Chapter 05 Testbank: of Mcgraw-Hill Education

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Chapter 05 Testbank

1. An investment decision differs from a financing decision in that:
A. investment decisions relate to assets that the firm has invested in, while financing decisions
relate to the firm's financial assets.
B. an investment decision first determines what assets the firm will invest in, while a financing
decision considers if the existing investments should be refinanced.
C. a financing decision first determines what financial assets the firm will invest in, while an
investment decision considers how the funds will be invested.
D. an investment decision first determines what assets the firm will invest in, while a financing
decision considers how the investments under consideration are to be funded.

2. When a company decides to issue an unsecured note to pay for a new machine, it has made
a/an:
A. capital market decision.
B. money market decision.
C. financing decision.
D. investment decision.

3. The finance required by a company to fund its day-to-day operations is called:
A. daily financing.
B. operational financing.
C. operational capital.
D. working capital.

4. When a company decides to pay for an investment project using a short-term bank loan, this is
best described as a/an:

5. Which of the following statements is correct for an investment proposal with a positive NPV?
A. The discount rate exceeds the required rate of return.
B. The IRR is greater than the required rate of return.
C. Accepting the investment proposal has an uncertain effect on shareholders.
D. The present value of the cash flow equals the cost of the investment.

6. Regarding project selection criteria based on IRR, a project will be considered when:
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A. IRR is higher than cost of capital.

B. IRR is lower than cost of capital.
C. IRR is greater than cost of capital, but NPV is less than 0.
D. all of the given answers.

7. Problems associated with calculating an internal rate of return include:
A. negative cash flows during the project's lifetime.
B. choosing one project from two or more projects.
C. timing of cash flows.

8. When a company's project results in a return and profits which exceed the cost of its debt
financing:
A. both the debt holders and shareholders can share in the profits.
B. only the shareholders may share in the profits.
C. the interest payments to the debt holders may increase.
D. its cost of capital increases.

9. Financial risk refers to the:
A. risk of owning financial assets.
B. overall risk of a financial services firm.
C. risk faced by the shareholders when debt is used.
D. risk of not finding finance for a firm's investment.

10. Increasing the financial leverage of a company will _______ shareholders' expected returns
and ______ their risk.
A. increase; not affect
B. increase; decrease
C. increase; increase
D. decrease; increase

11. Which of the following statements about financial risk is NOT correct?
A. A rise in interest rates will adversely affect the cost of a corporation's variable debt.
B. If a corporation imports goods from overseas then an appreciation in the exchange rate will
adversely affect the company's profits.
C. If a company (A) has sold goods to another company (B) with payment due in 30 days but
company B has gone into liquidation then company A faces credit default.
D. If a company breaches its debt-to-equity ratio loan covenants the value of the company may
be adversely affected.

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A. The higher the debt-to-equity ratio, the higher the degree of financial risk.
B. Interest payments on debt must be paid when they fall due.
C. When a business fails equity holders rank ahead of providers of debt due to their higher
financial risk.
D. The higher the proportion of debt the higher the potential return on shareholders' funds.

13. A company's business risk depends on:
A. its use of debt in financing the business.
B. the risk of the company's operations and assets.
C. how much debt a company has used.
D. the amount of shareholder equity in the company.

14. Which of the following criteria would be determinants of the appropriate ratio of debt to
equity if a company should not take on more debt than can be serviced under conservative
economic forecasts?
i. Maximisation of shareholder wealth
ii. Industry norms
iii. History of the ratio for the firm
iv. The stage of the current economic cycle
v. Limit imposed by lenders
vi. The company's capacity to service debt
A. i, iii, v, vi
B. ii, iii, v, vi
C. ii, iii, iv, v
D. iii, iv, v, vi

15. Restrictions placed on borrowers by lenders in the loan agreement are called loan:
A. covenants.
B. limits.
C. arrangements.
D. contracts.

16. An increase in a firm's level of debt will:
A. reduce the business risk of the firm.
B. increase the variability in earnings per share.
C. lower the expected return on shareholders' funds.
D. increase the return to the debt holders.

17. The operating activities of companies in the banking and retail sectors are different.
Compared with retail sector companies, banks have a:
A. high equity-to-debt ratio.
B. low gearing ratio.
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C. high debt-to-equity ratio.

D. conservative gearing ratio.

18. The claims of the equity holders on the assets of the firm have priority over those of:
A. the debt holders.
B. the preferred shareholders.
C. the unsecured debt holders.
D. no other holder.

19. Who are sometimes referred to as the residual owners of the corporation?
A. The secured creditors
B. The unsecured creditors
C. The common shareholders
D. The preferred shareholders

20. What is the function of a proxy statement for a shareholder?
A. It gives them the right of a vote for each share they own.
B. It gives them the right to transfer their share to another party.
C. It gives them the entitlement to new shares when issued.
D. It gives them the right to sell their shares at a premium.

21. Which of the following statements is NOT a feature of ordinary shares?
A. Ordinary shares are a major source of external equity financing for companies.
B. Ordinary shares entail voting rights at annual general meetings.
C. Ordinary shares have no fixed payment obligation.
D. Dividends of ordinary shares are always tax deductible.

22. Generally, an initial public offering (IPO) is:
A. an offer to potential investors of ordinary shares to newly list a company on a stock exchange.
B. an offer to potential investors of preference shares to newly list a company on a stock
exchange.
C. an offer to potential investors of company debentures to newly list a company on a stock
exchange.
D. an offer to potential investors of unsecured notes to newly list a company on a stock
exchange.

23. Common shareholders are:
A. guaranteed a periodic distribution of dividends
B. guaranteed a distribution in the liquidation of the company.
C. guaranteed both a periodic distribution of dividends and a distribution in the liquidation of the
company.
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D. not guaranteed a periodic distribution or a distribution in the liquidation of the company.

24. Which of the following statements best describes the role or function of the promoter of a
flotation?
A. The manager of the sub-underwriting panel or group
B. The broker responsible for the initial sale of shares to investors
C. The party seeking the flotation of the company
D. The agency responsible for marketing the issue to the public

25. Potential investors learn of the information concerning the company and its new issue
through a _____ sent by the broker.
A. registration statement
B. prospectus
C. letter of commitment
D. memorandum offering

26. As part of the listing process for an unlisted organisation, a document that provides detailed
information on the past and forecast performance for it is a:
A. flotation statement.
B. prospectus.
C. promotion report.
D. memorandum offering.

27. When a company undertakes an initial public offering (IPO) it may:
A. issue and list debentures in the capital markets.
B. offer shares to a few public institutional investors.
C. issue and list shares in the primary share market.
D. directly list corporate bonds in the capital markets.

28. Compared with raising debt through a bank, the raising of equity through an initial public
offering (IPO) for a firm is generally:
A. cheaper.
B. preferred.
C. roughly the same.
D. much cheaper.

29. The distinction between an initial public offering (IPO) and seasoned equity offering is best
described by which of the following statements?
A. An IPO is an offer to investors of ordinary shares in a newly listed company on a stock
exchange.
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B. A seasoned equity offering is an offer to both existing and new investors through right issue,
private placement and dividend re-investment scheme.
C. A seasoned equity offering is considered when an existing publicly traded company considers
raising additional capital by selling additional shares of its securities to the public.
D. All of the given answers.

30. A financial institution involved in underwriting the sale of new securities by buying them
from the issuing firms and then reselling them to the public in the primary capital market is an:
A. investment agent.
B. investment broker.
C. investment dealer.
D. investment banker.

31. Which of the following is NOT a role of an underwriter in a public offering of shares?
A. To provide pricing of the issue
B. To provide advice on the structure of the issue
C. To invest the funds raised in the offering
D. To provide guidance on the timing of the issue

32. If, for an IPO, circumstances change and the issue becomes unattractive, the underwriters:
A. charge the company more for raising the funds.
B. charge the company less for the IPO.
C. may purchase unsubscribed shares.
D. offer the shares at a lower price.

33. If, for an IPO, market prices have fallen, then underwriters with an out-clause that gives a
level of a specified price index that the index cannot fall below, then:
A. the underwriters have the right to charge the company more for raising the funds.
B. the underwriters need to only purchase a specified number of shares and not the total unsold.
C. the underwriters may be released from their obligations.
D. the underwriters may offer the shares at a lower price.

34. Ordinary shares in limited liability companies are the major source of external equity funding
for Australian companies. Which of the following statements regarding the issuance of ordinary
shares by a newly listed limited liability company is NOT correct?
A. Shares may be issued on a fully paid or partly paid basis.
B. A holder of instalment receipts only has to pay the remaining amount when due or called.
C. Share price is determined with reference to a range of variable factors.
D. No liability company can issue shares only on a fully paid basis because of the risk.

