Question 1

Which of the following statements is correct?

Accepted Answer

A)  As a rule,the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
B)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
C)  The optimal capital structure minimizes the cost of equity,which is a necessary condition for maximizing the stock price. 
D)  The optimal capital structure simultaneously minimizes the cost of debt,the cost of equity,and the WACC. 
E)  Each of the above statements is false. 
A)  As a rule,the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS. 
B)  The optimal capital structure simultaneously maximizes EPS and minimizes the WACC. 
C)  The optimal capital structure minimizes the cost of equity,which is a necessary condition for maximizing the stock price. 
D)  The optimal capital structure simultaneously minimizes the cost of debt,the cost of equity,and the WACC. 
E)  Each of the above statements is false. E

Question 2

What is the single most important determinant of capital structure for a company?

Accepted Answer

A)  Business risk 
B)  Financial risk 
C)  Exchange rate risk 
D)  Interest rate risk 
A)  Business risk 
B)  Financial risk 
C)  Exchange rate risk 
D)  Interest rate risk A

Question 3

According to MM,in a world without taxes,the optimal capital structure for a firm should approach 100 percent debt financing.

Accepted Answer

A) True 
 B)False  False

Question 4

One of the implications of signaling theory for capital structure decisions is that firms should normally seek to maintain a reserve borrowing capacity.

Accepted Answer

A) True 
 B)False

Question 5

The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized.

Accepted Answer

A) True 
 B)False

Question 6

Business risk is the single most important determinant of a firm's capital structure.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is correct?

Accepted Answer

A)  If the dividend irrelevance theory (which is associated with the names Modigliani and Miller)were exactly correct,and if this theory could be tested with "clean" data,then we would find,in a regression of dividend yield and capital gains,a line with a slope of −1.0. 
B)  The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy. 
C)  If a company raises its dividend by an unexpectedly large amount,the announcement of this new and higher dividend is generally accompanied by an increase in the stock price.This is consistent with the bird-in-the-hand theory,and Modigliani and Miller used these findings to support their position on dividend theory. 
D)  If it could be demonstrated that a clientele effect exists,this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs. 
E)  Each of the above statements is false. 
A)  If the dividend irrelevance theory (which is associated with the names Modigliani and Miller)were exactly correct,and if this theory could be tested with "clean" data,then we would find,in a regression of dividend yield and capital gains,a line with a slope of −1.0. 
B)  The tax preference and bird-in-the-hand theories lead to identical conclusions as to the optimal dividend policy. 
C)  If a company raises its dividend by an unexpectedly large amount,the announcement of this new and higher dividend is generally accompanied by an increase in the stock price.This is consistent with the bird-in-the-hand theory,and Modigliani and Miller used these findings to support their position on dividend theory. 
D)  If it could be demonstrated that a clientele effect exists,this would suggest that firms could alter their dividend payment policies from year to year to take advantage of investment opportunities without having to worry about the effects of changing dividends on capital costs. 
E)  Each of the above statements is false.

Question 8

If the shape of the curve depicting a firm's WACC versus its debt-to-assets ratio is more like a sharp "V",as opposed to a shallow "U",it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities from year to year.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following is not one of the four primary factors that influence capital structure?

Accepted Answer

A)  Geographic location of the firm. 
B)  Managerial attitude of the firm. 
C)  Financial flexibility of the firm. 
D)  Tax position of the firm. 
E)  Business risk of the firm. 
A)  Geographic location of the firm. 
B)  Managerial attitude of the firm. 
C)  Financial flexibility of the firm. 
D)  Tax position of the firm. 
E)  Business risk of the firm.

Question 10

Which of the following would not have an influence on the optimal dividend policy?

Accepted Answer

A)  The possibility of accelerating or delaying investment projects. 
B)  A strong shareholders' preference for current income versus capital gains. 
C)  Bond indenture constraints. 
D)  The costs associated with selling new common stock. 
E)  All of the above can have an effect on dividend policy. 
A)  The possibility of accelerating or delaying investment projects. 
B)  A strong shareholders' preference for current income versus capital gains. 
C)  Bond indenture constraints. 
D)  The costs associated with selling new common stock. 
E)  All of the above can have an effect on dividend policy.

