Question 1

What is meant by investors being able "to undo" the effects of corporate restructuring?

Accepted Answer

A) Investors repay their portion of the firm's debt. 
B) Investors only purchase securities in unlevered firms. 
C) Investors will pay more for unlevered shares. 
D) Investors borrow in their name and replicate the effects of restructuring. 
A) Investors repay their portion of the firm's debt. 
B) Investors only purchase securities in unlevered firms. 
C) Investors will pay more for unlevered shares. 
D) Investors borrow in their name and replicate the effects of restructuring.

Question 2

Financial risk refers to the:

Accepted Answer

A) risk of owning equity securities. 
B) risk faced by equity holders when debt is used. 
C) general business risk of the firm. 
D) possibility that interest rates will increase. 
A) risk of owning equity securities. 
B) risk faced by equity holders when debt is used. 
C) general business risk of the firm. 
D) possibility that interest rates will increase.

Question 3

Explain the pecking-order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

Accepted Answer

Managers who are choosing between debt a

Question 4

Calculate the WACC for a firm with a debt-equity ratio of 1.5.The debt pays 10% interest and the equity is expected to return 16%.Assume a 35% tax rate and risk-free debt.

Accepted Answer

If D/E = 1.5, then debt = 60%

Question 5

Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?

Accepted Answer

A) the tax shield has been calculated incorrectly. 
B) the firm is too heavily levered financially. 
C) the firm has reached its optimal debt level. 
D) the firm appears to have low risk of financial distress. 
A) the tax shield has been calculated incorrectly. 
B) the firm is too heavily levered financially. 
C) the firm has reached its optimal debt level. 
D) the firm appears to have low risk of financial distress.

Question 6

By changing the mix of securities a firm uses for financing, the financial manager:

Accepted Answer

A) can increase the book value of the firm. 
B) is changing the firm's capital structure. 
C) can increase the market value of the firm. 
D) is changing the firm's dividend policy. 
A) can increase the book value of the firm. 
B) is changing the firm's capital structure. 
C) can increase the market value of the firm. 
D) is changing the firm's dividend policy.

Question 7

Ignoring taxes, a firm's weighted-average cost of capital is equal to:

Accepted Answer

A) its expected return on assets. 
B) its expected return on equity. 
C) the sum of expected return on equity and expected return on debt. 
D) its expected return on assets times the debt-equity ratio. 
A) its expected return on assets. 
B) its expected return on equity. 
C) the sum of expected return on equity and expected return on debt. 
D) its expected return on assets times the debt-equity ratio.

Question 8

The "trade-off theory" of capital structure suggests that firms have an optimal level of debt.

Accepted Answer

A) True 
 B)False

Question 9

Management's perceived signals to investors form an important component of pecking-order theory.

Accepted Answer

A) True 
 B)False

Question 10

Stockholders' expected return on a stock priced at $25 per share with zero-growth dividends of $4.00 is:

Accepted Answer

A) 6.25%. 
B) 13.64%. 
C) 16.00%. 
D) 21.00%. 
A) 6.25%. 
B) 13.64%. 
C) 16.00%. 
D) 21.00%.

Question 11

At some debt-equity ratio, the costs of financial distress are expected to overcome the value of the tax shield for a firm.

Accepted Answer

A) True 
 B)False

Question 12

In an MM world, restructuring the firm will not change its overall value.

Accepted Answer

A) True 
 B)False

Question 13

The present value of the costs of financial distress increases with increases in the debt ratio because the:

Accepted Answer

A) expected return on assets increases. 
B) present value of the interest tax shield is greater. 
C) equity tax shield is depleted. 
D) probability of default and/or bankruptcy is greater. 
A) expected return on assets increases. 
B) present value of the interest tax shield is greater. 
C) equity tax shield is depleted. 
D) probability of default and/or bankruptcy is greater.