35. Companies can raise equity capital through:
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A. the money markets.

B. the inter-bank market.
C. internal sources of capital and the share market.
D. a major bank.

36. A person who is authorised to vote on a shareholder's behalf is called:
A. an underwriter.
B. a proxy.
C. an authorised shareholder.
D. a substitute.

37. Which of the following statements about a no liability company is NOT correct?
A. A no liability company will issue shares on a partly paid basis.
B. In Australia only mining companies can list as a no liability company.
C. A no liability company may also offer shareholders an option to sell shares back to the
company if the company exploration is not successful.
D. If a no liability gold-mining company discovers gold then for the product phase the company
may issue a further call on the partly paid shares.

38. Financing for high-risk companies is often in the form of:
A. limited liability shares.
B. no-liability shares.
C. limited instalment receipts.
D. contributing shares.

39. Which of the following requirements does NOT apply to a company seeking a public listing
on the Australian Securities Exchange (ASX)?
A. The entity must adhere to minimum standards of quality.
B. The entity must adhere to minimum standards of disclosure.
C. The company must issue a prospectus that is to be lodged with the ASX.
D. The company must have a structure and operation appropriate for a listed entity.

40. Most publicly listed companies raise funds by selling their securities in a:
A. public float.
B. private placement.
C. stock exchange.
D. direct placement.

41. A company may seek to raise further funds by issuing additional ordinary shares. The terms
and conditions of the new share issue are determined by the board of directors in consultation
with its financial advisers and others and having regard to the preferences of existing
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shareholders and the needs of the company. Which of the following is LEAST likely to be a
determinant of the price that is eventually struck?
A. The discount to current market price that can be offered to shareholders.
B. The company's cash requirements.
C. The projected earnings flow from the new investments.
D. The cost of alternative funding sources.

42. Some of the main principles that form the basis of a stock exchange's listing rules are:
A. sufficient investor interest must be shown to warrant an entity's participation in the markets.
B. information must be produced according to the highest standards.
C. minimum standards of quality size, operations and disclosure must be satisfied.
D. security holders must be consulted on matters of significance except for agreements between
the entity and related parties.

43. A rights offering is the issue of:
A. proxies to the shareholders to use their voting rights at the annual general meeting.
B. options on shares to the general public.
C. an option to purchase shares directly to the shareholders.
D. special options to the management.

44. A company may raise additional equity capital through:
A. a rights issue.
B. a placement.
C. a dividend reinvestment scheme.

45. A right that can only be exercised by the shareholder and not sold is called a:
A. non-saleable right.
B. renounceable right.
C. non-renounceable right.
D. pro-rata right.

46. Before making a rights issue, a company's management must consider several important
variables. Which of the following is NOT one of these variables?
A. The ability of the company to service the increased equity on issue
B. The costs of alternative funding sources
C. Whether there will be a sufficient take-up rate of the issue
D. The effect on the firm's profits

47. The subscription price in a rights offering is generally:
A. below the current share price.
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B. equal to the current share price.

C. above the current share price.
D. not related to the share price.

48. Which of the following is generally NOT a characteristic of rights?
A. No expiration date
B. If exercised, results in the dilution of earnings for existing shareholders
C. Can be renounceable or non-renounceable
D. Potential listing on a stock exchange

49. A pro-rata share rights offer means that the offer:
A. must be made to all the stakeholders of a company.
B. must be made to bond holders and shareholders who get their offer in before a cut-off date.
C. must be made to shareholders on the basis of the number of shares already held.
D. is made only to the shareholders with the largest number of shares on the share register at a
cut-off date.

50. A pro-rata share rights offer of 1:5 gives existing shareholders:
A. the right to purchase one new share for every five shares held.
B. the right to purchase five new shares for every one share held.
C. the right to purchase one share for every 1/5 shares held.
D. the right to purchase 10 shares for every five shares held.

51. For a share placement or private placement, the Australian authority ASIC requires:
A. that a placement must consist of subscriptions of not less than $1 000 000.
B. that any discount from the current market price not be more than 10 per cent.
C. a memorandum of information to be sent to all participating institutions.
D. a prospectus, which can be filed with them after the event.

52. For a share placement, the Australian authority ASIC or ASX listing rules require:
B. there must be no more than 20 participants.
C. the discount from market price must not be above 50 per cent.
D. that for a company that has had total placements of more than 15 per cent in the last 12
months, agreement for another must be sought from shareholders at the annual general meeting.

53. Share placements may, subject to compliance with certain regulations, be made to
institutional investors. Which of the following conditions is NOT a requirement of the Australian
authority ASIC for share placements?
A. The placement should consist of minimum subscriptions of $500 000 or be made up of not
more than 20 participants.
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B. The discount from current market price should not be excessive.

C. Under no circumstances should placements be in excess of 10 per cent of the issued shares
permitted.
D. There is no need to register a prospectus, but a memorandum of information detailing the
company's activities should be sent to all participants.

54. If a company raises equity funds by issuing shares to a selected number of institutional
investors, this is known as:
A. a share appointment.
B. a placement.
C. a share rights issue.
D. share transfer.

55. Compared with a pro-rata issue of shares, placements usually:
A. take a longer time to organise.
B. can be carried out much more quickly.
C. involve a far greater discount to the current market price.
D. involve no more than 50 participants.

56. The main advantage of placements or private placement to raise additional equity funds
compared to a rights issue is:
A. the discount to current market price may be less.
B. it can be carried out much more quickly.
C. a selective placement can sell shares to friendly institutional investors.
D. it reduces the proportion of ownership by existing shareholders.

57. When a takeover company issues additional shares to fund the acquisition of the shares in a
target company this is called:
A. a seasoned share offering.
B. an equity-funded takeover.
C. an initial share takeover.
D. a rights offering.

58. Which of the following does NOT apply to a dividend reinvestment plan?
A. A dividend reinvestment plan forms additional equity financing for the company.
B. For a dividend reinvestment scheme the company typically bears the associated transaction
costs.
C. Companies have encouraged shareholders to use dividend reinvestment plans.
D. Shareholders have the chance of purchasing additional shares through a dividend
reinvestment plan.

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59. Which of the following is NOT a feature of a dividend reinvestment scheme for a company?
A. Shareholders can acquire company shares at little or no transaction cost.
B. Shareholders can increase their return on the company share concerned.
C. The company can obtain additional equity funding.
D. The shareholders can redeem shares for dividends.

60. A dividend reinvestment plan generally _______ on the security.
A. decreases the return
B. increases the return
C. has no effect on the return
D. has an uncertain effect

61. Dividend reinvestment schemes are a significant source of equity for many Australian
companies. Which of the following advantages of dividend reinvestment schemes may, at times,
also be regarded as a disadvantage?
A. The shareholder avoids transaction costs on the share issue.
B. The share issue price is usually at a discount to the average market price.
C. Such schemes allow dividends to be paid while retaining cash for future growth.
D. The company is able to pass on franking credit to its shareholders.

62. _______ are promised a fixed periodic dividend, the payment of which must be paid before
that of ordinary shares.
A. Common shareholders
B. Preferred shareholders
C. Stakeholders
D. Creditors

63. Any unpaid dividends that must be paid before payment of dividends to ordinary
shareholders are called _________ preference shares.
A. participating
B. cumulative
C. non-cumulative
D. secured

64. A company is likely to issue _____ if it has reached its optimal gearing level.
A. options
B. rights
C. ordinary shares
D. preference shares

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65. Holders of _________ preference shares are entitled to dividend payments beyond the stated
dividend rate.
A. participating
B. cumulative
C. non-cumulative
D. secured

66. A preference share issue offers all of the following advantages to a company except:
A. a flexible dividend policy.
B. fixed interest borrowings that can count as equity.
C. extension of the equity base of the company.
D. an indefinite maturity.

67. Which of the following is NOT a feature of preference shares?
A. Convertible
B. Redeemable
C. Cumulative
D. An important source of company funding

68. Preference shares:
A. have their dividend fixed at the issue date.
B. rank behind ordinary shares in the payment of dividends.
C. rank behind ordinary shareholders in their claim on company assets in the event of
liquidation.
D. rank ahead of the company creditors.

69. Preference shares have a number of features similar to debt that distinguish them from
ordinary shares. Which of the following features may be incorporated in a preference share
issue?
i. Cumulative or non-cumulative
ii. Convertible or non-convertible
iii. Redeemable or non-redeemable
iv. Issued at different rankings
v. Participating or non-participating
A. i, ii, iii, iv
B. i, ii, iv, v
C. ii, iii, iv, v
D. All of the given answers

70. Convertible preference shares are normally converted into:
A. debentures.
B. bonds.
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C. shares.
D. warrants.

