Question 1

A firm's ________ ratio is the fraction of the firm's total value that corresponds to debt.

Accepted Answer

A)  debt-to-equity 
B)  asset 
C)  debt-to-value 
D)  liability 
E)  obligations 
A)  debt-to-equity 
B)  asset 
C)  debt-to-value 
D)  liability 
E)  obligations C

Question 2

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

Accepted Answer

A)  earnings after taxes 
B)  earnings after interest 
C)  cash flows after taxes 
D)  free cash flows 
E)  earnings after interest and taxes 
A)  earnings after taxes 
B)  earnings after interest 
C)  cash flows after taxes 
D)  free cash flows 
E)  earnings after interest and taxes D

Question 3

A firm has a market value of assets of $50,000.It borrows $10,000 at 5%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?

Accepted Answer

A)  15% 
B)  17.5% 
C)  18.5% 
D)  19.2% 
E)  20.6% 
A)  15% 
B)  17.5% 
C)  18.5% 
D)  19.2% 
E)  20.6% B

Question 4

A firm is currently financed with 40% equity and 60% debt.The firm generates perpetual earnings before interest and taxes of $2 million per year.The firm's cost of equity is 12%,its cost of debt is 5%,and it has a tax rate of 40%.What is the value of the levered firm?

Accepted Answer

A)  $2 million 
B)  $30.3 million 
C)  $25.6 million 
D)  $18.2 million 
E)  $17.6 million 
A)  $2 million 
B)  $30.3 million 
C)  $25.6 million 
D)  $18.2 million 
E)  $17.6 million

Question 5

Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders.

Accepted Answer

A)  debt holders 
B)  suppliers 
C)  managers 
D)  creditors 
E)  shareholders 
A)  debt holders 
B)  suppliers 
C)  managers 
D)  creditors 
E)  shareholders

Question 6

How do capital structure choices differ across industries?

Accepted Answer

The average debt-to-value rati

Question 7

The presence of a large amount of debt can encourage shareholders to take excessive risk because

Accepted Answer

A)  equity holders are risk seeking by nature. 
B)  the costs of failure are borne largely by debt holders. 
C)  debt holders are risk seeking. 
D)  firm value increases with risk taking. 
E)  this will increase profits. 
A)  equity holders are risk seeking by nature. 
B)  the costs of failure are borne largely by debt holders. 
C)  debt holders are risk seeking. 
D)  firm value increases with risk taking. 
E)  this will increase profits.

Question 8

Aside from direct costs of bankruptcy,a firm may also incur other indirect costs such as

Accepted Answer

A)  loss of customers and loss of suppliers. 
B)  loss of interest receipts. 
C)  loss of dividend receipts. 
D)  increase in raw material costs. 
E)  increase in salvage costs. 
A)  loss of customers and loss of suppliers. 
B)  loss of interest receipts. 
C)  loss of dividend receipts. 
D)  increase in raw material costs. 
E)  increase in salvage costs.

Question 9

By adding leverage,the returns of the firm are split between debt holders and equity holders,but equity-holder risk increases because

Accepted Answer

A)  interest payments can be rolled over. 
B)  dividends are paid first. 
C)  debt and equity have equal priority. 
D)  interest payments have first priority. 
E)  interest payments are so high. 
A)  interest payments can be rolled over. 
B)  dividends are paid first. 
C)  debt and equity have equal priority. 
D)  interest payments have first priority. 
E)  interest payments are so high.

Question 10

What is the capital structure of a firm?

Accepted Answer

The relative proport

Question 11

Managers should consider ________ for external financing when agency costs are significant.

Accepted Answer

A)  long-term debt 
B)  retained earnings 
C)  internal equity 
D)  short-term debt 
E)  preferred stock 
A)  long-term debt 
B)  retained earnings 
C)  internal equity 
D)  short-term debt 
E)  preferred stock

Question 12

Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would

Accepted Answer

A)  reduce dividends. 
B)  incur transactions costs. 
C)  increase fixed costs. 
D)  change incentives of stakeholders. 
E)  favour shareholders over debt holders. 
A)  reduce dividends. 
B)  incur transactions costs. 
C)  increase fixed costs. 
D)  change incentives of stakeholders. 
E)  favour shareholders over debt holders.

Question 13

The tradeoff theory suggests

Accepted Answer

A)  the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress. 
B)  with higher costs of financial distress, it is optimal for the firm to choose higher leverage. 
C)  differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries. 
D)  there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield. 
E)  the firm should choose a debt level where the cost of debt is equal to the cost of equity. 
A)  the firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress. 
B)  with higher costs of financial distress, it is optimal for the firm to choose higher leverage. 
C)  differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries. 
D)  there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield. 
E)  the firm should choose a debt level where the cost of debt is equal to the cost of equity.

