Question 1

According to the signaling theory, why will a firm with unfavorable prospects want to sell stock?

Accepted Answer

A)  To share the losses with new investors 
B)  To increase bankruptcy cost with more debt 
C)  To skip the dividends payable on common stock 
D)  To maintain a reserve borrowing capacity 
E)  To have tax benefit/bankruptcy cost trade-off 
A)  To share the losses with new investors 
B)  To increase bankruptcy cost with more debt 
C)  To skip the dividends payable on common stock 
D)  To maintain a reserve borrowing capacity 
E)  To have tax benefit/bankruptcy cost trade-off

Question 2

Which of the following is true of the times-interest earned (TIE) ratio of a firm?

Accepted Answer

A)  The lower the TIE ratio, the higher the probability that the firm will default on its debt. 
B)  The TIE ratio is calculated by dividing net income by interest charges. 
C)  The TIE ratio increases if the debt/assets ratio increases and vice versa. 
D)  The TIE ratio is always more than 1. 
E)  The TIE ratio shows the effects of both operating leverage and financial leverage. 
A)  The lower the TIE ratio, the higher the probability that the firm will default on its debt. 
B)  The TIE ratio is calculated by dividing net income by interest charges. 
C)  The TIE ratio increases if the debt/assets ratio increases and vice versa. 
D)  The TIE ratio is always more than 1. 
E)  The TIE ratio shows the effects of both operating leverage and financial leverage.

Question 3

Which of the following statements is true ofthe optimal capital structure?

Accepted Answer

A)  It is found by determining the debt-equity mix that maximizes expected EPS. 
B)  It simultaneously maximizes EPS and minimizes the WACC. 
C)  It minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
D)  It simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
E)  It should have the combination of debt and equity thatwill maximize the price of the firm's stock. 
A)  It is found by determining the debt-equity mix that maximizes expected EPS. 
B)  It simultaneously maximizes EPS and minimizes the WACC. 
C)  It minimizes the cost of equity, which is a necessary condition for maximizing the stock price. 
D)  It simultaneously minimizes the cost of debt, the cost of equity, and the WACC. 
E)  It should have the combination of debt and equity thatwill maximize the price of the firm's stock.

Question 4

The lower the times-interest-earned ratio, the lower the probability that a firm will default on its debt.

Accepted Answer

A) True 
 B)False

Question 5

According to Modigliani and Miller (MM)'s basic theory of capital structure, which of the following is considered when determining the value of a firm?

Accepted Answer

A)  Tax deductible interests 
B)  Personal income taxes 
C)  Brokerage costs 
D)  Bankruptcy costs 
E)  Retained earnings 
A)  Tax deductible interests 
B)  Personal income taxes 
C)  Brokerage costs 
D)  Bankruptcy costs 
E)  Retained earnings

Question 6

The combination of debt and equity that maximizes a firm's value is known as the:

Accepted Answer

A)  degree of financial leverage (DFL). 
B)  maximum weighted average cost of capital (WAC
C) . 
C)  maximum business risk. 
D)  optimal capital structure. 
E)  indifference point. 
A)  degree of financial leverage (DFL). 
B)  maximum weighted average cost of capital (WAC
C) . 
C)  maximum business risk. 
D)  optimal capital structure. 
E)  indifference point.

Question 7

Copybold Corporation is a start-up that has a capital structure that calls for a debt/assets ratio of 0.75. There are two possible scenarios with respect to the firm's operations: Feast andFamine. The Feast scenario has a 60 percent probability of occurring, and the forecast earnings before interest and taxes (EBIT) in this scenariois $60,000. The Famine scenariohas a 40 percent chance of occurring, and the EBIT is expected to be $20,000. Further, the cost of debt for this capital structure will be 12 percent. The firm will have $400,000 in total assets, and it will face a marginal tax rate of 40 percent. The company has 10,000 outstanding shares. What is the difference between the earnings per share (EPS) forecasts for Feast and Famine?

Accepted Answer

A)  $0 
B)  $2.40 
C)  $1.48 
D)  $0.62 
E)  $0.98 
A)  $0 
B)  $2.40 
C)  $1.48 
D)  $0.62 
E)  $0.98

Question 8

The combination of debt and equity used to finance a firm is known as _____.

