Question 1

Financial risk is the risk to shareholders that result from debt financing.

Accepted Answer

A) True 
 B)False

Question 2

According to pecking-order theory, managers will often choose to finance with:

Accepted Answer

A) new equity rather than debt, due to bankruptcy costs. 
B) debt rather than new equity, to avoid reduced share price. 
C) debt rather than retained earnings, to lower the WACC. 
D) new equity rather than debt, to strengthen EPS. 
A) new equity rather than debt, due to bankruptcy costs. 
B) debt rather than new equity, to avoid reduced share price. 
C) debt rather than retained earnings, to lower the WACC. 
D) new equity rather than debt, to strengthen EPS.

Question 3

Any financial benefit derived from the interest tax shield accrues to the:

Accepted Answer

A) bondholders. 
B) shareholders. 
C) bondholders and shareholders, equally. 
D) shareholders and the federal government. 
A) bondholders. 
B) shareholders. 
C) bondholders and shareholders, equally. 
D) shareholders and the federal government.

Question 4

Studies suggest that the indirect costs of bankruptcy are typically of a significant magnitude.

Accepted Answer

A) True 
 B)False

Question 5

An increase in a firm's financial leverage will:

Accepted Answer

A) increase the variability in earnings per share. 
B) reduce the operating risk of the firm. 
C) increase the value of the firm in a non-MM world. 
D) increase the WACC. 
A) increase the variability in earnings per share. 
B) reduce the operating risk of the firm. 
C) increase the value of the firm in a non-MM world. 
D) increase the WACC.

Question 6

MM Proposition I states that a firm's value is unaffected by its:

Accepted Answer

A) required rate of return on equity. 
B) operating income, in the absence of taxes. 
C) interest rate paid on debt. 
D) mixture of debt and equity. 
A) required rate of return on equity. 
B) operating income, in the absence of taxes. 
C) interest rate paid on debt. 
D) mixture of debt and equity.

Question 7

A firm's capital structure is represented by its mix of:

Accepted Answer

A) Assets. 
B) Debts and equity. 
C) assets and liabilities. 
D) assets, liabilities and equity. 
A) Assets. 
B) Debts and equity. 
C) assets and liabilities. 
D) assets, liabilities and equity.

Question 8

How do corporate income taxes modify MM's leverage irrelevance proposition?

Accepted Answer

Debt interest is a tax-deductible expens

Question 9

What is the expected rate of return to equity holders if the firm has a 35% tax rate, a 10% rate of interest paid on debt, a 15% WACC and a 60% debt-asset ratio?

Accepted Answer

A) 12.50% 
B) 21.25% 
C) 22.50% 
D) 27.75% 
A) 12.50% 
B) 21.25% 
C) 22.50% 
D) 27.75%

Question 10

What is the return on equity for a firm with 15% return on assets, 10% return on debt, and a.75 debt/equity ratio?

Accepted Answer

A) 18.75% 
B) 20.00% 
C) 23.75% 
D) 26.25% 
A) 18.75% 
B) 20.00% 
C) 23.75% 
D) 26.25%

Question 11

Debt may be the preferred form of external financing for many firms because:

Accepted Answer

A) most firms already have too much equity. 
B) tax rates on equity are lower. 
C) debt will not adversely affect the firm's financial ratios. 
D) equity issuance is considered by investors to be a negative sign. 
A) most firms already have too much equity. 
B) tax rates on equity are lower. 
C) debt will not adversely affect the firm's financial ratios. 
D) equity issuance is considered by investors to be a negative sign.

Question 12

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 70% of assets?

Accepted Answer

A) 16.14% 
B) 17.00% 
C) 19.00% 
D) 25.67% 
A) 16.14% 
B) 17.00% 
C) 19.00% 
D) 25.67%

Question 13

Those who benefit from the interest tax shield are:

Accepted Answer

A) debt holders. 
B) equity holders. 
C) both debt holders and equity holders. 
D) only the firm's customers benefit from the interest tax shield. 
A) debt holders. 
B) equity holders. 
C) both debt holders and equity holders. 
D) only the firm's customers benefit from the interest tax shield.

