Question 1

Restructuring a firm involves changing the:

Accepted Answer

A) mix of debts and equity. 
B) dividend payout ratio. 
C) managerial personnel. 
D) interest rate on debt. 
A) mix of debts and equity. 
B) dividend payout ratio. 
C) managerial personnel. 
D) interest rate on debt.

Question 2

When financial disaster is looming, management may borrow to invest in projects having a negative expected NPV because:

Accepted Answer

A) the firm's beta is now negative. 
B) taxes are no longer a concern. 
C) the interest tax shield will cover the loan costs. 
D) the lender bears all the risk. 
A) the firm's beta is now negative. 
B) taxes are no longer a concern. 
C) the interest tax shield will cover the loan costs. 
D) the lender bears all the risk.

Question 3

An implicit cost of adding debt to the capital structure is that it:

Accepted Answer

A) adds interest expense to the operating statement. 
B) increases the required return on equity. 
C) reduces the expected return on assets. 
D) decreases the firm's beta. 
A) adds interest expense to the operating statement. 
B) increases the required return on equity. 
C) reduces the expected return on assets. 
D) decreases the firm's beta.

Question 4

As a firm's debt/equity ratio approaches zero, the firm's expected return on equity approaches:

Accepted Answer

A) the expected return on debt. 
B) the expected return on assets. 
C) its maximum. 
D) zero. 
A) the expected return on debt. 
B) the expected return on assets. 
C) its maximum. 
D) zero.

Question 5

If the value of a levered firm is $4,000,000, then the value of the same firm yet all-equity financed is:

Accepted Answer

A) Less than $4,000,000 
B) Less than $4,500,000 
C) Less than $5,500,000 
D) Less than $6,000,000 
A) Less than $4,000,000 
B) Less than $4,500,000 
C) Less than $5,500,000 
D) Less than $6,000,000

Question 6

With the inclusion of taxes, MM I is incorrect and the capital structure of the firm can be important due to:

Accepted Answer

A) lower tax rates on dividends than on debt. 
B) higher tax rates on retained earnings than on debt. 
C) lower tax liability due to interest deductibility. 
D) higher operating income from less dividends. 
A) lower tax rates on dividends than on debt. 
B) higher tax rates on retained earnings than on debt. 
C) lower tax liability due to interest deductibility. 
D) higher operating income from less dividends.

Question 7

With risky debt and MM II, the expected return on assets _____ as the debt-equity ratio _____.

Accepted Answer

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

Question 8

Debt financing affects neither the operating risk nor the business risk of the firm.

Accepted Answer

A) True 
 B)False

Question 9

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

Accepted Answer

A) 6.50% 
B) 9.90% 
C) 10.67% 
D) 11.14% 
A) 6.50% 
B) 9.90% 
C) 10.67% 
D) 11.14%

Question 10

According to MM II, as a firm's debt-to-equity ratio decreases:

Accepted Answer

A) its financial risk increases. 
B) its operating risk increases. 
C) the required rate of return on equity increases. 
D) the required rate of return on equity decreases. 
A) its financial risk increases. 
B) its operating risk increases. 
C) the required rate of return on equity increases. 
D) the required rate of return on equity decreases.

Question 11

Leverage will __________ shareholders' expected return and _________ their risk.

Accepted Answer

A) increase; decrease 
B) decrease; increase 
C) increase; increase 
D) increase; do nothing to 
A) increase; decrease 
B) decrease; increase 
C) increase; increase 
D) increase; do nothing to

Question 12

The WACC is used to value:

Accepted Answer

A) projects with any risk. 
B) projects with the same risk as the firm's current business. 
C) projects with the same risk as the firm's debt. 
D) projects with the same risk as the firm's equity. 
A) projects with any risk. 
B) projects with the same risk as the firm's current business. 
C) projects with the same risk as the firm's debt. 
D) projects with the same risk as the firm's equity.

Question 13

With a tax rate of 35%, calculate the WACC for a firm that pays 10% on its debt, requires an 18% rate of return on its equity, and finances 45% of assets with debt.

Accepted Answer

A) 12.83% 
B) 14.00% 
C) 14.40% 
D) 18.20% 
A) 12.83% 
B) 14.00% 
C) 14.40% 
D) 18.20%

Question 14

A firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes, this will generate $12.50 earnings per share.What will happen to EPS if operating income increases to $2.0 million?(use the values in dollar)

Accepted Answer

A) EPS will increase to $15.63. 
B) EPS will increase to $16.67. 
C) EPS will increase to $17.50. 
D) EPS will increase to $20.00. 
A) EPS will increase to $15.63. 
B) EPS will increase to $16.67. 
C) EPS will increase to $17.50. 
D) EPS will increase to $20.00.