Accepted Answer

A)  capital budgeting 
B)  the trade-off theory 
C)  syndication 
D)  securitization 
E)  the capital structure 
A)  capital budgeting 
B)  the trade-off theory 
C)  syndication 
D)  securitization 
E)  the capital structure

Question 9

If the debt/assets ratio increases, the costs of both debt and equity decrease.

Accepted Answer

A) True 
 B)False

Question 10

The presence of fixed operating costs that do not change when the level of sales changes is known as _____.

Accepted Answer

A)  financial leverage 
B)  operating leverage 
C)  beta risk 
D)  market risk 
E)  firm-specific risk 
A)  financial leverage 
B)  operating leverage 
C)  beta risk 
D)  market risk 
E)  firm-specific risk

Question 11

When will a firm's degree of operating leverage be at its highest level?

Accepted Answer

A)  When sales is equal to zero 
B)  When earnings per share is equal to one 
C)  When fixed costs are equal to variable costs 
D)  When variable costs are more than sales 
E)  When EBIT is equal to zero 
A)  When sales is equal to zero 
B)  When earnings per share is equal to one 
C)  When fixed costs are equal to variable costs 
D)  When variable costs are more than sales 
E)  When EBIT is equal to zero

Question 12

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

Accepted Answer

A) True 
 B)False

Question 13

Which of the following statements is true of capital structures around the world?

Accepted Answer

A)  There have been no significant observed differences between the capital structures of U.S. corporations and their German and Japanese counterparts. 
B)  Different countries use essentially the same international accounting conventions with respect to reporting assets on a historical versus replacement cost basis. 
C)  An analysis of both bankruptcy and equity reporting costs leads to the conclusion that U.S. firms have more equity and less debt than firms in Japan and Germany. 
D)  Equity monitoring costs are higher in the United States than in Japan and Germany. 
E)  Debt monitoring costs are lower in the United States than in Japan and Germany. 
A)  There have been no significant observed differences between the capital structures of U.S. corporations and their German and Japanese counterparts. 
B)  Different countries use essentially the same international accounting conventions with respect to reporting assets on a historical versus replacement cost basis. 
C)  An analysis of both bankruptcy and equity reporting costs leads to the conclusion that U.S. firms have more equity and less debt than firms in Japan and Germany. 
D)  Equity monitoring costs are higher in the United States than in Japan and Germany. 
E)  Debt monitoring costs are lower in the United States than in Japan and Germany.

Question 14

Operating leverage refers tothe presence of _____ that do not change when the level of sales changes.

Accepted Answer

A)  fixed-income securities 
B)  beta risks 
C)  firm-specific risks 
D)  variable costs 
E)  fixed costs 
A)  fixed-income securities 
B)  beta risks 
C)  firm-specific risks 
D)  variable costs 
E)  fixed costs

Question 15

One implication of the signaling theory of capital structure is that firms should borrow as much as the trade-off theory of capital structure predicts.

Accepted Answer

A) True 
 B)False

Question 16

For every 1 percent decrease in sales of a firm, the EBIT decreases by 3.2 percent. What does this statement indicate?

Accepted Answer

A)  The debt/assets ratio of the firm is 3.2 times. 
B)  The degree of operating leverage of the firm is 3.2 times. 
C)  The current assets of the firm are 3.2 times its current liabilities. 
D)  The expenses of the firm are 3.2 percent of its income. 
E)  The degree of financial leverage of the firm is 3.2 times. 
A)  The debt/assets ratio of the firm is 3.2 times. 
B)  The degree of operating leverage of the firm is 3.2 times. 
C)  The current assets of the firm are 3.2 times its current liabilities. 
D)  The expenses of the firm are 3.2 percent of its income. 
E)  The degree of financial leverage of the firm is 3.2 times.

Question 17

In the United States, equity monitoring costs are comparatively lower than other countries.

Accepted Answer

A) True 
 B)False

Question 18

Which of the following is an indication of a firm's risk with its capital structure?

Accepted Answer

A)  Indifference point 
B)  Coefficient of variation 
C)  Earnings per share 
D)  Net operating income 
E)  Weighted average cost of capital 
A)  Indifference point 
B)  Coefficient of variation 
C)  Earnings per share 
D)  Net operating income 
E)  Weighted average cost of capital

Question 19

The risk associated with afirm's operations, ignoring any financing effects, is known as _____.

