Question 1

The Modigilian-Miller (M&M) theorem states that:

Accepted Answer

A)  in an efficient market without taxes and bankruptcy costs, the value of a firm depends upon the firm's capital structure. 
B)  in an efficient market without taxes and bankruptcy costs, the value of a firm does not depend upon the firm's capital structure. 
C)  in an efficient market without taxes and bankruptcy costs, the value of a firm does not depend upon the firm's cost of capital. 
D)  none of the options. 
A)  in an efficient market without taxes and bankruptcy costs, the value of a firm depends upon the firm's capital structure. 
B)  in an efficient market without taxes and bankruptcy costs, the value of a firm does not depend upon the firm's capital structure. 
C)  in an efficient market without taxes and bankruptcy costs, the value of a firm does not depend upon the firm's cost of capital. 
D)  none of the options.

Question 2

Which of the following allows for two types of bankruptcy for which most businesses can file?

Accepted Answer

A)  Securities Exchange Commission 
B)  Generally Accepted Accounting Principles 
C)  The Internal Revenue Service 
D)  The United States Bankruptcy Code 
A)  Securities Exchange Commission 
B)  Generally Accepted Accounting Principles 
C)  The Internal Revenue Service 
D)  The United States Bankruptcy Code

Question 3

All else the same, firms facing relatively high tax rates should:

Accepted Answer

A)  use more debt. 
B)  use less debt. 
C)  have lower D/E ratios. 
D)  none of the options. 
A)  use more debt. 
B)  use less debt. 
C)  have lower D/E ratios. 
D)  none of the options.

Question 4

Which of the following is the condition in which a firm is near bankruptcy?

Accepted Answer

A)  Passive capital structure 
B)  Active capital structure 
C)  Financial distress 
D)  Call position 
A)  Passive capital structure 
B)  Active capital structure 
C)  Financial distress 
D)  Call position

Question 5

All else the same, firms with stable, predictable income streams will be able to:

Accepted Answer

A)  use less debt. 
B)  use more debt. 
C)  have lower D/E ratios. 
D)  none of the options. 
A)  use less debt. 
B)  use more debt. 
C)  have lower D/E ratios. 
D)  none of the options.

Question 6

Your company has a 21 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $50 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c c } 
\text { State } & \text { Recession } & \text { Average } & \text { Boom } \
\text { Probability of state } & 0.15 & 0.65 & 0.20 \
\text { Expected EBIT in state } & \$ 100 \text { million } & \$ 175 \text { million } & \$ 235 \text { million }
\end{array}$$
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

Accepted Answer

A)  $8.56 
B)  $8.84 
C)  $11.70 
D)  $25.67 
A)  $8.56 
B)  $8.84 
C)  $11.70 
D)  $25.67

Question 7

Your company doesn't face any taxes and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c  } 
\text { State } & \text { Pessimistic } & \text { optimistic } & \
\text { Probability of state } & 0.3 & 0.7  \
\text { Expected EBIT in state } & \$ 15 \text { million } & \$ 40 \text { million } 
\end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the break-even EBIT?

Accepted Answer

A)  $18 million 
B)  $27.5 million 
C)  $32.5 million 
D)  $40 million 
A)  $18 million 
B)  $27.5 million 
C)  $32.5 million 
D)  $40 million

Question 8

Which of the following is a true statement regarding Proposition I?

Accepted Answer

A)  Vu in a world with taxes is going to be more than Vu in a world without taxes. 
B)  Vu in a world with taxes is going to be less than Vu in a world without taxes. 
C)  Vu in a world with taxes is going to be equal to Vu in a world without taxes. 
D)  Vu in a world with taxes cannot be compared to Vu in a world without taxes. 
A)  Vu in a world with taxes is going to be more than Vu in a world without taxes. 
B)  Vu in a world with taxes is going to be less than Vu in a world without taxes. 
C)  Vu in a world with taxes is going to be equal to Vu in a world without taxes. 
D)  Vu in a world with taxes cannot be compared to Vu in a world without taxes.

Question 9

Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c  } 
\text { State } & \text { Pessimistic } & \text { optimistic } & \
\text { Probability of state } & 0.55 & 0.55  \
\text { Expected EBIT in state } & \$ 20 \text { million } & \$ 70 \text { million } 
\end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

Accepted Answer

A)  $1.06 
B)  $1.17 
C)  $2.27 
D)  $2.28 
A)  $1.06 
B)  $1.17 
C)  $2.27 
D)  $2.28

Question 10

Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c  } 
\text { State } & \text { Pessimistic } & \text { optimistic } & \
\text { Probability of state } & 0.55 & 0.45  \
\text { Expected EBIT in state } & \$ 20 \text { million } & \$ 70 \text { million } 
\end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the break-even level of EBIT?