Question 14

What are indirect costs of financial distress?

Accepted Answer

Indirect costs of financial di

Question 15

What are the issues in determining the present value (PV)of financial distress?

Accepted Answer

Calculating the precise present value (P

Question 16

Agency costs arise when

Accepted Answer

A)  there are high labour costs. 
B)  input costs are higher than interest costs. 
C)  interest costs exceed dividend payments. 
D)  conflicts of interest exist between stakeholders. 
E)  a firm becomes financially distressed. 
A)  there are high labour costs. 
B)  input costs are higher than interest costs. 
C)  interest costs exceed dividend payments. 
D)  conflicts of interest exist between stakeholders. 
E)  a firm becomes financially distressed.

Question 17

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the pre-tax WACC?

Accepted Answer

A)  43% 
B)  25% 
C)  18% 
D)  39% 
E)  7% 
A)  43% 
B)  25% 
C)  18% 
D)  39% 
E)  7%

Question 18

The under-investment problem refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because

Accepted Answer

A)  future investments are contingent on debt financing. 
B)  projects are contingent on equity financing. 
C)  gains are evenly shared between all stakeholders. 
D)  most of the gains from the investment accrue to debt holders. 
E)  these investments will decrease share prices. 
A)  future investments are contingent on debt financing. 
B)  projects are contingent on equity financing. 
C)  gains are evenly shared between all stakeholders. 
D)  most of the gains from the investment accrue to debt holders. 
E)  these investments will decrease share prices.

Question 19

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the return on levered equity?

Accepted Answer

A)  43% 
B)  25% 
C)  18% 
D)  39% 
E)  7% 
A)  43% 
B)  25% 
C)  18% 
D)  39% 
E)  7%

Question 20

A firm requires an investment of $20,000 ,and will be financed with 50% equity and 50% debt.If the firm's debt cost of capital is 6%,and its return on equity is 15%,what is the firm's pre-tax WACC?

Accepted Answer

A)  10.5% 
B)  15% 
C)  6% 
D)  9% 
E)  21% 
A)  10.5% 
B)  15% 
C)  6% 
D)  9% 
E)  21%

Exam 16: Capital Structure

A firm's ________ ratio is the fraction of the firm's total value that corresponds to debt.

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

A firm has a market value of assets of $50,000.It borrows $10,000 at 5%.If the unlevered cost of equity is 15%,what is the firm's cost of equity capital?

A firm is currently financed with 40% equity and 60% debt.The firm generates perpetual earnings before interest and taxes of $2 million per year.The firm's cost of equity is 12%,its cost of debt is 5%,and it has a tax rate of 40%.What is the value of the levered firm?

Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders.

How do capital structure choices differ across industries?

The presence of a large amount of debt can encourage shareholders to take excessive risk because

Aside from direct costs of bankruptcy,a firm may also incur other indirect costs such as

By adding leverage,the returns of the firm are split between debt holders and equity holders,but equity-holder risk increases because

What is the capital structure of a firm?

Managers should consider ________ for external financing when agency costs are significant.

Managers should not change the capital structure unless it departs significantly from the optimal level because such a change would

The tradeoff theory suggests

What are indirect costs of financial distress?

What are the issues in determining the present value (PV)of financial distress?

Agency costs arise when

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the pre-tax WACC?

The under-investment problem refers to the problem that equity holders prefer not to invest in positive-NPV projects in highly levered firms because

A new business requires a $20,000 investment today,and will generate a one-time cash flow of $25,000 after one year.The business will be financed with 50% equity and 50% debt.If the firm can borrow at 7%,what is the return on levered equity?

A firm requires an investment of $20,000 ,and will be financed with 50% equity and 50% debt.If the firm's debt cost of capital is 6%,and its return on equity is 15%,what is the firm's pre-tax WACC?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

The Valuation Principle: the Foundation of Financial Decision Making

The Time Value of Money

Interest Rates

Bonds

Valuing Stocks

Investment Decision Rules

Fundamentals of Capital Budgeting

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

Determining the Cost of Capital

Risk and the Pricing of Options

Raising Equity Capital

Debt Financing

Payout Policy

Financial Modelling and Pro Forma Analysis

Working Capital Management

Short Term Financial Planning

Risk Management

International Corporate Finance

Leasing

Mergers and Acquisitions

Corporate Governance

Filters