
73. Example of Short Term financing sources
74. Define Debentures
75. What is Bond Valuation
76. Define Accruals
77. Define Business net worth or business equity
78. Define Discounted Cash Flow
79. Define Capital Market
80. Define Money Market

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 ANSWER KEY

1. D
2. C
3. C
4. B
5. B
6. A
7. A
8. C
9. B
10. D
11. D
12. A
13.. D
14. B
15. A
16. C
17. C
18.. D
19. B
20. C
21. C
22. D
23. A
24. A
25. B
26. C
27. C
28. A
29. D
30. C
31. A
32. A
33. C
34. A
35. B
36. B
37. B
38. A
39. D
40. B
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41. The cost of capital to a company is the rate of return it must earn in order to satisfy the
expectation of investors who provide long term funds to the firm. Cost of capital is a concept in
financial management linking the investment and financing decisions.
42.  For proper analysis of capital expenditure decisions, which are of prime importance to a firm, an
estimate of cost of capital is required. The cost of capital is the discount rate used in NPV
calculations and also the financial yardstick against which rate of return is evaluated.
2. Several other decisions like leasing, long ten, financing and working capital policy, require
estimates of cost of capital.
3. In order to maximize the value of the firm the costs of all inputs, including capital input, must
be minimum and in this context it should be able to measure the cost of capital.
43. (a) It is still larger, academic term and the problem of measuring it in operational terms is a recent
development. Earlier, the problem was either ignored or bypassed.
(b) Measurement of cost of capital, specifically for equity capital, is very complex subject

44. Cost of capital = Proportion of equity x Cost of equity + Proportion of debt x Cost of debt
45. The cost of debentures and long term loans is the contractual interest rate adjusted for the tax
liability of the company or put simply,
K = (1 – T) R
where, K = Cost of debt capital
T = Tax rate
46. One can adjust the cost of debt only if the EBIT (Earning Before Interest and Taxes) is equal to or
more than the interest rate. If, on the other hand, EBIT is less than the interest rate then the actual
interest payable becomes the cost of capital effectively.
47. Determining the cost of equity capital enables the corporate management to make decision in the
best interests of the equity share holders. In theory, management strives to maximize the returns
to the equity share holders and these effort involves many decisions in respect of capital
expenditures and financing.
48. The cost of equity capital indicates the minimum rate which must be earned on the projects,
before their acceptance and the raising of equity capital to finance them, i.e. it should lead to an
increase in the net present value of their wealth.
49. To establish the cost equity capital is to ascertain what rate of return an investor expects to
receive when he puts his money into an equity investment. There is an opportunity cost of
investment, in one company or another, and unless the rate offered by the company is comparable
to others, the company shall not attract future investment
50. Dividend price ratio
2. Earnings price ratio
3. Dividend price + growth rate of earnings
4. Realised yield approach

51. A firm’s cost of capital is the weighted arithmetic average of the cost of various sources of long
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 term finance used by it. Therefore, to calculate the cost of capital we should know (a) the specific
cost of each source of capital (b) the proportion of different sources of financing in the capital
structure.
52. 1. They have long term implications on the company.
2. Capital investment decisions are irreversible. This is owing to the fact that the markets for used
capital equipment is not an organized one. Further, the capital equipments ordered and bought
may have special tailor made specifications of the customer.
3. Capital investment decisions involve substantial outlays

53. Initial flows represent the cash outflows associated with investment in various project
components These can be: Outlays on plant, machinery, and other fixed assets, tax shields
relating to above investments plus outlays on new working capital.
54. Operational flows are cash inflows expected during the operational phase of the project. The
operational inflow for a particular year is equal to:
Profit after tax + Depreciation and any other non cash changes

55. Cash flows expected from the disposal of assets when the project is terminated are referred to as
terminal flows. Terminal flows are defined as:
Post tax salvage value of fixed assets + Post tax salvage value of working capital