Accepted Answer

A)  $20 million 
B)  $23.75 million 
C)  $42.5 million 
D)  $75 million 
A)  $20 million 
B)  $23.75 million 
C)  $42.5 million 
D)  $75 million

Question 11

Suppose that Lil John Industries' equity is currently selling for $64 per share and that there are 1 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 108 percent of par ($1,000), what are the firm's current capital structure weights?

Accepted Answer

A)  Weight of Equity = 25.23 percent; Weight of Debt = 74.77 percent 
B)  Weight of Equity = 84.77 percent; Weight of Debt = 15.23 percent 
C)  Weight of Equity = 74.77 percent; Weight of Debt = 25.23 percent 
D)  Weight of Equity = 32.23 percent; Weight of Debt = 67.77 percent 
A)  Weight of Equity = 25.23 percent; Weight of Debt = 74.77 percent 
B)  Weight of Equity = 84.77 percent; Weight of Debt = 15.23 percent 
C)  Weight of Equity = 74.77 percent; Weight of Debt = 25.23 percent 
D)  Weight of Equity = 32.23 percent; Weight of Debt = 67.77 percent

Question 12

GTB, Inc., has a 21 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c  } 
\text { State } & \text { Pessimistic } & \text { optimistic } & \
\text { Probability of state } & 0.45 & 0.55  \
\text { Expected EBIT in state } & \$ 10 \text { million } & \$ 20 \text { million } 
\end{array}$$
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 5 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

Accepted Answer

A)  $1.03 
B)  $0.42 
C)  $0.62 
D)  $0.66 
A)  $1.03 
B)  $0.42 
C)  $0.62 
D)  $0.66

Question 13

Why does allowing for the existence of corporate taxation cause firms to prefer the maximum amount of debt possible?

Accepted Answer

A)  Because the flotation costs associated with debt are significantly lower than the flotation costs associated with equity. 
B)  Because debt is tax-deductible, the effective cost of debt is much cheaper than using equity. 
C)  Because debt places fewer demands on the firm's cash flows. 
D)  None of the options cause firms to prefer the maximum amount of debt possible. 
A)  Because the flotation costs associated with debt are significantly lower than the flotation costs associated with equity. 
B)  Because debt is tax-deductible, the effective cost of debt is much cheaper than using equity. 
C)  Because debt places fewer demands on the firm's cash flows. 
D)  None of the options cause firms to prefer the maximum amount of debt possible.

Question 14

Your company has a 21 percent tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c c } 
\text { State } & \text { Recession } & \text { Average } & \text { Boorn } \
\text { Probability of state } & 0.15 & 0.60 & 0.25 \
\text { Expected EBIT in state } & \$ 20 \text { million } & \$ 50 \text { million } & \$ 100 \text { million }
\end{array}$$
The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

Accepted Answer

A)  $1.98 
B)  $2.29 
C)  $2.36 
D)  $3.11 
A)  $1.98 
B)  $2.29 
C)  $2.36 
D)  $3.11

Question 15

Your company faces a 21 percent tax rate and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c  } 
\text { State } & \text { Pessimistic } & \text { optimistic } & \
\text { Probability of state } & 0.55 & 0.45  \
\text { Expected EBIT in state } & \$ 20 \text { million } & \$ 70 \text { million } 
\end{array}$$
The firm is considering switching to a 25 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

Accepted Answer

A)  0.689 
B)  0.876 
C)  1.186 
D)  1.406 
A)  0.689 
B)  0.876 
C)  1.186 
D)  1.406

Question 16

If a firm changes their capital structure by immediately selling additional claims of one type of capital and using the proceeds to retire another kind of claim, they are using which type of capital structure change?

Accepted Answer

A)  Active 
B)  Passive 
C)  Separation 
D)  Supportive 
A)  Active 
B)  Passive 
C)  Separation 
D)  Supportive

Question 17

Your company faces a 21 percent tax rate and has $200 million in assets, currently financed entirely with equity. Equity is worth $10 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c  } 
\text { State } & \text { Pessimistic } & \text { optimistic } & \
\text { Probability of state } & 0.25 & 0.75  \
\text { Expected EBIT in state } & \$ 5 \text { million } & \$25\text { million } 
\end{array}$$
The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

Accepted Answer

A)  $0.893 
B)  $0.797 
C)  $0.946 
D)  $1.023 
A)  $0.893 
B)  $0.797 
C)  $0.946 
D)  $1.023

Question 18

JJJ Corp. has $10 million in assets and is currently financed with 100 percent equity. The firm decides to switch to a 60 percent equity/40 percent debt structure and decides to sell $4 million of debt and use the proceeds to retire $4 million in equity today. This is an example of:

Accepted Answer

A)  underinvestment. 
B)  active capital structure management. 
C)  Modigliani-Miller theorem in practice. 
D)  none of the options. 
A)  underinvestment. 
B)  active capital structure management. 
C)  Modigliani-Miller theorem in practice. 
D)  none of the options.