Question 15

According to MM, an increase in expected earnings per share can leave the share price unchanged if the:

Accepted Answer

A) firm's operating risk decreases. 
B) number of shares is decreased. 
C) required return on equity increases. 
D) firm has no financial leverage. 
A) firm's operating risk decreases. 
B) number of shares is decreased. 
C) required return on equity increases. 
D) firm has no financial leverage.

Question 16

A firm issues 100,000 equity shares with a total market value of $5,000,000.The firm's market value of debt is also of equal amount, i.e., $5,000,000.The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes, this will generate $12.50 earnings per share.What will happen to EPS if the firm's borrowing and interest expense increases by 75% and the number of shares in circulation is cut by 75% (assuming that the share price remains unchanged with this change in capital structure)?

Accepted Answer

A) EPS decrease to $10.00 
B) EPS decrease to $11.67 
C) EPS increase to $15.00 
D) EPS increase to $42.50 
A) EPS decrease to $10.00 
B) EPS decrease to $11.67 
C) EPS increase to $15.00 
D) EPS increase to $42.50

Question 17

Under the assumptions necessary for MM I, if investors can borrow or lend at the same terms as the firm, they will:

Accepted Answer

A) invest in debt only and ignore equity investments. 
B) not be willing to pay more for a restructured firm. 
C) require a higher rate of return on equity. 
D) accept a lower rate of return on equity. 
A) invest in debt only and ignore equity investments. 
B) not be willing to pay more for a restructured firm. 
C) require a higher rate of return on equity. 
D) accept a lower rate of return on equity.

Question 18

Equity Inc.is currently an all-equity financed firm.It has 10,000 shares outstanding that sell for $20 each.The firm has an operating income of $30,000 and pays no taxes.The firm contemplates a restructuring that would issue $50,000 in 8% debt, which will be used to repurchase stock.Assuming that individuals have the same borrowing opportunities as corporations, explain how an investor can undo the leverage that is proposed by Equity Inc.Under these conditions, what is the value of restructuring to a firm?

Accepted Answer

Since Equity Inc.will have a debt ratio

Question 19

What is the proportion of debt financing for a firm that expects a 35% return on equity, a 20% return on assets, and a 15% return on debt? Ignore taxes.

Accepted Answer

A) 15% 
B) 25% 
C) 75% 
D) 80% 
A) 15% 
B) 25% 
C) 75% 
D) 80%

Question 20

The interest tax shield is equal to the:

Accepted Answer

A) difference between interest expense and income taxes. 
B) amount of interest paid in a given year. 
C) product of the interest expense and the tax rate. 
D) product of the debt principal and the interest rate on debt. 
A) difference between interest expense and income taxes. 
B) amount of interest paid in a given year. 
C) product of the interest expense and the tax rate. 
D) product of the debt principal and the interest rate on debt.

Exam 16: Debt Policy

Restructuring a firm involves changing the:

When financial disaster is looming, management may borrow to invest in projects having a negative expected NPV because:

An implicit cost of adding debt to the capital structure is that it:

As a firm's debt/equity ratio approaches zero, the firm's expected return on equity approaches:

If the value of a levered firm is $4,000,000, then the value of the same firm yet all-equity financed is:

With the inclusion of taxes, MM I is incorrect and the capital structure of the firm can be important due to:

With risky debt and MM II, the expected return on assets _____ as the debt-equity ratio _____.

Debt financing affects neither the operating risk nor the business risk of the firm.

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

According to MM II, as a firm's debt-to-equity ratio decreases:

Leverage will __________ shareholders' expected return and _________ their risk.

The WACC is used to value:

With a tax rate of 35%, calculate the WACC for a firm that pays 10% on its debt, requires an 18% rate of return on its equity, and finances 45% of assets with debt.

A firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes, this will generate $12.50 earnings per share.What will happen to EPS if operating income increases to $2.0 million?(use the values in dollar)

According to MM, an increase in expected earnings per share can leave the share price unchanged if the:

Under the assumptions necessary for MM I, if investors can borrow or lend at the same terms as the firm, they will:

What is the proportion of debt financing for a firm that expects a 35% return on equity, a 20% return on assets, and a 15% return on debt? Ignore taxes.

The interest tax shield is equal to the:

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

With risky debt and MM II, the expected return on assets _ as the debt-equity ratio _.

Leverage will __ shareholders' expected return and _ their risk.