Question 14

A firm's business risk depends upon:

Accepted Answer

A) its use of debt in the capital structure. 
B) the risk of the firm's assets and operations. 
C) whether individuals are able to undo the leverage. 
D) the costs of financial distress. 
A) its use of debt in the capital structure. 
B) the risk of the firm's assets and operations. 
C) whether individuals are able to undo the leverage. 
D) the costs of financial distress.

Question 15

According to MM II, if the expected return on assets decreases, what happens to the expected return on equity?

Accepted Answer

A) depends on the firm's capital structure 
B) decreases 
C) remains constant 
D) increases 
A) depends on the firm's capital structure 
B) decreases 
C) remains constant 
D) increases

Question 16

The "trade-off theory" of capital structure suggests that:

Accepted Answer

A) Firms add leverage whenever interest rates are low. 
B) Firms with higher risk should use less debt. 
C) Firms should use 50% debt and 50% equity. 
D) Firms should use debt to overcome high par values of stock. 
A) Firms add leverage whenever interest rates are low. 
B) Firms with higher risk should use less debt. 
C) Firms should use 50% debt and 50% equity. 
D) Firms should use debt to overcome high par values of stock.

Question 17

The stability of a firm's operating income is the focus of:

Accepted Answer

A) financial leverage. 
B) weighted-average cost of capital. 
C) capital structure. 
D) business risk. 
A) financial leverage. 
B) weighted-average cost of capital. 
C) capital structure. 
D) business risk.

Question 18

In a world with corporate taxes but no possibility of financial distress, the value of the firm is maximized when the:

Accepted Answer

A) firm uses no debt in its capital structure. 
B) firm uses no equity in its capital structure. 
C) firm uses a debt-equity ratio of 1.0. 
D) corporate tax rate approaches 100%. 
A) firm uses no debt in its capital structure. 
B) firm uses no equity in its capital structure. 
C) firm uses a debt-equity ratio of 1.0. 
D) corporate tax rate approaches 100%.

Question 19

The benefit of an interest tax shield is captured by the equity holders.

Accepted Answer

A) True 
 B)False

Question 20

The optimal capital structure is met when:

Accepted Answer

A) additional borrowing results in lower financial distress costs. 
B) additional borrowing is offset by the interest tax shield. 
C) the tax savings from additional leverage is just offset by the costs of distress. 
D) the present value of the tax shield is greater than the value of an all-equity financed firm. 
A) additional borrowing results in lower financial distress costs. 
B) additional borrowing is offset by the interest tax shield. 
C) the tax savings from additional leverage is just offset by the costs of distress. 
D) the present value of the tax shield is greater than the value of an all-equity financed firm.

Exam 16: Debt Policy

What is meant by investors being able "to undo" the effects of corporate restructuring?

Financial risk refers to the:

Explain the pecking-order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

Calculate the WACC for a firm with a debt-equity ratio of 1.5.The debt pays 10% interest and the equity is expected to return 16%.Assume a 35% tax rate and risk-free debt.

Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?

By changing the mix of securities a firm uses for financing, the financial manager:

Ignoring taxes, a firm's weighted-average cost of capital is equal to:

The "trade-off theory" of capital structure suggests that firms have an optimal level of debt.

Management's perceived signals to investors form an important component of pecking-order theory.

Stockholders' expected return on a stock priced at $25 per share with zero-growth dividends of $4.00 is:

At some debt-equity ratio, the costs of financial distress are expected to overcome the value of the tax shield for a firm.

In an MM world, restructuring the firm will not change its overall value.

The present value of the costs of financial distress increases with increases in the debt ratio because the:

A firm's business risk depends upon:

According to MM II, if the expected return on assets decreases, what happens to the expected return on equity?

The "trade-off theory" of capital structure suggests that:

The stability of a firm's operating income is the focus of:

In a world with corporate taxes but no possibility of financial distress, the value of the firm is maximized when the:

The benefit of an interest tax shield is captured by the equity holders.

The optimal capital structure is met when:

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