Question 1

Calculate the required return on the company stock.

Accepted Answer

rS1U1B1assets S1U1B0= .5 × S1U1B1requityS1U1B0 + .5 × rS1U1B1debtS1U1B0 </

Question 2

Which of the following statements is true regarding the trade-off theory:

Accepted Answer

A)  target debt ratios are similar among firms in the same industry. 
B)  riskier firms tend to rely mostly on debt financing. 
C)  riskier firms should have high target debt ratios. 
D)  less risky firms ought to have a greater amount of debt financing. 
A)  target debt ratios are similar among firms in the same industry. 
B)  riskier firms tend to rely mostly on debt financing. 
C)  riskier firms should have high target debt ratios. 
D)  less risky firms ought to have a greater amount of debt financing.

Question 3

MM Proposition I states that a firm's value is unaffected by its:

Accepted Answer

A)  required rate of return on equity. 
B)  operating income, in the absence of taxes. 
C)  interest rate paid on debt. 
D)  mixture of debt and equity. 
A)  required rate of return on equity. 
B)  operating income, in the absence of taxes. 
C)  interest rate paid on debt. 
D)  mixture of debt and equity.

Question 4

Costs of distress are greater when a large amount of __________ affect(s)the prosperity of the firm.

Accepted Answer

A)  intangible assets 
B)  tangible assets 
C)  net working capital 
D)  retained earnings 
A)  intangible assets 
B)  tangible assets 
C)  net working capital 
D)  retained earnings

Question 5

Proposition II of MM states that the expected return on assets increases as the debt-equity ratio increases.

Accepted Answer

A) True 
 B)False

Question 6

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 70% 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 7

Debt may be the preferred form of external financing for many firms because:

Accepted Answer

A)  most firms already have too much equity. 
B)  tax rates on equity are lower. 
C)  debt will not adversely affect the firm's financial ratios. 
D)  equity issuance is considered by investors to be a negative sign. 
A)  most firms already have too much equity. 
B)  tax rates on equity are lower. 
C)  debt will not adversely affect the firm's financial ratios. 
D)  equity issuance is considered by investors to be a negative sign.

Question 8

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.(Use values in dollar.)

Accepted Answer

A)  EPS increase to $2.60 
B)  EPS increase to $3.00 
C)  EPS increase to $4.80 
D)  EPS increase to $5.20 
A)  EPS increase to $2.60 
B)  EPS increase to $3.00 
C)  EPS increase to $4.80 
D)  EPS increase to $5.20

Question 9

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?(Use value in dollar.)

Accepted Answer

A)  $126,000 
B)  $234,000 
C)  $360,000 
D)  $1,050,000 
A)  $126,000 
B)  $234,000 
C)  $360,000 
D)  $1,050,000

Question 10

Discuss the trade-off theory of capital structure,including the determination of an optimal debt level.

Accepted Answer

The trade-off theory of capital structur

Question 11

When a corporation issues permanent debt,the value of all its securities:

Accepted Answer

A)  increases by the present value of the tax shield. 
B)  decreases by the present value of the tax shield. 
C)  increases by the annual interest tax shield. 
D)  decreases by the annual interest tax shield. 
A)  increases by the present value of the tax shield. 
B)  decreases by the present value of the tax shield. 
C)  increases by the annual interest tax shield. 
D)  decreases by the annual interest tax shield.

Question 12

A firm has an expected return on equity of 15% and an after-tax cost of debt of 10%.What debt-equity ratio should be used in order to keep the WACC at 11%?

Accepted Answer

A)  1.00 
B)  2.00 
C)  3.00 
D)  4.00 
A)  1.00 
B)  2.00 
C)  3.00 
D)  4.00

Question 13

How much debt is outstanding in a firm that has calculated the present value of a perpetual tax shield to be $300,000 if the tax rate is 35% and the debt carries a 10% rate of return?

Accepted Answer

A)  $300,000 
B)  $857,143 
C)  $3,000,000 
D)  $3,750,000 
A)  $300,000 
B)  $857,143 
C)  $3,000,000 
D)  $3,750,000

Question 14

With risky debt and MM II,the expected return on assets _____ as the debt-equity ratio _____.

Accepted Answer

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

Question 15

Financial risk is the risk to shareholders that result from debt financing.

Accepted Answer

A) True 
 B)False

Question 16

At some debt-equity ratio,the costs of financial distress are expected to overcome the value of the tax shield for a firm.

Accepted Answer

A) True 
 B)False

Question 17

The stability of a firm's operating income is the focus of:

Accepted Answer

A)  financial leverage. 
B)  weighted-average cost of capital. 
C)  capital structure. 
D)  business risk. 
A)  financial leverage. 
B)  weighted-average cost of capital. 
C)  capital structure. 
D)  business risk.

Question 18

Calculate the firm's expected return on its assets if its expected return on debt is 10%,their expected return on equity is 20%,and its WACC is 14%.

Accepted Answer

A)  14% 
B)  15% 
C)  16% 
D)  Cannot be calculated 
A)  14% 
B)  15% 
C)  16% 
D)  Cannot be calculated

Question 19

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

Accepted Answer

A)  6.50% 
B)  9.90% 
C)  10.67% 
D)  11.14% 
A)  6.50% 
B)  9.90% 
C)  10.67% 
D)  11.14%

Question 20

Firms facing financial distress may pass up positive NPV projects rather than commit new equity because:

Accepted Answer

A)  they prefer to finance with debt. 
B)  the benefits may be shared with the bondholders. 
C)  no cash is available for dividends. 
D)  there is no interest tax shield associated with equity. 
A)  they prefer to finance with debt. 
B)  the benefits may be shared with the bondholders. 
C)  no cash is available for dividends. 
D)  there is no interest tax shield associated with equity.

Exam 16: Debt and Payout Policy

Calculate the required return on the company stock.

Which of the following statements is true regarding the trade-off theory:

MM Proposition I states that a firm's value is unaffected by its:

Costs of distress are greater when a large amount of __________ affect(s)the prosperity of the firm.

Proposition II of MM states that the expected return on assets increases as the debt-equity ratio increases.

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 70% of assets?

Debt may be the preferred form of external financing for many firms because:

What happens to an all-equity firm's EPS when $1 million of 20% debt is issued and proceeds used to repurchase two-thirds of the stock if operating income equals $1.5 million and EPS were $2 when the firm was all equity financed? Ignore taxes.(Use values in dollar.)

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?(Use value in dollar.)

Discuss the trade-off theory of capital structure,including the determination of an optimal debt level.

When a corporation issues permanent debt,the value of all its securities:

A firm has an expected return on equity of 15% and an after-tax cost of debt of 10%.What debt-equity ratio should be used in order to keep the WACC at 11%?

How much debt is outstanding in a firm that has calculated the present value of a perpetual tax shield to be $300,000 if the tax rate is 35% and the debt carries a 10% rate of return?

With risky debt and MM II,the expected return on assets _____ as the debt-equity ratio _____.

Financial risk is the risk to shareholders that result from debt financing.

At some debt-equity ratio,the costs of financial distress are expected to overcome the value of the tax shield for a firm.

The stability of a firm's operating income is the focus of:

Calculate the firm's expected return on its assets if its expected return on debt is 10%,their expected return on equity is 20%,and its WACC is 14%.

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

Firms facing financial distress may pass up positive NPV projects rather than commit new equity because:

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

With risky debt and MM II,the expected return on assets _ as the debt-equity ratio _.