Question 1

Those who benefit from the interest tax shield are:

Accepted Answer

A)  debt holders. 
B)  equity holders. 
C)  both debt holders and equity holders. 
D)  only the firm's customers benefit from the interest tax shield. 
A)  debt holders. 
B)  equity holders. 
C)  both debt holders and equity holders. 
D)  only the firm's customers benefit from the interest tax shield.

Question 2

What is the proportion of debt financing for a firm that expects a 35% return on equity,a 20% return on assets,and a 15% return on debt? Ignore taxes.

Accepted Answer

A)  15% 
B)  25% 
C)  75% 
D)  80% 
A)  15% 
B)  25% 
C)  75% 
D)  80%

Question 3

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

Accepted Answer

A)  depends on the firm's capital structure 
B)  decreases 
C)  remains constant 
D)  increases 
A)  depends on the firm's capital structure 
B)  decreases 
C)  remains constant 
D)  increases

Question 4

Which of the following is an example of restructuring the firm?

Accepted Answer

A)  dividends are increased from $1 to $2 per share. 
B)  a new investment increases the firm's business risk. 
C)  new equity is issued and the proceeds repay debt. 
D)  a new board of directors is elected to the firm. 
A)  dividends are increased from $1 to $2 per share. 
B)  a new investment increases the firm's business risk. 
C)  new equity is issued and the proceeds repay debt. 
D)  a new board of directors is elected to the firm.

Question 5

Calculate the required return on the debt.

Accepted Answer

The answer of Calculate the required return on the debt....

Question 6

The interest tax shield is equal to the:

Accepted Answer

A)  difference between interest expense and income taxes. 
B)  amount of interest paid in a given year. 
C)  product of the interest expense and the tax rate. 
D)  product of the debt principal and the interest rate on debt. 
A)  difference between interest expense and income taxes. 
B)  amount of interest paid in a given year. 
C)  product of the interest expense and the tax rate. 
D)  product of the debt principal and the interest rate on debt.

Question 7

The pecking-order theory suggests that less profitable firms borrow more because:

Accepted Answer

A)  equity issues are more expensive. 
B)  leverage is preferred over raising funds internally. 
C)  debt issues are good omens. 
D)  they have insufficient internal funds. 
A)  equity issues are more expensive. 
B)  leverage is preferred over raising funds internally. 
C)  debt issues are good omens. 
D)  they have insufficient internal funds.

Question 8

Leverage will __________ shareholders' expected return and _________ their risk.

Accepted Answer

A)  increase; decrease 
B)  decrease; increase 
C)  increase; increase 
D)  increase; do nothing to 
A)  increase; decrease 
B)  decrease; increase 
C)  increase; increase 
D)  increase; do nothing to

Question 9

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

Accepted Answer

A)  increases; increases 
B)  increases; decreases 
C)  decreases; decreases 
D)  decreases; increases 
A)  increases; increases 
B)  increases; decreases 
C)  decreases; decreases 
D)  decreases; increases

Question 10

The "trade-off theory" of capital structure suggests that:

Accepted Answer

A)  Firms add leverage whenever interest rates are low. 
B)  Firms with higher risk should use less debt. 
C)  Firms should use 50% debt and 50% equity. 
D)  Firms should use debt to overcome high par values of stock. 
A)  Firms add leverage whenever interest rates are low. 
B)  Firms with higher risk should use less debt. 
C)  Firms should use 50% debt and 50% equity. 
D)  Firms should use debt to overcome high par values of stock.

Question 11

Equity Inc.is currently an all-equity financed firm.It has 10,000 shares outstanding that sell for $20 each.The firm has an operating income of $30,000 and pays no taxes.The firm contemplates a restructuring that would issue $50,000 in 8% debt,which will be used to repurchase stock.Assuming that individuals have the same borrowing opportunities as corporations,explain how an investor can undo the leverage that is proposed by Equity Inc.Under these conditions,what is the value of restructuring to a firm?

Accepted Answer

Since Equity Inc.will have a debt ratio

Question 12

Ignoring taxes,a firm's weighted-average cost of capital is equal to:

Accepted Answer

A)  its expected return on assets. 
B)  its expected return on equity. 
C)  the sum of expected return on equity and expected return on debt. 
D)  its expected return on assets times the debt-equity ratio. 
A)  its expected return on assets. 
B)  its expected return on equity. 
C)  the sum of expected return on equity and expected return on debt. 
D)  its expected return on assets times the debt-equity ratio.