Question 11

A decrease in a firm's willingness to pay dividends might result from an increase in its

Accepted Answer

A)  Earnings stability. 
B)  Access to capital markets. 
C)  Profitable investment opportunities. 
D)  Collection of accounts receivable. 
E)  Stock price. 
A)  Earnings stability. 
B)  Access to capital markets. 
C)  Profitable investment opportunities. 
D)  Collection of accounts receivable. 
E)  Stock price.

Question 12

Using more debt in the firm's capital structure

Accepted Answer

A)  decreases the probability of filing for bankruptcy. 
B)  raises the riskiness of the firm's earnings stream. 
C)  generally leads to a lower expected rate of return. 
D)  none of the above. 
A)  decreases the probability of filing for bankruptcy. 
B)  raises the riskiness of the firm's earnings stream. 
C)  generally leads to a lower expected rate of return. 
D)  none of the above.

Question 13

Two firms,although they operate in different industries,have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

Accepted Answer

A) True 
 B)False

Question 14

Which of the following is correct?

Accepted Answer

A)  Generally,debt to total assets ratios do not vary much among different industries although they do vary for firms within a particular industry. 
B)  Utilities generally have very high common equity ratios due to their need for vast amounts of equity supported capital. 
C)  The drug industry has a high debt to common equity ratio because their earnings are very stable and thus,can support the large interest costs associated with higher debt levels. 
D)  Wide variations in capital structures exist between industries and also between individual firms within industries and are influenced by unique firm factors including managerial attitudes. 
E)  Since most stocks sell at or around their book values,using accounting values provides an accurate picture of a firm's capital structure. 
A)  Generally,debt to total assets ratios do not vary much among different industries although they do vary for firms within a particular industry. 
B)  Utilities generally have very high common equity ratios due to their need for vast amounts of equity supported capital. 
C)  The drug industry has a high debt to common equity ratio because their earnings are very stable and thus,can support the large interest costs associated with higher debt levels. 
D)  Wide variations in capital structures exist between industries and also between individual firms within industries and are influenced by unique firm factors including managerial attitudes. 
E)  Since most stocks sell at or around their book values,using accounting values provides an accurate picture of a firm's capital structure.

Question 15

Copybold Corporation
Copybold Corporation is a start-up firm considering two alternative capital structures⎯one is conservative and the other aggressive. The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75. Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is $60,000. The Famine state has a 40 percent chance of occurring and the EBIT is expected to be $20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent. The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share

-Refer to Copybold Corporation.What is the coefficient of variation of expected EPS under the aggressive capital structure plan?

Accepted Answer

A)  1.00 
B)  1.18 
C)  2.45 
D)  2.88 
E)  3.76 
A)  1.00 
B)  1.18 
C)  2.45 
D)  2.88 
E)  3.76

Question 16

Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

Accepted Answer

A) True 
 B)False

Question 17

Which of the following statements is correct?

Accepted Answer

A)  A firm's business risk is solely determined by the financial characteristics of its industry. 
B)  The factors which affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions.Unfortunately,these and other factors which affect a firm's business risk are not subject to any degree of managerial control. 
C)  One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important. 
D)  The firm's financial risk may have both market risk and diversifiable risk components. 
E)  The above statements are all false. 
A)  A firm's business risk is solely determined by the financial characteristics of its industry. 
B)  The factors which affect a firm's business risk are determined partly by industry characteristics and partly by economic conditions.Unfortunately,these and other factors which affect a firm's business risk are not subject to any degree of managerial control. 
C)  One of the benefits to a firm of being at or near its target capital structure is that financial flexibility becomes much less important. 
D)  The firm's financial risk may have both market risk and diversifiable risk components. 
E)  The above statements are all false.

Question 18

Financial leverage affects both EPS and EBIT,while operating leverage only affects EBIT.

