Question 1

According to the trade-off theory,the capital structure is a trade-off between:

Accepted Answer

A)  tangible and intangible asset risk. 
B)  high and low target debt ratios. 
C)  tax savings and financial distress costs. 
D)  tax shields and equity financing. 
A)  tangible and intangible asset risk. 
B)  high and low target debt ratios. 
C)  tax savings and financial distress costs. 
D)  tax shields and equity financing. C

Question 2

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

Accepted Answer

A) True 
 B)False  True

Question 3

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. B

Question 4

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 5

According to MM,if individuals cannot obtain the same borrowing terms as firms,then:

Accepted Answer

A)  capital structure may be relevant. 
B)  capital structure may be irrelevant. 
C)  individuals should not invest in levered firms. 
D)  firms should increase their payments to individuals. 
A)  capital structure may be relevant. 
B)  capital structure may be irrelevant. 
C)  individuals should not invest in levered firms. 
D)  firms should increase their payments to individuals.

Question 6

The benefit of an interest tax shield is captured by the equity holders.

Accepted Answer

A) True 
 B)False

Question 7

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 8

What is meant by investors being able "to undo" the effects of corporate restructuring?

Accepted Answer

A)  Investors repay their portion of the firm's debt. 
B)  Investors only purchase securities in unlevered firms. 
C)  Investors will pay more for unlevered shares. 
D)  Investors borrow in their name and replicate the effects of restructuring. 
A)  Investors repay their portion of the firm's debt. 
B)  Investors only purchase securities in unlevered firms. 
C)  Investors will pay more for unlevered shares. 
D)  Investors borrow in their name and replicate the effects of restructuring.

Question 9

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 10

The possibility of bankruptcy will do all of the following except:

Accepted Answer

A)  increase financial distress costs. 
B)  reduce the current market value of the firm. 
C)  reduce the interest rate on debt. 
D)  reduce the possible payoff to stockholders. 
A)  increase financial distress costs. 
B)  reduce the current market value of the firm. 
C)  reduce the interest rate on debt. 
D)  reduce the possible payoff to stockholders.

Question 11

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 12

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 13

Determine the expected return on equity for a firm with a WACC of 12%,$500,000 in 9% debt,$800,000 in equity.Both debt and equity are shown at market values,and the firm pays no taxes.How can the expected return on equity be reduced?

Accepted Answer

Recall with no taxes that the expected r

Question 14

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 15

When taxes are considered,the value of a levered firm equals the value of the:

Accepted Answer

A)  unlevered firm. 
B)  unlevered firm plus the value of the debt. 
C)  unlevered firm plus the present value of the tax shield. 
D)  unlevered firm plus the value of the debt plus the value of the tax shield. 
A)  unlevered firm. 
B)  unlevered firm plus the value of the debt. 
C)  unlevered firm plus the present value of the tax shield. 
D)  unlevered firm plus the value of the debt plus the value of the tax shield.

Question 16

How do corporate income taxes modify MM's leverage irrelevance proposition?
D. Future interest tax shields are usually valued by discounting at the borrowing rate rdebt. In the special case of permanent debt,
PV tax shield = Tc (rdebt x D)/rdebt = TcD
Of course interest tax shields are valuable only for companies that are making profits and paying taxes.

Accepted Answer

Debt interest is a tax-deductible expens

Question 17

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 18

A firm has a debt/equity ratio of ½.The debt pays a 6% rate of interest.The expected rate of return on equity is 12%.What would happen to the expected rate of return if the firm reduced its debt/equity ratio to 1/3?

Accepted Answer

A)  rate of return would increase to 11.33% 
B)  rate of return would increase to 12.50% 
C)  rate of return would decrease to 10.60% 
D)  rate of return would decrease to 8.33% 
A)  rate of return would increase to 11.33% 
B)  rate of return would increase to 12.50% 
C)  rate of return would decrease to 10.60% 
D)  rate of return would decrease to 8.33%

Question 19

Based upon the "trade-off theory" of capital structure,what differences might you expect in the capital structure of a food producer and a defence contractor?

Accepted Answer

A)  higher debt-equity ratio for food producer. 
B)  higher debt-equity ratio for defence contractor. 
C)  neither firm should use debt in their structure. 
D)  differences in capital structure will make no valuation differences in these firms. 
A)  higher debt-equity ratio for food producer. 
B)  higher debt-equity ratio for defence contractor. 
C)  neither firm should use debt in their structure. 
D)  differences in capital structure will make no valuation differences in these firms.

Question 20

MM's proposition II states that the:

Accepted Answer

A)  expected return on equity increases as financial leverage increases. 
B)  expected return on assets decreases as expected return on debt decreases. 
C)  firm's capital structure is irrelevant to value determination. 
D)  greater the proportion of equity, the higher the expected return on debt. 
A)  expected return on equity increases as financial leverage increases. 
B)  expected return on assets decreases as expected return on debt decreases. 
C)  firm's capital structure is irrelevant to value determination. 
D)  greater the proportion of equity, the higher the expected return on debt.

Exam 16: Debt and Payout Policy

According to the trade-off theory,the capital structure is a trade-off between:

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

The WACC is used to value:

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

According to MM,if individuals cannot obtain the same borrowing terms as firms,then:

The benefit of an interest tax shield is captured by the equity holders.

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

What is meant by investors being able "to undo" the effects of corporate restructuring?

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

The possibility of bankruptcy will do all of the following except:

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

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

Determine the expected return on equity for a firm with a WACC of 12%,$500,000 in 9% debt,$800,000 in equity.Both debt and equity are shown at market values,and the firm pays no taxes.How can the expected return on equity be reduced?

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

When taxes are considered,the value of a levered firm equals the value of the:

Restructuring a firm involves changing the:

A firm has a debt/equity ratio of ½.The debt pays a 6% rate of interest.The expected rate of return on equity is 12%.What would happen to the expected rate of return if the firm reduced its debt/equity ratio to 1/3?

Based upon the "trade-off theory" of capital structure,what differences might you expect in the capital structure of a food producer and a defence contractor?

MM's proposition II states that the:

Goals and Governance of the Firm

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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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Long-Term Financial Planning

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