Question 13

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

Accepted Answer

A)  faces high interest rates. 
B)  faces strong growth in business conditions. 
C)  pays taxes. 
D)  does not reinvest its earnings. 
A)  faces high interest rates. 
B)  faces strong growth in business conditions. 
C)  pays taxes. 
D)  does not reinvest its earnings.

Question 14

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Accepted Answer

A)  firm uses no debt in its capital structure. 
B)  firm uses no equity in its capital structure. 
C)  firm uses a debt-equity ratio of 1.0. 
D)  corporate tax rate approaches 100%. 
A)  firm uses no debt in its capital structure. 
B)  firm uses no equity in its capital structure. 
C)  firm uses a debt-equity ratio of 1.0. 
D)  corporate tax rate approaches 100%.

Question 15

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

Accepted Answer

Managers/owners may not have the proper

Question 16

A decrease in the possible range of percentage stock returns can be achieved by:

Accepted Answer

A)  a decrease in the firm's financial leverage. 
B)  an increase in the firm's asset risk. 
C)  an increase in the firm's business risk. 
D)  a decrease in the firm's debt beta. 
A)  a decrease in the firm's financial leverage. 
B)  an increase in the firm's asset risk. 
C)  an increase in the firm's business risk. 
D)  a decrease in the firm's debt beta.

Question 17

When large firms file for bankruptcy:

Accepted Answer

A)  the proceedings involve costly delays and legal tangles, and the business continues to deteriorate. 
B)  their purpose is usually to nurse the firm back to health and enable it to face the world again. 
C)  their benefit is that their creditors will be forced by law to give up their claims on the firm. 
D)  their creditors often try to seize the assets as soon as possible. 
A)  the proceedings involve costly delays and legal tangles, and the business continues to deteriorate. 
B)  their purpose is usually to nurse the firm back to health and enable it to face the world again. 
C)  their benefit is that their creditors will be forced by law to give up their claims on the firm. 
D)  their creditors often try to seize the assets as soon as possible.

Question 18

A firm issues 100,000 equity shares with a total market value of $5,000,000.The firm's market value of debt is also of equal amount,i.e.,$5,000,000.The firm is expected to generate $1.5 million in operating income and pay $250,000 in interest.Ignoring taxes,this will generate $12.50 earnings per share.What will happen to EPS if the firm's borrowing and interest expense increases by 50% and the number of shares in circulation is cut by 50% (assuming that the share price remains unchanged with this change in capital structure)?(Use values in dollar.)

Accepted Answer

A)  EPS decrease to $10.00 
B)  EPS decrease to $11.67 
C)  EPS increase to $15.00 
D)  EPS increase to $22.50 
A)  EPS decrease to $10.00 
B)  EPS decrease to $11.67 
C)  EPS increase to $15.00 
D)  EPS increase to $22.50

Question 19

As the debt to equity ratio decreases when debt is not risk free:

Accepted Answer

A)  debt holders demand a higher expected return. 
B)  debt holders demand a lower expected return. 
C)  the expected return on equity increases. 
D)  the expected return on assets increases. 
A)  debt holders demand a higher expected return. 
B)  debt holders demand a lower expected return. 
C)  the expected return on equity increases. 
D)  the expected return on assets increases.

Question 20

Management's perceived signals to investors form an important component of pecking-order theory.

Accepted Answer

A) True 
 B)False

Exam 16: Debt and Payout Policy

Those who benefit from the interest tax shield are:

What is the proportion of debt financing for a firm that expects a 35% return on equity,a 20% return on assets,and a 15% return on debt? Ignore taxes.

According to MM II,if the expected return on assets decreases,what happens to the expected return on equity?

Which of the following is an example of restructuring the firm?

Calculate the required return on the debt.

The interest tax shield is equal to the:

The pecking-order theory suggests that less profitable firms borrow more because:

Leverage will __________ shareholders' expected return and _________ their risk.

The present value of a perpetual tax shield increases as the firm's tax rate _____ and the amount of principal _____.

The "trade-off theory" of capital structure suggests that:

Ignoring taxes,a firm's weighted-average cost of capital is equal to:

A decrease of debt in the capital structure tends to reduce a firm's EPS when the firm:

In a world with corporate taxes but no possibility of financial distress,the value of the firm is maximized when the:

Discuss how agency problems can develop between shareholders and bondholders when the firm is experiencing financial distress.

A decrease in the possible range of percentage stock returns can be achieved by:

When large firms file for bankruptcy:

As the debt to equity ratio decreases when debt is not risk free:

Management's perceived signals to investors form an important component of pecking-order theory.

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

Leverage will __ shareholders' expected return and _ their risk.

The present value of a perpetual tax shield increases as the firm's tax rate _ and the amount of principal _.