Accepted Answer

A)  market risk 
B)  business risk 
C)  firm-specific risk 
D)  financial risk 
E)  beta risk 
A)  market risk 
B)  business risk 
C)  firm-specific risk 
D)  financial risk 
E)  beta risk

Question 20

According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?

Accepted Answer

A)  When it is financed entirely through equity 
B)  When it is financed 50 percent through debt and 50 percent through equity 
C)  When it is financed entirely through its retained earnings 
D)  When it is financed 100% through debt 
E)  When it is financed 50 percent through equity and 50 percent through its profits 
A)  When it is financed entirely through equity 
B)  When it is financed 50 percent through debt and 50 percent through equity 
C)  When it is financed entirely through its retained earnings 
D)  When it is financed 100% through debt 
E)  When it is financed 50 percent through equity and 50 percent through its profits

According to the signaling theory, why will a firm with unfavorable prospects want to sell stock?

Which of the following is true of the times-interest earned (TIE) ratio of a firm?

Which of the following statements is true ofthe optimal capital structure?

The lower the times-interest-earned ratio, the lower the probability that a firm will default on its debt.

According to Modigliani and Miller (MM)'s basic theory of capital structure, which of the following is considered when determining the value of a firm?

The combination of debt and equity that maximizes a firm's value is known as the:

The combination of debt and equity used to finance a firm is known as _____.

If the debt/assets ratio increases, the costs of both debt and equity decrease.

The presence of fixed operating costs that do not change when the level of sales changes is known as _____.

When will a firm's degree of operating leverage be at its highest level?

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

Which of the following statements is true of capital structures around the world?

Operating leverage refers tothe presence of _____ that do not change when the level of sales changes.

One implication of the signaling theory of capital structure is that firms should borrow as much as the trade-off theory of capital structure predicts.

For every 1 percent decrease in sales of a firm, the EBIT decreases by 3.2 percent. What does this statement indicate?

In the United States, equity monitoring costs are comparatively lower than other countries.

Which of the following is an indication of a firm's risk with its capital structure?

The risk associated with afirm's operations, ignoring any financing effects, is known as _____.

According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, Institutions, and Investment Banking

Time Value of Money

The Cost of Money Interest Rates

Bonds Debtcharacteristics and Valuation

Stocks Equity Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk

The Cost of Capital

Distribution of Retained Earnings: Dividends and Stock Repurchases

Managing Short-Term Financing Liabilities

Managing Short-Term Assets

Financial Planning and Control

Filters

Exam 12: Capital Structure

According to the signaling theory, why will a firm with unfavorable prospects want to sell stock?

Which of the following is true of the times-interest earned (TIE) ratio of a firm?

Which of the following statements is true ofthe optimal capital structure?

The lower the times-interest-earned ratio, the lower the probability that a firm will default on its debt.

According to Modigliani and Miller (MM)'s basic theory of capital structure, which of the following is considered when determining the value of a firm?

The combination of debt and equity that maximizes a firm's value is known as the:

The combination of debt and equity used to finance a firm is known as _____.

If the debt/assets ratio increases, the costs of both debt and equity decrease.

The presence of fixed operating costs that do not change when the level of sales changes is known as _____.

When will a firm's degree of operating leverage be at its highest level?

The optimal capital structure is the capital structure that strikes a balance between risk and return such that the firm's stock price is maximized.

Which of the following statements is true of capital structures around the world?

Operating leverage refers tothe presence of _____ that do not change when the level of sales changes.

One implication of the signaling theory of capital structure is that firms should borrow as much as the trade-off theory of capital structure predicts.

For every 1 percent decrease in sales of a firm, the EBIT decreases by 3.2 percent. What does this statement indicate?

In the United States, equity monitoring costs are comparatively lower than other countries.

Which of the following is an indication of a firm's risk with its capital structure?

The risk associated with afirm's operations, ignoring any financing effects, is known as _____.

According to the basic capital structure theory proposed by Modigliani and Miller (MM), when will a firm's value be maximum?

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, Institutions, and Investment Banking

Time Value of Money

The Cost of Money Interest Rates

Bonds Debtcharacteristics and Valuation

Stocks Equity Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk

The Cost of Capital

Distribution of Retained Earnings: Dividends and Stock Repurchases

Managing Short-Term Financing Liabilities

Managing Short-Term Assets

Financial Planning and Control

Filters