71. Compared with ordinary shares, preference shares usually:
A. rank ahead of a company's creditors in the case of a wind-up.
B. have dividends set at issue.
C. are viewed as debt financing.
D. pay their dividends after ordinary shares.

72. A convertible note is a/an:
A. equity instrument that converts into debt at maturity.
B. equity instrument that converts into a specified number of shares at maturity.
C. debt instrument that the holder has the option to convert into an initially specified number of
shares.
D. warrant that the holder has the option to convert into an initially agreed-upon number of
shares.

73. Which of the following statements is NOT a feature of convertible notes?
A. Convertible notes offer a lower interest rate than straight debt instruments.
B. Convertible notes are usually made available to ordinary shareholders.
C. Maturity of convertible notes is usually shorter than straight debt instruments.
D. Note holders can generally participate in new issues of equity.

74. Which of the following is NOT a feature of convertible notes?
A. Convertible notes are usually issued at a price close to the market price of the share.
B. The expectation of the note holder is that the share price will increase over the term of the
note.
C. Convertible notes offer a higher interest rate than straight debt instruments.
D. A convertible note may be made by direct placement to shareholders.

75. An advantage of a convertible security for a company is that it can generally be sold with
interest rates _______ other non-convertible debt securities.
A. higher than
B. equal to
C. lower than
D. unrelated to

76. The buyer of a convertible security accepts a lower rate of interest because of:
A. a lower default risk.
B. the possibility that the company may recall the security.
C. the accessibility of funds.
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D. the possibility of becoming a shareholder in the future.

77. When a convertible security is issued, the issue price is usually _______ the current market
price of the company's share.
A. well below
B. close to
C. well above
D. not related to

78. Which of the following is NOT an advantage for a company that issues a convertible note?
A. A lower interest rate can be offered, compared with straight debt.
B. It offers a method of raising cheap funds for the time being.
C. A longer maturity can often be offered.
D. There is an increase in financial leverage upon conversion.

79. A company is advised to issue convertible notes. They are advised of the conditions
applicable to the convertible note issue. Which of the following conditions is NOT correct?
A. The holder of the note has the right to convert the note into preference shares.
B. Notes are generally available on a pro-rata entitlement to shareholders.
C. Entitlements to convertible notes are generally not renounceable.
D. Notes are usually issued at a price close to the current share price at the time of issue.

80. Which of the following statements is/are true for convertible notes and preferences?
A. A convertible note is a hybrid fixed-interest debt security that gives the holder an option to
convert to ordinary share at specified date.
B. A preference share is considered a hybrid security that pays a fixed divided payment and
offers the right to convert to ordinary shares at a future date.
C. Convertible notes and preference shares possess characteristics of both debt and equity.

81. Compared with straight debt, convertible notes may offer a company:
A. lower borrowing costs.
B. higher borrowing costs.
C. a chance to issue more shares at maturity.
D. the opportunity to reduce debt.

82. When a company wants to increase the marketability of a rights issue, it may offer:
A. preference shares attached.
B. options attached.
C. convertible notes attached.
D. dividends attached.
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83. When warrants are converted by a holder:
A. debt is decreased.
B. debt is decreased but equity also increases.
C. only the number of shares increases.
D. there is no impact on the company's capital structure.

84. Which of the following is NOT an advantage for a company that sells a company-issued
option with a rights issue?
A. It may add to the marketability of the associated rights issue.
B. It reduces the necessity for the company to increase dividend payments immediately.
C. If the holder of the option exercises the right to buy the shares offered then the company
raises additional equity funds.
D. There is no certainty that the future funds from the exercise of the option will eventuate.

85. Which of the following about equity warrants is NOT correct?
A. Adding equity warrants to a bond issue increases its marketability.
B. Warrants are similar to conversion features on some bonds.
C. Warrants can be detached from the bond issue and sold separately.
D. Dividends for warrants are usually lower than for ordinary shares.

86. Which of the following statements about a company-issued option is NOT correct?
A. It is a security issued by a corporation that gives the holder the right, but not the obligation, to
buy ordinary shares in the company on a predetermined date and at a predetermined price.
B. If the holder of the option exercises the right to buy the shares offered, the company is able to
raise additional equity funds.
C. It is a security issued by a corporation that gives the holder the right, but with the obligation,
to buy ordinary shares in the company on a predetermined date and at a predetermined price.
D. It is considered a quasi-equity issue.

87. Which financial instrument gives the holder an option to purchase a specified number of
shares at a predetermined price over a given period?
A. An equity warrant
B. A put option
C. An ordinary preference share
D. A debenture

88. Which of the following statements about a pro-rata rights issue is NOT correct?
A. A proportional offer to buy securities is based on an investor’s current shareholding.
B. A 1:3 offer grants the existing shareholders the right to purchase a new share for every three
shares.
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C. The offer is made on the basis of a fixed ratio of new shares to the number of shares already
held.
D. It has no expiration date for the exercise.

89. Which one of the following conditions for an equity warrant that is generally attached to a
bond issue is NOT correct?
A. The holder has a conditional option to convert into ordinary shares of a company.
B. A warrant holder receives dividend payments over the life of the warrant.
C. Warrants may be detachable and traded separately from the bond issue.
D. The cost of borrowing through a bond issue may be lower with a warrant attached.

A. If the warrant is non-detachable it can only be sold with the associated bond.
B. Equity warrants add to the marketability of a corporate bond issue.
C. Equity warrants give an investor the right to convert the warrant into shares at a specified
price.
D. A warrant holder receives a dividend, unlike a rights holder.

91. Which of the following statements about company-issued equity warrants is NOT correct?
A. The terms of a warrant may allow the warrant to be detachable from the bond issue.
B. A company-issued equity warrant generally attaches to a bond issue.
C. Because company-issued equity warrants are attached to a bond they have no value.
D. Warrants may lower the costs of borrowing associated with the issue of the underlying
corporate bond.

92. Which of the following is NOT a similarity between a right and a warrant?
A. They both provide the right, without the obligation, to purchase a specified number of shares
at a predetermined price.
B. A right and a warrant both result in the company raising additional equity capital.
C. A right and a warrant can both be detached from the debt issue and traded separately.
D. A right and a warrant both have similar maturities.

on the ASX?
A. The entity must satisfy either the profit test or the net tangible assets test.
B. The company must have at least 500 holders of a parcel of main class securities valued at least
$2000.
C. The company must lodge a prospectus with the ASX on an annual basis.

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94. The internal relationship between shareholders, the board of directors and the managers of a
company is called:
A. agency theory.
B. corporate governance.
C. commercial theory.
D. organisational governance.

95. The placement of ordinary shares has this advantage:
A. money can be raised in a short time.
B. ownership of existing shareholders becomes more concentrated.
C. the price will be at a discount.
D. shares will be sold to a large number of investors.

96. Financial risk is higher when the debt-to-equity ratio is _____. Payment to creditors is _____,
and payment to shareholders is _____.
A. lower; obligatory; not obligatory
B. lower; not obligatory; obligatory
C. higher; obligatory; not obligatory
D. higher; not obligatory; obligatory

97. For listing on the ASX a firm must meet a number of criteria. Among them are:
A. continuous disclosure, either profits test or assets test.
B. continuous disclosure, profits test, assets test.
C. domiciled in Australia, continuous disclosure, either profits test or assets test.
D. domiciled in either Australia or New Zealand, continuous disclosure, profits test, assets test.

98. For capital budgeting projects:
A. NPV can be misleading or wrong when the cash flows are non-conventional.
B. IRR can be misleading or wrong when the cash flows change signs more than once.
C. NPV can be a problem when there are mutually exclusive projects.
D. IRR should be used since IRR is often regarded as being easier to understand than NPV.

99. Which statement best relates NPV and IRR?
A. NPV is in terms of present value and IRR is in terms of percentages.
B. NPV discounts cash flows by using the internal rate of return for discounting.
C. IRR is the NPV divided by the initial investment.
D. IRR is the discount rate that makes NPV equal zero.

100. A firm is considering a project with an initial investment of $25 000 and cash flows in the
following three years (1–3) of $10 000, $12 000, $14 000. This sort of project would be
discounted at a 14 per cent rate. Should the project be funded?
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A. Yes because the NPV is $11 000.

B. Yes because the NPV is $2455.
C. Yes because the NPV is $2701.
D. Yes because the NPV is $3264.

A. have a preferred position as compared to other claimants such as ordinary shareholders and
creditors.
B. may be cumulative, which requires the payment of dividends in the current year and unpaid
dividends from prior years before ordinary shareholders can receive a dividend in the current
year.
C. usually pay dividends that increase in line with dividends paid to ordinary shareholders.
D. include those equity securities that can be converted into debt.

