Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Generally, debt ratios do not vary much among different industries, although they do vary among firms within a given industry. 
B)  Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
C)  Airline companies tend to have very volatile earnings, and as a result they generally have high target debt-to-equity ratios. 
D)  Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes. 
E)  Since most stocks sell at or very close to their book values, book value capital structures are typically adequate for use in estimating firms' weighted average costs of capital. 
A)  Generally, debt ratios do not vary much among different industries, although they do vary among firms within a given industry. 
B)  Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries. 
C)  Airline companies tend to have very volatile earnings, and as a result they generally have high target debt-to-equity ratios. 
D)  Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes. 
E)  Since most stocks sell at or very close to their book values, book value capital structures are typically adequate for use in estimating firms' weighted average costs of capital.

Question 2

El Capitan Foods has a capital structure of 40% debt and 60% equity, its tax rate is 35%, and its beta (leveraged) is 1.25. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU?

Accepted Answer

A)  0.71 
B)  0.75 
C)  0.79 
D)  0.83 
E)  0.87 
A)  0.71 
B)  0.75 
C)  0.79 
D)  0.83 
E)  0.87

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A)  If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. 
B)  A change in the personal tax rate should not affect firms' capital structure decisions. 
C)  "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. 
D)  The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS. 
E)  If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio. 
A)  If Congress lowered corporate tax rates while other things were held constant, and if the Modigliani-Miller tax-adjusted theory of capital structure were correct, this would tend to cause corporations to decrease their use of debt. 
B)  A change in the personal tax rate should not affect firms' capital structure decisions. 
C)  "Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage. 
D)  The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS. 
E)  If changes in the bankruptcy code made bankruptcy less costly to corporations, this would likely reduce the average corporation's debt ratio.

Question 4

If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

Accepted Answer

A) True 
 B)False

Question 5

Other things held constant, the lower a firm's tax rate, the more logical it is for the firm to use debt.

Accepted Answer

A) True 
 B)False

Question 6

If two firms have the same expected earnings per share (EPS) and the same standard deviation of expected EPS, then they must have the same amount of business risk.

Accepted Answer

A) True 
 B)False

Question 7

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that maximizes expected EPS also maximizes the price per share of common stock. 
B)  The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. 
C)  The capital structure that minimizes the required return on equity also maximizes the stock price. 
D)  The capital structure that minimizes the WACC also maximizes the price per share of common stock. 
E)  The capital structure that gives the firm the best bond rating also maximizes the stock price. 
A)  The capital structure that maximizes expected EPS also maximizes the price per share of common stock. 
B)  The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. 
C)  The capital structure that minimizes the required return on equity also maximizes the stock price. 
D)  The capital structure that minimizes the WACC also maximizes the price per share of common stock. 
E)  The capital structure that gives the firm the best bond rating also maximizes the stock price.

Question 9

The Modigliani and Miller (MM) articles implicitly assumed, among other things, that outside stockholders have the same information about a firm's future prospects as its managers. That was called "symmetric information," and it is questionable. The introduction of "asymmetric information" led to the development of the "signaling" theory of capital structure, which postulated that firms are reluctant to issue new stock because investors will interpret such an act as a signal that the firm's managers are worried about its future. Other actions give off different signals, and the end result is that capital structure is affected by managers' perceptions about how their financing decisions will affect investors' views of the firm and thus its value.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  The capital structure that maximizes the stock price is also the capital structure that minimizes the cost of equity from retained earnings (rs). 
B)  The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. 
C)  The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TI
E)  ratio. 
D)  If a company increases its debt ratio, this will typically increase the marginal costs of both debt and equity, but it still may reduce the company's WACC. 
E)  If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. 
A)  The capital structure that maximizes the stock price is also the capital structure that minimizes the cost of equity from retained earnings (rs). 
B)  The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. 
C)  The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TI
E)  ratio. 
D)  If a company increases its debt ratio, this will typically increase the marginal costs of both debt and equity, but it still may reduce the company's WACC. 
E)  If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios.

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)  As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
B)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
C)  The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
D)  The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
E)  The optimal capital structure simultaneously maximizes the stock price and minimizes the WACC. 
A)  As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
B)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
C)  The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
D)  The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
E)  The optimal capital structure simultaneously maximizes the stock price and minimizes the WACC.

Question 12

Your uncle is considering investing in a new company that will produce high quality stereo speakers. The sales price would be set at 1.5 times the variable cost per unit; the variable cost per unit is estimated to be $75.00; and fixed costs are estimated at $1,200,000. What sales volume would be required to break even, i.e., to have EBIT = zero?

Accepted Answer

A)  28,880 
B)  30,400 
C)  32,000 
D)  33,600 
E)  35,280 
A)  28,880 
B)  30,400 
C)  32,000 
D)  33,600 
E)  35,280

Question 13

Some people--including the current chairman of the Federal Reserve Board of Governors (Ben Bernanke)--have argued that one advantage of corporate debt from the stockholders' standpoint is that the existence of debt forces managers to focus on cash flow and to refrain from spending too much of the firm's money on private plane and other "perks." This is one of the factors that led to the rise of LBOs and private equity firms.

Accepted Answer

A) True 
 B)False

Which of the following statements is CORRECT?

El Capitan Foods has a capital structure of 40% debt and 60% equity, its tax rate is 35%, and its beta (leveraged) is 1.25. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU?

Which of the following statements is CORRECT?

If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

Other things held constant, the lower a firm's tax rate, the more logical it is for the firm to use debt.

If two firms have the same expected earnings per share (EPS) and the same standard deviation of expected EPS, then they must have the same amount of business risk.

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Risk and Return

Stocks

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Real Options

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Hybrid Financing

Mergers

Filters

Exam 14: Capital Structure

Which of the following statements is CORRECT?

El Capitan Foods has a capital structure of 40% debt and 60% equity, its tax rate is 35%, and its beta (leveraged) is 1.25. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU?

Which of the following statements is CORRECT?

If a firm utilizes debt financing, a 10% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than 10%, and the higher the debt ratio, the larger this difference will be.

Other things held constant, the lower a firm's tax rate, the more logical it is for the firm to use debt.

If two firms have the same expected earnings per share (EPS) and the same standard deviation of expected EPS, then they must have the same amount of business risk.

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Risk and Return

Stocks

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Real Options

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Hybrid Financing

Mergers

Filters