Question 1

The pecking-order theory suggests that less profitable firms borrow more because:

Accepted Answer

A) equity issues are more expensive. 
B) leverage is preferred over raising funds internally. 
C) debt issues are good omens. 
D) they have insufficient internal funds. 
A) equity issues are more expensive. 
B) leverage is preferred over raising funds internally. 
C) debt issues are good omens. 
D) they have insufficient internal funds. D

Question 2

A firm with a debt equity ratio of 1/3, return on assets of 15%, and return on debt of 10% will have return on equity of:

Accepted Answer

A) 15.00%. 
B) 16.67%. 
C) 20.00%. 
D) 21.17%. 
A) 15.00%. 
B) 16.67%. 
C) 20.00%. 
D) 21.17%. B

Question 3

According to MM, if individuals cannot obtain the same borrowing terms as firms, then:

Accepted Answer

A) capital structure may be relevant. 
B) capital structure may be irrelevant. 
C) individuals should not invest in levered firms. 
D) firms should increase their payments to individuals. 
A) capital structure may be relevant. 
B) capital structure may be irrelevant. 
C) individuals should not invest in levered firms. 
D) firms should increase their payments to individuals. A

Question 4

Even after relaxing the MM assumption of no taxes, it can be observed that restructuring does not affect the value of the firm.

Accepted Answer

A) True 
 B)False

Question 5

When taxes are ignored, which of the following can be used to calculate the weighted-average cost of capital?

Accepted Answer

A) ratio of expected operating income to book value of all securities. 
B) the expected return on equity times the debt-equity ratio. 
C) ratio of expected operating income to market value of all securities. 
D) the required return on equity plus the required return on debt. 
A) ratio of expected operating income to book value of all securities. 
B) the expected return on equity times the debt-equity ratio. 
C) ratio of expected operating income to market value of all securities. 
D) the required return on equity plus the required return on debt.

Question 6

The reason that financial leverage increases shareholder risk is that there is:

Accepted Answer

A) more debt which increases the operating risk. 
B) less equity to absorb the operating risk. 
C) less business risk to be spread around. 
D) more financial risk due to reduced business risk. 
A) more debt which increases the operating risk. 
B) less equity to absorb the operating risk. 
C) less business risk to be spread around. 
D) more financial risk due to reduced business risk.

Question 7

Show how leverage increases financial risk by calculating the EPS and return on shares for a firm with $1 million in 10% debt.The firm also has 50,000 shares outstanding that sell for $40 each.Three states of the economy are possible: a slump under which the firm would have operating income of $150,000, a normal state under which the firm will earn $420,000, and a boom under which the firm will earn $600,000.The firm pays no taxes.

Accepted Answer

The answer of Show how leverage increases financial risk by...

Question 8

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Accepted Answer

A) faces high interest rates. 
B) faces strong growth in business conditions. 
C) pays taxes. 
D) does not reinvest its earnings. 
A) faces high interest rates. 
B) faces strong growth in business conditions. 
C) pays taxes. 
D) does not reinvest its earnings.

Question 9

Discuss the trade-off theory of capital structure, including the determination of an optimal debt level.

Accepted Answer

The trade-off theory of capital structur

Question 10

What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.

Accepted Answer

A) 54.0% 
B) 60.0% 
C) 66.7% 
D) 75.0% 
A) 54.0% 
B) 60.0% 
C) 66.7% 
D) 75.0%

Question 11

The possibility of bankruptcy will do all of the following except:

Accepted Answer

A) increase financial distress costs. 
B) reduce the current market value of the firm. 
C) reduce the interest rate on debt. 
D) reduce the possible payoff to stockholders. 
A) increase financial distress costs. 
B) reduce the current market value of the firm. 
C) reduce the interest rate on debt. 
D) reduce the possible payoff to stockholders.

Question 12

When a corporation issues permanent debt, the value of all its securities:

Accepted Answer

A) increases by the present value of the tax shield. 
B) decreases by the present value of the tax shield. 
C) increases by the annual interest tax shield. 
D) decreases by the annual interest tax shield. 
A) increases by the present value of the tax shield. 
B) decreases by the present value of the tax shield. 
C) increases by the annual interest tax shield. 
D) decreases by the annual interest tax shield.

Question 13

Is there a rule for finding optimal capital structure?