102. The _____ in an initial public offering probably has the biggest risk because of _____.
A. promoter; the obligation to buy up the unsold shares
B. adviser; the legal exposure for having miss-guessed the market
C. underwriter; the obligation to buy up the unsold shares
D. adviser; mistakes made in preparing the prospectus

103. The investment decision for a corporation involves the types of securities it is going to issue
or invest in.
True False

104. If the calculated IRR on an investment proposal is greater than the required rate of return,
the company should proceed with the project.
True False

105. Financial risk refers to risks arising from the different types of debt securities issued by a
company.
True False

106. The main objective of a business corporation is the maximisation of shareholder value.
True False

107. If a listed company violates the listing rules of the stock exchange, the company is likely to
be delisted.
True False

19
108. A company's debt-to-equity ratio is determined in practice with reference to four main
criteria and not by finance theory.
True False

109. In consultation with a company, the promoter (an investment bank) will seek flotation of the
company shares.
True False

110. Limited liability shares are generally sold to investors on a fully paid basis.
True False

111. A pro-rata offer of rights to existing shareholders must be accompanied by a prospectus.
True False

112. A placement occurs where a company offers additional shares to select institutional
investors.
True False

113. What is capital budgeting? Explain its importance for a company.
______________________________________________________________________________

114. Discuss relevant issues for a company that needs to decide on how to finance its investment
decisions.
______________________________________________________________________________

115. Discuss the attractions of a private placement for a company.
______________________________________________________________________________

116. What is an equity-funded takeover?
______________________________________________________________________________

117. Common shareholders are often referred as ‘residual claim holders’. Briefly discuss the
salient features of this statement.
______________________________________________________________________________

118. Lenders for real estate purchases usually require a security interest in the property, which
serves as collateral for the loan. How would the availability of suitable collateral impact a firm’s
debt-to-equity ratio? Explain.
20
______________________________________________________________________________

119. How does a firm’s debt-to-assets ratio relate to its debt-to-equity ratio? Assume equity is
positive.
______________________________________________________________________________
21
Chapter 05 Testbank Key

1. An investment decision differs from a financing decision in that:
A. investment decisions relate to assets that the firm has invested in, while financing decisions
relate to the firm's financial assets.
B. an investment decision first determines what assets the firm will invest in, while a financing
decision considers if the existing investments should be refinanced.
C. a financing decision first determines what financial assets the firm will invest in, while an
investment decision considers how the funds will be invested.
D. an investment decision first determines what assets the firm will invest in, while a financing
decision considers how the investments under consideration are to be funded.
Ans: D
AACSB: Communication
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute
Learning Objective: 5.01 Understand issues related to the capital budgeting investment decision.
Section: 5.01 The investment decision: capital budgeting
Topic: The investment decision: capital budgeting

2. When a company decides to issue an unsecured note to pay for a new machine, it has made
a/an:
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

3. The finance required by a company to fund its day-to-day operations is called:
A. daily financing.
B. operational financing.
C. operational capital.
D. working capital.
Ans: D
22
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Section: Introduction
Topic: Introduction

4. When a company decides to pay for an investment project using a short-term bank loan, this is
best described as a/an:
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

5. Which of the following statements is correct for an investment proposal with a positive NPV?
A. The discount rate exceeds the required rate of return.
B. The IRR is greater than the required rate of return.
C. Accepting the investment proposal has an uncertain effect on shareholders.
D. The present value of the cash flow equals the cost of the investment.
Ans: B
Bloom's: Comprehension
Difficulty: Medium
Est time: <1 minute

6. Regarding project selection criteria based on IRR, a project will be considered when:
A. IRR is higher than cost of capital.
B. IRR is lower than cost of capital.
C. IRR is greater than cost of capital, but NPV is less than 0.
Ans: B
Bloom's: Synthesis
Difficulty: Medium
Est time: <1 minute
23

7. Problems associated with calculating an internal rate of return include:
A. negative cash flows during the project's lifetime.
B. choosing one project from two or more projects.
C. timing of cash flows.
Ans: D
AACSB: Analysis
Difficulty: Medium
Est time: <1 minute

8. When a company's project results in a return and profits which exceed the cost of its debt
financing:
A. both the debt holders and shareholders can share in the profits.
B. only the shareholders may share in the profits.
C. the interest payments to the debt holders may increase.
D. its cost of capital increases.
Ans: B
Difficulty: Medium
Est time: <1 minute

9. Financial risk refers to the:
A. risk of owning financial assets.
B. overall risk of a financial services firm.
C. risk faced by the shareholders when debt is used.
D. risk of not finding finance for a firm's investment.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 5.02 Identify issues relevant to a corporation’s funding choice between debt and equity.
Section: 5.02 The financing decision: equity, debt and risk
Topic: The financing decision: equity, debt and risk

10. Increasing the financial leverage of a company will _______ shareholders' expected returns
and ______ their risk.
A. increase; not affect
B. increase; decrease
24
C. increase; increase
D. decrease; increase
Ans: C
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute

A. A rise in interest rates will adversely affect the cost of a corporation's variable debt.
B. If a corporation imports goods from overseas then an appreciation in the exchange rate will
adversely affect the company's profits.
C. If a company (A) has sold goods to another company (B) with payment due in 30 days but
company B has gone into liquidation then company A faces credit default.
D. If a company breaches its debt-to-equity ratio loan covenants the value of the company may
be adversely affected.
Ans: B
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

A. The higher the debt-to-equity ratio, the higher the degree of financial risk.
B. Interest payments on debt must be paid when they fall due.
C. When a business fails equity holders rank ahead of providers of debt due to their higher
financial risk.
D. The higher the proportion of debt the higher the potential return on shareholders' funds.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

13. A company's business risk depends on:
A. its use of debt in financing the business.
B. the risk of the company's operations and assets.
C. how much debt a company has used.
D. the amount of shareholder equity in the company.
Ans: B
25
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

14. Which of the following criteria would be determinants of the appropriate ratio of debt to
equity if a company should not take on more debt than can be serviced under conservative
economic forecasts?
i. Maximisation of shareholder wealth
ii. Industry norms
iii. History of the ratio for the firm
iv. The stage of the current economic cycle
v. Limit imposed by lenders
vi. The company's capacity to service debt
A. i, iii, v, vi
B. ii, iii, v, vi
C. ii, iii, iv, v
D. iii, iv, v, vi
Ans: B
AACSB: Reflective thinking
Bloom's: Synthesis
Difficulty: Hard
Est time: <1 minute

15. Restrictions placed on borrowers by lenders in the loan agreement are called loan:
A. covenants.
B. limits.
C. arrangements.
D. contracts.
Ans: A
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

16. An increase in a firm's level of debt will:
A. reduce the business risk of the firm.
B. increase the variability in earnings per share.
C. lower the expected return on shareholders' funds.
D. increase the return to the debt holders.
26
Ans: B
AACSB: Diverse and multicultural
Bloom's: Evaluation
Difficulty: Medium
Est time: <1 minute

17. The operating activities of companies in the banking and retail sectors are different.
Compared with retail sector companies, banks have a:
A. high equity-to-debt ratio.
B. low gearing ratio.
C. high debt-to-equity ratio.
D. conservative gearing ratio.
Ans: C
Bloom's: Evaluation
Difficulty: Medium
Est time: <1 minute

18. The claims of the equity holders on the assets of the firm have priority over those of:
A. the debt holders.
B. the preferred shareholders.
C. the unsecured debt holders.
D. no other holder.
Ans: D
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

19. Who are sometimes referred to as the residual owners of the corporation?
A. The secured creditors
B. The unsecured creditors
C. The common shareholders
D. The preferred shareholders
Ans: C
27
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Learning Objective: 5.03 Examine the listing and flotation or initial public offering (IPO) of a business on a stock exchange, including
equity-funding alternatives that are available to a newly listed corporation.
Section: 5.03 Initial public offering
Topic: Initial public offering

20. What is the function of a proxy statement for a shareholder?
A. It gives them the right of a vote for each share they own.
B. It gives them the right to transfer their share to another party.
C. It gives them the entitlement to new shares when issued.
D. It gives them the right to sell their shares at a premium.
Ans: A
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

21. Which of the following statements is NOT a feature of ordinary shares?
A. Ordinary shares are a major source of external equity financing for companies.
B. Ordinary shares entail voting rights at annual general meetings.
C. Ordinary shares have no fixed payment obligation.
D. Dividends of ordinary shares are always tax deductible.
Ans: D
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

