Question

1. After big stock price run ups, debt ratio falls, but firms tend to issue equity instead of debt. This observation is not consistent with the trade-off theory of capital structure.

True

False

2. A conservative current asset investment policy implies that relatively large amounts of cash and inventories are carried, and sales are stimulated by the use of credit policy that provides liberal financing to customers and a corresponding high level of accounts receivable.

True

False

3. In the Baumol model of setting target cash balance, it is assumed that all cash flows are certain and that net cash outflows occur at a constant rate.

True

False

Answer 1

Ans 1) False

Trade off theory of capital structure is the idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits. In this case debt ratio is falling due to excess issue of Equity which will Result in Less Earning to shareholders and Dis balance Between Equity And debt of company.

Ans 2) False

It is True that conservative current asset investment policy implies that relatively large amounts of cash and inventories are carried, and sales are stimulated by the use of credit policy that provides liberal financing to customers But it does result into high level of accounts receivable, instead it reduces account receivable due to Providing Liberal Finance to the Customer.

Ans 3) True

  Baumol Model is based on the following assumptions

-The cash needs of the firm are known with certainty.

- The cash disbursement (usage) of the firm occurs uniformly. over the period of time and is known with certainty.

- The opportunity cost of holding cash is known and it remains constant.

- The transaction cost of converting securities into cash is known and remains constant.

Therefore the above statement is true.