Question 1

All of the following methods can be used to estimate the cost of equity except:

Accepted Answer

A) Like debt and preferred stock,cash flows from common equity are fixed. 
B) Firms have two sources of common equity,retained earnings and new stock issues,but only one single cost of common equity. 
C) From the shareholders' perspective,the opportunity cost of retained earnings is the return the shareholders could earn by investing the funds in long-term treasury securities. 
D) If the firm cannot invest its retained earnings to achieve a sufficient risk-adjusted return,shareholders would be better off receiving additional shares of stock. 
E) None of the above statements are correct. 
A) Like debt and preferred stock,cash flows from common equity are fixed. 
B) Firms have two sources of common equity,retained earnings and new stock issues,but only one single cost of common equity. 
C) From the shareholders' perspective,the opportunity cost of retained earnings is the return the shareholders could earn by investing the funds in long-term treasury securities. 
D) If the firm cannot invest its retained earnings to achieve a sufficient risk-adjusted return,shareholders would be better off receiving additional shares of stock. 
E) None of the above statements are correct.

Question 2

The cost of capital for retained earnings:

Accepted Answer

A) cannot be determined 
B) may be determined by more than method 
C) is greater than the cost of capital for common stock 
D) none of the above 
A) cannot be determined 
B) may be determined by more than method 
C) is greater than the cost of capital for common stock 
D) none of the above

Question 3

Using the constant dividend growth model,which of the following components not be considered?

Accepted Answer

A) current stock price 
B) dividend growth rate 
C) risk-free rate 
D) all the above are considered in the constant dividend growth model 
A) current stock price 
B) dividend growth rate 
C) risk-free rate 
D) all the above are considered in the constant dividend growth model

Question 4

The sustainable growth rate measures how quickly a firm can grow when it uses both internal equity and debt financing to keep its capital structure constant over time.

Accepted Answer

A) True 
 B)False

Question 5

Finance theory favors the use of ____________ value weights in the calculation of the weighted average cost of capital.

Accepted Answer

A) book 
B) future 
C) market 
D) none of the above 
A) book 
B) future 
C) market 
D) none of the above

Question 6

If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on equity,how quickly can the firm grow while maintaining a constant debt to equity mix?

Accepted Answer

A) 6.4%. 
B) 10.2%. 
C) 14.3%. 
D) 20.0%. 
E) none of the above. 
A) 6.4%. 
B) 10.2%. 
C) 14.3%. 
D) 20.0%. 
E) none of the above.

Question 7

The degree of combined leverage is the percentage change in earnings per share that results from a one percent change in EBIT.

Accepted Answer

A) True 
 B)False

Question 8

As a general rule,the capital structure that maximizes stock price also:

Accepted Answer

A) minimizes the weighted average cost of capital 
B) maximizes the weighted average cost of capital 
C) minimizes the required rate of return on equity 
D) maximizes the cost of debt 
A) minimizes the weighted average cost of capital 
B) maximizes the weighted average cost of capital 
C) minimizes the required rate of return on equity 
D) maximizes the cost of debt

Question 9

All of the following statements are correct except:

Accepted Answer

A) Relevant cash flows are incremental after-tax cash flows,which must be discounted using an incremental after-tax cost of capital. 
B) The firm's relevant cost of capital is computed from after-tax financing costs. 
C) A project's incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project,that is,the cost of raising one additional dollar of capital. 
D) In estimating the cost of capital,the firm's analysts need to evaluate investors' expected returns under likely market conditions and then use these expected returns to compute the firm's marginal future cost of raising funds. 
E) All of the above statements are correct. 
A) Relevant cash flows are incremental after-tax cash flows,which must be discounted using an incremental after-tax cost of capital. 
B) The firm's relevant cost of capital is computed from after-tax financing costs. 
C) A project's incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project,that is,the cost of raising one additional dollar of capital. 
D) In estimating the cost of capital,the firm's analysts need to evaluate investors' expected returns under likely market conditions and then use these expected returns to compute the firm's marginal future cost of raising funds. 
E) All of the above statements are correct.

Question 10

A firm's business risk is measured by its variability in EBIT over time.