22. Generally, an initial public offering (IPO) is:
A. an offer to potential investors of ordinary shares to newly list a company on a stock exchange.
B. an offer to potential investors of preference shares to newly list a company on a stock
exchange.
C. an offer to potential investors of company debentures to newly list a company on a stock
exchange.
D. an offer to potential investors of unsecured notes to newly list a company on a stock
exchange.
Ans: A
28
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

23. Common shareholders are:
A. guaranteed a periodic distribution of dividends
B. guaranteed a distribution in the liquidation of the company.
C. guaranteed both a periodic distribution of dividends and a distribution in the liquidation of the
company.
D. not guaranteed a periodic distribution or a distribution in the liquidation of the company.
Ans: D
Difficulty: Medium
Est time: <1 minute

24. Which of the following statements best describes the role or function of the promoter of a
flotation?
A. The manager of the sub-underwriting panel or group
B. The broker responsible for the initial sale of shares to investors
C. The party seeking the flotation of the company
D. The agency responsible for marketing the issue to the public
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

25. Potential investors learn of the information concerning the company and its new issue
through a _____ sent by the broker.
A. registration statement
B. prospectus
C. letter of commitment
D. memorandum offering
Ans: B
29
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

26. As part of the listing process for an unlisted organisation, a document that provides detailed
information on the past and forecast performance for it is a:
A. flotation statement.
B. prospectus.
C. promotion report.
D. memorandum offering.
Ans: B
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

27. When a company undertakes an initial public offering (IPO) it may:
A. issue and list debentures in the capital markets.
B. offer shares to a few public institutional investors.
C. issue and list shares in the primary share market.
D. directly list corporate bonds in the capital markets.
Ans: C
Difficulty: Medium
Est time: <1 minute

28. Compared with raising debt through a bank, the raising of equity through an initial public
offering (IPO) for a firm is generally:
A. cheaper.
B. preferred.
C. roughly the same.
D. much cheaper.
Ans: B
30
Difficulty: Medium
Est time: <1 minute

29. The distinction between an initial public offering (IPO) and seasoned equity offering is best
described by which of the following statements?
A. An IPO is an offer to investors of ordinary shares in a newly listed company on a stock
exchange.
B. A seasoned equity offering is an offer to both existing and new investors through right issue,
private placement and dividend re-investment scheme.
C. A seasoned equity offering is considered when an existing publicly traded company considers
raising additional capital by selling additional shares of its securities to the public.
Ans: D
Difficulty: Medium
Est time: <1 minute

30. A financial institution involved in underwriting the sale of new securities by buying them
from the issuing firms and then reselling them to the public in the primary capital market is an:
A. investment agent.
B. investment broker.
C. investment dealer.
D. investment banker.
Ans: D
Difficulty: Easy
Est time: <1 minute

31. Which of the following is NOT a role of an underwriter in a public offering of shares?
A. To provide pricing of the issue
B. To provide advice on the structure of the issue
C. To invest the funds raised in the offering
D. To provide guidance on the timing of the issue
Ans: C
31
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

32. If, for an IPO, circumstances change and the issue becomes unattractive, the underwriters:
A. charge the company more for raising the funds.
B. charge the company less for the IPO.
C. may purchase unsubscribed shares.
D. offer the shares at a lower price.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

33. If, for an IPO, market prices have fallen, then underwriters with an out-clause that gives a
level of a specified price index that the index cannot fall below, then:
A. the underwriters have the right to charge the company more for raising the funds.
B. the underwriters need to only purchase a specified number of shares and not the total unsold.
C. the underwriters may be released from their obligations.
D. the underwriters may offer the shares at a lower price.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

34. Ordinary shares in limited liability companies are the major source of external equity funding
for Australian companies. Which of the following statements regarding the issuance of ordinary
shares by a newly listed limited liability company is NOT correct?
A. Shares may be issued on a fully paid or partly paid basis.
B. A holder of instalment receipts only has to pay the remaining amount when due or called.
C. Share price is determined with reference to a range of variable factors.
D. No liability company can issue shares only on a fully paid basis because of the risk.
Ans: D
32
Bloom's: Knowledge
Difficulty: Hard
Est time: <1 minute

35. Companies can raise equity capital through:
A. the money markets.
B. the inter-bank market.
C. internal sources of capital and the share market.
D. a major bank.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

36. A person who is authorised to vote on a shareholder's behalf is called:
A. an underwriter.
B. a proxy.
C. an authorised shareholder.
D. a substitute.
Ans: B
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

37. Which of the following statements about a no liability company is NOT correct?
A. A no liability company will issue shares on a partly paid basis.
B. In Australia only mining companies can list as a no liability company.
C. A no liability company may also offer shareholders an option to sell shares back to the
company if the company exploration is not successful.
D. If a no liability gold-mining company discovers gold then for the product phase the company
may issue a further call on the partly paid shares.
Ans: C
33
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

38. Financing for high-risk companies is often in the form of:
A. limited liability shares.
B. no-liability shares.
C. limited instalment receipts.
D. contributing shares.
Ans: B
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute

on the Australian Securities Exchange (ASX)?
A. The entity must adhere to minimum standards of quality.
B. The entity must adhere to minimum standards of disclosure.
C. The company must issue a prospectus that is to be lodged with the ASX.
Ans: C
Bloom's: Evaluation
Difficulty: Hard
Est time: <1 minute
Learning Objective: 5.04 Consider important issues associated with listing a business on a stock exchange.
Section: 5.04 Listing a business on a stock exchange
Topic: Listing a business on a stock exchange

40. Most publicly listed companies raise funds by selling their securities in a:
A. public float.
B. private placement.
C. stock exchange.
D. direct placement.
Ans: A
34
Difficulty: Medium
Est time: <1 minute

41. A company may seek to raise further funds by issuing additional ordinary shares. The terms
and conditions of the new share issue are determined by the board of directors in consultation
with its financial advisers and others and having regard to the preferences of existing
shareholders and the needs of the company. Which of the following is LEAST likely to be a
determinant of the price that is eventually struck?
A. The discount to current market price that can be offered to shareholders.
B. The company's cash requirements.
C. The projected earnings flow from the new investments.
D. The cost of alternative funding sources.
Ans: A
Bloom's: Synthesis
Difficulty: Hard
Est time: <1 minute
Learning Objective: 5.05 Explore equity-funding alternatives that are available to an established listed corporation, including right
issues, share purchase plans, placements, takeover issues, dividend reinvestment schemes, preference shares, convertible notes
and other quasi-equity securities.
Section: 5.05 Equity-funding alternatives for listed companies
Topic: Equity-funding alternatives for listed companies

42. Some of the main principles that form the basis of a stock exchange's listing rules are:
A. sufficient investor interest must be shown to warrant an entity's participation in the markets.
B. information must be produced according to the highest standards.
C. minimum standards of quality size, operations and disclosure must be satisfied.
D. security holders must be consulted on matters of significance except for agreements between
the entity and related parties.
Ans: D
Difficulty: Medium
Est time: <1 minute

43. A rights offering is the issue of:
A. proxies to the shareholders to use their voting rights at the annual general meeting.
B. options on shares to the general public.
C. an option to purchase shares directly to the shareholders.
D. special options to the management.
Ans: C
35
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

44. A company may raise additional equity capital through:
A. a rights issue.
B. a placement.
C. a dividend reinvestment scheme.
Ans: D
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

45. A right that can only be exercised by the shareholder and not sold is called a:
A. non-saleable right.
B. renounceable right.
C. non-renounceable right.
D. pro-rata right.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

46. Before making a rights issue, a company's management must consider several important
variables. Which of the following is NOT one of these variables?
A. The ability of the company to service the increased equity on issue
B. The costs of alternative funding sources
C. Whether there will be a sufficient take-up rate of the issue
D. The effect on the firm's profits
Ans: D
36
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute

47. The subscription price in a rights offering is generally:
A. below the current share price.
B. equal to the current share price.
C. above the current share price.
D. not related to the share price.
Ans: A
Difficulty: Medium
Est time: <1 minute

48. Which of the following is generally NOT a characteristic of rights?
A. No expiration date
B. If exercised, results in the dilution of earnings for existing shareholders
C. Can be renounceable or non-renounceable
D. Potential listing on a stock exchange
Ans: A
Difficulty: Medium
Est time: <1 minute

49. A pro-rata share rights offer means that the offer:
A. must be made to all the stakeholders of a company.
B. must be made to bond holders and shareholders who get their offer in before a cut-off date.
C. must be made to shareholders on the basis of the number of shares already held.
D. is made only to the shareholders with the largest number of shares on the share register at a
cut-off date.
Ans: C
37