Question 14

Proposition II of MM states that the expected return on assets increases as the debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 15

A firm's capital structure refers to the maturity of debt it employs.

Accepted Answer

A) True 
 B)False

Question 16

If a firm's expected return on equity equals its expected return on assets, then the:

Accepted Answer

A) expected return on debt exceeds the expected return on assets. 
B) likelihood of financial distress is high. 
C) firm has too much debt. 
D) firm has no debt in its capital structure. 
A) expected return on debt exceeds the expected return on assets. 
B) likelihood of financial distress is high. 
C) firm has too much debt. 
D) firm has no debt in its capital structure.

Question 17

Which of the following lists presents the order of financing from most preferred to least preferred according to the pecking order theory?

Accepted Answer

A) debt issue, stock issue, internally generated funds. 
B) internally generated funds, debt issue, stock issue. 
C) stock issue, internally generated funds, debt issue. 
D) internally generated funds, stock issue, debt issue. 
A) debt issue, stock issue, internally generated funds. 
B) internally generated funds, debt issue, stock issue. 
C) stock issue, internally generated funds, debt issue. 
D) internally generated funds, stock issue, debt issue.

Question 18

When corporate taxes are considered, how does leverage affect the WACC?

Accepted Answer

A) an increase in leverage will be offset by a decrease in equity financing, thus leaving WACC unchanged. 
B) changes in leverage will affect the WACC only if the interest rate on debt changes. 
C) increased leverage will increase the WACC. 
D) increased leverage will decrease the WACC. 
A) an increase in leverage will be offset by a decrease in equity financing, thus leaving WACC unchanged. 
B) changes in leverage will affect the WACC only if the interest rate on debt changes. 
C) increased leverage will increase the WACC. 
D) increased leverage will decrease the WACC.

Question 19

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.(Use values in dollar.)

Accepted Answer

A) EPS increase to $2.60 
B) EPS increase to $3.00 
C) EPS increase to $4.80 
D) EPS increase to $5.20 
A) EPS increase to $2.60 
B) EPS increase to $3.00 
C) EPS increase to $4.80 
D) EPS increase to $5.20

Question 20

What is the proportion of equity financing for a firm that expects a 15% return on equity, a 10% return on assets, and an 8% return on debt? Ignore taxes.

Accepted Answer

A) 25% 
B) 29% 
C) 75% 
D) 71% 
A) 25% 
B) 29% 
C) 75% 
D) 71%

Exam 16: Debt Policy

Financial risk is the risk to shareholders that result from debt financing.

According to pecking-order theory, managers will often choose to finance with:

Any financial benefit derived from the interest tax shield accrues to the:

Studies suggest that the indirect costs of bankruptcy are typically of a significant magnitude.

An increase in a firm's financial leverage will:

MM Proposition I states that a firm's value is unaffected by its:

A firm's capital structure is represented by its mix of:

How do corporate income taxes modify MM's leverage irrelevance proposition?

What is the expected rate of return to equity holders if the firm has a 35% tax rate, a 10% rate of interest paid on debt, a 15% WACC and a 60% debt-asset ratio?

What is the return on equity for a firm with 15% return on assets, 10% return on debt, and a.75 debt/equity ratio?

Debt may be the preferred form of external financing for many firms because:

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt, which totals 70% of assets?

Those who benefit from the interest tax shield are:

Proposition II of MM states that the expected return on assets increases as the debt-equity ratio increases.

A firm's capital structure refers to the maturity of debt it employs.

If a firm's expected return on equity equals its expected return on assets, then the:

Which of the following lists presents the order of financing from most preferred to least preferred according to the pecking order theory?

When corporate taxes are considered, how does leverage affect the WACC?

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.(Use values in dollar.)

What is the proportion of equity financing for a firm that expects a 15% return on equity, a 10% return on assets, and an 8% return on debt? Ignore taxes.

Goals and Governance of the Firm

Financial Markets and Institutions

Accounting and Finance

Measuring Corporate Performance

The Time Value of Money

Valuing Bonds

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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

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Cash and Inventory Management

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Mergers, Acquisitions, and Corporate Control

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