Question 19

Epic Inc. has a 21 percent tax rate and has $13 million in assets, currently financed entirely with equity. Equity is worth $25 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected values for EBIT depend upon which state of the economy occurs this year, with the possible values of EBIT and their associated probabilities shown as follows:
$$\begin{array} { c c c c } 
\text { State } & \text { Recession } & \text { Average } & \text { Boom } \
\text { Probability of state } & 0.10 & 0.70 & 0.20 \
\text { Expected EBIT in state } & \$ 5 \text { million } & \$ 10 \text { million } & \$ 15 \text { million }
\end{array}$$
The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

Accepted Answer

A)  $19.23 
B)  $22.11 
C)  $16.10 
D)  $15.97 
A)  $19.23 
B)  $22.11 
C)  $16.10 
D)  $15.97

Question 20

If a firm changes their capital structure by waiting until the firm requires additional capital to cover capital budgeting needs and then selling more of the type of claims they wish to increase, they are using which type of capital structure change?

Accepted Answer

A)  Active 
B)  Passive 
C)  Separation 
D)  Supportive 
A)  Active 
B)  Passive 
C)  Separation 
D)  Supportive

The Modigilian-Miller (M&M) theorem states that:

Which of the following allows for two types of bankruptcy for which most businesses can file?

All else the same, firms facing relatively high tax rates should:

Which of the following is the condition in which a firm is near bankruptcy?

All else the same, firms with stable, predictable income streams will be able to:

Which of the following is a true statement regarding Proposition I?

Suppose that Lil John Industries' equity is currently selling for $64 per share and that there are 1 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 108 percent of par ($1,000), what are the firm's current capital structure weights?

Why does allowing for the existence of corporate taxation cause firms to prefer the maximum amount of debt possible?

If a firm changes their capital structure by immediately selling additional claims of one type of capital and using the proceeds to retire another kind of claim, they are using which type of capital structure change?

JJJ Corp. has $10 million in assets and is currently financed with 100 percent equity. The firm decides to switch to a 60 percent equity/40 percent debt structure and decides to sell $4 million of debt and use the proceeds to retire $4 million in equity today. This is an example of:

If a firm changes their capital structure by waiting until the firm requires additional capital to cover capital budgeting needs and then selling more of the type of claims they wish to increase, they are using which type of capital structure change?

Introduction to Financial Management

Reviewing Financial Statements

Analyzing Financial Statements

Time Value of Money 1: Analyzing Single Cash Flows

Time Value of Money 2: Analyzing Annuity Cash Flows

Understanding Financial Markets and Institutions

Valuing Bonds

Valuing Stocks

Characterizing Risk and Return

Estimating Risk and Return

Calculating the Cost of Capital

Estimating Cash Flows on Capital Budgeting Projects

Weighing Net Present Value and Other Capital Budgeting Criteria

Working Capital Management and Policies

Financial Planning and Forecasting

Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts

Issuing Capital and the Investment Banking Process

International Corporate Finance

Mergers and Acquisitions and Financial Distress

Filters

Exam 16: Assessing Long-Term Debt, Equity, and Capital Structure

The Modigilian-Miller (M&M) theorem states that:

Which of the following allows for two types of bankruptcy for which most businesses can file?

All else the same, firms facing relatively high tax rates should:

Which of the following is the condition in which a firm is near bankruptcy?

All else the same, firms with stable, predictable income streams will be able to:

Which of the following is a true statement regarding Proposition I?

Suppose that Lil John Industries' equity is currently selling for $64 per share and that there are 1 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 108 percent of par ($1,000), what are the firm's current capital structure weights?

Why does allowing for the existence of corporate taxation cause firms to prefer the maximum amount of debt possible?

If a firm changes their capital structure by immediately selling additional claims of one type of capital and using the proceeds to retire another kind of claim, they are using which type of capital structure change?

JJJ Corp. has $10 million in assets and is currently financed with 100 percent equity. The firm decides to switch to a 60 percent equity/40 percent debt structure and decides to sell $4 million of debt and use the proceeds to retire $4 million in equity today. This is an example of:

If a firm changes their capital structure by waiting until the firm requires additional capital to cover capital budgeting needs and then selling more of the type of claims they wish to increase, they are using which type of capital structure change?

Introduction to Financial Management

Reviewing Financial Statements

Analyzing Financial Statements

Time Value of Money 1: Analyzing Single Cash Flows

Time Value of Money 2: Analyzing Annuity Cash Flows

Understanding Financial Markets and Institutions

Valuing Bonds

Valuing Stocks

Characterizing Risk and Return

Estimating Risk and Return

Calculating the Cost of Capital

Estimating Cash Flows on Capital Budgeting Projects

Weighing Net Present Value and Other Capital Budgeting Criteria

Working Capital Management and Policies

Financial Planning and Forecasting

Sharing Firm Wealth: Dividends, Share Repurchases, and Other Payouts

Issuing Capital and the Investment Banking Process

International Corporate Finance

Mergers and Acquisitions and Financial Distress

Filters