Difficulty: Medium
Est time: <1 minute

50. A pro-rata share rights offer of 1:5 gives existing shareholders:
A. the right to purchase one new share for every five shares held.
B. the right to purchase five new shares for every one share held.
C. the right to purchase one share for every 1/5 shares held.
D. the right to purchase 10 shares for every five shares held.
Ans: C
AACSB: Analysis
Difficulty: Medium
Est time: <1 minute

51. For a share placement or private placement, the Australian authority ASIC requires:
B. that any discount from the current market price not be more than 10 per cent.
C. a memorandum of information to be sent to all participating institutions.
D. a prospectus, which can be filed with them after the event.
Ans: C
Difficulty: Medium
Est time: <1 minute

52. For a share placement, the Australian authority ASIC or ASX listing rules require:
B. there must be no more than 20 participants.
C. the discount from market price must not be above 50 per cent.
D. that for a company that has had total placements of more than 15 per cent in the last 12
months, agreement for another must be sought from shareholders at the annual general meeting.
Ans: C
38
Difficulty: Medium
Est time: <1 minute

53. Share placements may, subject to compliance with certain regulations, be made to
institutional investors. Which of the following conditions is NOT a requirement of the Australian
authority ASIC for share placements?
A. The placement should consist of minimum subscriptions of $500 000 or be made up of not
more than 20 participants.
B. The discount from current market price should not be excessive.
C. Under no circumstances should placements be in excess of 10 per cent of the issued shares
permitted.
D. There is no need to register a prospectus, but a memorandum of information detailing the
company's activities should be sent to all participants.
Ans: C
Bloom's: Evaluation
Difficulty: Hard
Est time: <1 minute

54. If a company raises equity funds by issuing shares to a selected number of institutional
investors, this is known as:
A. a share appointment.
B. a placement.
C. a share rights issue.
D. share transfer.
Ans: B
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

55. Compared with a pro-rata issue of shares, placements usually:
A. take a longer time to organise.
B. can be carried out much more quickly.
39
C. involve a far greater discount to the current market price.

D. involve no more than 50 participants.
Ans: B
Difficulty: Medium
Est time: <1 minute

56. The main advantage of placements or private placement to raise additional equity funds
compared to a rights issue is:
A. the discount to current market price may be less.
B. it can be carried out much more quickly.
C. a selective placement can sell shares to friendly institutional investors.
D. it reduces the proportion of ownership by existing shareholders.
Ans: D
Difficulty: Medium
Est time: <1 minute

57. When a takeover company issues additional shares to fund the acquisition of the shares in a
target company this is called:
A. a seasoned share offering.
B. an equity-funded takeover.
C. an initial share takeover.
D. a rights offering.
Ans: B
Bloom's: Synthesis
Difficulty: Medium
Est time: <1 minute

58. Which of the following does NOT apply to a dividend reinvestment plan?
A. A dividend reinvestment plan forms additional equity financing for the company.
B. For a dividend reinvestment scheme the company typically bears the associated transaction
costs.
40
C. Companies have encouraged shareholders to use dividend reinvestment plans.

D. Shareholders have the chance of purchasing additional shares through a dividend
reinvestment plan.
Ans: C
Difficulty: Medium
Est time: <1 minute

59. Which of the following is NOT a feature of a dividend reinvestment scheme for a company?
A. Shareholders can acquire company shares at little or no transaction cost.
B. Shareholders can increase their return on the company share concerned.
C. The company can obtain additional equity funding.
D. The shareholders can redeem shares for dividends.
Ans: D
Difficulty: Medium
Est time: <1 minute

60. A dividend reinvestment plan generally _______ on the security.
A. decreases the return
B. increases the return
C. has no effect on the return
D. has an uncertain effect
Ans: B
Difficulty: Medium
Est time: <1 minute

61. Dividend reinvestment schemes are a significant source of equity for many Australian
companies. Which of the following advantages of dividend reinvestment schemes may, at times,
also be regarded as a disadvantage?
A. The shareholder avoids transaction costs on the share issue.
B. The share issue price is usually at a discount to the average market price.
41
C. Such schemes allow dividends to be paid while retaining cash for future growth.
D. The company is able to pass on franking credit to its shareholders.
Ans: C
Difficulty: Medium
Est time: <1 minute

62. _______ are promised a fixed periodic dividend, the payment of which must be paid before
that of ordinary shares.
A. Common shareholders
B. Preferred shareholders
C. Stakeholders
D. Creditors
Ans: B
Bloom's: Knowledge
Difficulty: Medium
Est time: <1 minute

63. Any unpaid dividends that must be paid before payment of dividends to ordinary
shareholders are called _________ preference shares.
A. participating
B. cumulative
C. non-cumulative
D. secured
Ans: B
Difficulty: Medium
Est time: <1 minute

64. A company is likely to issue _____ if it has reached its optimal gearing level.
A. options
B. rights
C. ordinary shares
42
D. preference shares
Ans: D
Difficulty: Easy
Est time: <1 minute

65. Holders of _________ preference shares are entitled to dividend payments beyond the stated
dividend rate.
A. participating
B. cumulative
C. non-cumulative
D. secured
Ans: A
Difficulty: Medium
Est time: <1 minute

66. A preference share issue offers all of the following advantages to a company except:
A. a flexible dividend policy.
B. fixed interest borrowings that can count as equity.
C. extension of the equity base of the company.
D. an indefinite maturity.
Ans: D
Difficulty: Medium
Est time: <1 minute

67. Which of the following is NOT a feature of preference shares?
A. Convertible
B. Redeemable
C. Cumulative
D. An important source of company funding
Ans: D
43
Difficulty: Easy
Est time: <1 minute

A. have their dividend fixed at the issue date.
B. rank behind ordinary shares in the payment of dividends.
C. rank behind ordinary shareholders in their claim on company assets in the event of
liquidation.
D. rank ahead of the company creditors.
Ans: A
Difficulty: Medium
Est time: <1 minute

69. Preference shares have a number of features similar to debt that distinguish them from
ordinary shares. Which of the following features may be incorporated in a preference share
issue?
i. Cumulative or non-cumulative
ii. Convertible or non-convertible
iii. Redeemable or non-redeemable
iv. Issued at different rankings
v. Participating or non-participating
A. i, ii, iii, iv
B. i, ii, iv, v
C. ii, iii, iv, v
D. All of the given answers
Ans: D
Difficulty: Medium
Est time: <1 minute

70. Convertible preference shares are normally converted into:
44
A. debentures.
B. bonds.
C. shares.
D. warrants.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

71. Compared with ordinary shares, preference shares usually:
A. rank ahead of a company's creditors in the case of a wind-up.
B. have dividends set at issue.
C. are viewed as debt financing.
D. pay their dividends after ordinary shares.
Ans: B
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

72. A convertible note is a/an:
A. equity instrument that converts into debt at maturity.
B. equity instrument that converts into a specified number of shares at maturity.
C. debt instrument that the holder has the option to convert into an initially specified number of
shares.
D. warrant that the holder has the option to convert into an initially agreed-upon number of
shares.
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

73. Which of the following statements is NOT a feature of convertible notes?
A. Convertible notes offer a lower interest rate than straight debt instruments.
45
B. Convertible notes are usually made available to ordinary shareholders.

C. Maturity of convertible notes is usually shorter than straight debt instruments.
D. Note holders can generally participate in new issues of equity.
Ans: C
Difficulty: Medium
Est time: <1 minute

74. Which of the following is NOT a feature of convertible notes?
A. Convertible notes are usually issued at a price close to the market price of the share.
B. The expectation of the note holder is that the share price will increase over the term of the
note.
C. Convertible notes offer a higher interest rate than straight debt instruments.
D. A convertible note may be made by direct placement to shareholders.
Ans: C
Difficulty: Medium
Est time: <1 minute

75. An advantage of a convertible security for a company is that it can generally be sold with
interest rates _______ other non-convertible debt securities.
A. higher than
B. equal to
C. lower than
D. unrelated to
Ans: C
Difficulty: Medium
Est time: <1 minute

76. The buyer of a convertible security accepts a lower rate of interest because of:
A. a lower default risk.
B. the possibility that the company may recall the security.
46
C. the accessibility of funds.

