Question 1

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 2

Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?

Accepted Answer

A)  An increase in the corporate tax rate. 
B)  An increase in the personal tax rate. 
C)  An increase in the company's operating leverage. 
D)  The Federal Reserve tightens interest rates in an effort to fight inflation. 
E)  The company's stock price hits a new high. 
A)  An increase in the corporate tax rate. 
B)  An increase in the personal tax rate. 
C)  An increase in the company's operating leverage. 
D)  The Federal Reserve tightens interest rates in an effort to fight inflation. 
E)  The company's stock price hits a new high.

Question 3

Modigliani and Miller (MM), in their second article, took account of taxes, bankruptcy, and other factors that were assumed away in their original article. Once they took account of all these assumptions, they concluded that efirm has a unique optimal capital structure. Moreover, a manager can use the second MM model to determine his or her firm's optimal debt ratio.

Accepted Answer

A) True 
 B)False

Question 4

Other things held constant, which of the following events would be most likely to encourage a firm to increase the amount of debt in its capital structure?

Accepted Answer

A)  Its sales are projected to become less stable in the future. 
B)  The bankruptcy laws are changed in a way that would make bankruptcy more costly to the firm and its stockholders. 
C)  Management believes that the firm's stock is currently overvalued. 
D)  The firm decides to automate its factory with specialized equipment and thus increase its use of operating leverage. 
E)  The corporate tax rate is increased. 
A)  Its sales are projected to become less stable in the future. 
B)  The bankruptcy laws are changed in a way that would make bankruptcy more costly to the firm and its stockholders. 
C)  Management believes that the firm's stock is currently overvalued. 
D)  The firm decides to automate its factory with specialized equipment and thus increase its use of operating leverage. 
E)  The corporate tax rate is increased.

Question 5

It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.

Accepted Answer

A) True 
 B)False

Question 6

An increase in the debt ratio will generally have no effect on which of these items?

Accepted Answer

A)  Business risk. 
B)  Total risk. 
C)  Financial risk. 
D)  Market risk. 
E)  The firm's beta. 
A)  Business risk. 
B)  Total risk. 
C)  Financial risk. 
D)  Market risk. 
E)  The firm's beta.

Question 7

Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk?

Accepted Answer

A)  Demand variability. 
B)  Sales price variability. 
C)  The extent to which operating costs are fixed. 
D)  The extent to which interest rates on the firm's debt fluctuate. 
E)  Input price variability. 
A)  Demand variability. 
B)  Sales price variability. 
C)  The extent to which operating costs are fixed. 
D)  The extent to which interest rates on the firm's debt fluctuate. 
E)  Input price variability.

Question 8

The firm's target capital structure should do which of the following?

Accepted Answer

A)  Maximize the earnings per share (EPS). 
B)  Minimize the cost of debt (rd). 
C)  Obtain the highest possible bond rating. 
D)  Minimize the cost of equity (rs). 
E)  Minimize the weighted average cost of capital (WAC
C) . 
A)  Maximize the earnings per share (EPS). 
B)  Minimize the cost of debt (rd). 
C)  Obtain the highest possible bond rating. 
D)  Minimize the cost of equity (rs). 
E)  Minimize the weighted average cost of capital (WAC
C) .

Question 9

A group of venture investors is considering putting money into Lemma Books, which wants to produce a new reader for electronic books. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, or $500, and fixed costs are estimated at $750,000. The investors will put up the funds if the project is likely to have an operating income of $500,000 or more. What sales volume would be required in order to meet the minimum profit goal? (Hint: Use the breakeven formula, but include the required profit in the numerator.)

Accepted Answer

A)  4,513 
B)  4,750 
C)  5,000 
D)  5,250 
E)  5,513 
A)  4,513 
B)  4,750 
C)  5,000 
D)  5,250 
E)  5,513

Question 10

The Miller model begins with the Modigliani and Miller (MM) model with corporate taxes and then adds personal taxes.

Accepted Answer

A) True 
 B)False

Question 11

A major contribution of the Miller model is that it demonstrates, other things held constant, that

Accepted Answer

A)  personal taxes increase the value of using corporate debt. 
B)  personal taxes lower the value of using corporate debt. 
C)  personal taxes have no effect on the value of using corporate debt. 
D)  financial distress and agency costs reduce the value of using corporate debt. 
E)  debt costs increase with financial leverage. 
A)  personal taxes increase the value of using corporate debt. 
B)  personal taxes lower the value of using corporate debt. 
C)  personal taxes have no effect on the value of using corporate debt. 
D)  financial distress and agency costs reduce the value of using corporate debt. 
E)  debt costs increase with financial leverage.

Question 12

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Accepted Answer

A) True 
 B)False

Question 13

You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $400,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEU?

