Question 1

Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?

Accepted Answer

A)  the tax shield has been calculated incorrectly. 
B)  the firm is too heavily levered financially. 
C)  the firm has reached its optimal debt level. 
D)  the firm appears to have low risk of financial distress. 
A)  the tax shield has been calculated incorrectly. 
B)  the firm is too heavily levered financially. 
C)  the firm has reached its optimal debt level. 
D)  the firm appears to have low risk of financial distress.

Question 2

Which of the following statements is false regarding MM's proposition I:

Accepted Answer

A)  firm value is unaffected by its capital structure. 
B)  it is also called the debt irrelevance proposition. 
C)  shareholders should care about the firm's debt policy. 
D)  after restructuring, the firm's value should be the same as it was prior to restructuring. 
A)  firm value is unaffected by its capital structure. 
B)  it is also called the debt irrelevance proposition. 
C)  shareholders should care about the firm's debt policy. 
D)  after restructuring, the firm's value should be the same as it was prior to restructuring.

Question 3

In an MM world,restructuring the firm will not change its overall value.

Accepted Answer

A) True 
 B)False

Question 4

An increase in a firm's financial leverage will:

Accepted Answer

A)  increase the variability in earnings per share. 
B)  reduce the operating risk of the firm. 
C)  increase the value of the firm in a non-MM world. 
D)  increase the WACC. 
A)  increase the variability in earnings per share. 
B)  reduce the operating risk of the firm. 
C)  increase the value of the firm in a non-MM world. 
D)  increase the WACC.

Question 5

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 6

What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?(Use values in dollar.)

Accepted Answer

A)  $245,000 
B)  $700,000 
C)  $3,500,000 
D)  $10,000,000 
A)  $245,000 
B)  $700,000 
C)  $3,500,000 
D)  $10,000,000

Question 7

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt,which totals 30% of assets?

Accepted Answer

A)  16.14% 
B)  17.00% 
C)  19.00% 
D)  25.67% 
A)  16.14% 
B)  17.00% 
C)  19.00% 
D)  25.67%

Question 8

A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%.What debt-equity ratio should be used in order to keep the WACC at 12%?

Accepted Answer

A)  .50 
B)  .75 
C)  1.00 
D)  1.50 
A)  .50 
B)  .75 
C)  1.00 
D)  1.50

Question 9

Even after relaxing the MM assumption of no taxes,it can be observed that restructuring does not affect the value of the firm.

Accepted Answer

A) True 
 B)False

Question 10

Is there a rule for finding optimal capital structure?

Accepted Answer

There are no simple answers for capital

Question 11

Calculate the WACC for a firm with a debt-equity ratio of .6.The debt pays 12% interest and the equity is expected to return 14%.Assume a 40% tax rate and risk-free debt.

Accepted Answer

A)  11.45% 
B)  12.50% 
C)  13.55% 
D)  14.60% 
A)  11.45% 
B)  12.50% 
C)  13.55% 
D)  14.60%

Question 12

A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS is reduced by half,to $1? Ignore taxes.

Accepted Answer

A)  operating income drops to $3.5 million. 
B)  operating income drops to $3.0 million. 
C)  operating income drops to $2.5 million. 
D)  operating income drops to $2.0 million. 
A)  operating income drops to $3.5 million. 
B)  operating income drops to $3.0 million. 
C)  operating income drops to $2.5 million. 
D)  operating income drops to $2.0 million.

Question 13

If a firm's expected return on equity equals its expected return on assets,then the:

Accepted Answer

A)  expected return on debt exceeds the expected return on assets. 
B)  likelihood of financial distress is high. 
C)  firm has too much debt. 
D)  firm has no debt in its capital structure. 
A)  expected return on debt exceeds the expected return on assets. 
B)  likelihood of financial distress is high. 
C)  firm has too much debt. 
D)  firm has no debt in its capital structure.

Question 14

What is the amount of the annual interest tax shield for a firm with $5 million in debt that pays 10% interest if the firm is in the 40% tax bracket?(Use value in the dollar.)

Accepted Answer

A)  $100,000 
B)  $200,000 
C)  $300,000 
D)  $400,000 
A)  $100,000 
B)  $200,000 
C)  $300,000 
D)  $400,000

Question 15

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

Accepted Answer

Under MM Proposition II,the expected ret

Question 16

MM's Proposition II states that the expected return on equity increases as the firm's debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 17

One advantage of debt financing over equity financing is:

Accepted Answer

A)  tax deductible dividends. 
B)  tax deductible interest. 
C)  tax deductible principal repayment. 
D)  tax free interest income. 
A)  tax deductible dividends. 
B)  tax deductible interest. 
C)  tax deductible principal repayment. 
D)  tax free interest income.

Question 18

Financial risk refers to the:

Accepted Answer

A)  risk of owning equity securities. 
B)  risk faced by equity holders when debt is used. 
C)  general business risk of the firm. 
D)  possibility that interest rates will increase. 
A)  risk of owning equity securities. 
B)  risk faced by equity holders when debt is used. 
C)  general business risk of the firm. 
D)  possibility that interest rates will increase.

Question 19

Explain the pecking-order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

Accepted Answer

Managers who are choosing between debt a

Question 20

The present value of the costs of financial distress increases with increases in the debt ratio because the:

Accepted Answer

A)  expected return on assets increases. 
B)  present value of the interest tax shield is greater. 
C)  equity tax shield is depleted. 
D)  probability of default and/or bankruptcy is greater. 
A)  expected return on assets increases. 
B)  present value of the interest tax shield is greater. 
C)  equity tax shield is depleted. 
D)  probability of default and/or bankruptcy is greater.

Exam 16: Debt and Payout Policy

Which of the following is a safe assumption for a firm in which the PV of the tax shield is approximately equal to the costs of financial distress?

Which of the following statements is false regarding MM's proposition I:

In an MM world,restructuring the firm will not change its overall value.

An increase in a firm's financial leverage will:

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

What is the present value of the tax shields for a firm that anticipates a perpetual debt level of $10 million at an interest rate of 7% and a tax rate of 35%?(Use values in dollar.)

What is the expected return on equity for a firm with a 14% expected return on assets that pays 9% on its debt,which totals 30% of assets?

A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%.What debt-equity ratio should be used in order to keep the WACC at 12%?

Even after relaxing the MM assumption of no taxes,it can be observed that restructuring does not affect the value of the firm.

Is there a rule for finding optimal capital structure?

Calculate the WACC for a firm with a debt-equity ratio of .6.The debt pays 12% interest and the equity is expected to return 14%.Assume a 40% tax rate and risk-free debt.

A firm is currently expected to develop $2 EPS when operating income equals $4 million and interest expense equals $2 million.How low can operating income drop before EPS is reduced by half,to $1? Ignore taxes.

If a firm's expected return on equity equals its expected return on assets,then the:

What is the amount of the annual interest tax shield for a firm with $5 million in debt that pays 10% interest if the firm is in the 40% tax bracket?(Use value in the dollar.)

Explain MM Proposition II under conditions of corporate taxes and risk-free debt.How does the analysis change when debt can be risky?

MM's Proposition II states that the expected return on equity increases as the firm's debt-equity ratio increases.

One advantage of debt financing over equity financing is:

Financial risk refers to the:

Explain the pecking-order theory of capital structure.How will this affect the "optimal" capital structure for a firm?

The present value of the costs of financial distress increases with increases in the debt ratio because 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