D. the possibility of becoming a shareholder in the future.
Ans: D
Difficulty: Medium
Est time: <1 minute

77. When a convertible security is issued, the issue price is usually _______ the current market
price of the company's share.
A. well below
B. close to
C. well above
D. not related to
Ans: B
Difficulty: Medium
Est time: <1 minute

78. Which of the following is NOT an advantage for a company that issues a convertible note?
A. A lower interest rate can be offered, compared with straight debt.
B. It offers a method of raising cheap funds for the time being.
C. A longer maturity can often be offered.
D. There is an increase in financial leverage upon conversion.
Ans: D
Bloom's: Synthesis
Difficulty: Hard
Est time: <1 minute

79. A company is advised to issue convertible notes. They are advised of the conditions
applicable to the convertible note issue. Which of the following conditions is NOT correct?
A. The holder of the note has the right to convert the note into preference shares.
B. Notes are generally available on a pro-rata entitlement to shareholders.
C. Entitlements to convertible notes are generally not renounceable.
47
D. Notes are usually issued at a price close to the current share price at the time of issue.
Ans: A
Bloom's: Evaluation
Difficulty: Medium
Est time: <1 minute

80. Which of the following statements is/are true for convertible notes and preferences?
A. A convertible note is a hybrid fixed-interest debt security that gives the holder an option to
convert to ordinary share at specified date.
B. A preference share is considered a hybrid security that pays a fixed divided payment and
offers the right to convert to ordinary shares at a future date.
C. Convertible notes and preference shares possess characteristics of both debt and equity.
Ans: D
Bloom's: Evaluation
Difficulty: Medium
Est time: <1 minute

81. Compared with straight debt, convertible notes may offer a company:
A. lower borrowing costs.
B. higher borrowing costs.
C. a chance to issue more shares at maturity.
D. the opportunity to reduce debt.
Ans: A
Bloom's: Evaluation
Difficulty: Medium
Est time: <1 minute

82. When a company wants to increase the marketability of a rights issue, it may offer:
A. preference shares attached.
B. options attached.
C. convertible notes attached.
D. dividends attached.
48
Ans: B
Difficulty: Medium
Est time: <1 minute

83. When warrants are converted by a holder:
A. debt is decreased.
B. debt is decreased but equity also increases.
C. only the number of shares increases.
D. there is no impact on the company's capital structure.
Ans: C
Bloom's: Synthesis
Difficulty: Hard
Est time: <1 minute

84. Which of the following is NOT an advantage for a company that sells a company-issued
option with a rights issue?
A. It may add to the marketability of the associated rights issue.
B. It reduces the necessity for the company to increase dividend payments immediately.
C. If the holder of the option exercises the right to buy the shares offered then the company
raises additional equity funds.
D. There is no certainty that the future funds from the exercise of the option will eventuate.
Ans: D
Difficulty: Medium
Est time: <1 minute

A. Adding equity warrants to a bond issue increases its marketability.
B. Warrants are similar to conversion features on some bonds.
C. Warrants can be detached from the bond issue and sold separately.
D. Dividends for warrants are usually lower than for ordinary shares.
Ans: D
49
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

86. Which of the following statements about a company-issued option is NOT correct?
A. It is a security issued by a corporation that gives the holder the right, but not the obligation, to
buy ordinary shares in the company on a predetermined date and at a predetermined price.
B. If the holder of the option exercises the right to buy the shares offered, the company is able to
raise additional equity funds.
C. It is a security issued by a corporation that gives the holder the right, but with the obligation,
to buy ordinary shares in the company on a predetermined date and at a predetermined price.
D. It is considered a quasi-equity issue.
Ans: D
Difficulty: Medium
Est time: <1 minute

87. Which financial instrument gives the holder an option to purchase a specified number of
shares at a predetermined price over a given period?
A. An equity warrant
B. A put option
C. An ordinary preference share
D. A debenture
Ans: A
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

88. Which of the following statements about a pro-rata rights issue is NOT correct?
A. A proportional offer to buy securities is based on an investor’s current shareholding.
B. A 1:3 offer grants the existing shareholders the right to purchase a new share for every three
shares.
50
C. The offer is made on the basis of a fixed ratio of new shares to the number of shares already
held.
D. It has no expiration date for the exercise.
Ans: D
Bloom's: Evaluation
Difficulty: Easy
Est time: <1 minute

89. Which one of the following conditions for an equity warrant that is generally attached to a
bond issue is NOT correct?
A. The holder has a conditional option to convert into ordinary shares of a company.
B. A warrant holder receives dividend payments over the life of the warrant.
C. Warrants may be detachable and traded separately from the bond issue.
D. The cost of borrowing through a bond issue may be lower with a warrant attached.
Ans: B
Bloom's: Synthesis
Difficulty: Hard
Est time: <1 minute

A. If the warrant is non-detachable it can only be sold with the associated bond.
B. Equity warrants add to the marketability of a corporate bond issue.
C. Equity warrants give an investor the right to convert the warrant into shares at a specified
price.
D. A warrant holder receives a dividend, unlike a rights holder.
Ans: D
Difficulty: Medium
Est time: <1 minute

91. Which of the following statements about company-issued equity warrants is NOT correct?
A. The terms of a warrant may allow the warrant to be detachable from the bond issue.
B. A company-issued equity warrant generally attaches to a bond issue.
51
C. Because company-issued equity warrants are attached to a bond they have no value.
D. Warrants may lower the costs of borrowing associated with the issue of the underlying
corporate bond.
Ans: C
Difficulty: Medium
Est time: <1 minute

92. Which of the following is NOT a similarity between a right and a warrant?
A. They both provide the right, without the obligation, to purchase a specified number of shares
at a predetermined price.
B. A right and a warrant both result in the company raising additional equity capital.
C. A right and a warrant can both be detached from the debt issue and traded separately.
D. A right and a warrant both have similar maturities.
Ans: D
Difficulty: Medium
Est time: <1 minute

on the ASX?
A. The entity must satisfy either the profit test or the net tangible assets test.
B. The company must have at least 500 holders of a parcel of main class securities valued at least
$2000.
C. The company must lodge a prospectus with the ASX on an annual basis.
Ans: C
Difficulty: Hard
Est time: <1 minute
Learning Objective: 5.06 Explain the listing requirements of the Australian Securities Exchange.
Section: Extended learning
Topic: Extended learning

94. The internal relationship between shareholders, the board of directors and the managers of a
company is called:
A. agency theory.
52
B. corporate governance.
C. commercial theory.
D. organisational governance.
Ans: B
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute
Topic: Extended learning

95. The placement of ordinary shares has this advantage:
A. money can be raised in a short time.
B. ownership of existing shareholders becomes more concentrated.
C. the price will be at a discount.
D. shares will be sold to a large number of investors.
Ans: A
Difficulty: Medium
Est time: <1 minute

96. Financial risk is higher when the debt-to-equity ratio is _____. Payment to creditors is _____,
and payment to shareholders is _____.
A. lower; obligatory; not obligatory
B. lower; not obligatory; obligatory
C. higher; obligatory; not obligatory
D. higher; not obligatory; obligatory
Ans: C
Bloom's: Knowledge
Difficulty: Easy
Difficulty: Easy
Est time: <1 minute

97. For listing on the ASX a firm must meet a number of criteria. Among them are:
A. continuous disclosure, either profits test or assets test.
B. continuous disclosure, profits test, assets test.
C. domiciled in Australia, continuous disclosure, either profits test or assets test.
D. domiciled in either Australia or New Zealand, continuous disclosure, profits test, assets test.
Ans: A
53
Difficulty: Easy
Difficulty: Hard
Est time: <1 minute
Topic: Australian Securities Exchange (ASX) listing rule requirements

98. For capital budgeting projects:
A. NPV can be misleading or wrong when the cash flows are non-conventional.
B. IRR can be misleading or wrong when the cash flows change signs more than once.
C. NPV can be a problem when there are mutually exclusive projects.
D. IRR should be used since IRR is often regarded as being easier to understand than NPV.
Ans: B
Difficulty: Medium
Est time: <1 minute

99. Which statement best relates NPV and IRR?
A. NPV is in terms of present value and IRR is in terms of percentages.
B. NPV discounts cash flows by using the internal rate of return for discounting.
C. IRR is the NPV divided by the initial investment.
D. IRR is the discount rate that makes NPV equal zero.
Ans: D
Difficulty: Medium
Est time: <1 minute

100. A firm is considering a project with an initial investment of $25 000 and cash flows in the
following three years (1–3) of $10 000, $12 000, $14 000. This sort of project would be
discounted at a 14 per cent rate. Should the project be funded?
A. Yes because the NPV is $11 000.
B. Yes because the NPV is $2455.
C. Yes because the NPV is $2701.
D. Yes because the NPV is $3264.
Ans: B
54
AACSB: Analysis
Bloom's: Valuation
Difficulty: Medium
Est time: <1 minute

