Question 1

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 2

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 3

By changing the mix of securities a firm uses for financing, the financial manager:

Accepted Answer

A) Can increase the book value of the firm 
B) Is changing the firm's capital structure 
C) Can increase the market value of the firm 
D) Is changing the firm's dividend policy 
A) Can increase the book value of the firm 
B) Is changing the firm's capital structure 
C) Can increase the market value of the firm 
D) Is changing the firm's dividend policy

Question 4

If the present value of the tax shield equals the present value of the costs of financial distress, then the:

Accepted Answer

A) Firm is using the optimal level of debt 
B) Firm is paying too high an interest rate 
C) Firm's market value equals the value of the unlevered firm 
D) Firm should increase its use of debt 
A) Firm is using the optimal level of debt 
B) Firm is paying too high an interest rate 
C) Firm's market value equals the value of the unlevered firm 
D) Firm should increase its use of debt

Question 5

Calculate the required return risk premium on the common stock before the refinancing.

Accepted Answer

r_equity = r_assets = 10

Question 6

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

Accepted Answer

A) True 
 B)False

Question 7

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 8

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 9

Stockholders' expected return on a stock priced at $25 per share with zero-growth dividends of $4.00 is:

Accepted Answer

A) 6.25%. 
B) 13.64%. 
C) 16.00%. 
D) 21.00%. 
A) 6.25%. 
B) 13.64%. 
C) 16.00%. 
D) 21.00%.

Question 10

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 11

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 12

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 13

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 14

Debt usage will have an effect on:

Accepted Answer

A) Business risk 
B) Financial risk 
C) Operating risk 
D) Asset risk 
A) Business risk 
B) Financial risk 
C) Operating risk 
D) Asset risk

Question 15

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 16

What is the return on equity for a firm with 15% return on assets, 10% return on debt, and a .75 debt/equity ratio?

Accepted Answer

A) 18.75% 
B) 20.00% 
C) 23.75% 
D) 26.25% requity = rassets + 
A) 18.75% 
B) 20.00% 
C) 23.75% 
D) 26.25% requity = rassets +

Question 17

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

Question 18

According to MM, an increase in expected earnings per share can leave the share price unchanged if the:

Accepted Answer

A) Firm's operating risk decreases 
B) Number of shares is decreased 
C) Required return on equity increases 
D) Firm has no financial leverage 
A) Firm's operating risk decreases 
B) Number of shares is decreased 
C) Required return on equity increases 
D) Firm has no financial leverage

Question 19

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

Question 20

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%

Exam 16: Debt Policy

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

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?

By changing the mix of securities a firm uses for financing, the financial manager:

If the present value of the tax shield equals the present value of the costs of financial distress, then the:

Calculate the required return risk premium on the common stock before the refinancing.

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

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?

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

Stockholders' expected return on a stock priced at $25 per share with zero-growth dividends of $4.00 is:

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

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

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

Financial risk refers to the:

Debt usage will have an effect on:

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?

What is the return on equity for a firm with 15% return on assets, 10% return on debt, and a .75 debt/equity ratio?

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

According to MM, an increase in expected earnings per share can leave the share price unchanged if the:

MM's proposition II states that the:

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.

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

Payout Policy

Long-Term Financial Planning

Short-Term Financial Planning

Working Capital Management

Mergers, Acquisitions, and Corporate Control

International Financial Management

Options

Risk Management

Conclusion

What We Do and Do Not Know About Finance

Filters

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