Question 1

Which of the following are correct according to pecking-order theory?
I.Firms stockpile internally-generated cash.
II.There is an inverse relationship between a firm's profit level and its debt level.
III.Firms avoid external debt at all costs.
IV.A firm's capital structure is dictated by its need for external financing.

Accepted Answer

A)  I and III only
B)  II and IV only
C)  I, III, and IV only
D)  I, II, and IV only
E)  I, II, III, and IVF) None of the above
G) C) and D)

Question 2

Based on M & M Proposition II with taxes,the weighted average cost of capital:

Accepted Answer

A)  is equal to the aftertax cost of debt.
B)  has a linear relationship with the cost of equity capital.
C)  is unaffected by the tax rate.
D)  decreases as the debt-equity ratio increases.
E)  is equal to RU × (1 - T
C)  .F) A) and E)
G) B) and E)

Question 3

The optimal capital structure has been achieved when the:

Accepted Answer

A)  debt-equity ratio is equal to 1.
B)  weight of equity is equal to the weight of debt.
C)  cost of equity is maximized given a pre-tax cost of debt.
D)  debt-equity ratio is such that the cost of debt exceeds the cost of equity.
E)  debt-equity ratio results in the lowest possible weighted average cost of capital.F) A) and E)
G) A) and D)

Question 4

Which of the following statements related to financial risk are correct?
I.Financial risk is the risk associated with the use of debt financing.
II.As financial risk increases so too does the cost of equity.
III.Financial risk is wholly dependent upon the financial policy of a firm.
IV.Financial risk is the risk that is inherent in a firm's operations.

Accepted Answer

A)  I and III only
B)  II and IV only
C)  II and III only
D)  I, II, and III only
E)  I, II, III, and IVF) C) and D)
G) B) and E)

Question 5

East Side,Inc.has no debt outstanding and a total market value of $136,000.Earnings before interest and taxes,EBIT,are projected to be $12,000 if economic conditions are normal.If there is strong expansion in the economy,then EBIT will be 27 percent higher.If there is a recession,then EBIT will be 55 percent lower.East Side is considering a $54,000 debt issue with a 5 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,000 shares outstanding.Ignore taxes.If the economy enters a recession,EPS will change by ____ percent as compared to a normal economy,assuming that the firm recapitalizes.

Accepted Answer

A)  -70.97 percent
B)  -63.15 percent
C)  -58.08 percent
D)  -42.29 percent
E)  -38.87 percentF) D) and E)
G) C) and D)

Question 6

Douglass & Frank has a debt-equity ratio of 0.35.The pre-tax cost of debt is 8.2 percent while the unlevered cost of capital is 13.3 percent.What is the cost of equity if the tax rate is 39 percent?

Accepted Answer

A)  13.79 percent
B)  14.39 percent
C)  14.86 percent
D)  18.40 percent
E)  18.87 percentF) B) and C)
G) A) and B)

Question 7

You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:

Accepted Answer

A)  firm is just earning enough to pay for the cost of the debt.
B)  firm's earnings before interest and taxes are equal to zero.
C)  earnings per share for the levered option are exactly double those of the unlevered option.
D)  advantages of leverage exceed the disadvantages of leverage.
E)  firm has a debt-equity ratio of .50.F) A) and C)
G) D) and E)

Question 8

North Side,Inc.has no debt outstanding and a total market value of $175,000.Earnings before interest and taxes,EBIT,are projected to be $16,000 if economic conditions are normal.If there is strong expansion in the economy,then EBIT will be 30 percent higher.If there is a recession,then EBIT will be 70 percent lower.North Side is considering a $70,000 debt issue with a 7 percent interest rate.The proceeds will be used to repurchase shares of stock.There are currently 2,500 shares outstanding.North Side has a tax rate of 34 percent.If the economy expands strongly,EPS will change by ____ percent as compared to a normal economy,assuming that the firm recapitalizes.

Accepted Answer

A)  38.80 percent
B)  41.26 percent
C)  43.24 percent
D)  50.45 percent
E)  53.92 percentF) A) and D)
G) B) and E)

Question 9

Lamont Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $38 million and there are no taxes.What is EBIT?

Accepted Answer

A)  $3,423,000
B)  $3,508,600
C)  $3,781,100
D)  $3,898,700
E)  $4,180,000F) None of the above
G) B) and C)

Question 10

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Accepted Answer

A)  permits creditors to file a prepack immediately after a firm files for bankruptcy protection.
B)  prevents creditors from submitting any reorganization plans.
C)  prevents firms from filing for bankruptcy protection more than once.
D)  permits key employee retention plans only if an employee has another job offer.
E)  allows firms to pay bonuses to all key employees to entice those employees to remain in the firm's employ.F) B) and D)
G) A) and E)

Question 11

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Accepted Answer

A)  the firm's capital structure.
B)  the total cash flow of the firm.
C)  minimizing the marketed claims.
D)  the amount of marketed claims to that firm.
E)  size of the stockholders' claims.F) D) and E)
G) C) and D)

Question 12

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Accepted Answer

A)  Capital Asset Pricing Model
B)  M & M Proposition I
C)  M & M Proposition II
D)  Law of One Price
E)  Efficient Markets HypothesisF) A) and B)
G) A) and C)

Question 13

A firm should select the capital structure that:

Accepted Answer

A)  produces the highest cost of capital.
B)  maximizes the value of the firm.
C)  minimizes taxes.
D)  is fully unlevered.
E)  equates the value of debt with the value of equity.F) A) and B)
G) A) and C)

Question 14

The explicit costs,such as legal and administrative expenses,associated with corporate default are classified as _____ costs.