Accepted Answer

There are no simple answers for capital

Question 14

Calculate the firm's expected return on its assets if its expected return on debt is 10%, their expected return on equity is 20%, and its WACC is 14%.

Accepted Answer

A) 14% 
B) 15% 
C) 16% 
D) Cannot be calculated 
A) 14% 
B) 15% 
C) 16% 
D) Cannot be calculated

Question 15

What can be promised by loan covenants? What cannot be ensured by loan covenants?

Accepted Answer

The company knows that lenders will dema

Question 16

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

Accepted Answer

A) increases; increases 
B) increases; decreases 
C) decreases; decreases 
D) decreases; increases 
A) increases; increases 
B) increases; decreases 
C) decreases; decreases 
D) decreases; increases

Question 17

As the debt to equity ratio decreases when debt is not risk free:

Accepted Answer

A) debt holders demand a higher expected return. 
B) debt holders demand a lower expected return. 
C) the expected return on equity increases. 
D) the expected return on assets increases. 
A) debt holders demand a higher expected return. 
B) debt holders demand a lower expected return. 
C) the expected return on equity increases. 
D) the expected return on assets increases.

Question 18

What's the pecking order theory?

Accepted Answer

The pecking order theory says that firms

Question 19

When large firms file for bankruptcy:

Accepted Answer

A) the proceedings involve costly delays and legal tangles, and the business continues to deteriorate. 
B) their purpose is usually to nurse the firm back to health and enable it to face the world again. 
C) their benefit is that their creditors will be forced by law to give up their claims on the firm. 
D) their creditors often try to seize the assets as soon as possible. 
A) the proceedings involve costly delays and legal tangles, and the business continues to deteriorate. 
B) their purpose is usually to nurse the firm back to health and enable it to face the world again. 
C) their benefit is that their creditors will be forced by law to give up their claims on the firm. 
D) their creditors often try to seize the assets as soon as possible.

Question 20

Calculate the WACC for a firm with a debt-equity ratio of .6.The debt pays 12% interest and the equity is expected to return 14%.Assume a 40% tax rate and risk-free debt.

Accepted Answer

A) 11.45% 
B) 12.50% 
C) 13.55% 
D) 14.60% 
A) 11.45% 
B) 12.50% 
C) 13.55% 
D) 14.60%

Exam 16: Debt Policy

The pecking-order theory suggests that less profitable firms borrow more because:

A firm with a debt equity ratio of 1/3, return on assets of 15%, and return on debt of 10% will have return on equity of:

According to MM, if individuals cannot obtain the same borrowing terms as firms, then:

Even after relaxing the MM assumption of no taxes, it can be observed that restructuring does not affect the value of the firm.

When taxes are ignored, which of the following can be used to calculate the weighted-average cost of capital?

The reason that financial leverage increases shareholder risk is that there is:

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Discuss the trade-off theory of capital structure, including the determination of an optimal debt level.

What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.

The possibility of bankruptcy will do all of the following except:

When a corporation issues permanent debt, the value of all its securities:

Is there a rule for finding optimal capital structure?

Calculate the firm's expected return on its assets if its expected return on debt is 10%, their expected return on equity is 20%, and its WACC is 14%.

What can be promised by loan covenants? What cannot be ensured by loan covenants?

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

As the debt to equity ratio decreases when debt is not risk free:

What's the pecking order theory?

When large firms file for bankruptcy:

Calculate the WACC for a firm with a debt-equity ratio of .6.The debt pays 12% interest and the equity is expected to return 14%.Assume a 40% tax rate and risk-free debt.

Goals and Governance of the Firm

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

Valuing Stocks

Net Present Value and Other Investment Criteria

Using Discounted Cash Flow Analysis to Make Investment Decisions

Project Analysis

Introduction to Risk, Return, and the Opportunity Cost of Capital

Risk, Return, and Capital Budgeting

The Weighted-Average Cost of Capital and Company Valuation

Introduction to Corporate Financing and Governance

Venture Capital, Ipos, and Seasoned Offerings

Leasing

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Cash and Inventory Management

Credit Management and Collection

Mergers, Acquisitions, and Corporate Control

International Financial Management

Options

Risk Management

Filters

The present value of a perpetual tax shield increases as the firm's tax rate _ and the amount of principal _.