A. have a preferred position as compared to other claimants such as ordinary shareholders and
creditors.
B. may be cumulative, which requires the payment of dividends in the current year and unpaid
dividends from prior years before ordinary shareholders can receive a dividend in the current
year.
C. usually pay dividends that increase in line with dividends paid to ordinary shareholders.
D. include those equity securities that can be converted into debt.
Ans: B
Difficulty: Medium
Est time: <1 minute

102. The _____ in an initial public offering probably has the biggest risk because of _____.
A. promoter; the obligation to buy up the unsold shares
B. adviser; the legal exposure for having miss-guessed the market
C. underwriter; the obligation to buy up the unsold shares
D. adviser; mistakes made in preparing the prospectus
Ans: C
Bloom's: Knowledge
Difficulty: Easy

103. The investment decision for a corporation involves the types of securities it is going to issue
or invest in.
Ans: False
Feedback: The investment decision is the capital budgeting decision that determines the strategic
activities of the firm and what assets it needs to acquire so it can carry out its business.
55
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

104. If the calculated IRR on an investment proposal is greater than the required rate of return,
the company should proceed with the project.
Ans: True
Feedback: The IRR provides an actual rate of return that can be measured against a company's
required rate of return.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

105. Financial risk refers to risks arising from the different types of debt securities issued by a
company.
Ans: False
Feedback: Financial risk attaches to both equity and debt issued by a company.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

106. The main objective of a business corporation is the maximisation of shareholder value.
Ans: True
Feedback: The overriding objective is the maximisation of the market value of a company’s
shares, that is, any improvement in share price helps achieved this objective.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

107. If a listed company violates the listing rules of the stock exchange, the company is likely to
be delisted.
Ans: True
56
Feedback: A stock exchange’s listing rules are additional to a company’s statutory obligations
under the corporations legislation of the nation-state in which the stock exchange is located. If
the listed companies do not comply with the listing rule, they may be delisted.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

108. A company's debt-to-equity ratio is determined in practice with reference to four main
criteria and not by finance theory.
Ans: True
Feedback: Four main criteria are norms in the industry, history of the gearing ratio, limits
imposed by lenders and management decisions.
Difficulty: Easy
Est time: <1 minute

109. In consultation with a company, the promoter (an investment bank) will seek flotation of the
company shares.
Ans: False
Feedback: The promoter is the company seeking to issue new shares.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

110. Limited liability shares are generally sold to investors on a fully paid basis.
Ans: True
Feedback: Ordinary shares issued on a limited liability basis are the principal form of funding.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

111. A pro-rata offer of rights to existing shareholders must be accompanied by a prospectus.
57
Ans: True
Feedback: Generally, regulations require a prospectus to be attached.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

112. A placement occurs where a company offers additional shares to select institutional
investors.
Ans: True
Feedback: Corporations Law places limits on the issue of shares through a placement in order to
protect existing shareholders.
Bloom's: Knowledge
Difficulty: Easy
Est time: <1 minute

113. What is capital budgeting? Explain its importance for a company.
Ans: Capital budgeting is the process of evaluating and selecting long-term investments
consistent with the firms' goal of owner-wealth maximisation. A company needs to determine
what assets it needs to invest in so it may carry out its planned business operations. Two
important quantitative measures it may use are net present value and internal rate of return.
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3 minutes

114. Discuss relevant issues for a company that needs to decide on how to finance its investment
decisions.
Ans: The financing decision relates to the question of how a business investment is to be funded.
There is the choice of debt or equity and what kind of risk this exposes the firm to. These
generally entail business risk and financial risk.
Bloom's: Knowledge
Difficulty: Medium
58

115. Discuss the attractions of a private placement for a company.
Ans: There are a number of advantages—a placement can be arranged more quickly than a rights
issue; it may also involve less of a discount to current market value than a rights issue and so be
less expensive. A placement may also be made directly with institutions without the need to
lodge a prospectus but rather a less comprehensive and less costly memorandum of information.
Difficulty: Medium

116. What is an equity-funded takeover?
Ans: In the case of a merger or acquisition, a company may decide to issue additional shares to
fund a full-equity takeover rather than using other sources of funding such as debt. A company
(A) may offer these shares on a pro-rata basis to existing shareholders in the takeover target,
company (B). The target shareholders may be offered two shares in company A for every five
shares they hold in company B. The pro-rata basis of the offer will be based on the value of
company A shares compared to that of company B.
Bloom's: Synthesis
Difficulty: Hard

117. Common shareholders are often referred as ‘residual claim holders’. Briefly discuss the
salient features of this statement.
Ans: Ordinary shares or common stock represent a residual ownership claim on the assets of the
firm; that is, they provide a return to the shareholders only after the firm has met its obligations
to all other providers of funds, and after all operating expenses have been paid. In other words, as
residual claimants, they only receive the dividend payment after payments to all other
stakeholders in the firm have been made. Therefore the common shareholders are last in the
priority lists for possible payment to be received.
Bloom's: Synthesis
Difficulty: Hard
59
118. Lenders for real estate purchases usually require a security interest in the property, which
serves as collateral for the loan. How would the availability of suitable collateral impact a firm’s
debt-to-equity ratio? Explain.
Ans: When there is collateral a lender may be more willing to lend. The debt of the firm can
therefore be higher. Firms in high tech or service industries are less likely to have suitable
collateral. Accordingly, these firms typically have lower debt-to-equity ratios than those firms
with collateral, such as tangible assets like land or machinery.
Difficulty: Hard

119. How does a firm’s debt-to-assets ratio relate to its debt-to-equity ratio? Assume equity is
positive.
Ans: They are both positively related. A change in debt will alter the D/E ratio more than it alters
the D/A ratio, but in the same direction. For instance, if D=50 and E=150, then the D/A ratio is
50/200 = .25 and D/E is 50/150 = .33. Now if we borrow an additional 50, the D/A ratio
increases to 100/250 = .40 and the D/E ratio increases to 100/150 = .67.
AACSB: Analysis
Bloom's: Valuation
Difficulty: Hard
Difficulty: Medium
60
Chapter 05 Testbank Summary

# of
Category Questions
AACSB: Analysis 4
AACSB: Communication 85
AACSB: Diverse and multicultural 5
AACSB: Reflective thinking 25
Bloom's: Comprehension 49
Bloom's: Evaluation 8
Bloom's: Knowledge 51
Bloom's: Synthesis 9
Bloom's: Valuation 2
Difficulty: Easy 50
Difficulty: Hard 14
Difficulty: Medium 58
Est time: 1-3 minutes 5
Est time: 2-3 minutes 2
Est time: <1 minute 111
Learning Objective: 5.01 Understand issues related to the capital budgeting 18
investment decision.
Learning Objective: 5.02 Identify issues relevant to a corporation’s funding 14
choice between debt and equity.
Learning Objective: 5.03 Examine the listing and flotation or initial public 24
offering (IPO) of a business on a stock exchange, including equity-funding
alternatives that are available to a newly listed corporation.
Learning Objective: 5.04 Consider important issues associated with listing a 4
business on a stock exchange.
Learning Objective: 5.05 Explore equity-funding alternatives that are available to 57
an established listed corporation, including right issues, share purchase plans,
placements, takeover issues, dividend reinvestment schemes, preference shares,
convertible notes and other quasi-equity securities.
Learning Objective: 5.06 Explain the listing requirements of the Australian 3
Securities Exchange.
Section: 5.01 The investment decision: capital budgeting 17
Section: 5.02 The financing decision: equity, debt and risk 13
Section: 5.03 Initial public offering 23
Section: 5.04 Listing a business on a stock exchange 4
Section: 5.05 Equity-funding alternatives for listed companies 57
Section: Extended learning 3
Section: Introduction 1
Topic: Australian Securities Exchange (ASX) listing rule requirements 1
Topic: Equity-funding alternatives for listed companies 57
Topic: Extended learning 2
Topic: Initial public offering 24
61
Topic: Introduction 1
Topic: Listing a business on a stock exchange 4
Topic: The financing decision: equity, debt and risk 13
Topic: The investment decision: capital budgeting 17

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1

A. IRR is higher than cost of capital.

C. high debt-to-equity ratio.

D. not guaranteed a periodic distribution or a distribution in the liquidation of the company.

A. the money markets.

B. equal to the current share price.

B. The discount from current market price should not be excessive.

D. the possibility of becoming a shareholder in the future.

A. Yes because the NPV is $11 000.

Chapter 05 Testbank Key

AACSB: Reflective thinking

C. involve a far greater discount to the current market price.

C. Companies have encouraged shareholders to use dividend reinvestment plans.

B. Convertible notes are usually made available to ordinary shareholders.

C. the accessibility of funds.

Chapter 05 Testbank Summary

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