Financial Management and Investment Flashcards

A company has EBIT of $800,000, interest expense of $100,000, and a tax rate of 30%. What is the interest coverage ratio?

Answer: 8.0x

Interest coverage = EBIT / Interest = $800,000 / $100,000 = 8.0 times.

Which of the following is the main advantage of issuing convertible bonds from the issuer's perspective?

Answer: Lower coupon rates due to the embedded conversion option

Convertible bonds carry a lower coupon because investors value the option to convert into equity, reducing the issuer's interest cost.

In Modigliani-Miller theory with taxes, what happens to firm value as financial leverage increases?

Answer: Firm value increases due to the tax shield on debt interest

MM with taxes shows firm value rises with debt because interest payments are tax-deductible, creating a tax shield that adds value.

A portfolio contains two assets. Asset A has a standard deviation of 10% and Asset B has 20%. The correlation between them is 0. What is the portfolio standard deviation if equal weights are used?

Answer: 11.18%

Portfolio variance = (0.5)²(0.1)² + (0.5)²(0.2)² = 0.0025 + 0.01 = 0.0125; SD = √0.0125 ≈ 11.18%.

Which ratio measures how efficiently a company uses its assets to generate sales?

Answer: Asset turnover ratio

Asset turnover = Revenue / Total Assets, measuring how much revenue is generated per dollar of assets.

A call option on a stock has a strike price of $40 and the stock currently trades at $45. What is the intrinsic value of this option?

Answer: $5

Intrinsic value of a call = max(S - K, 0) = max($45 - $40, 0) = $5.

Under the Pecking Order Theory, which source of financing do firms prefer first?

Answer: Retained earnings (internal finance)

Pecking Order Theory states firms prefer internal financing first to avoid the adverse selection signaling problems of external finance.