Accepted Answer

A)  flotation
B)  issue
C)  direct bankruptcy
D)  indirect bankruptcy
E)  unleveredF) A) and E)
G) B) and D)

Question 15

Galaxy Products is comparing two different capital structures,an all-equity plan (Plan I) and a levered plan (Plan II) .Under Plan I,Galaxy would have 178,500 shares of stock outstanding.Under Plan II,there would be 71,400 shares of stock outstanding and $1.79 million in debt outstanding.The interest rate on the debt is 10 percent and there are no taxes.What is the breakeven EBIT?

Accepted Answer

A)  $287,878.78
B)  $298,333.33
C)  $351,111.11
D)  $333,333.33
E)  $341,414.14F) A) and E)
G) A) and D)

Question 16

In general,the capital structures used by U.S.firms:

Accepted Answer

A)  tend to overweigh debt in relation to equity.
B)  generally result in debt-equity ratios between 0.45 and 0.60.
C)  are fairly standard for all SIC codes.
D)  tend to be those which maximize the use of the firm's available tax shelters.
E)  vary significantly across industries.F) A) and D)
G) B) and E)

Question 17

Down Bedding has an unlevered cost of capital of 14 percent,a cost of debt of 7.8 percent,and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Accepted Answer

A)  .24
B)  .29
C)  .36
D)  .52
E)  .71F) A) and B)
G) C) and D)

Question 18

The interest tax shield is a key reason why:

Accepted Answer

A)  the required rate of return on assets rises when debt is added to the capital structure.
B)  the value of an unlevered firm is equal to the value of a levered firm.
C)  the net cost of debt to a firm is generally less than the cost of equity.
D)  the cost of debt is equal to the cost of equity for a levered firm.
E)  firms prefer equity financing over debt financing.F) C) and D)
G) All of the above

Question 19

Jessica invested in Quantro stock when the firm was unlevered.Since then,Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position,Jessica needs to:

Accepted Answer

A)  borrow some money and purchase additional shares of Quantro stock.
B)  maintain her current equity position as the debt of the firm did not affect her personally.
C)  sell some shares of Quantro stock and hold the proceeds in cash.
D)  sell some shares of Quantro stock and loan out the sale proceeds.
E)  create a personal debt-equity ratio of 0.30.F) A) and C)
G) A) and E)

Question 20

Young's Home Supply has a debt-equity ratio of 0.80.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent.What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

Accepted Answer

A)  10.89 percent
B)  11.47 percent
C)  11.70 percent
D)  13.89 percent
E)  13.97 percentF) A) and E)
G) A) and B)

Exam 16: Financial Leverage and Capital Structure Policy

The interest tax shield is a key reason why:

Correct Answer
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Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Correct Answer
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Correct Answer
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A firm should select the capital structure that:

Correct Answer
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Down Bedding has an unlevered cost of capital of 14 percent,a cost of debt of 7.8 percent,and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Correct Answer
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Correct Answer
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The explicit costs,such as legal and administrative expenses,associated with corporate default are classified as _____ costs.

Correct Answer
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Correct Answer
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Correct Answer
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The optimal capital structure has been achieved when the:

Correct Answer
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Based on M & M Proposition II with taxes,the weighted average cost of capital:

Correct Answer
verified

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Correct Answer
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Correct Answer
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You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:

Correct Answer
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Young's Home Supply has a debt-equity ratio of 0.80.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent.What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

Correct Answer
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The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Correct Answer
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Douglass & Frank has a debt-equity ratio of 0.35.The pre-tax cost of debt is 8.2 percent while the unlevered cost of capital is 13.3 percent.What is the cost of equity if the tax rate is 39 percent?

Correct Answer
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Jessica invested in Quantro stock when the firm was unlevered.Since then,Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position,Jessica needs to:

Correct Answer
verified

In general,the capital structures used by U.S.firms:

Correct Answer
verified

Lamont Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $38 million and there are no taxes.What is EBIT?

Correct Answer
verified

Exam 16: Financial Leverage and Capital Structure Policy

The interest tax shield is a key reason why:

Correct AnswerverifiedShow Answer

Which one of the following states that the value of a firm is unrelated to the firm's capital structure?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

A firm should select the capital structure that:

Correct AnswerverifiedShow Answer

Down Bedding has an unlevered cost of capital of 14 percent,a cost of debt of 7.8 percent,and a tax rate of 32 percent.What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The explicit costs,such as legal and administrative expenses,associated with corporate default are classified as _____ costs.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The optimal capital structure has been achieved when the:

Correct AnswerverifiedShow Answer

Based on M & M Proposition II with taxes,the weighted average cost of capital:

Correct AnswerverifiedShow Answer

The basic lesson of M & M Theory is that the value of a firm is dependent upon:

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

You have computed the break-even point between a levered and an unlevered capital structure.Assume there are no taxes.At the break-even level,the:

Correct AnswerverifiedShow Answer

Young's Home Supply has a debt-equity ratio of 0.80.The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent.What will the firm's cost of equity be if the debt-equity ratio is revised to 0.70?

Correct AnswerverifiedShow Answer

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005:

Correct AnswerverifiedShow Answer

Douglass & Frank has a debt-equity ratio of 0.35.The pre-tax cost of debt is 8.2 percent while the unlevered cost of capital is 13.3 percent.What is the cost of equity if the tax rate is 39 percent?

Correct AnswerverifiedShow Answer

Jessica invested in Quantro stock when the firm was unlevered.Since then,Quantro has changed its capital structure and now has a debt-equity ratio of 0.30.To unlever her position,Jessica needs to:

Correct AnswerverifiedShow Answer

In general,the capital structures used by U.S.firms:

Correct AnswerverifiedShow Answer

Lamont Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $38 million and there are no taxes.What is EBIT?

Correct AnswerverifiedShow Answer

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