Accepted Answer

A)  5.85% 
B)  6.14% 
C)  6.45% 
D)  6.77% 
E)  7.11% 
A)  5.85% 
B)  6.14% 
C)  6.45% 
D)  6.77% 
E)  7.11%

Question 14

You work for the CEO of a new company that plans to manufacture and sell a new type of laptop computer. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $600,000. Other data for the firm are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL - EPSU?

Accepted Answer

A)  $1.00 
B)  $1.11 
C)  $1.23 
D)  $1.37 
E)  $1.50 
A)  $1.00 
B)  $1.11 
C)  $1.23 
D)  $1.37 
E)  $1.50

Question 15

Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT.

Accepted Answer

A) True 
 B)False

Question 16

Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value.

Accepted Answer

A) True 
 B)False

Question 17

Modigliani and Miller's second article, which assumed the existence of corporate income taxes, led to the conclusion that a firm's value would be maximized, and its cost of capital minimized, if it used (almost) 100% debt. However, this model did not take account of bankruptcy costs. The existence of bankruptcy costs leads to the assumption of an optimal capital structure where the debt ratio is less than 100%.

Accepted Answer

A) True 
 B)False

Question 18

Southwest U's campus book store sells course packs for $15 each, the variable cost per pack is $9, fixed costs to produce the packs are $200,000, and expected annual sales are 50,000 packs. What are the pre-tax profits from sales of course packs?

Accepted Answer

A)  $72,900 
B)  $81,000 
C)  $90,000 
D)  $100,000 
E)  $110,000 
A)  $72,900 
B)  $81,000 
C)  $90,000 
D)  $100,000 
E)  $110,000

Question 19

Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.

Accepted Answer

A) True 
 B)False

Question 20

A firm's CFO is considering increasing the target debt ratio, which would also increase the company's interest expense. New bonds would be issued and the proceeds would be used to buy back shares of common stock. Neither total assets nor operating income would change, but expected earnings per share (EPS) would increase. Assuming the CFO's estimates are correct, which of the following statements is CORRECT?

Accepted Answer

A)  Since the proposed plan increases the firm's financial risk, the stock price might fall even if EPS increases. 
B)  If the plan reduces the WACC, the stock price is likely to decline. 
C)  Since the plan is expected to increase EPS, this implies that net income is also expected to increase. 
D)  If the plan does increase the EPS, the stock price will automatically increase at the same rate. 
E)  Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds. 
A)  Since the proposed plan increases the firm's financial risk, the stock price might fall even if EPS increases. 
B)  If the plan reduces the WACC, the stock price is likely to decline. 
C)  Since the plan is expected to increase EPS, this implies that net income is also expected to increase. 
D)  If the plan does increase the EPS, the stock price will automatically increase at the same rate. 
E)  Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds.

Which of the following statements is CORRECT?

Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?

Other things held constant, which of the following events would be most likely to encourage a firm to increase the amount of debt in its capital structure?

It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.

An increase in the debt ratio will generally have no effect on which of these items?

Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk?

The firm's target capital structure should do which of the following?

The Miller model begins with the Modigliani and Miller (MM) model with corporate taxes and then adds personal taxes.

A major contribution of the Miller model is that it demonstrates, other things held constant, that

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT.

Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value.

Southwest U's campus book store sells course packs for $15 each, the variable cost per pack is $9, fixed costs to produce the packs are $200,000, and expected annual sales are 50,000 packs. What are the pre-tax profits from sales of course packs?

Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds and Their Valuation

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Distributions to Shareholders: Dividends and

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles

Mergers and Acquisitions

Financial Management and Stock Equilibrium

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Exam 14: Capital Structure and Leverage

Which of the following statements is CORRECT?

Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant?

Other things held constant, which of the following events would be most likely to encourage a firm to increase the amount of debt in its capital structure?

It is possible for Firms A and B to have identical financial and operating leverage, yet for Firm A to have more risk as measured by the variability of EPS. This would occur if Firm A has more business risk than Firm B.

An increase in the debt ratio will generally have no effect on which of these items?

Business risk is affected by a firm's operations. Which of the following is NOT directly associated with (or does not directly contribute to) business risk?

The firm's target capital structure should do which of the following?

The Miller model begins with the Modigliani and Miller (MM) model with corporate taxes and then adds personal taxes.

A major contribution of the Miller model is that it demonstrates, other things held constant, that

A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.

Provided a firm does not use an extreme amount of debt, operating leverage typically affects only EPS, while financial leverage affects both EPS and EBIT.

Modigliani and Miller's first article led to the conclusion that capital structure is "irrelevant" because it has no effect on a firm's value.

Southwest U's campus book store sells course packs for $15 each, the variable cost per pack is $9, fixed costs to produce the packs are $200,000, and expected annual sales are 50,000 packs. What are the pre-tax profits from sales of course packs?

Modigliani and Miller (MM) won Nobel Prizes for their work on capital structure theory.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds and Their Valuation

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Distributions to Shareholders: Dividends and

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles

Mergers and Acquisitions

Financial Management and Stock Equilibrium

Filters