Accepted Answer

A) True 
 B)False

Question 19

Modigliani and Miller (MM)argued that dividend policy is irrelevant.On the other hand,others,such as Gordon and Lintner (GL),argued that dividend policy does matter.GL's argument rests on the contention that

Accepted Answer

A)  rs =
  /P0 + g is constant for any dividend policy. 
B)  Because of perceived differences in risk,investors value a dollar of dividends more highly than a dollar of expected capital gains. 
C)  Investors,because of tax differentials,value a dollar of expected capital gains more highly than a dollar of dividends. 
D)  Most investors will reinvest rather than spend dividends,so it would save investors' money (taxes)if corporations simply reinvested earnings rather than paid them out as dividends. 
E)  None of the above. 
A)  rs =
  /P0 + g is constant for any dividend policy. 
B)  Because of perceived differences in risk,investors value a dollar of dividends more highly than a dollar of expected capital gains. 
C)  Investors,because of tax differentials,value a dollar of expected capital gains more highly than a dollar of dividends. 
D)  Most investors will reinvest rather than spend dividends,so it would save investors' money (taxes)if corporations simply reinvested earnings rather than paid them out as dividends. 
E)  None of the above.

Question 20

An increase in the financial leverage of a firm will generally increase the variability in EPS for the firm.

Accepted Answer

A) True 
 B)False

Which of the following statements is correct?

What is the single most important determinant of capital structure for a company?

According to MM,in a world without taxes,the optimal capital structure for a firm should approach 100 percent debt financing.

One of the implications of signaling theory for capital structure decisions is that firms should normally seek to maintain a reserve borrowing capacity.

The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized.

Business risk is the single most important determinant of a firm's capital structure.

Which of the following statements is correct?

If the shape of the curve depicting a firm's WACC versus its debt-to-assets ratio is more like a sharp "V",as opposed to a shallow "U",it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities from year to year.

Which of the following is not one of the four primary factors that influence capital structure?

Which of the following would not have an influence on the optimal dividend policy?

A decrease in a firm's willingness to pay dividends might result from an increase in its

Using more debt in the firm's capital structure

Two firms,although they operate in different industries,have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

Which of the following is correct?

Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

Which of the following statements is correct?

Financial leverage affects both EPS and EBIT,while operating leverage only affects EBIT.

Modigliani and Miller (MM)argued that dividend policy is irrelevant.On the other hand,others,such as Gordon and Lintner (GL),argued that dividend policy does matter.GL's argument rests on the contention that

An increase in the financial leverage of a firm will generally increase the variability in EPS for the firm.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Budgeting

Working Capital Management

Investment and Securities

Investment Analysis and Valuation Techniques

Filters

Exam 14: Capital Structure and Dividend Policy Decisions

Which of the following statements is correct?

What is the single most important determinant of capital structure for a company?

According to MM,in a world without taxes,the optimal capital structure for a firm should approach 100 percent debt financing.

One of the implications of signaling theory for capital structure decisions is that firms should normally seek to maintain a reserve borrowing capacity.

The optimal capital structure is that capital structure which strikes a balance between risk and return such that the firm's stock price is maximized.

Business risk is the single most important determinant of a firm's capital structure.

Which of the following statements is correct?

If the shape of the curve depicting a firm's WACC versus its debt-to-assets ratio is more like a sharp "V",as opposed to a shallow "U",it will be easier for the firm to maintain a steady dividend in the face of varying investment opportunities from year to year.

Which of the following is not one of the four primary factors that influence capital structure?

Which of the following would not have an influence on the optimal dividend policy?

A decrease in a firm's willingness to pay dividends might result from an increase in its

Using more debt in the firm's capital structure

Two firms,although they operate in different industries,have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

Which of the following is correct?

Financial risk refers to the extra risk stockholders bear as a result of the use of debt as compared with the risk they would bear if no debt were used.

Which of the following statements is correct?

Financial leverage affects both EPS and EBIT,while operating leverage only affects EBIT.

Modigliani and Miller (MM)argued that dividend policy is irrelevant.On the other hand,others,such as Gordon and Lintner (GL),argued that dividend policy does matter.GL's argument rests on the contention that

An increase in the financial leverage of a firm will generally increase the variability in EPS for the firm.

An Overview of Finance

Financial Assets Instruments

Financial Markets and the Investment Banking Process

Financial Intermediaries and the Banking System

The Cost of Money Interest Rates

Business Organizations and the Tax Environment

Analysis of Financial Statements

Financial Planning and Control

Time Value of Money

Valuation Concepts

Risk and Rates of Return

The Cost of Capital

Capital Budgeting

Working Capital Management

Investment and Securities

Investment Analysis and Valuation Techniques

Filters