56. Payback period represents the length of time required for the stream of cash proceeds generated
by the investment, to be equal to the original investment. In other words this is the time required
for the project to pay itself. The formula is
Payback period = Original investment/Annual cash flow

57. According to the payback criteria the shorter the pay back period the more desirable the project.
Firms using this method specify the maximum payback period acceptable. If the specified
payback is n years then projects with payback of n years or less than n years are accepted
58. 1. It fails to take into account the time value of money. Cash inflows are added without any
discounting. This violates the most basic principle of financial accounting which stipulates cash
flows accruing at different points of time can be added or subtracted after suitable
discounting/compounding.
2. It does not take into account the cash flows after the payback period This leads to
discrimination against projects which generate cash flows in later years

59. The average rate of return, also called the accounting rate of return, is defined as
Average rate of return = Profit after tax/Book value of fixed assets
In the ratio, the numerator is the annual average post tax profit over the life of the investment and
the denominator, the average book value of the fixed assets committed to the project.

60. - Profit Maximisation

- Wealth Maximisation
61. A business enterprise has many functions apart from finance function such as production,
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 marketing and personnel. All these functions are related to the finance function as they all require
funds for their execution.
62. The procedure of managing the financial resources, as well as accounting and financial reporting,
budgeting, collecting accounts receivable, risk management, and insurance for a business.
63. Shareholder is any possessor of one or more shares in a corporation. A shareholder usually has
proof that they are a shareholder; this evidence is represented by a stock certificate.
64. Stakeholders are the particular people or groups who have a stake, or an interest, in the
conclusion of the project. Usually stakeholders are from within the company, and could include
internal clients, management, employees, administrators... etc
65. Money put in property or other projects with the hope of making a profit, with enough security to
return and protect the capital; not speculation.
66. Corporate bonds: which are sold by the representative bank. Junk bonds or high yield bonds:
which are bonds from risky companies, so therefore they offer higher interest rates to compensate
for the risk. Municipal bonds: which are issued by various cities. These are tax free, but have
slightly lower interest rates. Savings bonds: which are issued by the Treasury Department and are
in low enough amounts to make them affordable for individuals. I Bonds: which are like Savings
Bonds, except they are adjusted for inflation every six months
67. Money received sooner rather than later allows one to use the funds for investment of
consumption purposes. This concept is referred as to Time Value of Money
68. The current value of a series of future net cash flows that will result from an investment, minus
the amount of the original investment.
69. Annuities are sums of money payable each year.
70. The discount or interest rate at which the net present worth of an investment is equal to zero.
71. The reduction in the value of an intangible asset (a copyright, a patent, an address list, or other
similar property) taken as an expense (written off) in each accounting period.
72. Inflows of funds from sales of goods or services offered for sale through the principal business
activities of a business.
73. There are many ways for which a firm can look for short terms financing some of these include: •
Overdrafts • Short-term loans • Bills of exchange • Promissory notes/commercial paper •
Inventory loan • Letters of credit • Short term Eurocurrency advances • Factoring
74. Debentures are the most general corporate bonds. They're backed by the credit of the issuer,
rather than by any specific assets.
75. Bond valuation is the process of determining the fair price of a bond.
76. Amounts owed to or owed by a business that have not yet been recorded in the books of the
business.
77. The owners’ interest in a business. Equity is calculated as the value of all business assets minus
all business liabilities. (Often called owners equity or owners net worth.).
78. A method or procedure for valuing a financial instrument by applying a discount rate (or a series
of discount rates) to compute a present value of each future interest and principal cash flow
expected from a financial instrument. The sum of the market values of the cash flows is
considered to be the value of the instrument. For financial instruments with readily available,
current trade prices, this value is called the fair value and is used in lieu of a trade- or transaction-
based market value.
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79. The capital market is the market for securities, w h e r e companies a n d governments can liftup
longterm funds. Capital market includes the stock market and the bond market
80. In finance, the money market is the worldwide financial market for short-term borrowing and
lending. It provides short-term liquid funding for the global financial system

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