Accepted Answer

A) True 
 B)False

Question 11

All of the following statements are correct except:

Accepted Answer

A) The tax deductibility of debt becomes more important to firms with large nondebt tax shields such as foreign tax credits granted by the U.S.government to firms that pay taxes to foreign governments. 
B) As the debt/total asset ratio falls,or as earnings become less volatile,the firm will face higher borrowing costs,driven upward by bond investors requiring higher yields to compensate for additional risk. 
C) The static tradeoff hypothesis states that firms will balance the advantages of equity (its lower cost and tax-deductibility of dividends)with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs). 
D) Agency costs increase the optimal level of debt financing for a firm above the level that would be appropriate if agency costs were zero. 
E) None of the above statements are correct. 
A) The tax deductibility of debt becomes more important to firms with large nondebt tax shields such as foreign tax credits granted by the U.S.government to firms that pay taxes to foreign governments. 
B) As the debt/total asset ratio falls,or as earnings become less volatile,the firm will face higher borrowing costs,driven upward by bond investors requiring higher yields to compensate for additional risk. 
C) The static tradeoff hypothesis states that firms will balance the advantages of equity (its lower cost and tax-deductibility of dividends)with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs). 
D) Agency costs increase the optimal level of debt financing for a firm above the level that would be appropriate if agency costs were zero. 
E) None of the above statements are correct.

Question 12

Other factors being constant,higher fixed operating costs mean:

Accepted Answer

A) higher financial leverage 
B) higher operating leverage 
C) lower combined leverage 
D) the degree of financial leverage is equal to 1.0 
A) higher financial leverage 
B) higher operating leverage 
C) lower combined leverage 
D) the degree of financial leverage is equal to 1.0

Question 13

A high degree of financial leverage means that a small change in sales will result in:

Accepted Answer

A) a small change in earnings per share 
B) a large change in earnings per share 
C) no change in earnings per share 
D) none of the above 
A) a small change in earnings per share 
B) a large change in earnings per share 
C) no change in earnings per share 
D) none of the above

Question 14

The firm's optimum debt/equity mix minimizes the firm's cost of capital,which in turn will help the firm to maximize shareholder wealth.

Accepted Answer

A) True 
 B)False

Question 15

Of the components shown below,which is least likely to be of value in calculating the cost of preferred stock?

Accepted Answer

A) flotation costs per share 
B) book value of a preferred share 
C) dividends per share 
D) initial market price per share 
A) flotation costs per share 
B) book value of a preferred share 
C) dividends per share 
D) initial market price per share

Question 16

A firm's mix of debt and equity defines the firm's:

Accepted Answer

A) capital structure 
B) working capital 
C) net working capital 
D) degree of operating leverage 
A) capital structure 
B) working capital 
C) net working capital 
D) degree of operating leverage

Question 17

A company experienced a 12 % increase in earnings before interest and taxes and a 3 % increase in sales.What is the degree of operating leverage for this company?

Accepted Answer

A) 36 
B) 6 
C) 4 
D) none of the above 
A) 36 
B) 6 
C) 4 
D) none of the above

Question 18

If a firm has current earnings per share of $2 and a degree of combined leverage of 4,a 10% increase in sales would result in earnings per share of:

Accepted Answer

A) $2.80 
B) $8 
C) $2.20 
D) cannot tell from this information 
A) $2.80 
B) $8 
C) $2.20 
D) cannot tell from this information

Question 19

A decrease in contractual managers' salaries will result in:

Accepted Answer

A) an increase in the degree of financial leverage 
B) a decrease in the degree of financial leverage 
C) no change in the degree of financial leverage 
A) an increase in the degree of financial leverage 
B) a decrease in the degree of financial leverage 
C) no change in the degree of financial leverage

Question 20

All of the following statements are correct except:

Accepted Answer

A) The firm's optimum debt/equity mix minimizes the firm's cost of capital,which in turn helps the firm to maximize shareholder wealth 
B) A firm's mix of debt and equity used to finance its assets defines the firm's capital structure. 
C) A nonoptimal capital structure with either too much or too little debt leads to higher financing costs,and the firm will likely reject some capital budgeting projects that could have increased shareholder wealth with an optimal financing mix. 
D) A project's NPV represents the increase in shareholders' wealth from undertaking a project;thus,a lower weighted average cost of capital gives higher project net present values and results in higher levels of shareholder wealth. 
E) All of the above statements are correct. 
A) The firm's optimum debt/equity mix minimizes the firm's cost of capital,which in turn helps the firm to maximize shareholder wealth 
B) A firm's mix of debt and equity used to finance its assets defines the firm's capital structure. 
C) A nonoptimal capital structure with either too much or too little debt leads to higher financing costs,and the firm will likely reject some capital budgeting projects that could have increased shareholder wealth with an optimal financing mix. 
D) A project's NPV represents the increase in shareholders' wealth from undertaking a project;thus,a lower weighted average cost of capital gives higher project net present values and results in higher levels of shareholder wealth. 
E) All of the above statements are correct.

All of the following methods can be used to estimate the cost of equity except:

The cost of capital for retained earnings:

Using the constant dividend growth model,which of the following components not be considered?

The sustainable growth rate measures how quickly a firm can grow when it uses both internal equity and debt financing to keep its capital structure constant over time.

Finance theory favors the use of ____________ value weights in the calculation of the weighted average cost of capital.

If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on equity,how quickly can the firm grow while maintaining a constant debt to equity mix?

The degree of combined leverage is the percentage change in earnings per share that results from a one percent change in EBIT.

As a general rule,the capital structure that maximizes stock price also:

All of the following statements are correct except:

A firm's business risk is measured by its variability in EBIT over time.

All of the following statements are correct except:

Other factors being constant,higher fixed operating costs mean:

A high degree of financial leverage means that a small change in sales will result in:

The firm's optimum debt/equity mix minimizes the firm's cost of capital,which in turn will help the firm to maximize shareholder wealth.

Of the components shown below,which is least likely to be of value in calculating the cost of preferred stock?

A firm's mix of debt and equity defines the firm's:

A company experienced a 12 % increase in earnings before interest and taxes and a 3 % increase in sales.What is the degree of operating leverage for this company?

If a firm has current earnings per share of $2 and a degree of combined leverage of 4,a 10% increase in sales would result in earnings per share of:

A decrease in contractual managers' salaries will result in:

All of the following statements are correct except:

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Exam 18: Capital Structure and the Cost of Capital

All of the following methods can be used to estimate the cost of equity except:

The cost of capital for retained earnings:

Using the constant dividend growth model,which of the following components not be considered?

The sustainable growth rate measures how quickly a firm can grow when it uses both internal equity and debt financing to keep its capital structure constant over time.

Finance theory favors the use of ____________ value weights in the calculation of the weighted average cost of capital.

If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on equity,how quickly can the firm grow while maintaining a constant debt to equity mix?

The degree of combined leverage is the percentage change in earnings per share that results from a one percent change in EBIT.

As a general rule,the capital structure that maximizes stock price also:

All of the following statements are correct except:

A firm's business risk is measured by its variability in EBIT over time.

All of the following statements are correct except:

Other factors being constant,higher fixed operating costs mean:

A high degree of financial leverage means that a small change in sales will result in:

The firm's optimum debt/equity mix minimizes the firm's cost of capital,which in turn will help the firm to maximize shareholder wealth.

Of the components shown below,which is least likely to be of value in calculating the cost of preferred stock?

A firm's mix of debt and equity defines the firm's:

A company experienced a 12 % increase in earnings before interest and taxes and a 3 % increase in sales.What is the degree of operating leverage for this company?

If a firm has current earnings per share of $2 and a degree of combined leverage of 4,a 10% increase in sales would result in earnings per share of:

A decrease in contractual managers' salaries will result in:

All of the following statements are correct except:

The Financial Environment

Money and the Monetary System

Banks and Other Financial Institutions

Federal Reserve System

Policy Makers and the Money Supply

International Finance and Trade

Savings and Investment Process

Interest Rates

Time Value of Money

Bonds and Stocks: Characteristics and Valuation

Securities Markets

Financial Return and Risk Concepts

Business Organization and Financial Data

Financial Analysis and Long-Term Financial Planning

Managing Working Capital

Short-Term Business Financing

Capital Budgeting Analysis

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